There are so many contradictory views about the role that the Chinese economy plays in globalization, particularly in the deepening global imbalance. To help decipher some puzzling problems that this issue presents, it will be of value to look into the the discourses of economists and bankers.
This paper answers three questions with one sub-question: Where did the prospects for a global imbalance derive? What are the phases of China's foreign exchange policies? What is the role played by China in the global imbalance. After a discussion on these questions, this paper finally ends with a short conclusion.
Prospects for a global imbalance, where derive
To understand the concept of global imbalance, it is said one must confront issues of definition and interpretation immediately (Sombart 1930; Dobb 1946), and that diversity must be taken into account (Hodgon, et. al 2001). By this end, some schools argue that it is best to postpone any attempt to define it until one has inquired into its history. Global imbalance must not be considered as timeless thing that is wanting of change and variety. Like all the other aspects of the realm of human experience, it has a history; therefore, one's understanding of global imbalance must be sensitive to those changes. Relative to this discussion are the views of revolutionists Max Weber and Friedrich Nietzsche during their time.
Weber (1864-1920) said, "Definition can be attempted, if at all, only at the conclusion of the study." Meanwhile, Nietzsche (1844-1900) held that "only that which has no history can be defined." To understand then global imbalance, we look to at least some bits of history.
During the 1990s, the United States experienced persistent deficits, then Japan and the euro area first, and later emerging Asia and oil-exporting countries enjoying trade surpluses which created wide-scale trade imbalances in the different regions of the world (Cova, Pisani,& Rebucci 2009). Currently, the United States absorbs huge share of the globe's current account surpluses, and net US liabilities remain close to record-highs, representing about a fifth of US gross domestic product or GDP.
These economic scenarios has polarized theorists about the sources and possible resolutions of these imbalances. Some are in favor of global imbalance, suggesting that it should not be resisted largely because such manifest as an "equilibrium" phenomenon, brought about by the interaction of growth and financial development differentials among nations. With such phenomenon, the differentials will resolve themselves gradually over time (Engel & Rogers 2006, Branchard 2006, et. al.), however. Many believe these imbalances sprang from economic distortions, suggesting the adoption of policy adjustment such as effecting exchange rates and fiscal policies or both to resolve these issues primarily (IMF 2005, Blanchard Giovazzi & Sa 2005, et. al).
When China's economy reported a remarkable net saving surplus generated from its trade surplus that increased since 2000, its outstanding current-account surplus posted US$359 billion improvement in 2007, in turn, sending mixed reactions to and from various economic markets in the world, more particularly the US. What this means is that such figure then covers almost half of the much wider US current-account deficit amounting to US$750 billion, and analysts predict should such trend continue, more than half will be covered. The political pressure from the United States pushed upward the renminbi's peg to the dollar since 2005 and may continue to accelerate even more. As a result, China's ever-increasing official exchange reserves, financed by building up exchange reserves, contrasts with other large surplus-saving nations such as Germany and Japan.
In 2007, China had step up efforts to banish foreign exchange controls on capital outflows by industrial companies and the financial sector. Individuals, however, are afforded generous foreign exchange allowances for traveling abroad. Despite this fact, however, that private financial institutions and individuals refuse to diversify by investing outside of the country. China, on one hand, is struggling to restrict the deluge of "hot" money inflows. With this economic realities, participants in the foreign exchange markets expect the renminbi will appreciate even more against the dollar at the back of the abnormally low interest rates in the US, thus, they are reluctant to hold dollar assets.
McKinnon and Shnabl (2009) argued that this is a juncture in international finance, which thus demand to distinguish between two definitions of "global imbalance". In the first definition, the great saving imbalances manifests across nations that are mirrored in the large trade deficit of the United States and large trade surpluses of China, Japan, Germany oil exporters, and a host of emerging countries. In the second, global imbalance sprang out of the financial intermediation for China's big current account surplus with the United States. In this case, China's central bank accumulates huge amounts of foreign exchange - whereby some of which is invested in US treasury bonds - instead of just of a normal outflow of private capital to finance China's trade surplus.
