How much does the Greek crisis matter for China? There are, as far as I see, broadly two schools of thought. One school says that the Greek crisis is largely a problem internal to Europe, and its impact on Europe and the rest of the world is too small to matter much. In support they point to limited bilateral trade relationships between China and the most affected European countries.
The second school focuses on the impact of the Greek crisis on the real exchange value of the RMB and the threat of diminished demand in Europe’s deficits countries. Thanks to the collapse of the euro, they point out, the RMB has already revalued in real terms and this, combined with expected weakness in the European market for imports, means that China should be more cautious than ever in adjusting the value of the currency. An article in Monday’s South China Morning Post makes this point:
The yuan has risen strongly against the euro and this appreciation will harm mainland exporters, a Commerce Ministry official said on Monday. Pegged to a rising US dollar, the yuan has appreciated against a trade-weighted basket of currencies in recent months, which many analysts believe could constrain the scope for a possible revaluation of yuan.
Commerce Ministry spokesman Yao Jian did not say how US dollar strength might affect a long-awaited move to resume yuan appreciation, but he highlighted the impact of the weaker euro. “The yuan has risen about 14.5 per cent against the euro during the past four months, which will increase cost pressure for Chinese exporters and also have a negative impact on China’s exports to European countries,” he told a news conference.
Yao Jian’s comments notwithstanding, I think both schools are wrong. The first school makes the typical mistake of misunderstanding and misinterpreting bilateral trade numbers. This is almost certainly the wrong way to understand international trade issues.
The second school is correct in evaluating the impact of the Greek crisis on the global balance of payments, but shunts aside the issue of how the adjustment burden is to be shared globally – basically the members of this school do not see this as China’s problem. In doing so they propose a strategy that may be the exact opposite of what the world, and China, needs. The Greek crisis, rather than reduce the urgency for China to revalue its currency and adjust its trade policy, may on the contrary require that China react much more aggressively than originally planned.
Why? Because any sharp adjustment in trade or capital flows in one part of the world must automatically force a series of equally sharp adjustments elsewhere. I explain why in an earlier post, and in a piece in today’s Financial Times Martin Wolf – as usual one of the few analysts who automatically thinks through balance-of-payments implications – makes the same argument. This need to balance implies that the problems in Europe are going to make international trade relations, and especially those between China and its largest trading partners, much tenser. In fact I worry that the sudden and unpredicted speed of the European adjustment will force a resolution of the global imbalances at a far faster pace than I, already pessimistic, was expecting.
Is pressure to revalue abating?
I say pessimistic because I believe China needs many years to adjust, and I had always assumed that the speed of China’s adjustment would be determined largely by political considerations in the US – after all if one side of the imbalance adjusts, the other side has no choice but to adjust just as quickly. This was always likely to be faster that China wanted.
But now the Greek and European crisis may make the global adjustment even faster than that because of the speed with which European finances are unraveling. To put this in context, it is worth noting that, according to an article in Friday’s Bloomberg, India’s Finance Minister, Pranab Mukherjee suggested that China might begin revaluing the RMB around the time of the G20 meeting in Canada this June.
Mukherjee’s comments indicate sustained pressure for a stronger yuan even as Europe’s debt crisis underscores Chinese policy makers’ concern about the durability of the global recovery. Yuan forwards are headed for the biggest weekly gain this year on bets China will soon relax its peg to the dollar.
China, the world’s fastest-growing major economy, halted the currency’s 21 percent, three-year advance against the dollar in July 2008 to help exporters weather recessions in the U.S., Europe and Japan. Authorities in Beijing have kept the currency at about 6.8 to a dollar, a policy that has blunted the competitiveness of Asia’s export-dependent nations, whose currencies have appreciated this year.
Mukherjee, who served as the foreign and defense minister in Prime Minister Manmohan Singh’s cabinet before being appointed as the finance minister, is under pressure from local exporters to use the Group of 20 platform to campaign against China’s currency policy.
