Although I agree that it is in the best long-term interest of the U.S. and other countries throughout the globe for China to revalue its currency, it isn't entirely clear to me that such a maneuver is in the near-term interests of China, …or maybe even the global economy.
Robert's concerns are focused on the effects of a sudden revaluation—a movement in the exchange rate that would be disruptive to Chinese production and plunge that country into recession. But that scenario hardly seems likely.
Even if the United States decides to press China hard on the exchange rate issue, we currently lack instruments to make this pressure effective. Working through the International Monetary Fund (IMF) is not appealing—because it just won't work—and the World Trade Organization (WTO) does not have sufficient jurisdiction on exchange rate issues (if pushed today, it would bring in the IMF to determine the extent of exchange rate undervaluation; again, we're back to the IMF impasse).
To be sure, Congress could threaten bilateral action, but this is a blunt weapon that can easily cause a great deal of collateral damage. At the US-China Economic and Security Review Commission's hearings on Capitol Hill yesterday, the consensus appeared to be that China should be pressed harder on its exchange rate—including being labeled a "currency manipulator" by Treasury at the next opportunity (in April)—but we should not rush towards any kind of trade war.
It would be much better to give the WTO teeth vis-à-vis exchange rate manipulation, but this will take a while. Even in the best case scenario, effective pressure will build only slowly on China.
On the other hand, if China steadfastly refuses to appreciate the renminbi in any significant manner, the damage when the exchange rate does eventually move could be even greater.
We should not fear China—our problems are about ourselves, not anyone else. China should likewise mostly fear the unintended consequences of their own misguided policies.
Also posted on Simon Johnson’s blog, Baseline Scenario. Following were previously posted:
Volcker Rules? (February 24)
Bloomberg reports that Treasury is gently letting the Volcker Rule (limiting proprietary trading for big banks) slip—Secretary Geithner would grant greater discretion to regulators which, in today's context, most likely means not making the restriction effective.
This step is consistent with the broader assessment of the Volcker Rules that Peter Boone and I have in the New Republic (print and on-line): The underlying principles are sound, but the Rules have not been well-designed, and top people in the administration show little sign of wanting to make them effective. This dimension of financial reform does not appear to be headed anywhere meaningful—and the main issues (bank size, capital, and derivatives) are not yet seriously on the table.
In the recent Senate Banking hearings on the Volcker Rules, John Reed—former head of Citibank—was adamant that the Volcker Rules made sense and could be made to work. His point is that the executives know who is taking risk with the bank's balance sheet—it's a well-defined group within any bank with its own (speculative) culture—and this should be discontinued for banks that are in any sense too big to fail.
You really do not want high octane speculators at the heart of this country's largest banks. Make banking boring, Reed argues with conviction.
Prospects for Financial Reform (February 23)
The best opportunity for immediate reform of our financial sector was missed at the start of the Obama administration. As Larry Summers and Tim Geithner know very well—e.g., from their extensive experience around the world during the 1990s (see Summers's 2000 Ely lecture)—when a financial system is in deep crisis, you have an opportunity to fix the most egregious problems. Major financial sector players are always good at blocking reform—except when they are on the ropes. (Look again at Paul Blustein's The Chastening for more detail on what Geithner-Summers, with David Lipton and others, got right when they sided with reformers in Korea.)
Naturally, the Obama administration's generally weak and unfocused financial reform proposals have morphed into generally weak and unfocused congressional bills. The overall narrative has been lost—despite moments of clarity from the president (e.g., when he spoke first about the Volcker Rules, but this was spun away within 12 hours by Secretary Geithner and others on the team).
Some limited change may now emerge from the Dodd-Corker compromise. I expect we'll see a version of the "resolution authority," despite the fact this is a complete unicorn—a mythical beast with magical properties, but not actually useful in the real world.
I've recently asked senior executives from both Goldman Sachs and JP Morgan Chase—both proponents of a resolution authority—point blank to explain how a US resolution authority of this kind would help close down their cross-border firms (or Citigroup). I'm still waiting for an answer.
No doubt there will be some sort of "systemic regulator," meaning a group chaired most likely by Treasury. This is a great fuss about essentially nothing. On top of the obvious points about how hard it would be for such a body to act preemptively—particularly when our next wave of problems will again be cross-border, in terms of exuberant lending into emerging markets—we actually already have the functional equivalent: the President's Working Group on Financial Markets.
This group, of course, was used to great effect by Robert Rubin and others in blocking Brooksley Born in 1998—to them, she was the systemic threat, because she wanted to regulate over-the-counter derivatives. And the same group was used to no effect whatsoever by Hank Paulson in the run-up to the September 2008 crisis. In the European Union, creating new committees can make a difference; we're better on form over structure in the United States—but when the big banks are so powerful and out of control, we're lousy at both.
