As U.S. President Barack Obama prepares for his China visit , China and other Asian countries are under pressure to let their currencies float upwards against the dollar, amid extreme financial uncertainty and the disturbing prospect of political tensions. This is the wrong way to do things. The Sino-American currency relationship is certainly critical to any prospective recovery of the world economy, but we need a new, more revolutionary, approach.
Despite its recent financial woes, the U.S. remains the only actor on the world stage that can break down the barriers impeding the natural flow of capital around the world. These barriers are global, and have a dramatic impact on the destinies of not only the aging and affluent people of the West but also the young but impoverished people of the developing world, including China. These destinies are joined by a very simple economic fact: The old tend to have savings, while the young tend to have energy. To fund their retirements, old people must find young people to whom they can lend. And to start families and businesses, young people must find old people from whom they can borrow.
With the continued rise in American unemployment, despite nearly a trillion dollars in stimulus and over eight trillion dollars in federal subsidies and guarantees to the financial system, this co- dependency should be glaringly obvious. Americans, at the cusp of the biggest retirement wave in their history, must save as they never have before, particularly after the wealth destruction of the past two years.
Two decisive actions would help open the floodgates that separate the capital-thirsty developing world from the capital-rich savers of the West. We need, first, monetary policy to stabilize currencies (currencies of developing nations, in particular) while creating conditions for the rapid development of their domestic capital markets. And we need fiscal and regulatory changes to encourage savings and investment in the United States.
Rather than exporting and saving, America is vacuuming capital out of the rest of the world and going further into debt. Once we exclude the option of admitting a few million skilled, entrepreneurial young immigrants — as Israel did from Russia two decades ago — the present crisis can be solved only by opening the world to American exports and restructuring the American economy to create the necessary export capacity.
The greatest crisis the present administration faces is the collapse of the dollar and its role as the world’s main reserve currency. Paradoxically, preventing the dollar’s collapse also represents a once-in-a-century opportunity for American leadership. U.S. fiscal and monetary policies degrade the dollar’s value and force part of the burden of financing a misguided fiscal stimulus on America’s trading partners.
The United States should instead establish a fixed parity for the dollar with the currencies of its largest trading partners, starting with China. By stabilizing the dollar against the renminbi and, eventually, other currencies, the United States can create a shield behind which the capital markets of developing countries could flourish and capital continue to flow to the United States.
Currently, developed nations can protect themselves against sudden shifts in the flow of capital, but poor nations with nascent capital markets cannot. Currency stability is the first step for the creation of capital markets in the developing world.
The Obama administration (influenced, apparently, by the Keynesian outlook of Larry Summers, director of the White House’s National Economic Council) insists that the U.S. financial crisis endures because Americans save too much and spend too little.
There are two things terribly wrong with this notion. The first is related to the fact that the administration perceives the situation through the Keynesian notion of a diminished “marginal propensity to consume.” But Keynes was constructing a short-run model of a closed economy, and the United States today confronts the accumulation of long-run problems.
The second thing wrong with the administration’s present course stems from an insular focus on spurring consumer spending within the United States, the lip service paid to global cooperation notwithstanding. The solution to the savings–investment disparity does not lie in tinkering with government spending but in helping savers and investors come together across national frontiers. We can correct the balance sheets of both the United States and its trading partners by financing the capital markets in places where young people actually live.
China, in particular, is the natural fulcrum for America’s proper economic policy. China’s requirements for infrastructure and capital equipment are enormous: Two-thirds of its people still live in conditions of extreme backwardness. But rather than invest in its own interior, China has diverted its savings to securities in Western currencies as a rainy-day hedge against potential political and economic disruption.
America should help China stabilize its currency by solemn and formal agreement to link the renminbi to the dollar, and China should in turn make its currency convertible and open its capital market to American institutions. A Sino-American currency agreement would quickly become the point of orientation for the rest of Asia and eventually for other countries.
In effect, China needs to reduce its saving rate drastically while America increases hers. Why would not just letting its currency to be convertible, on its own, without coordinating with the United States, be part of the solution, as some propose?
The simple answer is that China’s capital markets — and by extension its political system — are still too fragile to withstand the tsunami-sized capital flows caused by the dollar’s instability. Dollar devaluation sends capital rushing into China, distorting asset prices. By contrast, a repetition of the global liquidity crisis that followed last year’s failure of Lehman Brothers could provoke massive capital flows out of China, in a repeat of the 1997 Asian crisis. As long as the United States subjects its currency to extreme volatility, China cannot take the risk of making its own currency convertible.
As part of this strategy, America should ease restrictions on Chinese and other foreign investment in American companies. A crucial part of stabilizing the dollar is to increase global demand for dollars, by selling more American assets to reduce America’s overhang of foreign debt.
A partnership on this scale would constitute a revolution in American policy. Opening the world for American exports is half the task. The other half requires our restoring the nation’s export capacity. Despite the present crisis, America remains the world’s strongest platform for innovation. America continues to lead in every field of technology: software, communications equipment, aircraft, biotechnology, and electricity production.
The way to increase American export capacity is economically simple, but it requires visionary political leadership. The United States has been borrowing in order to consume; it needs now to save in order to invest. It needs to shift the tax burden, moving it away from savings and investment and on to consumption. Individual and corporate income tax should be replaced with consumption-based taxes (value-added and sales tax).
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