West can’t have it both ways

William Pesek

Christine Lagarde, head of the International Monetary Fund, assigns very low odds to a Chinese hard landing. But what if the West is increasing the chances of a crash in the world’s second-biggest economy?

I’m talking about demands that China boost the yuan’s value. The outcry over the currency’s move the other way - down more than 2 percent in three months - roiled the IMF’s annual meeting in Washington last week. Pressed by reporters, Lagarde said China wasn’t engaged in “intended depreciation.” Rather, she said, Beijing’s move to widen the yuan’s trading band reflected an “internationalization” of the currency.

Lagarde is just being diplomatic. Of course China is actively weakening the yuan, as it should be. Leaders in Beijing have at least three good reasons to do so: hot-money flows, Japan and the desperate need for growth.

Ever since China joined the World Trade Organization in 2001, the U.S. Treasury Department has been demanding ever-bigger upward yuan revaluations. The idea is that a rising currency would make China less mercantilist and more entrepreneurial. Yet a dozen years on, China faces a serious capital-inflow problem not unlike the one that overwhelmed Asia in the late 1990s.

Zero-rate regimes in Frankfurt, London, Tokyo and Washington are causing considerable control problems. With interbank rates around 4 percent and a currency that, until recently, was rising about 3 percent a year, China had become a giant money magnet. That attractive spread gave speculators the world over every incentive to find creative ways around Beijing’s capital controls. Look no further than the mainland’s white-hot real-estate markets.

The ways in which a rising yuan can do more harm than good is a pet topic of Stanford University economist Ronald McKinnon, author of “The Unloved Dollar Standard: From Bretton Woods to the Rise of China.” Beijing is “caught in a currency trap, owing to its own saving surplus (and America’s saving deficiency) and near-zero interest rates on dollar assets,” McKinnon wrote in a Project Syndicate op-ed. “Although fully liberalizing China’s domestic financial markets and ‘internationalizing’ the renminbi may be possible one day, that day is far off. For now, if China tries to liberalize its financial markets, hot money will flow the wrong way - into the economy, rather than out.”

The second reason involves basic fairness. Japanese Prime Minister Shinzo Abe pledged to deploy three policy arrows to achieve his target for ending deflation in his country. But nearly 16 months on, “Abenomics” is looking suspiciously like a one-arrow affair. The first arrow - a burst of monetary stimulus - hasn’t been matched by the fiscal-policy and deregulatory measures Abe promised. So let’s call the prime minister’s revival plan what it really is: a massive currency devaluation.

With the yen plunging 20 percent, U.S. Treasury Secretary Jacob Lew’s call for Beijing to strengthen the yuan sounds awfully hypocritical. Why should it be OK for wealthy Japan to devalue when poor, unbalanced China can’t? It’s becoming harder and harder for Washington to make this case with a straight face.

The third rationale for a weaker yuan is to offer China wiggle room to reform its economic and political systems. It’s easy for Lew or Lagarde to advise China to accelerate the shift away from excessive investment and exports toward a more services-based model. But they’re not in President Xi Jinping’s shoes. When Xi pledges to revamp China’s economy, he’s talking about yanking lucrative interests out of the hands of Communist Party officials who are currently making millions - sometimes billions - of dollars off the current system.

It’s hard to exaggerate how destabilizing it will be to free state-owned enterprises and shadow banks from the clutches of corrupt politicians. The only way to carry out such a purge is to stop adding fresh stimulus and allow gross domestic product to slip below 5 percent. “The problem China faces, I think, continues to be a long, slow, grinding away of debt and many years of much slower growth,” says Michael Pettis, a finance professor at Peking University.

Xi must be willing to stomach reduced liquidity, mini crises in money markets, massive corporate defaults, and a drumbeat of bearish chatter from the George Soroses and Nouriel Roubinis of the world. Amid such tumult and uncertainty, Xi will could use a growth lever or two to prevent China from crashing. A weaker yuan is an obvious one. The world can’t have it both ways. If China is to do its part to rebalance global growth, we need to meet the Chinese halfway. China can either recalibrate its economy or raise the yuan. The West can’t have both.

*The author is a Bloomberg View columnist.

By William Pesek