At a joint press conference to welcome Chinese President Hu Jintao to the U.S. on Jan. 19, President Barack Obama downplayed contentious issues, such as China’s undervalued currency, and focused instead on areas of economic cooperation.
“We want to sell you all kinds of stuff,” Obama said. “We want to sell you planes, we want to sell you cars, we want to sell you software.”
One thing not on his export list: inflation.
It’s become commonplace to accuse the U.S. of exporting inflation to the rest of the world. After all, the dollar is the world’s reserve currency. International trade is conducted in dollars. Print too many of them, and inflation is sure to follow.
Not so fast. The U.S. needs a partner in crime, a willing counterparty to import what the U.S. is selling.
It has a perfect ally in the People’s Bank of China, which prints yuan to absorb the dollars that flow into the country in exchange for its exports.
At an earlier point in time, Federal Reserve Chairman Ben Bernanke was eager to remind us that the central bank has a “technology called a printing press that allows it to produce as many U.S. dollars as it wishes at essentially no cost.”
He didn’t explain that the printing press has only one setting: U.S. dollars. The Fed can’t churn out British pounds, Swiss francs or Chinese yuan. How is it, then, the Fed can export inflation to all these other countries?
First, let’s define inflation so we’re all on the same page. Inflation is, depending on one’s orientation, too much money chasing too few goods and services or, in the extreme case favored by Austrian economists, an increase in the money supply. In other words, money is key.
The Fed can print dollars, and those dollars may very well find their way into global commodities prices, emerging debt and equity markets or country-specific goods. That’s not inflation. No matter how many dollars the Fed prints, it cannot affect another country’s inflation unless that country is complicit in increasing its own money supply to prevent its currency from appreciating.
China is making a choice to import inflation. (Actually, in pegging the yuan to the dollar, the PBOC is choosing to cede control over its domestic monetary policy to the Federal Reserve. Inflation is the result.)
Whether a zero percent interest-rate policy is suitable for the U.S. is an open question. It’s not appropriate for a country like China, which grew 10.3 percent in 2010 and is faced with accelerating inflation, a property bubble and soaring money and credit growth.
The PBOC has been raising reserve requirements and short-term interest rates, selling bills and setting caps on loan growth in an attempt to reduce liquidity and fight inflation. It has allowed the yuan to appreciate only gradually ― about 3 percent in the last six months ― even as China receives an average of $20 billion each month as a result of its trade surplus with the U.S.
Of course, the choice not to import inflation isn’t quite as simple as trade-surplus countries allowing their currencies to appreciate. It never is.
“Exchange rates have lots of effects on the rest of the economy that a country may or may not be able to tolerate,” says Neal Soss, chief economist at Credit Suisse in New York.
Because international trade is conducted in dollars, a rise in commodity prices affects all countries, he says. If it’s “pure dollar price inflation,” prices in other currencies would be stable, says Marvin Goodfriend, a professor of economics at Carnegie Mellon University in Pittsburgh.
China’s economy has grown 100-fold, in nominal terms, since Communist Party leader Deng Xiaoping introduced free-market policies in 1978. It has done that by adopting a mercantilist policy of selling more abroad than it buys, holding its exchange rate down to maintain that advantage.
“China keeps consumers poor so it can grow through mercantilism,” Goodfriend says. “The route they are taking is reducing the purchasing power of consumers’ lifetime savings held in the bank.”
Prices and wages eventually move up, making Chinese goods less competitive. In the long run, inflation will destroy any competitive edge China derived from its undervalued currency.
Some economists claim that because the dollar is the world’s reserve currency, the Fed must act as central bank to the world.
Sovereign nations need sovereign monetary policies. The European Central Bank is learning just how hard it is to fashion a one-size-fits-all short-term interest rate for 17 very different countries.
No single central bank can play that role for the world (gold standard bearers, hold your fire), just as no central bank can export inflation without a willing importer on the other side.
By Caroline Baum
Caroline Baum, author of “Just What I Said,” is a Bloomberg News columnist. The opinions expressed are her own. ― Ed.