The Chinese Disconnect?

Leo Kolivakis's picture

Submitted by Leo Kolivakis, publisher of Pension Pulse.

A follow-up to my last comment on the death-defying dollar. In his NYT op-ed column, Paul Krugman writes about The Chinese Disconnect and notes the following:

economists, myself included, believe that China’s asset-buying spree
helped inflate the housing bubble, setting the stage for the global
financial crisis. But China’s insistence on keeping the yuan/dollar
rate fixed, even when the dollar declines, may be doing even more harm


Although there has been a lot of
doomsaying about the falling dollar, that decline is actually both
natural and desirable. America needs a weaker dollar to help reduce its
trade deficit, and it’s getting that weaker dollar as nervous
investors, who flocked into the presumed safety of U.S. debt at the
peak of the crisis, have started putting their money to work elsewhere.


But China has been keeping its currency pegged to the dollar —
which means that a country with a huge trade surplus and a rapidly
recovering economy, a country whose currency should be rising in value,
is in effect engineering a large devaluation instead.

And that’s
a particularly bad thing to do at a time when the world economy remains
deeply depressed due to inadequate overall demand. By pursuing a
weak-currency policy, China is siphoning some of that inadequate demand
away from other nations, which is hurting growth almost everywhere. The
biggest victims, by the way, are probably workers in other poor
countries. In normal times, I’d be among the first to reject claims
that China is stealing other peoples’ jobs, but right now it’s the
simple truth.


So what are we going to do?


U.S. officials
have been extremely cautious about confronting the China problem, to
such an extent that last week the Treasury Department, while expressing
“concerns,” certified in a required report to Congress that China is
not — repeat not — manipulating its currency. They’re kidding, right?


thing is, right now this caution makes little sense. Suppose the
Chinese were to do what Wall Street and Washington seem to fear and
start selling some of their dollar hoard. Under current conditions,
this would actually help the U.S. economy by making our exports more


In fact, some countries, most notably Switzerland,
have been trying to support their economies by selling their own
currencies on the foreign exchange market. The United States, mainly
for diplomatic reasons, can’t do this; but if the Chinese decide to do
it on our behalf, we should send them a thank-you note.

point is that with the world economy still in a precarious state,
beggar-thy-neighbor policies by major players can’t be tolerated.
Something must be done about China’s currency.

Krugman's article prompted this response by Zachary Karabell on the Huffington Post:

what exactly must be done? And more to the point, what can be?
Declaiming that something must be done assumes that the United States
or some other world power can coerce or force the Chinese government to
change their approach to currency in particular and economic policy in
general. Before the crisis of the past year, Chinese authorities had
actually begun a slow, quiet revaluation of the currency, but only
after American politicians and officials stopped using the currency
question as a cudgel against China. The recent decision of Timothy
Geithner and the Obama Administration not to label China a currency
manipulator marked a welcome change in tactics. Compare that choice to
the much-publicized Schumer-Graham tariff of 27.5%. It never went into
effect, but it hovered as a threat that if China didn't immediately
revalue its currency, dire things would follow.


But with China now
accounting for nearly $1 trillion of American debt, and with the two
economies in a symbiotic relationship that neither loves but that
neither can escape, the U.S. can't simply insist that China do
something about its currency and expect action. These economies are now
fused (see my new book Superfusion).
Much like the United States for last half of the 20th century, China is
becoming a global economic behemoth. It isn't supplanting the United
States anytime soon, but it is rapidly joining the U.S. as the other
most important engine of the global system. It remains much poorer and
less developed, but it is generating a substantial share of global
activity and its cascade can be felt from Rio to Melbourne.


that, why would China decide to disrupt the system simply because it
causes consternation in America or Europe? Its economy is booming and
its policies, however unorthodox, are working. China will again allow
its currency to appreciate when it feels that doing so won't cause a
crisis of disrupt growth. Its massive accumulation of reserves is an
issue. As the crisis eases, it's likely that Beijing will return to its
pre-2008 policy of gradual appreciation, especially now that it is
focusing on generating domestic demand and wants greater purchasing
power for Chinese citizens. But Secretary Geithner - contrary to the
criticisms of Krugman and others - has been exactly right in not
publicly calling out China. Such an act would be both arrogant and
foolish. In the world today, the United States can afford to be
neither. Let's hope we remember that.

