Brad Setser: Just Because the Dollar Has Fallen (Against the Euro) and the Current-Account Deficit Is Shrinking (as a Share of GDP) Does Not Mean that the Future Is Rosy
Rilo Kiley: Silver Lining

Larry Summers Writes About U.S. Policy Toward China

I think Larry Summers has the rhetoric wrong. The right things for reality-based political economists to be saying right now are:

  • To the U.S. Congress: a rapidly-growing China that views the U.S. as a helping friend rather than an enemy is an enormous source of strength and wealth; the overall U.S. unemployment rate is set on the Mall rather than in Beijing; yes, China's economic policies have transferred wealth from America's manufacturers and manufacturing workers to the construction sector and to coastal homeowners--but dealing with that transfer is an internal matter for us.

  • To the government of China: the longer China delays rebalancing--delays shifting from export-led development driven by an undervalued currency to development driven by domestic demand--the greater the likelihood of a major crash someday, the greater the magnitude of that crash should it come, and the higher the chances that China's economic development will suffer a severe check and that the cadres of the CCP will wind up in the garbage dump of history.

Summers is in the Financial Times: / Columnists / Lawrence Summers - How America must handle the falling dollar: The falling dollar generates anxiety almost everywhere. Americans and those dependent on American growth worry about the proverbial “hard landing” as inflation and interest rates rise with a weakening dollar, causing asset prices and output to fall. Europeans and others with currencies that float freely against the dollar worry that their currencies will... appreciate too far, leading to competitiveness problems.... The dollar’s decline may provoke anxiety but it should not be a surprise.... There is nothing very new about a decline in currency of a country running a large current account deficit and whose economy is softening.

But in important respects the situation of the dollar is almost without precedent.

The vast majority of the US current account deficit is now being funded by central banks accumulating reserves.... The Clinton administration approach of asserting the desirability of a strong dollar based on strong fundamentals while allowing its value to be set on foreign exchange markets... is insufficient in the current world, where the dollar’s trade-weighted exchange rate is to an important extent managed abroad. Some means of engagement must be found....

The US has responded in an ad hoc way by carrying on a “strategic dialogue” with China... backed by congressional threats to address exchange rate issues using the tools of trade policy and references to communiqués from the Group of Seven leading industrial nations. In reality the dialogue is anything but strategic.... [The Bushies] confuse the firm statement of legitimate desire with the serious conduct of diplomacy.

Think of the questions Chinese policymakers must ask themselves. What is the highest US priority – global financial stability or market access for well-connected US firms? Can the US take yes for an answer or is it a certainty that a new president will insist in 18 months on a new set of economic diplomacy accomplishments with China? In which areas, if any, is the US prepared to adjust its policies in response to global interests? Given that the Chinese authorities have presided over nearly double-digit annual growth for a generation, do US officials who make assertions about what is in China’s interest have the experience and knowledge of China that should cause their views to be taken seriously?...

Maintaining global financial stability and the role of the dollar requires a more strategic approach – a task that, given the political calendar, is likely to fall to the next US administration.... The right and potentially effective case for adjustments in the current alignment of exchange rates relies on their unsustainability and the distortions they induce in macroeconomic policies, not on ideas of fairness to workers.... [M]ultilateralism is better politics and economics than unilateralism.... The stakes are high. Well-managed finance cannot on its own make a country stable and prosperous, let alone the world. But history tells us that poorly managed finance foments instability and economic insecurity.