As Mukherjee’s comments suggest, pressure continues growing from a number of countries, especially in Asia, for a Chinese revaluation, and for a while it seemed pretty obvious that China was going to begin revaluing very soon.
The events in Greece, however, have undermined expectations dramatically. Among other consequences of the Greek crisis, the discussion about the currency seems to have become more polarized than ever within China, with proponents insisting that revaluation is still necessary for China’s rebalancing (in fact I would say that even without the Greek crisis the recent decline in real Chinese interest rates makes it more necessary than ever), and opponents arguing that the collapse of the euro against the dollar has already caused an effective (and large) RMB revaluation.
Xinhua today, in a front-page piece, makes this argument very explicitly, suggesting that the RMB devaluation will be put on the “back burner”.
The chances of an early revaluation of the renminbi look unlikely and could happen much later than expected, considering that the nation’s trade surplus may see steep erosions due to the European debt crisis and the growing trade protectionist measures against China’s exports, leading economists and experts said on Tuesday.
Earlier estimates were that the nation would allow the renminbi to rise during the second quarter, with overall gains of 3 to 5 percent for the whole year. Economists now consider such a move unlikely and expect any currency moves to be deferred till the end of the year with a smaller range and overall gains of 2 to 3 percent.
Ministry of Commerce officials had on Monday indicated that the prospects for the nation’s exports were not that hopeful this year and the annual trade surplus may see a big drop. “The improved trade balance will lay a good foundation for China to implement its macro-economic policy and the currency issue should not be too politicized,” said ministry spokesman Yao Jian.
Trade and finance must balance
The argument – very seductive on the surface but also, like many other seductions, a little dangerous – is that with a weak euro the RMB has effectively strengthened against China’s trade partners, so China has “done its bit” to help in the global rebalancing. But I would argue that the problems in Europe, rather than partially resolve RMB undervaluaton, actually make the global rebalancing much more difficult and require more a aggressive, not a less aggressive, response from China. Why? Take a look the table below, which lists the top ten current account surplus countries based on CIA estimates for 2009:
| Top ten surplus countries | Trade surplus | As a % of total surpluses |
| China | 296,200,000,000 | 26.6% |
| Japan | 131,200,000,000 | 11.8% |
| Germany | 109,700,000,000 | 9.9% |
| Switzerland | 79,180,000,000 | 7.1% |
| Norway | 58,560,000,000 | 5.3% |
| Russia | 42,080,000,000 | 3.8% |
| Netherlands | 33,720,000,000 | 3.0% |
| Taiwan | 31,100,000,000 | 2.8% |
| Korea, South | 30,380,000,000 | 2.7% |
| Hong Kong | 28,340,000,000 | 2.5% |
Obviously China leads, with largest trade surplus by far of any country, accounting for just over a quarter of all trade surpluses. This share has been rising steadily, especially since 2004, and also increased during the financial crisis. Japan is a distant second, with a trade surplus less than half that of China’s, followed by Germany.
However if you add up all the European trade surpluses – the largest being, after that of Germany, Switzerland, Norway, the Netherlands, Sweden and Denmark – together they amount to nearly 28% of total trade surpluses, or a little more than China’s trade surplus (I know, I know, not all of these countries are part of “Europe”, but they are nonetheless going to be part of the same economic process). Together these numbers are very large.
