Because the United States' bilateral trade deficit with China is so large and has grown so quickly, and because we depend so heavily on China to finance our deficit spending, the U.S.-China trade relationship attracts attention and commentary as if it were qualitatively, as well as quantitatively, different from the relationship between the United States and other major trading nations which, like China, have for years run large structural trade surpluses- e.g., Japan, Germany, Korea, and Taiwan. During Treasury Secretary Geithner's confirmation, Senator Schumer of New York pressed Mr. Geithner on the issue of China's trade surplus and currency manipulation. Mr. Geithner's response, that "President Obama ... believes that China is manipulating its currency" and that his "new economic team will forge an integrated strategy on how best to achieve currency realignments in the current economic environment,"1 suggests a belief that if China were more flexible on the question of currency appreciation, it would go a long way towards resolving our current account deficit problem.
In the time since Secretary Geithner's answer to Senator Schumer's questions, others have blamed China's currency manipulation for the global economic crisis we are in:
Geithner is correct that China manipulates its currency. What's more, this manipulation is arguably the most important cause of the financial crisis. Starting around the middle of this decade, China's cheap currency led it to run a massive trade surplus. The earnings from that surplus poured into the United States. The result was the mortgage bubble.2
The contention is that trade deficit leads to massive inflows of surplus country savings, which inflate investment bubbles.
There is much to the claim that China's policy has been to keep the value of its currency low enough to promote export-led growth which, in turn, is meant to create millions of jobs to support the migration of tens of millions of China's peasants to its industrial cities.3 It is also fair to link China's economic policies to the present monumental imbalances in trade flows and to link these global trade imbalances to the present global economic crisis. But it is neither fair nor productive to single out China for blame, much less to blame China's "currency manipulation" as "the most important cause of the financial crisis." The problem is the imbalance in U.S. trade with the world as a whole. The United State's bilateral deficit with China is a significant part of that problem, but is troublesome only because of the size of its global deficit.
Once the immediate challenge of regenerating the growth of global demand has been met, policy makers here and overseas would be well advised to address the need for changes to the structure of the economic incentives and disincentives in both deficit and surplus countries that lie behind the trade imbalances. In particular, China, Japan, Germany, Korea, and other surplus countries will have to temper their reliance on export-led growth generally and exports to the United States in particular. The United States will have to move to improve the competitiveness of its industry, to promote production in the United States, and to reduce its dependence on debt-financed imports for consumption.
Structural change will be very difficult, but without it, the risk is that restoration of global economic growth will simply set the stage for the next global economic crisis. A return to the pre-crisis status quo, albeit with tighter financial sector regulation, will not change the incentives that producers in China, Japan, Germany, and elsewhere have to produce for export, nor will it change the mix of incentives and disincentives in the United States that leads the United States to import so much more than it is able to export. Structural change should be the product of international cooperation and accommodation, but if it …