Sadly, the consumer protection agency is likely to be gutted as the price of bringing Senator Corker on board. This is of course an affront to everyone who has been—and continues to be—ripped off by the financial sector. But we are where we are in terms of the blatant mistreatment of customers in this society. Business people often tell me that we need to "rebuild confidence" in this economy. I couldn't agree more, but how does cheating people—and refusing to prevent others from cheating—lead to more confidence?
Despite—or rather because—of all the arrogance and misbehavior among our more prominent financial players, we are making progress on the bigger agenda: changing the consensus on what is regarded as safe and sound in all kinds of banking.
You can strike out one more purported reason why we should keep massive global financial institutions. They do not enhance transparency, they do not bring clarity, they do not keep governments accountable. Instead, they are paid a great deal of cash to mislead people. What is the social value of that exactly?
With the broader financial picture unchanged—major banks will make lots of money, while unemployment remains sickeningly high—legitimate concerns about the practices of Big Finance continue to build. Small and medium-sized banks find themselves increasingly hit by commercial real estate woes. The alliance that has held back reform begins to crack.
Very few people now claim that serious reform is only proposed by people carrying pitchforks; that myth is long gone. The middle of the consensus has started to move, against mega-banks and against dangerous overborrowing by the financial sector. This will be a long hard slog, but we are finally heading in the right direction.
Greece Should Approach the IMF (February 18)
European Union pressure is growing for Greece to "do the right thing"—which means, to EU leaders, a massive and sudden cut in the Greek budget deficit. Greece, without doubt, has gotten itself into a fine mess; still, it is now time for the Greek government to push back more effectively.
Fuming at EU arrogance will accomplish nothing. And, while global investment banks may have helped hide the evidence, it seems unlikely they actually designed the great blunder of eurozone admission (and broken Greek promises). It's time to stop blaming others and get crafty.
Greece should open a semi-official channel to the IMF and talk discretely about taking out a loan.
This is not an anti-Greek suggestion. The IMF has changed a great deal over the past 10 years—learning lessons and developing new ways of thinking. (For more detail, see my current Project Syndicate column.) Today's IMF would give Greece a much more reasonable deal than would the European Union acting alone.
But the main reason to approach the IMF is that this, if done properly, would drive the European Union nuts in a most productive manner.
The Germans really do not want more IMF pressure to ease up on European Central Bank monetary policy or—heaven forbid—to engage in some fiscal expansion (or other increase in domestic demand). The Germans want to export their way out of recession, and the devil take the hindmost.
And President Sarkozy absolutely may not want the current IMF Managing Director—Dominique Strauss-Kahn—to do anything that can be presented as a statesman-like contribution to the world. Strauss-Kahn is a contender for the French presidential election in 2012, so you can see how that works.
By approaching the IMF, Greece will get a better deal from the European Union. Our baseline view is still that the IMF's role will only be "technical," but behind the scenes the prospect of greater IMF engagement (and even a standby loan) is a powerful card that Greece should threaten to play.
Greece Derails—Is Europe Far Behind? (February 12)
Already facing serious difficulties—both internal and with regard to its EU partners (see our longer essay in Saturday's WSJ)—Greece's predicament just became substantially worse.
Speaking on national television this evening, the Greek Prime Minister—George Papandreou—lashed out at the European Union (presumably meaning mostly Germany) for creating a "psychology of looming collapse which could be self-fulfilling." He also implied that Greece was being treated, in some senses, like a "lab animal."
Without doubt, EU engagement with Greece over the past week or three has not been well-managed—and the pseudo-announcement of support after the summit on Thursday was a complete amateur hour.
But Greece has real problems that need to be confronted, and it will go much easier for everyone if there is external assistance. You cannot overspend in the Greek fashion without eventually facing a reckoning.
The Greek government is implicitly suggesting collapse—with the possibility of contagion to Portugal and Spain (and thence to the banking system of Latin America, etc.). But this is a very dangerous game. Greece is not Goldman Sachs—it cannot credibly threaten to bring down the world's entire financial system.
Less well-run countries default on their debts with some regularity. To be sure, it is awkward for a eurozone member to be forced into the arms of the IMF—but several European Union members are there already (e.g., Latvia, Romania). Korea had to borrow from the Fund in 1997, despite having recently become a member of the OECD—a stamp which previously was considered to connote respectability and stability.
Greece is well down the path to becoming regarded more like Argentina—a country that struggles over many decades (and whose leaders frequently rail against the world) and for which episodes of reasonable prosperity and new economic models are punctuated by gut-wrenching crises, most of which do not shake the world.
Will the European Union save Greece? Much will depend on how bad the situation could become in other "related" (in the eyes of the financial markets) places.
But destabilizing actions or inflammatory statements by Greece make an orderly rescue less likely and put another major international economic crisis firmly on the table.