These large trade surpluses haven’t mattered much in the global context because within Europe there are also several trade-deficit countries with equally large trade imbalances. The table below lists the eleven largest trade deficit countries in the world.
| Top eleven deficit countries | Trade deficit | As a % of total deficits |
| United States | 380,100,000,000 | 34.2% |
| Spain | 69,460,000,000 | 6.2% |
| Italy | 55,440,000,000 | 5.0% |
| France | 43,670,000,000 | 3.9% |
| Canada | 36,320,000,000 | 3.3% |
| Greece | 34,430,000,000 | 3.1% |
| Australia | 33,310,000,000 | 3.0% |
| United Kingdom | 32,370,000,000 | 2.9% |
| Iraq | 19,900,000,000 | 1.8% |
| Belgium | 18,920,000,000 | 1.7% |
| Portugal | 18,610,000,000 | 1.7% |
Obviously the US is the largest by far. It accounts currently for just under one-third of all trade deficits. Some research prepared for me by the Corporate Executive Board, and based on IMF numbers, breaks the data down a little differently, and shows that the US currently accounts for about 40% of total trade deficits, down from 70% in 2003.[1] I am not sure what the discrepancy is, but it doesn’t matter much to the rest of this argument.
Besides the US, there are a number of other countries with large trade deficits (and even larger than that of the US relative to national GDP). Most of these are in Europe. If you add up the trade deficits of all the trade-deficit countries in Europe, the sum amounts to just over 26% of total trade deficits.
So who will bear the brunt of the adjustment?
The numbers on both the surplus and deficit sides, in other words, are fairly large, but they net out to a small number. So until now we could pretty much ignore the impact of Europe on the global trade imbalances because on a net basis Europe didn’t seem to matter too much (and it is aggregate numbers, not bilateral numbers, which really matter in this context).
But thanks to the crisis, we are almost certainly going to see a large and rapid adjustment on one side of the internal European imbalance. This necessarily must have an equally large and equally rapid impact elsewhere. Why do I expect a large and rapid adjustment? Because a country cannot run trade deficits if these deficits are not automatically balanced by net capital inflows. The balance of payments always balances.
One consequence of the Greek crisis is that over the next year or two Spain, Italy, Greece and Portugal may all find it much more difficult to attract net capital inflows. Today’s Financial Times, for example, has a very worrying article on the recent Spanish auction:
Spain came close to its first debt auction failure on Tuesday, highlighting the funding problems for weaker eurozone economies.
The government’s difficulties in selling €6.44bn ($7.96bn) in one-year and 18-month bills sparked worries over its 10-year debt auction on Thursday. Madrid had planned to issue €8bn, but only just attracted that amount of bids, with yields at record highs. This prompted debt managers to reduce the size of the sale by €1.56bn. Normally a government bill auction would be covered at least 1.5 times.
Will southern European countries have trouble attracting capital inflows? Probably. In fact, almost certainly. In that case, they are all going to see sharp contractions in their current account deficits, exactly equal to the contraction in net capital inflows – and of course if any if these countries experience flight capital, this contraction can be very sharp. Again, the reasoning behind this is explained in an earlier post
To get a sense of magnitude, those four countries are the equivalent in trade deficit terms of more than half the US. If we assume that other European countries with large trade-deficits are also going to have to pay down debt, and may even find difficulty in attracting net capital inflows, then roughly 26% of all trade deficits in the world, an amount equal to more than two-thirds of the US trade deficit, are under pressure to contract rapidly.
Why does this matter to China? Because, of course, the global balance of trade must balance. Every dollar reduction in the trade balance of a European trade-deficit country must be matched, either by a dollar reduction in the trade surplus of Germany or some other European country, or by a dollar increase in Europe’s trade surplus.
Which will it be? Probably a combination of both, but the sharp decline in the value of the euro against the dollar makes it likely that we will see much more of the latter than of the former. In fact for many Europeans, the “silver lining” of the Greek crisis is that by pushing down the euro, it is making all of Europe, even countries like Germany that already have locked-in structural trade surpluses, more competitive in the international markets. Europe’s trade surplus is likely to surge.
So where is the countervailing trade impact? Beijing argues that the depreciation of the euro has automatically forced an appreciation of the RMB, and with deteriorating international markets, there is no need for China to accelerate the process. I would argue that with real interest rates declining in China, it is as if the RMB has been depreciating in real terms in order to protect China from the cost of the trade adjustment. China (along with Japan) does not want to bear the brunt of the global adjustment.
