CAMBRIDGE – Will a possibly imminent US-China trade agreement exacerbate global business cycles or even plant the seeds of the next Asian financial crisis? If the eventual agreement – assuming there is one – forces China to hew indefinitely to its outmoded, overly rigid exchange-rate regime, then the answer may be yes.
Keeping the renminbi’s exchange rate stable against the US dollar would require the Chinese authorities either to match changes in US interest rates, or go through capital-control contortions to try to offset exchange-rate pressures in other ways. But China is simply too big and too global to adhere to an exchange-rate policy that is better suited to a small, open economy.
Moreover, neither approach to keeping the renminbi stable – maintaining interest-rate parity or applying capital controls – makes sense for an economy with business cycles that seldom coincide precisely with those of the United States. With its declining trend economic performance, overbuilt housing sector, and overleveraged regional governments, China will inevitably confront politically sensitive growth problems. When it does, the People’s Bank of China will need to be able to loosen monetary conditions without having to worry about supporting the exchange rate.
When a country comes under serious financial and macroeconomic pressures, maintaining an inflexible exchange rate is a well-known recipe for disaster. The International Monetary Fund, along with most academic economists, has been making this point for a very long time.
Such an exchange-rate deal between America and China would be out of tune with other elements of a potential bilateral trade agreement, many of which are “win-win.” For example, China has pledged to enforce intellectual-property rights much more vigorously, although just how strongly remains to be seen. Greater Chinese rigor in this area may benefit American and European firms in the near term, but over the long run it will help to fuel competition and innovation in China’s own manufacturing and tech sectors.
After all, back in the 1800s, the US, like China today, had little interest in protecting the intellectual-property rights of foreign (then mostly British) firms, and Americans widely copied their ideas and blueprints. However, as American innovators became more successful, they, too, needed their rights protected, and in due course the US brought its patent and intellectual-property laws up to world-leading standards.
Another win-win could result from America’s insistence that the Chinese government refrain from lavishing subsidies on exporters. Most of these subsidies go to China’s inefficient state-owned firms, sucking credit and other resources away from the more dynamic private sector.
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© Project Syndicate