Between these two types of global imbalance, the best known and most intractable in the short run is saving-investment imbalances across countries. However, by re-balancing through reducing excess saving in large creditor countries, increasing the net saving in the United States is most likely in the longer run when exchange rates are not disturbed (McKinnon 2009).
Evolution of China's Exchange Rate Regime
To better understand China's current monetary conundrum, it is said it is best to investigate the path leading to its current foreign exchange policies which began since market-oriented liberalization in 1979.
Chinese currency's inconvertibility and exchange depreciation before 1994. Prior to 2004, China adopted multiple exchange rates for various reasons, making its currency inconvertible. It then introduced an official rate and floating swap rates for new exports in several parts of its country. There is also an exchange controls adopted for both its current and capital account transactions, while exports and imports had to be channeled through state trading corporations. The result of this "airlock system" insulated domestic relative prices from those prevailing on world markets. As a result, there was an arbitrary set-up of the official exchange rate thus incentives for exporting or importing were not much affected nor was the domestic price level. Within this tight exchange controls, "hot" money flows are prevented because official exchange rate was not economically very meaningful.
The fixed dollar exchange rate from 1995 to 2005. During this period, the state imposed a monetary policy of ten-year fix at 8.28 Yuan per dollar that was paved by the currency unification in 1994 and the effort to current account convertibility from 1994 to 1996. There was a remarkable improvement then in anchoring the domestic price level through 2004 and smoothing fluctuations in real economic growth to allay fears that the policy was meant to cunningly undervalue the renminbi in order to establish a mercantile advantage by artificially stimulating exports.
The appreciation by a predictable upward crawl through mid-2008. On this part, China was pushed off its fixed rate anchor since July 21, 2005. This followed after 2003 when China posted large balance of payment (BoP) surpluses after having an unexpected net saving surpluses, coupled with large inflows of foreign direct investment. Then, China's BoP surpluses were misinterpreted by economists, arguing that renminbi was artificially undervalued Its rapid build-up of official exchange reserves from 2003 to 2005 was also construed erroneously as evidence of unfair currency manipulation. On this phase also, the US pressured China to begin appreciating the renminbi or it will be effect import tariffs sanctions. In effect, China has turned from being a deflationary force in the world economy into an inflationary one - as we shall see (McKinnon and Shnabl 2009).
China's Role in the Global Imbalance
In discussing the cause of the Financial Crisis, the focus often lies on regulatory failure in the mortgage and finance industry. Some never bother to look into the large global imbalance between the US and the Asian economy, particularly that of China. However, not until China experienced in the mid-2000s huge current-account surplus that its connection with that of the US's current-account deficit was explored, thus leading some to inspect the role of the economy of this state in the global imbalance. However, is it really fair to heap all the blame on China if it became successful for adopting an export-led model?
McKinley (2009), who has been looking into China's miraculous growth path only recently when it begun running large current-account surpluses, asked if choosing an export-led strategy - which should critically rely on maintaining a competitive exchange rate - is malign, citing this was the same strategy adopted by first world nations like Japan and Germany, and also East Asian Tigers like Singapore and Taiwan. He argued that the US has the propensity to 'live beyond its means' even before China became a major exporter of capital.
According to an Asian Development Bank Outlook for 2009, China's exports shipped to the US dropped from about 20 percent in 2000 to about 16 percent in 2007, which means that neither pegging the Chinese renminbi to the dollar does not make sense nor does pumping reserves into US securities to abate the depreciation of the dollar (McKinley). The most logical reaction from China would be to abandon such risky strategy. But the debate on its exchange-rate policies and its development platform has been sparked from commentators in the West. McKinley stressed that the economic milestone of China speaks for itself, citing as an example what it achieved in increasing by ten-fold its GDP per capita from US$807 in 1980 to US$8,539 in 2008 (using constant prices). The World Bank reported that China was able to lift up to 630 million of its citizens out of poverty, which it owed from following in the footsteps of its East Asian neighbors like Singapore and Japan influenced by the economic turmoil that swept Asia during the Financial Crisis in 1997 to 1998. The Asian Financial Crisis taught the countries in Asia, including China, to avoid running current-account deficits if their adopted development model calls for trade liberalization and capital flow transactions.
