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US-Asia Economic Policy: Saving the Dollar from the Renminbi

The US global merchandise trade and current account deficit in 2006 was the largest ever recorded by one country, amounting to $857 billion in 2006. On the opposite side of the spectrum, China’s current account surplus for 2007 will be the largest surplus ever recorded by a single country, projected at $300 billion. China has surpassed all countries in its holding of foreign exchange reserves, which now exceed $1 trillion in order to hold the Renminbi (RMB) down.

For fear of losing competitiveness, other Asian countries have followed suit. Today they make up 40% of the dollar’s trade-weighted index and account for half the global surpluses countering the US deficit; they hold global reserves essential to correcting the exchange rate of the dollar. These imbalances pose the single largest threat to US and world economies.

Fixing the Dollar

The United States must attract $8 billion of capital every day to finance the current account deficit and foreign investment outflows. Any decline in capital flows could increase US inflation and interest rates, potentially triggering a recession. Bergsten therefore makes the following recommendations on behalf of the Petersen Institute of International Economics:

Global Strategy

• Reduce the US current account deficit to 3.5% of GDP (half its current level) through global adjustment
• Eliminate China’s current account surplus and cease building up foreign exchange reserves
• Cut the US budget deficit to 4% of GDP through fiscal tightening in order to diminish reliance on foreign capital inflows that keep the dollar up and undermine US trade competitiveness
• Increase domestic Chinese consumption to reduce the immense national saving rate, e.g. through government spending on health care, education etc.
• Most importantly, increase the value of the RMB by 20% against other currencies over several years (this implies a 40% increase against the dollar)
• Get other Asian countries to follow suit, thereby reducing US global current account deficit to more than one third of total adjustment needed
• Adopt a flexible exchange rate in China once its banking system has been reformed

US Strategy

• Warn China that it will be labeled a currency “manipulator” if current interventions continue.
• Bring in the G8 and IMF as multilateral backup. The objective should be to reach a “Plaza II” or “Asian Plaza” agreement.
• File a WTO case on behalf of the US Administration and as many other countries as possible, against China’s violation of Article XV (4): China’s intervention effectively represents a subsidy to exports as well as an import barrier.
• Take unilateral action if multilateral action fails: the US Treasury should enter the currency market itself.
• Craft federal legislation, through prior notification to Congress, which sanctions the Chinese (and possibly other Asian countries) for failure to observe international currency obligations.
  
  
  This summary was prepared by the Atlantic Community editorial team from a statement by C. Fred Bergsten of the Petersen Institute of International Economics, made before the US Senate at the hearing on US Economic Relations with China.

Peter G. Peterson Institute for International Economics, May 23, 2007

Members of the Atlantic Community, how much do you worry about a recession in the United States or Europe? Do you see ways in which global surpluses in Asia could make an impact on your own daily life and finances? What do you think about China’s foreign exchange rate behavior? Make your comments below.

Related Materials from the Atlantic Community:

• McKinsey: Multinational Acquisition Highlights China’s Strength in a Global Economy
• Foreign Affairs, Hands Off Hedge Funds
  
  
  

  Prepared by Julia Frohneberg