A very reluctant US?
So that leaves the US. Most policymakers around the world – while publicly excoriating the US for its spendthrift habits – are intentionally or unintentionally putting into place polices that require even greater US trade deficits.
This cannot be expected to happen without a great deal of anger and resistance in the US. The idea that suffering countries should regain growth by exporting more to the world, and that rapidly growing surplus countries should not absorb much of this burden, will only force the US into even greater deficits as US unemployment rises to reduce unemployment pressure in Europe, China, Japan and elsewhere.
I would be surprised if the US accepted this with equanimity. On the contrary, I expect it will only exacerbate trade tensions and ensure that next year the dispute will become nastier than ever.
To summarize, and to make the sequence clearer using nothing more than explicit assumptions and accounting identities, let me suggest schematically the list of factors that require either much greater flexibility on the part of surplus nations or much greater deficits on the part of the US:
- I assume that for the foreseeable future the major trade deficit countries in Europe are going to find it very difficult to attract net new financing. At best they will be able, through official help, to refinance part of their existing liabilities.
- If these countries cannot attract net new capital inflows, their currency account deficits, currently equal to two-thirds that of the US, must automatically contract.
- If European trade deficits contact, there must be one or both of two automatic consequences. Either the trade surpluses of Germany and other European surplus countries – larger than that of China and just a little larger in sum than the European deficits – must contract by the same amount, or Europe’s overall surplus must expand by the same amount.
- We will probably get a combination of the two, but a much weaker euro – combined with credit contraction, rising unemployment, and German reluctance to reverse policies that constrain domestic consumption – will mean that a very large share of the adjustment will be forced abroad via an expanding European current account surplus.
- If Europe’s current account surplus grows, there must be one or both of two automatic consequences. Either the current account surplus of surplus countries like China and Japan must contract by the same amount, or the current account deficits of deficit countries like the US must grow by that amount, or some combination of the two.
- If the Chinas and Japans of the world lower interest rates, slow credit contraction, and otherwise try to maintain their exports – let alone try to grow them – most of the adjustment burden will be shifted onto countries that do not intervene in trade directly. The most obvious are current account deficit countries like the US.
- The only way for this not to happen is for the deficit countries to intervene in trade themselves. Since the US cannot use interest rate and wage policies, or currency intervention, to interfere in trade, it must use tariffs.
Tariffs in the US, Asia and probably in Latin America and Europe will rise. These are big numbers and the risk is that the adjustments are likely to occur rapidly. This means the rest of the world will also have to adjust just as rapidly.
I don’t really see how the numbers are going to work. Europe, China and Japan are all implicitly demanding that the US trade deficit rise. The US is determined to bring the trade deficit down. Both sides cannot win. There doesn’t seem to be the much serious attempt at global coordination. In fact the easiest part of any global coordination – that between surplus Europe and deficit Europe – has already degenerated into a nasty round of accusations, counter-accusations and insults.
The hard part of the coordination is almost certain to fail. It will take a few months for the impact of the euro weakness and the withdrawal of net financing to deficit Europe to be felt, but it will be felt. Expect trade tensions to get nastier than ever by the end of this year or the beginning of the next.
By the way is there anything that China can do to head off conflict? Yes. It can buy euros. The more the better – and just lift every offer out there. By strengthening the euro, or at least limiting its weakness, this strategy will force the brunt of the adjustment back onto European surplus countries rather than onto the US and, via the US, back onto China. Sarkozy and other European leaders might not be very happy, of course, but they will be at least partially mollified by the net capital inflows and the reduced humiliation of a collapsing euro.
But make no mistake – if southern European trade deficits decline, someone somewhere must bear the brunt of the corresponding adjustment. The only question is who?