Writing for the WSJ's China Real Time Report, Jason Dean reports that the yuan may rise later rather than sooner:

the government’s handling of the exchange rate has generally proven a
fool’s errand: Analysts were saying a de-pegging was imminent for years
before it finally happened in 2005, and few foresaw the re-pegging last


The yuan bulls may well be right - there are many strong arguments for appreciation.

the difficulties involved for Beijing haven’t disappeared, either. Does
it go fast or slow? The gradual-but-seemingly-inexorable rise from July
2005 to July 2008 drew a flood of speculative hot money into the
economy – which China’s leaders hated. A rapid, one-time jump could
catch speculators off guard – but also shock domestic companies and
disrupt the economy, which Beijing would hate even more.


also worth remembering the circumstances last year when the re-pegging
occurred. True, China’s export growth had slowed a bit in some months,
but exports rose a blistering 27% in July 2008, and continued to grow
by around 20% for three more months. GDP grew 10.1% in the second
quarter. It wasn’t till September that the People’s Bank of China
started cutting interest rates, and Beijing didn’t truly go into crisis
mode till November – the month exports started falling for the first
time in years, and China unveiled its monster 4 trillion yuan stimulus


If China put the brakes on the yuan’s rise well before
the real crisis hit, it could be a while after the crisis disappears
before it taps the gas again.


Stephen Green, China economist for
Standard Chartered, said in a note last month that exports will need to
be growing at a double-digit rate before the yuan is allowed to resume
its rise. He doesn’t think the exchange rate will start to budge until
the second half of next year – and projects a move of less than 1%
between now and the end of 2010.

Finally, Chrystia Freeland, US managing editor of the Financial Times interviewed George Soros about the state of the world economy. It is an excellent interview, worth reading in its entirety (you can also watch it by clicking here). Here is what Mr. Soros had to say about the U.S. dollar and China's peg:

FT: Given this continued weakness in the US economy, are people right to start to be concerned about the dollar?


Well, they are of course and the dollar is a very weak currency except
for all the others. So there is a general lack of confidence in
currencies and a move away from currencies into real assets. The
Chinese are continuing to run a big trade surplus and they're still
accumulating assets and basically the renminbi is permanently
undervalued because it's tied to the dollar. There is a diversification
from assets that are normally held by central banks into other assets,
especially in the area of commodities. So there is a push in gold,
there's a strength in oil, and that is in a way a flight from


FT: Is there going to be a tipping point, a moment at which the dollar is fatally weakened? Or does it just sort of carry on?


As long as the renminbi is tied to the dollar, I don't see how the
decline in the dollar can go too far. Now, of course, to some extent
it's very helpful because with the US consumers saving more and
spending less, exports can be way for the US economy to be balanced.
So, an orderly decline of the dollar is actually desirable.

An orderly decline of the dollar? We've already seen a steep decline in
the U.S. dollar. The big question is how will other nations respond to
the symbiotic relationship between the U.S. and China? This week we saw
Asian currencies declining on intervention speculation.
Will we see intervention in the currency markets? I am not sure, but
the current path is unsustainable and will require some sort of
intervention as it poses serious risks to the global recovery.

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Bruce Krasting's picture

I am going disagree with you on this:

"(it) will require some sort of intervention as it poses serious risks to the global recovery."

We have already done far too much intervention. The list of non market intervention is endless over the last year. It will kill us. The cost of the intervention is too high.

You are probably right, the Fed will intervene if the dollar keeps falling. But it is just good money chasing bad.


Anonymous's picture

WTF? Blame china for our housing bubble/cre party? There is no serious connection here--did chinese banks load up on CDO's? And the next line--Krugman just noticed that the chinese peg might be "harmful". TPTB have been moving out the factories for what?, fifteen years?. In five years they'll be selling Caterpillar knockoffs and Dreamliners in ten(?). And no, the technology design shop is mobile too. We are already totally $##%@#. Blaming china is like blaming the bartender for keeping serving them up and taking the money.