Meanwhile, critics of China's reform calls the state as an 'immature creditor country' on accounts that it cannot lend to foreigners its renminbi to finance its cumulating current account surpluses. While this practice or inability to lend one's own currency is also being shared by some creditor economies in East Asia like Taiwan, Korea, Malaysia, and Singapore. Oil-producing nations with large trade surpluses like Gulf Coast states and Russia also implement this practice however. But in the case of China, its continuing effort to restrict the flow of domestic bank deposits and loans, including high reserve requirements on domestic banks, in effect make he renminbi unusable for international lending into the indefinite future. Hence, globally, the effect of the mismatch then makes securing portfolio equilibrium in domestic financial markets, and monetary management, more difficult.
While some large creditor countries like the Britain of 19th Century lend in their own currencies and the United States after World War II had its large current account surpluses financed by making dollar loans to foreigners. Together with, in the more recent past, Germany finances its large current account surplus by lending heavily abroad in Euros. China, on the other hand, runs the risk of being affected by the exchange rate fluctuations because its private financial intermediaries face enormous currency risk from buying dollar asset.
The criticisms hurled against China by commentarists from Western publications state that the country plays a critical role in causing the current global crisis, deriding the country's 'protectionist' exchange rate policies, then implying that it can choose to allow its currency to appreciate and significantly reduce its surpluses. For quite a long time, China has been accused of trying to keep the Yuan undervalued to boost its exports, which in effect would make its exports cheaper and boost its trade surplus.
But if these were all correct, McKinley argued that the US, the world's economically dominant, reserve-currency country, would then become blameless for all these. By all account, the great majority of Chinese are still relatively poor by developed-country standards even though it followed its export-oriented development strategy and it has a high savings rate. But it is said it would be unfair to accuse China of adopting mercantilist policies, Machiavellian nor malign, but rather it should be looked at as a development success.
For its part, China claimed that the global imbalance was the result of US's decision to pursue low interest rates and of its lax standards in lending criteria. But it was explained that the reason the US can impose a low long-term interest rates is because there was great demand for savings in the US, encouraging US banks to offer increasingly sophisticated forms of investment. But China defended itself, saying it is their right to pursue their own exchange rate policy.
To some extent, researches polarized by these realities argued that while there may be good in store in the global imbalance, it also have negative impacts. The International Monetary Fund (IMF) addresses that global imbalances may be a reflection of the differences across countries in the rate of return on investment, or difference in the degree of risk or liquidity of different assets. The agency as well notes that there are dark sides on the global imbalances, citing such may mirror domestic problems or distortions.
Economists and global market players are in contention about the role played by China's economy, its development strategy and its monetary policies in pulling down the global balance. To some eminent opinions, it is claimed that China is the central source and the "driving force" of the worsening state of global imbalances, being so it is considered its role. These commentators clamor that China has imposed an 'exchange-rate manipulation' that started it all, but all the blame should not be heaped to the country but also to the United States, which has lost its edge in global competitiveness over the years. What the commentators have failed to consider is how the global imbalance should be looked at constructively and how the players in this malaise can be improved through the implementation of a well-thought out structural adjustment. The significance of these adjustments should be concentrated within the context of the current global economic climate in hopes of reducing the basis for future global imbalances.
The global imbalances may have declined during the global recession yet it should keep market players wary and cautious that it could widen again within the context that the global economy is yet to normalize. Given all these realities, the best approach for all economic players from the United States to China is to resolve this issue in order to secure a sustainable global recovery that will not benefit just one country, but other small nations as well.
There are few recommended actions that Chinese authorities should undertake to boost its private consumption which is necessary in rebalancing its economy. Among them are as follows - 1) to thresh out social policies to make more funds available for consumption; 2) to develop its financial markets for better distribution of capital; 3) to provide saving vehicles to raise household incomes; 4) to expand the availability of insurance products; and, 5) to strengthen the corporate governance.