Jim O'Neill: Tough talk on China ignores economic reality
Comment of the Day

April 01 2010

Commentary by David Fuller

Jim O'Neill: Tough talk on China ignores economic reality

This informative article by the chief economist at Goldman Sachs for the Financial Times. Here is the opening
In the past few weeks, Washington has upped the rhetoric concerning China and its currency. Coming at a time when there are a number of other sensitive issues facing the US-China relationship, it is not obvious to some of us why Congress is so excitable about this issue. With the biannual decision of the US Treasury on whether to name China as a currency "manipulator" due on April 15, it is far from clear that all this noise is helpful to anyone.

Indeed, from a macro-economic perspective, the timing could not seem more inappropriate. About four weeks ago, President Barack Obama announced a plan to double exports over the next five years. This is ambitious, but given the past weakness of the dollar and the strength of domestic demand in many big emerging countries, China included, the US has a chance of reaching its goal. So why go down a path of tit-for-tat retaliation that would take things in the opposite direction?

There are three fundamental issues that US policymakers should focus on: domestic demand in China, China's trade with the rest of the world, and exchange rates.

With respect to domestic demand in China, there is rather clear evidence that, if anything, it is currently too strong, and certainly not at a level to justify accusations that China is not doing its "bit" for the world economy. For about 13 years we have used our own proprietary gross domestic product indicator for China, the so-called Goldman Sachs China Activity index. At the moment, this is growing at an annual rate of more than 14 per cent. Indeed, and somewhat ironically, it is likely that if Washington and others could keep quiet, Chinese policymakers would probably be more eager to do things to ease the inflationary pressures arising from this growth, including introducing more flexibility to the exchange rate.

Looking at a number of indicators, whether they be anecdotal from domestic or global companies that do business in China, published data on consumption and investment, or, importantly, the trade data, all of this is clear. Speak to anyone involved at any level of the consumer business, whether it be Tesco, Walmart or Louis Vuitton, and their evidence backs up the data. Chinese consumption is probably growing at about 15 per cent, similar to a 2-3 per cent rate for the US consumer.

David Fuller's view This is in line with the Fullermoney view which I last expressed on Tuesday 23rd March:

The trade/currency rhetoric from the White House and Congress is disingenuous, in my view. It is also predictably populist during an election year. In the fiat money era all governments are currency manipulators at some point, usually via excessive printing and periodic jawboning.

The US has a large trade deficit with China because so many American companies choose to manufacture in the PRC (and other countries) where labour costs are much lower. The tradeoff is fewer US jobs but lower prices for consumers. The US produces little of what China actually wants, other than foods and to a lesser extent some heavy machinery. These exports to the PRC are a tiny proportion of US GDP, perhaps 2% according to most assessments.

If China revalued the yuan by approximately 10% against the dollar, would it import that many more soybeans, tractors or other items? I doubt it. Even if exports to China doubled it would still only account for approximately 4% of US GDP. However the stronger yuan would increase US consumer prices.

The US and other developed countries do have one big, legitimate economic complaint about China - patent violation and piracy of intellectual property. Unfortunately, developing countries have long copied western and Japanese technology, to the degree that it is now regarded as an acceptable and inevitable practice. From the west's perspective, patent and copyright protection is difficult to enforce at an acceptable price. These issues are best handled quietly and diplomatically.

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