The denoument of the banking system just completes the ripoff of John Q. The squid is bound for Hong Kong or Singapore.

bkrolik's picture

The fact is, the current peg is very beneficial for China. Another fact is, there is no mechanism within the current system of treaties, that would allow US to force China to revalue. My understanding is that there are two possibilities for the resolution of this problem. Either there will be quick and complete recovery, after which China would resume orderly voluntary yuan revaluation, or there will be severe and prolonged trade wars which ultimately restore trade balance. I believe in the second possibility.


Dont Taze Me Bro's picture

Always remember to put your bullshit filters when reading New York Times.

Paul Krugman, Thomas Friedman and the rest of the pack at NYT are globalization propaganda artists. These people cannot accept the fact that globalization theory might be flawed and that some of the problems that we are experiencing are caused by globalization, and that no amount of currency manipulation, domestic production enhancement, labor re-education, etc will make much a of a difference in the bigger scheme of things.

Under the current regime, the US will continue to decay and devaluate (quiet literally) and China will slowly rise until the two countries are at par, both economically and militarily.

I’ll give Krugman some credit for acknowledging in this article that the change of fortune occurred in 2001, not in 2008 as most people commonly believe. The GDP growth from 2001-2008 was bogus -- it was driven by the Mortgage Equity Withdrawal effect:

Anonymous's picture

It's been my position that this time, the Smoot-Hawley moment will play out in the currency markets rather than in Congress.

Leo Kolivakis's picture

You guys are hung up over Krugman? He's one of my favorite economists and he deserved to win the Nobel prize. So did Stiglitz. But in case you didn't notice, I agree with Zachary Karabell here who thinks Krugman is wrong and that China won't revalue. Let's leave the childish statements out of ZH. Stuff like "why quote Krugman" or "a policy on no Krugman in ZH" is just silly, bordering on imbecilic. Love him or hate him, Krugman has done more to restore the prestige of the economics profession than all other economists combined. (I am exaggerating but do believe you have to give him some credit for showing the world that economists are not just irrelevant academics who solve mathematical equations).

Anonymous's picture

The real reason Krugman is not welcome at the Fed is because Uncle Ben is as we speak having the last lingering doubts removed as to what caused the Great Depression. (Keynes and the money machine) Soon he will only have to look in the mirror to find the cause for the second Great Depression.
Krugman deserved to win the Nobel prize......RRRRRRight...... just like Obama did. There is a disconnect here and I don't think it's China

Cheeky Bastard's picture

Leo i like you, but ...


I think we should compile a list of Paul Krugman's greatest hits (or just post the link to Bill Anderson's LRC archives).

My favorite happened recently, and was just refuted by one of the newer LRC writers.

"What we want is a system in which banks own the downs as well as the ups. And the road to that system runs through nationalization." -Paul Krugman

"Someone should remind Dr. Krugman that the system in which banks 'own the downs as well as the ups' is called private enterprise." -Lila Rajiva

This, I believe, is one of the classics. A top five hit. The Broken Window Fallacy at its finest, after September 11, 2001.

"So the direct economic impact of the attacks will probably not be that bad. And there will, potentially, be two favorable effects."

First, the driving force behind the economic slowdown has been a plunge in business investment. Now, all of a sudden, we need some new office buildings. As I've already indicated, the destruction isn't big compared with the economy, but rebuilding will generate at least some increase in business spending."

"Second, the attack opens the door to some sensible recession-fighting measures ... Now it seems that we will indeed get a quick burst of public spending, however tragic the reasons."

“The fact that we're here celebrating Social Security shows some politicians' promises are worth more than others. Social Security as it is currently constituted is very efficient. We're talking about a system that really works quite well.”

“Those tax cuts, rather than the spending binge, are the primary cause of the (federal) deficit.”


Do you want me to continue or is this enough for you to see how big of a moron Krugman is ....

Unscarred's picture

Thanks for the contribution, Cheeky.  Still hoping that Leo gets back with me, too...

Leo Kolivakis's picture

I am not here to compile Krugman's greatest hits. He gets a lot of exposure so he is bound to make a few mistakes. By the way, both he and Stiglitz were advocating for the nationalization of the financial system, and we got the de facto (partial) one, which Krugman correctly says is worse. As long as we extol the virtues of the private financial system, why don't we also cite the drastic failures too? These guys take excessive risks to print money and get big bonuses at the end of the year. And if they fail, they get bailed out. I agree with Soros, get rid of the hedge funds in banks, spin them off, let them risk their own capital, not that of depositors.

