The G-20 Currency Skirmish

By • on November 13, 2010 at 4:35 pm

President Obama spent all week in Asia, posing with heads of state prior to the G-20 economic summit in Seoul, South Korea. It was all in vain.

Both Obama and Treasury Secretary Timothy Geithner were rebuffed at the summit. They came to the table arguing that the group needed to agree on ways to address trade imbalances between nations. In other words, they wanted China to raise the value of its currency.

A trade imbalance occurs when one nation’s population buys more goods from abroad than it can sell on the world market. This creates a national trade deficit, which is very similar to a person charging goods on a credit card and not paying it off every month. If the trade imbalance accumulates for too long and becomes too high, it can negatively affect the nation’s economy. No population can consume more than it produces without eventually suffering a collapse, and the US trade deficit has hovered at record highs for some time now.

China, on the other hand, has a record trade surplus. While China has a large population, most of its citizens don’t make enough money to afford expensive imports. In addition, the Chinese government holds the value of the Chinese currency tied to a peg—in other words, the government determines the value of the renminbi by averaging the value of a basket of other nations’ currencies and arbitrarily deciding how many renminbi can buy a share of that basket.

Since World War II, the US government has worked assiduously to force smaller nations to unpeg their currencies (i.e., allow them to “float”) so that the value of most currencies in the world now rise and fall according to the markets (and market speculation, but that’s another issue.) As a consequence, those nations whose currencies are strong (have a higher value) can buy more imported goods, while those countries whose currencies are weak (have a lower value) can’t afford many imports, but can sell a lot of their manufactured goods on the world market because their goods are cheap to buy. This gives developing nations like China an incentive to artificially keep the value of their currencies low—their populations don’t have much buying power, but their industries make a lot of money selling cheap goods to the rest of the world…especially to the US.

Obama and Geithner were articulating a long-term US goal that’s been on the national agenda since the Clinton era: China has a lot of cash to spend, and the US can no longer be the consumer of last resort for the entire world.

At the G-20 meeting, however, the Americans were literally laughed off the stage. The Federal Reserve’s recent announcement that it would print money in an effort to stimulate the economy has the whole rest of the world aghast. By increasing the supply of US dollars, the Fed is weakening the value of the dollar and making US exports cheaper. The rest of the world views this as outright currency manipulation very similar to what China has been doing for decades.

Recently, however, China has been slowly allowing the value of its currency to rise in an effort to control runaway growth and a worrisome asset bubble. It may not be happening fast enough for the US government, but the renminbi is already increasing in value. China doesn’t want its economy to crash, as it would if they were to suddenly let the renminbi float; instead, they’re bringing the plane in for a soft landing.

That’s a lesson we could learn from them: how government regulation can smooth over both the peaks and valleys in a national economy. In our free-for-all economy, we’ve eliminated regulations so the peaks can grow extremely high, but the ensuing plummet can be precipitous and long-lasting.

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