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Correction to This Article
Steven Pearlstein's column, which discussed China's manipulation of the value of its currency, incorrectly described congressional testimony by Fred Bergsten of the Peterson Institute for International Economics. Bergsten, a free-trade advocate and currency expert, said the Chinese renminbi is currently undervalued, not overvalued, by about 40 percent against the dollar

China's control freaks

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By Steven Pearlstein
Friday, March 26, 2010

The Chinese government reflexively responds to almost any criticism, or any calls for it to sign on to international policies, as interference in its internal affairs. Which is why it is so entertaining to watch the control freaks in the Forbidden City respond to Google's decision to suspend regular service in China rather than continue to kowtow to the country's censorship regime.

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We'll leave aside for now the question of whether the Chinese government "interfered in the internal affairs" of Google when it hacked into the company's servers to steal proprietary software and check the online activities of Chinese dissidents.

By signaling that it is willing to abandon the Chinese market, Google has neutralized the "meddling" defense and forced the Chinese to face the possibility that their economy may not be as indispensable as they had come to assume. We're about to find out whether China needs Google more than Google needs China.

One can only hope that the U.S. Treasury will follow Google's lead in the next few weeks as it decides whether China is manipulating its currency to achieve commercial advantage. For years, the Treasury under three different administrations has undermined its credibility and professionalism by denying the obvious on the theory that we wouldn't want to ruffle the sensibilities of Chinese leaders by appearing to interfere in their internal affairs.

This wink-and-nod approach yielded modest results from 2005 to 2008, when Chinese exports were booming and China allowed the value of its currency to gradually float up by 20 percent or so. But all that came to an end when the global recession hit and Chinese leaders decided it was more important to save Chinese jobs than American ones.

Fred Bergsten, the card-carrying free-trader and currency expert from the Peterson Institute for International Economics, told the House Ways and Means Committee this week that China now has to intervene in currency markets to the tune of $1 billion a day to keep its currency, the renminbi, from increasing in value against the dollar. Bergsten estimates that the Chinese currency is now overvalued by about 40 percent against the dollar, which, as he reminded the committee, is effectively the equivalent of a 40 percent tariff on imported American goods and a 40 percent subsidy to Chinese exports to the United States. That roughly translates to the loss of 1 million American jobs.

The first step in responding to this mercantilist attack on the U.S. economy is for the U.S. Treasury to start telling the truth about Chinese currency manipulation. What to do after that is more of a puzzle.

For starters, because Singapore, Malaysia, Taiwan and Hong Kong are all essentially part of the Chinese export machine and peg their currencies to the dollar as well, it's only fair to add them in some fashion to the manipulation declaration.

And though a declaration opens the way for retaliatory tariffs under U.S. law, the risk is that it will trigger a tit-for-tat trade war while inviting an embarrassing legal challenge at the World Trade Organization. At least initially, Bergsten and others have suggested that a better approach might be trying to turn this from a U.S.-China confrontation into an issue of international concern, challenging China's mercantilist policies at both the WTO and the International Monetary Fund. Perhaps the only thing Chinese leaders dislike as much as interference in their internal affairs is the prospect of being shunned and isolated from the rest of the world, which in the past hasn't worked out particularly well for them.

The Chinese remain in denial about the causes and consequences of the recent economic bubble. In their view, the reasons the United States keeps running large trade deficits are that Americans save too little and that the government insists on running large budget deficits, both of which are undeniable. But if we were to immediately do as they recommend, it would surely throw the U.S. economy into a much deeper recession and result in a dramatic reduction in Chinese exports, dragging the Chinese economy down with it. It's hard to see how that's better than agreeing to a gradual revaluation of the renminbi.

The reality is that until we finally break the symbiotic relationship between a U.S. economy that consumes so much more than it produces and a Chinese economy that produces so much more than it consumes, there will continue to be huge global imbalances that perpetuate the boom-and-bust cycle. Floating exchange rates are the way a market system corrects for those imbalances.

China refuses to allow that corrective mechanism to work, not only by massively intervening in currency markets but also by tightly controlling the flow of capital across its borders. In effect, China wants all the advantages of open global product markets so it can export its way to prosperity while resisting opening the financial markets that are necessary to keep the system in balance. And this netherworld between a market economy and a controlled one is inherently unstable and unsustainable -- not just for us but also for China, which is now finding it increasingly difficult to contain the investment bubble and inflationary pressures building in its own economy.

China has made amazing strides the past two decades in opening up its economy and lifting its people out of poverty. As a developing economy, it was entitled to a grace period from the normal rules of global commerce as it transitioned from state control to open markets. But with China's extraordinary success, its grace period has now run its course. The Obama administration needs to make it clear to Chinese leaders that if they are not willing to begin playing by the same rules as the rest of the world, they should find somewhere else to sell all those television sets and running shoes. Like the Google guys, we should pick up our ball and go home.


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