The long running international squabble about China's management (or 'manipulation') of its exchange rate, quiescent over the past couple of years, has sprung to life again.
The original accusation was that China held down its exchange rate to enhance its international competitiveness, boosting its own growth at the expense of others. Over the past few years there was not much to complain about, as the renminbi (RMB) appreciated in real (inflation adjusted) terms by 20%, trimming China's export competitiveness and putting a brake on its external surplus. But the RMB has depreciated by 3% so far this year. China's foreign exchange reserves have risen to almost US$4 trillion, suggesting that the Chinese authorities have been engineering the currency fall. The improvement in international competitiveness would help, at the margin, to keep the Chinese economy growing.
In the latest of its regular reports to Congress on these issues, the US Treasury went well short of declaring China to be a 'currency manipulator', but said: 'Recent developments in the RMB exchange rate would raise particularly serious concerns if they presage renewed resistance to currency appreciation'.
The report also noted other recalcitrants, notably Germany, where the external surplus is running at 7% of GDP (compared with China's 3%). But it is China which will be the butt of criticism. The Financial Times reported this news under the headline: 'US Treasury slams China on currency'. Congress members will call for retaliatory measures. As well, it's sure to reappear at meetings where international economic coordination is discussed.
When it does, there will be a new element in the debate. Raghuram Rajan (pictured), the Indian central bank governor, has argued that quantitative easing (specifically, America's QE) is analytically much the same as foreign exchange intervention, in that it distorts free market outcomes and that this distortion adversely affects emerging economies. Ben Bernanke, just retired from the US Fed chairmanship, is reported to have 'taken him to task' for this view.
The analytical logic, however, favours Rajan.
Monetary policy, by its nature, is an intervention in financial markets, as it sets the short term interest rate. QE goes further still in intervention, influencing interest rates further out on the yield curve. Changes in interest rates influence economic activity directly, but interest rates also work via their impact on the exchange rate, enhancing the external competitiveness of countries implementing QE.
Thus Bernanke is wrong in arguing that QE is a justified intervention because it boosts activity (which benefits everyone) while foreign exchange intervention is unacceptable because it just shifts growth from one country to another. QE gave the US the double benefit of boosting domestic demand from the lower interest rate and stronger export demand from its depreciated exchange rate. This second effect has been at the expense of US trading partners.
If America is going to complain about China's intervention in the RMB exchange rate, then it is open to the same charge of intervention in financial markets with QE.
When the new Fed chair, Janet Yellen, firmly asserts that American monetary policy will be set solely by domestic considerations, she reflects the American political environment in which she has to operate. Suppose, however, there was a world monetary authority. Optimal policy would take some account of the external impact of the advanced countries' monetary policies.
This debate will play out at international groupings such as the IMF and G20. To the extent that QE (both when it was applied and when it is unwound) presents new challenges for emerging economies, it will be worthwhile to develop a form of dialogue which recognises the inherent complexity of these issues. The old reliance on simple assertion of free market principles will not be enough.
Photo by Flickr user World Economic Forum.