Friday, May 27, 2005

WSJ : China's Obligation

By JOHN W. SNOW [Mr. Snow is the Treasury secretary.]

May 26, 2005; Page A12

When finance ministers and central bank governors meet at various fora such as the G7, the discussion regularly turns to the broad subject of global imbalances and what can be done about them. Our deliberations on the subject have led to a shared framework which begins with the recognition that addressing imbalances in the global economy is a shared responsibility among the world's major economies.

We recognize that we all have a part to play in addressing the issue and in fact through the G7 have put in place a broad conceptual framework for addressing it. This framework recognizes that imbalances occur as the patterns of trade and investment flows shift between economic regions. They reflect uneven rates of growth in the major economies and are exacerbated by policies that restrict an efficient adjustment process. Economic policymakers must address these imbalances now; waiting only increases the risk that imbalances will occur abruptly and cause greater damage to the international financial system.

Most observers agree that the international economy performs best when large economies embrace free trade, free flow of capital, and flexible currencies.

Obstacles in any of these areas prevent smooth adjustments. At best, such obstacles result in less than maximum growth; at worst, they create distortions and increase risks. The U.S. is doing its part to address global imbalances by aggressively attacking our fiscal deficit and our long-term unfunded obligations. With the strong economic growth we have seen for the last several years, governmental receipts are up significantly and the fiscal deficit is coming down. We are committed to bringing the deficit down over the next few years to a level well below the historic average. Doing so requires continued economic growth and controls on government spending. We also recognize that we must increase household savings rates in the U.S. and have put in place policies to do so.

Other major economies -- Europe and Japan -- must do their share to reduce imbalances. Large imbalances will continue if growth in our major trading partners continues to lag. These economies must implement necessary structural reforms to achieve higher growth rates -- to benefit their own citizens and to prevent the build-up of imbalances in the global economy.

* * *

Last week I sent to Congress a report outlining the currency practices of America's major trading partners. The report addresses the third and most immediately pressing element of the effort to address global imbalances: the imperative of exchange-rate flexibility, especially in large emerging Asian economies. My report did not cite China as a "currency manipulator," but it would be a mistake to interpret this as acquiescence with China's foreign exchange policies. In fact, we are actively engaged with several economies to promote the adoption of flexible, market-based exchange policies. Most notable among these is China.

As China is now a larger participant in the global economy, its currency practices become a larger concern for its trading partners and for the international financial system. China's rigid currency regime is highly distortionary and poses risks to China's economy -- sowing the seeds for excess liquidity creation; asset price inflation; large speculative capital flows; and over-investment. It also limits the ability of China's neighbors to follow independent, anti-inflationary monetary policies because of competitiveness considerations relative to China. Sustained, non-inflationary growth in China is important for maintaining strong global growth and a more flexible and market-based renminbi exchange rate would help the Chinese achieve this goal.

A more flexible system will also support economic stability, which we understand is of paramount concern to Chinese leadership. China's 10-year-long pegged currency regime may have contributed to stability in the past, but that is no longer the case today, as China has grown to be a more significant participant in global trade and financial flows.

A more flexible system will allow for a more efficient allocation of resources and higher productivity. The current system is fueling over-investment and excessive reliance on export-led growth while underemphasizing domestic consumption. Moreover, much of the investment and capital flows into these favored sectors and projects may be going to businesses that do not best reflect China's competitive advantage, which ultimately could lead to another investment hard landing, more nonperforming loans and a weakened banking sector.

A more flexible system would also quell speculative capital inflows that are costly to China's government and increasingly likely to prove disruptive. China's ability to sterilize capital inflows is increasingly limited and harmful to its banking sector.

Finally, recent history has taught us that it's better to move from a fixed to a flexible currency system from a position of strength, and not when economic weakness compels reform.

Chinese officials have publicly acknowledged the need to move to a more flexible system, they have repeatedly vowed to do so, and have undertaken the necessary and appropriate steps to prepare for such a move.

Unfortunately, the debate on China's currency regime is clouded by a number of misconceptions of U.S. policy. First, we are not calling for an immediate full float with fully liberalized capital markets. This would be a mistake at this time -- China's banking sector is not prepared for such a move today. What we are calling for is an intermediate step that reflects underlying market conditions and allows for a smooth transition -- when appropriate -- to a full float.

Second, we recognize that a more flexible system in China, in and of itself, will not solve global imbalances. As I have said, this is a shared responsibility.

However, greater flexibility in China and other Asian economies is a necessary component and will contribute to that result.

Third, some argue that a more flexible system will prove deflationary and increase Chinese unemployment. In fact, a flexible system will provide China with a more sophisticated array of policy tools -- namely an independent monetary policy -- that will prove much more effective in achieving price stability and the ability to adjust to shocks.

Our engagement with China over the past two years, including fruitful accomplishments associated with Treasury's joint Technical Cooperation Program, leaves me with little doubt that China is now prepared to begin reform of the currency regime. In fact, I believe that the risks associated with delay far outweigh any concerns with immediate reform. The current system poses a risk to China's economy, its trading partners, and global economic growth.

It is critical that we address the issues of imbalances aggressively and in a cooperative spirit with the goal of raising global growth. Nothing would do more damage to the prospects of increasing living standards throughout the world than efforts to inhibit the flow of trade. However, it is incumbent on China to address concerns before the mounting pressures worldwide to restrict trade harm the openness of the international trading system.


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