The remark by Tim Geithner, president Obama’s new treasury secretary, that president Obama believes China is manipulating its exchange rate has, it can safely be said, not gone down well in Beijing.
On the contrary, it is condemned as presumptuous blame-shifting by the originator of the catastrophe. This is clear from several discussions I have heard in Davos. But I did not need to go to Switzerland to learn that.
There is little question that China is sensitive about public criticism of any kind. Nevertheless, this is not a question to be avoided. It is far too important for that.
The reason for this is one I have frequently advanced: part of the solution to this crisis is a rebalancing of demand and supply in the world economy. In other words, growth in net exports has to be part of the solution to this crisis for deficit countries, such as the US and UK. That requires a reduction in the current account surpluses of surplus countries (or, much less probably, increases in deficits elsewhere).
So let us consider three questions: first, is China a currency manipulator? Second, if so, is it an important problem? Finally, how should the US deal with this vexed topic?
So here are my answers.
First, of course, China is a currency manipulator. It is so in a precise sense: it intervenes very heavily in the foreign currency market and it also sterilises the monetary consequences of the intervention.
This means that China is targetting the real exchange rate. Moreover, contrary to the views of some economists, it has been able to do so for a long while and continues to be able to do so.
The reason for this, as I have argued in my recent book, Fixing Global Finance, is that the Chinese government has substantial influence over the country’s national savings rate and so over both the equilibrium real exchange rate and the current account surplus.
Second, the exchange rate is, none the less, not the central issue. That issue is Chinese domestic spending. If domestic spending rises relative to potential output, the current account surplus will diminish automatically.
This means that Chinese spending must rise by 10 per cent relative to output if its surplus is to disappear. That would, in my view, also be very desirable for both China and the world.
Let us put this in round numbers: if potential real growth in China is 10 per cent a year, real domestic spending must grow at 12 per cent a year if the surplus is to disappear over five years. This is evidently quite a challenge.
Third, this also means that the intelligent discussion must be not about exchange rates, but about a mutually supportive global adjustment in spending patterns. I think it is up to the Chinese to decide whether appreciation of the nominal exchange rate is part of this solution. Reasonable people can differ on that. (I think it is.)
The US does need to focus on this bigger issue of domestic spending. The question is how to organise such a discussion effectively.
I believe it would be best to organise that discussion multilaterally. An ultimatum from the US to China must be avoided if at all possible. The relationship is too important to risk. Nevertheless, China must also accept that robust dialogue is an inevitable part of its new and bigger role in the world.
In sum, Mr Geithner’s remark is true and the issue important, but the timing was unhelpful and the focus on the exchange rate misdirected.
Martin Wolf is associate editor of the Financial Times and chief economics commentator