G20 nations should seek to rebalance global demand by adopting trade balance targets instead of the current account targets proposed recently by the US, a top adviser to China’s central bank has said.
“It would be great to see both sides agree in principle on efforts to reduce trade imbalances,” said Li Daokui, an economist at Beijing’s Tsinghua University, in an interview with Emerging Markets as G20 leaders gathered for a summit in South Korea.
His suggestion follows a proposal last month by US Treasury Secretary Timothy Geithner for new rules that would limit current account balances to plus/minus 4%. The US dropped its push for explicit targets amid strong opposition from China and Germany, both of which run chronic surpluses.
Li said China could not achieve a 4% current account surplus target, since the current account balance includes profits made on Chinese holdings of US Treasury bills, which, at $2.65 trillion, are the world’s largest.
The G20 should instead agree on voluntary trade balance targets, he said. China could achieve a 4% trade surplus over the next fiscal year, as wage increases and structural reforms to boost Chinese domestic consumption gather pace, he added. The People’s Bank of China (PBOC) forecasts China will achieve a 4% current account surplus within three to five years.
Li acknowledged that while such neither a trade or current account target is likely to be agreed in Seoul, the debate had nevertheless moved the global rebalancing agenda forward by reducing the focus on currencies.
Trade balance targets focus on the outcome of economic and financial policies, while exchange rate levels are just one factor in determining a nation’s export and import trends, Li noted.
But he acknowledged that China, the world’s production house, is reluctant to agree on either current account or trade targets, since its trade balance depends on international import and export patterns.
“Around 50% of China’s trade surplus is out of our control, as we are a re-exporting hub for the globe. We buy raw materials from Chile or Australia and then assembly goods, and send them to places like Korea,” he said.
In other comments, Li said Chinese businesses productivity gains and the growing use of its currency, the yuan, in cross-border trade and Asian financial markets will reinforce upward pressure on the currency over the medium-term. But he said that for the pace of currency reform to pick up, concerns over US Federal Reserve monetary policy must first be addressed.
A new round of quantitative easing (QE2) by the US Fed have sparked fears that China’s dollar reserves are in danger as the policy risks debasing the dollar by sparking inflation, Li noted.
But he said that QE2 was nevertheless needed to re-inflate Western bank balance sheets – provided emerging market nations impose capital controls to stem hot money inflows.
The view that QE2 is directly exacerbating capital flows to emerging markets is not universally accepted. IMF chief economist Olivier Blanchard told a meeting of the Emerging Markets Forum last month: “The notion that the Fed’s expansion of its balance sheet has by itself – that is independently of its effect on interest rates – had an impact on capital flows to emerging markets is not correct.”
“There is no mechanical link between the size of a central bank’s balance sheet and capital flows, especially to emerging markets.”
Stephen Lewis chief economist at Monument Securities, said US QE2 “will enhance the attractions of proposed alternatives to a dollar-based global monetary system.”
Ousmène Mandeng, head of public sector investment advisory at Ashmore Investment Management noted that emerging market nations increasingly recognize the downside of relying on US monetary policy, which is governed by domestic concerns rather than international factors.
He called for a facility to unwind unwanted holdings of dollar-denominated international reserves in order to depreciate the greenback and internationalize emerging market currencies.
With the G20 not expected to agree on even voluntary current account targets, reform of the international monetary architecture remains elusive for now. “Dialogue and gradualism” when crafting global economic policies should remain the hallmark of G20 commitments as well as public moves to ease perceived economic and political tensions, Li said.
But if US and Chinese discord over monetary and exchange rate policies intensifies, this dispute “may well be the saddest tragedy of economic policy making in the post-crisis world," Li said. “Both the Chinese and US side share the same fundamental interest in rebalancing trade and growth but in the end may ruin each other’s endeavours.”