Treasury’s Nonsense about China’s Exchange Rate

The Treasury Department issued their annual report this morning examining whether any countries are using their exchange rates to unfairly take advantage of the US. Unsurprisingly, the report discusses the politically important issue of China’s exchange rate vis-à-vis the US in some detail. (If you want some background on the China exchange rate issue, go to earlier posts here and here.) The report contains some rather disingenuous tidbits.

China has pegged its currency since 1994 at 8.28 to the dollar. This policy is not appropriate for a major economy like China and should be changed.

I’m slightly puzzled as to why a fixed exchange rate is no longer “appropriate” for a major economy. Depending on the situation, there can be perfectly good reasons to have a fixed exchange rate, just as there are sometimes perfectly good reasons to have a flexible exchange rate. It’s interesting to note that the US had a fixed exchange rate with its largest trading partner through most of the 19th century, and again during the period of remarkable economic growth from 1945-1970. Here’s a helpful graph:

The bits on the graph that are essentially flat represent periods when the US had a fixed exchange rate. Judging by how long the fixed exchange rate was maintained and how much the US economy grew during those periods, a reasonable conclusion is that fixed exchange rates worked pretty well for the US during its development.

Another bit of misdirection contained in the report is this:

Greater exchange rate flexibility would also allow China greater scope to maintain a low-inflation, pro-growth monetary policy.

I’d be very curious to know why they think that China needs a flexible exchange rate in order to achieve low inflation and high growth. Over the last 3 years China’s GDP growth has averaged about 7% per year. It’s inflation rate has averaged about 0%. Does China really need help achieving high growth with low inflation?

There may well be some valid reasons that China should change its peg, but let’s be honest here. The reasons contained in this Treasury report are nonsense.