Sudhir Mulji: Revaluing the yuan

Nothing demonstrates the advantages of reducing the Chinese balance of payments surplus

If I have understood the principles of Say's law, the present anxiety expressed by economists of the growing imbalance in world economics should not really be a matter of any concern.

The disparity in world trade has been caused by the supposedly under-valued Chinese exchange rate, and presumably an over-valued American dollar.

Followers of Say would not find this disquieting; they could tell the Chinese, who retain their surpluses in dollars: "You say you only want money, I say you want other commodities and not money" ("Of the Demand or Market for Products," Jean Baptiste Say).

Say's common sense reasoning went on: "For what in point of fact, do you want the money? Is it not for the purchase of raw materials or stock for your trade or victuals for your support? Even when money is obtained with a view to hoard or bury it, the ultimate objective is always so to employ it in purchase of some kind; for money as money has no other use than to buy with" (Say, ibid.).

If one accepts""as really one must""the logic of this argument, one should not be at all anxious of Chinese, or Japanese, or even Indian trade surpluses.

Their accumulation of US treasury securities must be only a temporary solution. They will eventually and inevitably want to use these surpluses to purchase goods.

The essential problem is not that the surplus country will never purchase goods.

For, as Say rightly pointed out, the money they accumulate has no other use than to buy goods, but until the nature of this potential demand is resolved by actual purchases, a climate of uncertainty is created, particularly for those nations which will need eventually to supply goods when hoarders decided to use accumulated money for purchases.

It is in an attempt to reduce this uncertainty that induces world authorities to persuade the Chinese to revalue their currency in the hope that a re-valued yuan will tempt the Chinese to buy goods more immediately.

Apart from the timing of the expenditure, advocates of revaluation also hope that such a currency change will induce the Chinese to import more and export less; that is, a commodity as an asset class will become cheaper and more attractive compared to government security.

But if that were to happen, would the world be better-off? If, for example, the Chinese chose to buy more oil using their revalued yuan, would that be beneficial for the world, which would now face higher oil prices, stimulated by additional Chinese purchases.

Would not the world prefer the Chinese to purchase at least readily reproducible securities to the purchase of scarce commodities?

Clearly such an induced shift in Chinese demand could damage the world's economy much more than the relatively costless purchase of reproducible government securities.

Thus, unless Chinese demand was directed either to new investment or towards goods that are in inadequate demand, induced changes would not be necessarily beneficial.

Economic analysis would be considerably assisted if it were to be acknowledged, as obviously must be the case, that for the world as a whole there can be no imbalance of trade; whatever the surplus of some nations, it has to be equalled by the deficit of others.

If, therefore, the surplus of the Chinese was so revised that its deficits increased but this only added to the surplus of the oil countries, no one would gain, not even the Americans, who may end up by having to sell as many securities as previously with less credit for the Chinese and more credit to the oil-rich nations.

In point of fact, securities in the hands of the Chinese may be more beneficial.

If, as a broad category, we divide countries into rich and poor, we might conclude that poor countries with more potential for demand should be in surplus, for then they can pay for any increase in demand while richer, more productive countries that can satisfy increases in demand should run deficits.

In the past, that has seldom happened; normally developed countries have not only been wealthier but have produced balance of payments surpluses.

Thus, the burden of rectifying trade and payments imbalances has fallen on poorer developing countries, compelling them to contraction.

In plain words, deficit countries have only been able to improve their imbalances by reducing demand, thereby slowing down the pace of world growth and their own development.

This time, however, the course of events is quite different. The balance of payments and trade surpluses are being run by poorer developing countries.

This is a rare outcome but one that provides greater opportunities for an expanding world economy. From an economic point of view, this has been made possible by tolerating an under-valued exchange rate by China, thereby giving an opportunity to cheaper labour to gain from comparative advantage of lower wages.

Although these issues are not strictly a matter of economics but also of global financial politics, it is important to analyse the economic outcome carefully.

When an apparent phenomenon is assumed likely to continue forever, it is possible to make grave economic errors.

In the early fifties, many distinguished economists warned about the dollar shortage in the expectation that it would persist over so long a period that the world would need to make radical changes to cope with these difficulties.

Yet within a few years there was a new resurgence in Europe and what was thought to be impossible,convertible European currencies not only make possible but those like Britain who failed to respond to these changes by maintaining an over-valued exchange rate lost their way.

From the point of view of world politics, it is possibly necessary to maintain the pressure on the Chinese to revalue the yuan; but if that actually happens, the outcome is unclear.

Most importantly, will a Chinese re-valuation have a substantial deflationary effect on the world economy?

At present, China, because of or with its under-valued currency, is ensuring that it is the strongest engine for growth in the world. It is accumulating surplus dollars but in no way have these surpluses discouraged policy makers in Beijing to slow down the economy.

On the contrary, its balance of payments surplus has been a source of confidence in China's ability to sustain a high level of growth.

Those recommending a re-valuation should at the very least attempt to demonstrate the economic benefits they anticipate will follow.

It is undoubtedly true that many critics of the present exchange rate complain that it gives an unfair advantage to China, and they threaten to counter these advantages by imposing special duties and tariffs on Chinese goods; but that having been said, no one has as yet demonstrated how a more balanced trade will economically assist the world, either in demand or supply of goods.

From the point of view of international politics, what they say is right but from the more limited perspective of technical economics, nothing yet has been shown to demonstrate the advantages of reducing the Chinese balance of payments surplus.

The views here are those of the author and not any organisation.

sjmulji@aol.com