TKX for crystalclear diagnosis. The real hard part of the story is, beside the total and uppermost incompetence of political class, to implement some viable solutions, not to mention any viable idea thereof. Not on the horizon. Everybody tight in denial. There is only one historical, automatic solution to exponentially rising tensions, in response to denial, the seismic shift. It is called war. Nature teaches as much. So let as take our places, ladies and gentlemen, commercials were aired, now the real show starts…
Michael,
You don’t mention the possibility of a eurozone break-up, the medium-term possibility (~2012) of which Martin Wolf seems to view as having significantly risen over the past few months. You mention that Europe will likely see increases in exports due to the Euro rising, and on this point Wolf believes that the benefit of this will likely go to those countries like Germany and Norway, who already have a current account surplus and competitive advantages, limiting the options for balance, employment, and growth in the southern countries.
If I’m right on these points, what do you think about the destabilizing influence this will have, and does China buying Euros help mitigate this?
Canada’s trade deficit was closer to 5 billion than 35. Not sure where the CIA gets its numbers. http://www40.statcan.gc.ca/l01/cst01/gblec02a-eng.htm I’m interested in how this will affect the CAD and AUD. These were 2 countries that seemed to avoid debt troubles at least for now. We can see some adjustments downwards in their currencies already in the last few days. I’m thinking this will just make it easier for China to buy some more commodity companies.
So might one assume your prior statement that your concern over trade conflicts had lessened is no longer the case?
I suspect that in addition to tariffs, we are going to continue to see various governments bolix things even more with capital controls. Yesterday’s ban of certain short selling activities by Germany is just a small step in that direction.
Europe is China’s biggest export market throwing a number of its companies in peril due to the Greek Contagion . A 15% movement in currency makes it very difficult for a company to adjust particularly if it is running on paper thin margins.A Chinese company with 10% margins which exports solely to Europe has the potential to go bankrupt if the situation sustains for a long time.
I think it might not be inconceivable for the yuan to devalue against the dollar for the Chinese to save their massive employment generating export industries. Note unlike a lot of the US companies , most of the Chinese exports are commodities which have much lower margins.
I have always been fascinated by large movements of money (though it doesn’t ever seem to stop anywhere near my bank account). What you say makes sense to me, so how does one apply what you say to what one does?
Can you explain what policies Japan is pursuing to maintain its exports? Japan hasn’t intervened in the currency markets recently and BoJ policy isn’t excessively loose relative to the strength of the economy.
Thanks very much
I’m not sure that a majority of the US economic and political leadership is determined to bring the trade deficit down. Some factions of it would, but probably more powerful factions would be against those type of policies.
most of euroland trade takes place between euroland contries
the necessary adjustment will mainly take place between them
(the US and China will not accept a very week euro and will act accordingly)
China should use it’s dollar reserve to buy euro. China should not devalue the RMB. Devaluing the RMB will only widen the imbalance within Europe and make the situation worse for the world.
Today, China and many developing countries have huge foreign reserves denominated in dollar. The key issue to note is this accumulation of dollar is grossly in excess of the proportion of trade surplus with the US. China didn’t just export to the US. China exported to the whole world and US is only a fraction of the total export. In other words, a few years ago China and other countries did have a choice to evenly diversify into other currencies besides the dollar but did not.
After the Asian financial criss of 1997, many central banks piled into the dollar because dollar is the dominate currency used for trade and US treasury is considered the world safest investment. Unfortunately, when everyone crowds into a safe investment and drive up the price, the investment, very predictably, becomes unsafe. In 2004-2008, high treasury bond price means low interest rate. The low US treasury interest rate drives down mortgage rate and fueled the biggest housing bubble in the last one hundred years. While the US treasury did not default, the prices of most other assets and the world’s economy collapsed. The various developing countries’ preference for dollar also unfairly weakened the US export while strengthened European export.
Today the euro is weak. Tomorrow it will be the dollar. From the data below, it is clear the euro zone’s over all debt level and spending level are both much healthier than the US. In deed the European Central Bank has historically been much more vigilant about controlling inflation than the US Federal Reserve.