Back to Krugman, my two favorite books are Peddling Prosperity and Pop Internationalism. Here is a link to his Nobel prize lecture:



Unscarred's picture

Leo, thanks for the reply.

You stated:

...By the way, both he and Stiglitz were advocating for the nationalization of the financial system, and we got the de facto (partial) one, which Krugman correctly says is worse.  As long as we extol the virtues of the private financial system, why don't we also cite the drastic failures too?

So long as you wish to extol the virtues of nationalization (to which I'm still searching for), be mindful of the drastic failures, as well.  Further, to agree with Krugman AND Soros is incongruent.  Soros states that he favors reinstituting Glass-Steagall (which I do, too), but falls FAR SHORT of the nationalization preached by Krugman/Stiglitz.

To piggyback the post prior to, be vary wary of your political rhetoric here at ZH.  The truth is only viewed through objectivity.  Political meanderings will not come without consequences.

Having said all that, I appreciate your perspective, and thank you for your recommended selections by Krugman.

Leo Kolivakis's picture


I am afraid the way things are going, there will be another financial disaster down the road and that will force the US government to fully nationalize the banking system. I hope I am wrong but Einstein said it best: "insanity is repeating the same mistakes over and over and expecting a different result."

Anonymous's picture

I come to ZH because an honest effort is made at this site to drag the truth out into the light of day. Anytime someone has tried to come here within their cloak of political bias whether left or right they have gotten their ass handed to them. Political bias is a form of denial used to avoid reality. The ugly reality is it renders capable men like yourself and Krugman useless with the smug idea that it's everyone else's fault. And as soon as they change everything will be utopia. This mess is everyone's fault. Surrounding myself with a group of like minded individuals so I don't have to change is not the answer. To effect change I must look reality straight in the face and make the necessary adjustments to be part of the solution, other wise I'm part of the problem.

Unscarred's picture

I am curious to know what about Paul Krugman fascinates you?  What policies and/or ideas of his do you find so compelling?

TRUST ME, I'm not being a smart ass, I just really want to know.  Hell, I even cited his work in my prior post - I just disagree with his conclusion.

Please, post several links to works of his that you find the most engaging.  I would like to learn more.

Cheeky Bastard's picture

Krugman, i mean, come on .... why not just quoting Obama ...

Anonymous's picture

China is comparable to a Monopolistic company with no government interference. Ultimately theory would predict failure however in the short term they are better organized than any other economy in the world. If we are not going to start trade wars then we need to invest in Technologies that China wants to buy from us and we are late to the party.

Anonymous's picture

Krugman missed calling the subprime because he was too busy spending his Nobel prize money on a NY apartment at the top of the housing bubble. He is shunned by the Fed, seems every time the Fed went to wipe their ass Krugman was in the way! He's a political panderer.

hooligan2009's picture

I am sure currency pegs etc are relevant to currency traders and statisticians, but the relevance of the Remnimbi, oops, Yuan to the dollar doesn't exactly thrill me. The issue is the openness of the US and Chinese economy to each other. Sure, at the margin, Sino-US trade is important, but the majoirty of world trade occurs outside these economies, not between them. A case for "get over yourselves" if ever I heard one. I see the growing trade penetration in other countries traded goods sector as a function of the three times lower costs for manufacturing of goods, in a larger permutatoin of Chinese regions as the Chinese correct their impoverished living standards by creating a middle class while our Governments and regulators reveal their low IQ's by encouraging it. Does this mean that our middle class is overpriced relative to China's? Yes, does this mean that we need to solve the problem by making the Chinese middle class more expensive (richer) nd Americas (fast diminishing) middle class poorer by currency manipulation? I think not. I find it hilarious that the US doesnt accuse itself of currency manipulation also, given my view that monetary, fiscal and exchange rate policy are one and the same thing these days.

Unscarred's picture

From Paul Krugman's blog:

So something has to give — specifically, the relative price of US output, and along with it such things as US relative wages, has to fall...

