FT.com / Why China’s exchange rate policy concerns us

COMMENT: Many comparison have been made between 1980s Japan and 2000s China. The question has been, is there a bubble building in China, much like there was in Japan? Over the past 30 years China’s economy has grown to represent 17% of world GDP from 5% in 1980, a stunning rise. From 1950 to 1990 Japan’s economy grew from 3% of world GDP to 8%, a remarkable feat for a small island nation that has virtually no raw materials that was decimated by World War II.

Both economies dramatic ascensions were driven by exports, much of which was directed at the wealthy nations of the world. Many wealthy nations such as the United States began ringing up large deficits and the trade balance began to become distorted. Japan’s current account balance grew from a record deficit of US$10.7 billion in 1980 to a record surplus of US$87 billion in 1987 before declining to US$57.1 billion in 1989. As a share of GNP, this surplus reached a peak of 4.4 percent in 1985, a large value for a current account surplus. The appreciation of the yen against the United States dollar and other currencies, beginning in 1985, was slow to have any impact on the dollar value of the current account surplus, although it did decline by US$8 billion in 1988. (Library of Congress Country Studies).

As the article points out, “if China’s current account surplus were to rise towards 10 per cent of GDP once again, the country’s surplus could be $800 billion in today’s dollars, by 2018. Who might absorb such sums? US households are broken on the wheel of debt, as are those of most of the other countries that ran large current account deficits. That is why governments are now borrowers of last resort.” If China does not allow its currency to appreciate then it will continue to distort its economy. As the author states, “its real exchange rate is, for example, no higher than in early 1998 and depreciated by 12 per cent over the past seven months.” This continued manipulation of currency is likely not only delaying an inevitable bubble, but quite possibly pumping it up to even greater levels.