Public debt as % of GDP for 2010
Eurozone ~84%
US 98%
Fiscal deficit as percent of GDP:
Eurozone 6.9
US 12%
China and many developing countries are still holding huge excess of dollar reserve. The Euro, on the other hand, has depreciated 20%. Now is an excellent opportunity for China and other developing countries to buy low (euro) and sell high (dollar). It will significantly help stabilize the euro and the troubled European financial markets. In the long run, buy low sell high out of dollar and into euro is also the best way to safe guard the wealth created by the people of these nations. Lastly, will also give time to US and China to correct their own imbalances.
Here is professor pettis’ analysis of what China can do with its reserve:
http://mpettis.com/2010/02/what-the-pboc-cannot-do-with-its-reserves/
and my comment at the time:
http://mpettis.com/2010/02/what-the-pboc-cannot-do-with-its-reserves/#comment-5079
China should not devalue the RMB. It will only make the imbalance in Europe worse. Today, China is no longer a significant trade surplus country. China’s trade imbalance with the world has been correcting for more than a year.
http://4.bp.blogspot.com/_K3ry7Q_rEB4/S-e3g6JjOsI/AAAAAAAAAeU/J3QMqFLSUqc/s1600/10maychintrade.bmp
On the other hand, German’s huge trade surplus is soaring as the euro slumps.
http://www.eubusiness.com/news-eu/germany-economy.4ln
Martin Wolf from the FT.com has written many excellent articles on German’s current account surplus as a cause of Europe’s imbalance.
http://www.ft.com/comment/columnists/martinwolf
Quite frankly, I find Germany’s self righteous finger wagging suffocating. Germany itself is part of the causes of today’s global imbalance.
China devalue the RMB will only encourage Germany and other surplus countries. It will exacerbate the global imbalance and Europe’s imbalance.
In summary, China and other nations with excess dollar reserve should forcefully rotate into their holding into the euro. Europe, US, China, and the world economy will all win.
“By the way is there anything that China can do to head off conflict? Yes. It can buy euros, the more the better –just lift every offer out there. By strengthening the euro, or at least limiting its weakness, this strategy will force the brunt of the adjustment back onto European surplus countries rather than onto the US and, via the US, back onto China.”
Translation: Keep on using the beggar thy neighbour policy, but don’t only manipulate the US-currency rate but also the euro. The euro has its fair value (purchasing power parity) at 1,17 which means that the euro is still an overvalued currency. Do you have any really good arguments why european surplus countries should burden the majority of the adjustments?
Michael,
Thank you for nice post. It resonates very well with my thinking.
Pendulum of eur depreciation is moving really fast. I doubt politicians will be able to grasp all the consequences before it is too late. In my opinion: the right approach to tackle this problem, is to find what will break first given the direction exchange rates are moving.
Most likely outcome we will have at least several more month of eur/usd in 1.2 zone or below. This will make US trade imbalance to grow fast. China will be defending its turf, because they can not loos face and bow to pressure of foreigners. The possibility of Chinese buying junk bonds from southern Europe is not likely, because trade balance with Europe will diminish… And they have tendency to invest proceeds of trade into government securities.
So in my opinion some nasty action from US is the most likely outcome given situation. And that would be the most damaging for world economy at this juncture. The best outcome for world economy is combination of china unpegging and China buying euros by truckload. Let’s see will the reason prevail or not….
Prof Pettis
You have laid out the facts clearly, and they are pretty well inescapable. Unfortunately most people just do not seem to get it (including a few of your readers based on some of the comments a couple of weeks ago).
Your idea that China can buy lots of Euros to help head off the chrisis is a good one for the short term at least. Is there much chance they would actually do it? Another idea (which you do not seem to favor) is for China and Germany to immediately step up direct government spending to help soak up some of their excess savings. Seems like their people should be happy to support loaning the money to their own goverments to spend on things beneficial to them rather than loan it to trade deficit countries with questionable prospects that it will ever be repaid at full value.
