NEW YORK (
) -- U.S. unemployment is stuck near 10%, and deflation and a stock market collapse loom.
and President Obama are out of bullets. Near-zero federal funds rates, central bank purchases of mortgage-backed bonds and other securities, and a $1.6 trillion deficit have failed to revive the economy
This is no mystery.
In a globalized economy, government-controlled exchange rates often render monetary policy ineffective, and bigger budget deficits that don't adequately increase purchases of domestic goods and services won't stimulate the economy.
China fixes the value of the yuan against the dollar at an arbitrarily low level to make its products much less expensive than U.S. goods. This juices China's exports and limits imports beyond what its low labor costs advantage require.
Beijing prints yuan, to purchase dollars in foreign exchange markets -- suppressing the value of the yuan against the dollar by about 40%. It uses those dollars to purchase U.S. Treasuries and other Western debt, and to buy oil and other mineral deposits around the world.
The net effect is to suppress medium- and longer-term U.S. interest rates. For example, when the Federal Reserve raised the federal funds rate from 1.25% to 5.25% from 2004 to 2007, bond rates did not rise much, and mortgage money remained cheap and easy, helping finance the U.S. real estate bubble. Similarly, easy credit helped the U.S. and European governments dig into their present fiscal messes.
China buys so much U.S. debt that it effectively caps U.S. medium- and long-term lending rates. And in a recession, efforts by the Federal Reserve to spur economic activity by cutting overnight lending rates to near zero or purchasing government bonds or mortgage-back securities do little to lower medium- and longer-term lending rates and encourage business spending or new home purchases.
President Obama has countered with massive stimulus spending, but temporary tax cuts generate a lot of savings, and his spending on real goods have too often gone into Chinese imports or projects that only displace private investments. For example, the amount of commercial space built over the next several years depends on anticipated demand, and subsidies for green buildings only change the character of what gets built. They don't change very much the absolute amount of space that gets constructed.
The combination of a huge trade deficit with China and the bursting of the credit bubble has left U.S. housing and other asset prices deflated, unemployment near 10% and the U.S. economy laboring under deflationary pressures.
Deflationary pressures play out in high unemployment or falling prices, and so far we have gotten a lot more of the former than the latter.
China has enjoyed breakneck growth, but all those yuan printed to buy dollars have returned to China, through export sales and foreign investment, and have created Chinese inflation and asset speculation.
Now, China's high property and stock prices look as though they could be ready to collapse and take down China's miracle.
Just as the Federal Reserve cannot resuscitate the U.S. economy by slashing the federal funds rate to zero, the Peoples Bank of China can't cool Chinese inflation and speculation by raising interest rates or regulating bank lending.
In 2009, China printed about $450 billion in yuan to purchase foreign currency that has mostly returned home through export sales. That came to about 10% of China's GDP. If a bank won't lend money to an entrepreneur or home buyer, surely a Chinese merchant with a shoebox full of cash can accommodate.
China can't unwind inflation, asset speculation and a threatened collapse in housing and stock prices without unwinding its currency market intervention and letting the yuan rise to its market value against the dollar.
The U.S. and Europe can't solve their growth, unemployment and budget problems without China revaluing the yuan. More taxes will only drive down Western growth and increase unemployment, no matter how much President Obama believes high taxes on upper classes are a moral imperative.
China could revalue in steps, or the United States and EU could impose gradually increasing taxes on dollar-yuan and dollar-euro conversions to simulate the effects of a stronger yuan on Western and Chinese economies.
No other fiscal policy or monetary scheme will work as long China's currency is so undervalued.
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Professor Peter Morici, of the Robert H. Smith School of Business at the University of Maryland, is a recognized expert on economic policy and international economics. Prior to joining the university, he served as director of the Office of Economics at the U.S. International Trade Commission. He is the author of 18 books and monographs and has published widely in leading public policy and business journals, including the Harvard Business Review and Foreign Policy. Morici has lectured and offered executive programs at more than 100 institutions, including Columbia University, the Harvard Business School and Oxford University. His views are frequently featured on CNN, CBS, BBC, FOX, ABC, CNBC, NPR, NPB and national broadcast networks around the world.