Last week, the Obama administration declined to cite China for currency manipulation despite the fact that most experts — including Treasury Secretary Timothy Geithner during his confirmation testimony — do not deny the obvious currency-rate fixing by China. Almost certainly, this decision reflected merely a tactical judgment not to offend China, given China’s vital role in the international economic recovery effort.
But Chinese currency manipulation provides a useful entry point into an important Washington debate: Do we understand well enough — and are we in a political position to discuss honestly — the causes of the current financial and economic crisis to be ready, this year, to enact financial re-regulation legislation?
I would argue not only that we do not understand enough yet but also that we have plenty of time before new financial regulations need to be enacted. (Disclosure: I have given professional advice to a financial institution.) Everyone — from President Barack Obama to House Financial Services Committee Chairman Barney Frank to major free market economists and Republicans — currently agrees that the gravamen of any new financial re-regulations must be to guard against financial institutions and major players taking systemic risks that may undermine national and international finance again.
And, while the day may well come when that risk will arise, for at least the next year (and probably for several years), the problem will be trying to induce financial institutions to trust one another, trying to induce holders of capital to take any chances on investment. Thus, the financial danger for the time being is not risk taking; it’s risk aversion. At their heart, financial relations are based on trust. That trust has been shattered. It almost certainly will take new financial regulations, particularly in the United States, to rebuild that trust.
But for the regulations to serve that necessary function, they must be seen to reflect a correct assessment of the causes of the current calamity, as well as a credible and timely check on those dangers — and still permit the financial system to generate prosperity.
A number of members of Congress — mostly from the left side of the political spectrum — have called for hearings on the causes of the financial failures. Though they may well have ideological oxen they plan to gore at such hearings, I agree with them that there ought to be extensive public hearings.
While cause and effect in human affairs is inevitably a muddled matter (scholars still debate the causes of the French Revolution and the cures of the Great Depression), we owe it to our hopes for future prosperity to make a serious effort to understand what just happened and why. That brings me back to the question of Chinese currency manipulation.
A growing body of leading experts believe that the Chinese refused to allow their exporting strength vis-à-vis the United States to be reflected in a true value of their basic monetary unit, the yuan (also known as the renminbi). By pegging it to the dollar, they ran up huge surpluses and recycled the money back to the United States.
But more significantly, the global account imbalances — profoundly exaggerated by their fixing the yuan — may have been the primary cause of the world financial crisis. The case against this act of "exchange rate protectionism" (professor Max Corden coined the phrase) was put forcefully and presciently by Martin Wolf, the Financial Times’ chief economic commentator (and as close to a 21st-century Walter Bagehot as we have), in his 2008 book, "Fixing Global Finance": "Many blame the United States’ predicament on the policies of the Federal Reserve and lax regulation of the financial system. These arguments are not without merit, but they are exaggerated." He goes on to make a powerful case that China’s currency-rate fixing supercharged the current account imbalances and led to the disaster.
What makes Wolf’s argument piquant is that he cites — and relies on for the "significance" argument — the powerful lecture "Reflections on Global Account Imbalances," delivered in 2006 in India by Lawrence Summers — then a private citizen and now President Obama’s chief economic adviser.
It is doubly interesting that Summers gave the following dust-cover endorsement last year to Wolf’s book: "Wolf is the world’s preeminent financial journalist. This book should be read by anyone who cares about the future of the international system."
Major reviews of his book all point to the centrality of this currency-manipulation charge against the Chinese. For example, the review in The Observer — a British newspaper — by Will Hutton, states: "Wolf is tough on China’s role in all of this and his book will be very unpopular with the Politburo and Chinese Communist party, which want to blame the hegemonic US for the crisis."
White House public talking points cite "Wall Street greed" and the shortcomings of our health, energy, carbon and education policies as major causes of the crisis. It would appear that the president’s senior economic adviser may have a somewhat different point of view.
Both the administration and the two major parties in Congress owe the public their best non-ideological, nonpartisan public analysis of the causes of the current conditions. The financial re-regulation decisions they make may well decide whether our grandchildren live in prosperity or poverty. Let’s not rush to write and pass this fateful legislation, as we did with previous economic legislation, until the public and the government know what we are doing — and the politics permit an honest discussion.