A couple of economists have weighed in on the Chinese proposal for a world reserve currency. They are both worth reading in full, as I think it highlights a perhaps overlooked aspect of the current crisis.Stephen Flanders at the BBC is impressed, giving the Chinese kudos for global leadership for a proposal that
- ….would have made it quite difficult for economies like China to exist. If there had been a Keynes-style global currency system, China would have had to rein in exports and cut domestic saving a long time ago. There would have been no wall of cash looking for safe, or pseudo-safe, assets in countries like the US. And we wouldn’t be where we are today.
- Maybe Governor Zhou is making mischief at America’s expense. Maybe he hasn’t gone back to the Keynesian roots of his idea to see where, exactly it would lead (though I would find that very surprising).
I suspect Paul Krugman would not find it all that surprising, though:
- But theres both less and more here than meets the eye. S.D.R.s arent real money. Theyre accounting units whose value is set by a basket of dollars, euros, Japanese yen and British pounds. And theres nothing to keep China from diversifying its reserves away from the dollar, indeed from holding a reserve basket matching the composition of the S.D.R.s nothing, that is, except for the fact that China now owns so many dollars that it cant sell them off without driving the dollar down and triggering the very capital loss its leaders fear.
So what Mr. Zhous proposal actually amounts to is a plea that someone rescue China from the consequences of its own investment mistakes. Thats not going to happen.
I think this is a key point. It is very easy to berate the US, UK and similar economies for running deficits and going on a spending spree. It fits with our intuition. Spending bad, saving good. We should have been like China, Japan and Germany, saving heavily and runnign surpluses. But it is worth bearing in mind that those sprees essentially financed world growth over the last decade, and that they had to financed from somewhere. The finance came from those countries that were running huge trade surpluses, particularly China. That too played its role in the present mess.
In order to truly fix the world economy, those countries that were running huge deficits need to become more restrained. But those countries that were running huge surpluses need to begin to start adding a significant contribution to global demand, and reduce their savings. This does not fit with our intuition. If they do not, it will be difficult to find something to fill the gap left by the busting of the booms in the housing and financial sectors. Even if we could get past that problem, it would lead to a glut of cheap money looking for a home: exactly what put us into the mess in the first place. As Krugman puts it
- And the call for some magical solution to the problem of Chinas excess of dollars suggests something else: that Chinas leaders havent come to grips with the fact that the rules of the game have changed in a fundamental way….
The bottom line is that China hasnt yet faced up to the wrenching changes that will be needed to deal with this global crisis. The same could, of course, be said of the Japanese, the Europeans and us.