I believe it is way past due for the US to start playing hardball. All evidence indicates that the surplus countries just do not get it and will not do what they need to do unless they are pushed. The US and other deficit countries need to make it very clear that access to their markets is a priviledge not a right, and that this priviledge will be severely restricted if the surplus countries do not get their trade into balance.
Hi Michael, the trade surpluses and deficit figures are for 2009. For 2010, the surpluses and deficits so far for some countries have vastly reversed. I wonder if it is still valid to use 2009 data and trends as basis for your argument?
Intesting article. So, if for a moment we say that Chinese government for whatever reason does not want to revalue the Yuan. Can The Chinese government not say loan USD 50 to 100 billion to EU governments, which will be a net inflow of capital for these countries (equivalent to buying Euros)? This should solve the problem for now and the puzzle should fall neatly into place, right? And they can with the goodwill earned, bargain for greater market access as well.
I nearly always read your articles and I must say your blog is one of my best if not
the best macro economic resource. I hope you will find the time to write something
about the specifics of the tariffs you expect from the US. Which industries or sectors
would be most affected? I understand this might not be your specialty but I think
it would be interesting for your readers.
Zezorro, I am not sure I see how war ended the last major period of trade tensions, between Japan in the US in the 1980s. Trade tensions are a problem, but there is no need to get apocalyptical. Most trade disputes are not resolved by war but rather by negotiation, bluster, aggressive actions, and all the usual stuff.
Chris, actually I have been warning of a eurozone breakup for over a decade. My point, which I have made many times in this blog, is that no “successful” currency union in history has ever survived the end of a globalization cycle, and that until we reached our own end, the euro had never been truly tested. Now, two years into the process, we see how unlikely the euro was. Two weeks ago I wrote that the only plausible options, in my opinion, are the transfer of sovereignty or the break-up of the euro. I am betting on the latter. But I agree with you and Martin that much of the “benefit” will accrue to European surplus countries unless the world can find a way to halt euro depreciation.
Dean, I am not sure which prior statement you mean but I have been pretty consistent in saying that I do not believe trade conflicts will ease. And yes, I suspect that both trade and capital constraints will become more intellectually respectable over the next few years. This always seems to happen during periods of global demand contraction.
Michael,
You write: “My point, which I have made many times in this blog, is that no “successful” currency union in history has ever survived the end of a globalization cycle”
What are some examples of such currency unions?
So in essence China should change a portion of their vendor financing from the US to Europe?
That seems like as good a strategy as any to buy time, but re-balancing will still need to take place and I am personally deeply troubled by how little has gone on in the last two years in the US or China.
Michael,
Are there other examples in economic history of a set of nations, governments, societies, etc. using a common currency and then breaking up the arrangement and reverting to separate currencies? i.e. what time periods can I look back to for clues as to what could happen if the Euro were eliminated? Perhaps early in China’s history when the strength of a central government was limited, or maybe the Ottomans, Mongols, British, etc. I imagine there could be multiple former empires where something like this happened.
In present times, would you expect a disorderly switch from fiat to specie and perhaps a lasting distrust of fiat currencies or an orderly replacement of one fiat currency with another?
I’m not sure how relevant historic examples may be as the currencies were likely backed with specie. Perhaps there are no examples of a breakup of a shared fiat currency.
Perhaps I put too much emphasis on this statement at the start of your April 28th post on accounting identities:
“I revisit this old controversy because although the period of nasty trade dispute seems to have come to an end, with conciliatory noises being made between the major parties, trade tension is not going away.”
I interpreted it as being less pessimistic than I have interpreted you to be on other occasions wrt the potential for trade conflict growing.
