The Informationist

World Currency, or Why is Everyone Picking on China?

I was fortunate enough to be a fly on the wall at Bob Mundell’s World Money conference in his Tuscan villa last week.

Not a bad coup for a guy who professes no particular expertise in monetary theory--or even macroeconomics.

For those just tuning in, Mundell has been engaged in a decades-long debate, most famously with Milton Friedman, over the relative merits of fixed and floating exchange rates. Fixed exchange rates, of course, were the norm through most of history. Because most currencies were tied to gold (or less frequently, some other precious metal), conversion was relatively straightforward. After WW II, the Bretton Woods agreement tied the dollar to gold and everything else to the dollar. The stability of this system began to erode in the late 1960s, and came completey undone when Nixon pulled the U.S. off the gold standard. That move ushered in an era of floating exchange rates. Within that overall floating system, though, some countries have agreed to tie their currencies together. The most significant rate fixing obviously led to the Euro, but numerous small or developing countries have tied their currencies to a major one.

Which brings us to China. China tied its currency to ours more than a decade ago, when it fixed the Yuan/Dollar exchange rate. This move was quite a concession, it meant that for all intents and purposes, China decided not to pursue an independent monetary policy, but rather to rise and fall according to Alan Greenspan’s judgments about the health and pressing needs of the American economy.

Now, it seems to me that this decision should make us happy. China, along with a number of other countries, basically tied its hands to the mast rather than face the sirens. China knew that, at some point in its development cycle, its citizens would demand more money and it might be tempted to print it--likely setting off a wave of inflation. Instead, it agreed to a system in which economic conditions in Detroit, Los Angeles, and Dallas would have a greater impact on the Chinese money supply than the economic conditions in Beijing. All of a sudden, this decision makes us unhappy. Could someone please explain why?

It seems to me that we should appreciate the control that we have over Chinese monetary policy. We should certainly be pushing China to make the Yuan convertible--a move that would represent a great stride towards freeing ordinary Chinese citizens from at least a fraction of Beijing’s yolk--and then let them fix it at as many or as few dollars as they wish.

And that, I believe, ties in to Mundell’s broader point--at least as I understand it. A system of floating exchange rates (currently in vogue) gives many policy makers a great deal of flexibility. Flexibility, however, creates both the opportunity and the likelihood of mistakes. A fixed regime should promote monetary stability, which, one would hope, would build a platform upon which other types of stability could emerge (e.g., poverty reduction, good governance, etc.).

Of course, I approach the problem as an information economy guy, not as a monetary theorist. And to me it seems to be a no-brainer. We value having a single currency in the U.S. because it makes our transactions fast and easy. For a long time, we viewed transactions internal to a single country as a fundamentally different beast than international transactions. As we all know, however, that distinction is fast losing meaning. Globalization, integration, and (Tom) Friedmanesque “flattening” all scream for a fixed, noncontroversial medium of exchange.

Though I’m not a big fan of China (what with their essentially being fascists in communist clothing, and all), I can tell when they’re right. Let’s save our leverage for moves that will push the Chinese towards reassessing the value they place on freedom--not the value they place on the Yuan.

(This is beginning to feel like a real blog, at least to me--as I sit and write on a German keyboard in the Zurich airport during an unfortunate detour between Florence and Athens).

Posted by Bruce Abramson from on 07/03 at 02:23 PM in The Not-Quite-Yet Information Economy, Foreign Affairs and the World beyond Our Borders