So, the bottom line: to narrow international imbalances, we need a lower relative price of US output. Because prices are sticky (including labor prices), by far the easiest way to get there is dollar depreciation.

This obviously is the easiest way, but also by far the most painful way (inflation through increased cost of imports; higher borrowing costs for Federal Gov't; and loss of reserve status for dollar, to name a few reasons why).

Spain is facing a similar circumstance, as their exports are unable to complete globally because of high relative wages.  With 18.5% unemployment (twice the average of the European Union), Spain would "benefit" from a currency devaluation; however, they remain affiliated with the EU and the euro.

Over the past decade, Spain's labor costs have risen at nearly twice the rate of the other nations that use the euro as their currency, making Spain increasingly uncompetitive internationally. Because it has no currency of its own to devalue, economists say it can regain its competitiveness only through years of painful wage and price disinflation.

Even though high domestic labor costs have already crippled several industries in the U.S. (airlines, autos, etc.), don't expect this administration to allow years of painful wage deflation to take place for "real people who work for a living."

Accordingly, this type of action will keep domestic wage rates mostly in tact, but it will cripple the value of domestic capital.  This will also have a PROFOUND impact with regards to wealth redistribution, possibly even more so than the ensuing hefty tax increases, depending on how far the White House and Treasury decide to let the dollar fall.

P Kennedy's picture

I have to echo #109745- put Krugman on ignore..seriously ( any chance we can get that as ZH policy? )

Second, expand your horizons from unilateral to multilateral: check out the commentary coming out of the EU finance ministers

All that said, don't expect anythinig more than a "controlled " rate of appreciation - it perpetuates the myth. China is well aware their banking system is vapor...

torabora's picture

They are selling some of their dollar hoard....they're buying commodities esp scrap metal. It's always cheaper to reuse aluminum and copper than to dig it out of the ground.

Lux Fiat's picture

Interesting interview with Niall Ferguson at!-China-Is-Already-Dumping-the-Dollar-Niall-Ferguson-Says.

He may be overly optimistic on China's ability to jump start internal consumption to a level that sufficiently offsets exports, but his take is that the Chinese may be in a position within a year to not take a major hit if the dollar tanks.

"People in Washington rather assume because the U.S. consumer was so dominant there really isn't a substitute," Ferguson says. But China's trade surplus stood at $12.9 billion in September, down about 56% from a year earlier, according to

From 1998-2007, China engaged in a form of vendor financing, lending money to the U.S. so the U.S. would buy Chinese goods, Ferguson explains. "I think that model has basically broken. They know it and have a new one in which we play a much less important role."

While I would think that given the size of the $ market, it would take a while to make a meaningful switch, never underestimate the domino effect of spooked global investors who are watching the "smart" money heading for the exits.  I think that there is to much complacency in many quarters about the nature of the changes taking place, and not enough concern.

Gilgamesh's picture

China's Central Bank newspaper is out now saying that China should increase its holdings of Euros and Yen for FX reserves.

Dollar is getting dumped on this; EUR/USD new yearly highs, other carries vs. the dollar doing well.  USD/JPY starting to dump again.

Anonymous's picture

I normally get a lot out of your posts. Not this time Leo. Starting off with any way the wind blows Krugman almost stopped me. Expecting substance from Krugman is on par with the expectation that Obama will stop lying. Stick to the sports section, layoff Krugman your starting to sound like him. Intervention got us here,if our current path is unsustainable. All the more to the good. There is alot of shit that needs to hit the fan the sooner the better.

Anonymous's picture

You're right Anon, Krugman is oblivious to the fact that is is a sustained loose monetary policy that ignites booms and busts. He fails to grasp that low short term interest rates fuel speculation and that asset prices can easily be reigned in with tighter policy.

I think it's evident Krugman is a smart guy when it comes to theory but in practice I can't think of a single important issue he's nailed in the last three or four years. Roubini usurped him, then Ferguson and hell even Summers is pushing to distance himself from the radical liberal Keynesian economist.

I remember reading a paper a little over a year ago that pointed out every 1% increase in short term lending rates was equivalent to a 25% decrease in oil prices. If asset prices need to be tamed raise rates. The paradox would be if rates were raised but printing outpaced this causing the dollar to decline at the same time.