Michael, Where would you assign the probability of a Chinese DEvaluation at this point? I think the chances grow if the euro continues to fall. Cheers, -Kangnick
Mr Pettis:So until now we could pretty much ignore the impact of Europe on the global trade imbalances because on a net basis Europe didn’t seem to matter too much (and it is aggregate numbers, not bilateral numbers, which really matter in this context).
For the sake of consistency, compare like with like, aggregates with aggregates, which would bilaterally, if you continue with those dear accounting equations, still lead to net figures. Unless of course when the Eurozone implodes and takes everyone else on its periphery along with it.
Mr Pettis:I am not sure what the discrepancy is, but it doesn’t matter much to the rest of this argument.
Just to play devil’s advocate, “leakage” mayhap? which of course suggests the equations aren’t as water tight as they may be? ooh, can feel the arrows of disapproval already!
TC, the trade figures for 2010 and for 2011 will be very different. That is the point. We are going to see rapid changes from the 2007-09 numbers and these changes are going to be costly and painful. This is why I expect most countries to do what they can to pass the burden off elsewhere.
Ronnie, Chinese flows to Europe may relieve some of the burden, but Beijing will wonder if that comes at the cost of full repayment. After all it isn’t German bonds that need to be financed but rather Greek.
Thanks Shan, but it is tough enough just trying to keep track of China.
SV, probably the most famous example is the Latin Monetary Union involving several European countries led by France established, if I remember correctly, in the late 1840s but it didn’t really take off, with several countries joining, until the 1860s. It technically survived the 1873 crisis but was forced to abandon silver shortly thereafter and generally lost all importance as countries switched gradually to the de facto gold standard. It was formally disbanded in the 1920s. The Scandinavian monetary Union was formed in the 1870s, but it was largely a gold standard union until 1900 when it accepted banknotes. It pretty much dies with the financial crisis associated with the advent of WW1. The East African Union based on sterling was always a bit shaky but was kept together by large dollops of British cash. The 1950s-60s “globalization” sequence more or less came apart in 1973 and the EAU fell apart in 1977. There are other interesting periods. You might want to look at the US experience, both before monetary union before the Civil War and after monetary union. It shows the relative ease of maintaining strong relationships between different currencies during periods of liquidity expansion. These relationships rarely survived periods of liquidity contraction associated with deep financial crises.
OGT, I could have written your comment myself.
Matt L., see my response to SV. This may make me a heretic, but I see no evidence that currency stability is necessary to rapid growth. Look at the US for much of the 19th Century. Even looking at the case of Europe before 2007-08 it is hard to argue that the euro brought more growth or higher quality growth to Europe than before EMU or the euro. It seems that good fiscal policy and a systematic mechanism for transferring resources to the productive sector (interestingly enough, the US “way” in the 19th Century might have been periodic bank failures) are far more important
Dean Jackson, my confusing writing was meant to say that although there seemed to be an improvement in the nastiness of the debate over trade, in no way was the underlying problem resolved, and the nastiness would soon come back.
Kangnick, I think the probability of an RMB devaluation is low but not zero. However it would almost certainly cause outrage around the world and would force every other country to respond either by beggar-thy-neighbor depreciations in the case of countries that can intervene, and import tariffs in the case of countries that cannot.
Judy, I don’t know what your first comment means. As for the second, the difficulty in measuring complex transactions in no way proves that accounting identities don’t hold. It may be very difficult for me to count accurately 200 thousand grains of sand and 300 thousand grains of sand, but that in no way implies that adding 200 thousand grains of sand to 300 thousand grains would not necessarily leave a pile of 500 thousand. I really do not see why this is so difficult to understand. Perhaps I am missing something.
Michael do you think the tepid core inflation numbers in the US will fuel pressure from them for a PMB revaluation? It seems to me that the recent figures show that it would be a good time to induce none core inflation via a higher price for imports. In a way, the US could use a currency tax on Chinese imports to ward off deflation.