International Law

Krugman on China?s Dollar Dilemma

By Stan

I didn’t get to Paul Krugman’s NYT column about China and the dollar last week, so I’ll take the opportunity provided by the holiday weekend for a short comment. Here’s the intro:

On one side, the world?s appetite for Chinese goods has fallen off sharply. China?s exports have plunged in recent months and are now down 26 percent from a year ago. On the other side, the Chinese are evidently getting anxious about those securities.But China still seems to have unrealistic expectations. And that?s a problem for all of us.

A little background. Krugman is a U.S. economist and left of center political commentator. In the U.S., most China bashers occupy ground at the far right and far left of the political spectrum, with the solid middle being in favor of things like free trade and good relations with the PRC (i.e. a policy of engagement).

Although his critics would disagree, Krugman is by no means a radical. So I would not expect him to have any sort of anti-China bias.

One other important note: Krugman’s area of expertise is international trade and monetary policy, so his focus on the recent complaints from Beijing about the US dollar and its status as the world’s reserve currency is a perfect topic for Krugman.

OK, with that out of the way, some substance. As the above quote suggests, Krugman’s main point is that China’s approach to their dollar problem reflects weakness and puts forward some very unrealistic ideas.

My last post on this topic was that this whole talk about a new reserve currency (instead of the US dollar) was an interesting idea, but purely academic at this point. It would have been a cool research paper for my International Monetary Policy class in grad school — that’s as useful as I can imagine. I suppose I was being more charitable than Krugman when I called the suggestions “academic” as opposed to unrealistic, but the conclusion is the same.

Also not charitable, but certainly accurate, is the following from Krugman:

So what Mr. Zhou?s proposal actually amounts to is a plea that someone rescue China from the consequences of its own investment mistakes. That?s not going to happen.

And the call for some magical solution to the problem of China?s excess of dollars suggests something else: that China?s leaders haven?t come to grips with the fact that the rules of the game have changed in a fundamental way.

Hard to argue with this. Prior to this, Krugman recounts how China (and the world) got into the mess we are in with respect to global imbalances. For China, this was a reliance on exports and the maintenance of a fixed exchange rate system, which because of large surpluses led to the accumulation of an enormous amount of dollars. As folks like Michael Pettis have reminded us on a regular basis, this whole problem was, and is, systemic and must be fundamentally altered to get China back to a real balanced economy. To a large degree, that means a shift towards domestic consumption and away from exports as the main demand drivers of the economy — Pettis also emphasizes fixed asset investment and the resulting industrial overcapacity as keys to understanding exports.

The jury is still out on whether that will happen or whether China understands that, in Krugman’s words, the “rules of the game have changed” in this regard. To his credit, Krugman also points out that neither the U.S., EU or the Japanese have yet come to terms with their own restructuring challenges — Krugman has repeatedly blasted just about everyone on the failings of their stimulus plans and regulatory regimes.

To finish this off, Krugman’s column is decidedly critical. However, not only is Krugman not the typical American lefty China critic, but his arguments are tough to assail.

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Full post as published by China Hearsay on April 06, 2009 (boomark / email).