The U.S. Should Stop Its Despicable Moral Criticism of China’s Exchange Rate

Because China pegs its undervalued currency to the dollar, after the American financial crisis, every time the dollar depreciates, the Renminbi depreciates vis-à-vis other countries’ currencies. However, is China really the main culprit behind the outbreak of the worldwide currency war?

The central banks of Korea, Brazil, Taiwan, Japan, Switzerland and other countries are buying American dollars to prevent their own currencies from appreciating and to protect their exports. Europe is also incessantly strained by the Euro’s more than $1.40 exchange rate. This rate clearly surpasses the $1.17 purchasing power parity rate.

Now, the U.S. is taking strict measures to deal with China and is preparing for a trade war. The U.S. Congress has already authorized the president to impose heavy tariffs on Chinese goods if China continues to refuse to significantly appreciate the Renminbi relative to the U.S. dollar.

However, the undervaluation of the Renminbi — currently by 45 percent — has already existed for many years. Why is the U.S. taking measures full of encroachment? Why didn’t the U.S. take such measures previously?

The reason lies in the flow of capital. Previously, China used earnings from trade between China and the U.S. to make up for America’s financial deficits, and therefore the U.S. accepted the undervaluation of the Renminbi. But today, China likes to use the capital to invest in Africa’s and other areas’ raw materials. This has made American policymakers incessantly angry.

China’s investment changes are extreme. In 2008-2009, China was buying U.S. government bonds at the rate of $17 billion per month. However, in September 2009, China changed its direction of investment. In the first seven months of 2010, China not only stopped purchasing American bonds, but even began to sell its bond holdings. China sold $7 billion dollars of U.S. government bonds per month. That the U.S.’ nerves are now stretched taut is completely understandable.

London filled the investment crack China left, raising its purchase volume of U.S. government bonds. In 2008-2009, London’s purchase volume was around $1 billion; in the first seven months of this year, it rose to an average of $28 billion per month. Because the United Kingdom is originally a capital-importing country, we can therefore surmise that London is not holding these bonds itself, but rather that it is simply repackaging these bonds and renaming them by affixing London’s seal, reselling them to other places in the world.

Even if China is no longer providing funds to the U.S. government, it is still the world’s largest capital-exporting country. Since 2006, China has kept this position. In 2007-2008, China exported an average of $400 billion of capital per year. At the time, the U.S. needed $800 billion of import capital to offset almost all private savings of the middle class, and a large part of China’s capital exports flowed to the U.S. Chinese people’s unwillingness to consume allowed Americans, for several years, to rely on borrowed funds to build new houses, maintaining a level of consumption that could not be sustained by the American economy.

Of course, Chinese people usually don’t fund U.S. private real estate. They usually just buy government bonds and securitized real estate instruments issued by the semi-nationalized Fannie Mae and Freddie Mac. Direct private real estate capital investment is mainly from other countries, such as Germany. Be that as it may, the Chinese, by providing funds to the American government that originally should have come from American taxpayers, have helped the U.S. reach a higher standard of living.

From this period of history, the current denouncement of China’s exchange rate policy is a bit despicable. For such a long period of time, China’s exchange rate policy allowed Americans to enjoy a standard of living beyond their incomes. The U.S. often claims that the undervaluation of the Renminbi harms American interests, but, in reality, it is the undervaluation of the Renminbi that allows Americans to dream the dream of everyone owning a house. Cheap Chinese imports allowed the U.S. to spare capital and labor and expand on a large scale real estate volume, thereby rapidly raising Americans’ level of living.

Now, the Chinese aren’t willing to continue investing in the U.S. — this is understandable. They once tried to acquire Unocal and enter the U.S. energy market, but American government officials prevented the move. Similarly, Congress used national security as an excuse to prevent other Chinese direct investment.

People only have to think of the bids for the fiber optics company Emcore and gold mining company Firstgold to understand. The U.S. wants China’s funds, and yet is only willing to offer unsecured structured securities and government bonds with the risks of inflation and depreciation.

It would be a benefit to world peace if the U.S. stops despicably criticizing China’s morals. Reality is more subtle than naked political interests.

(Author: Hans-Werner Sinn, Professor of Economics and Public Finance at the University of Munich, President of the German Ifo Institute for Economic Research)