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Special> Boao Forum for Asia 2014> Archive
UPDATED: May 15, 2007 NO.20 MAY 17, 2007
Deciphering China-U.S. Economic Relations
It is not a good idea to allow 20,000 textile workers in South Carolina to determine China’s monetary policy

During the Annual Conference 2007 of the Boao Forum for Asia held

on April 21-22, Beijing Review reporter Liu Yunyun had a chance to sit down with Dr. John Rutledge, former financial advisor to U.S. presidents Ronald Reagan and George H.W. Bush, to discuss his views on China-U.S. economic and trade relations.

Beijing Review: Currently, the U.S. government is trying hard to pressure China to revalue its currency and let the yuan appreciate, with the aim of cutting its trade deficit with China. In your opinion, to what degree should the yuan appreciate? Also, according to first-quarter trade statistics, yuan appreciation didn't cut the Chinese trade surplus at all. Can you comment on that?

John Rutledge: I think yuan appreciation will cause a bigger problem, because it's not going to solve the trade situation. China is the lowest cost producer in the world today. It will also be the lowest cost producer after the revaluation. Americans will buy the same goods from China at a higher price, our imports will rise, and the trade deficit will get bigger. So it's a terrible thing to do. I believe the best policy for China is to continue to keep the rate fixed where it has been since 1995. When the U.S. government says it's important, it's probably not. It's probably political pressure speaking, not economic policy.

That's very interesting. Why do you believe that the exchange rate should be fixed?

The fixed exchange rate was in place for a simple reason-to make the price level in China and the price level in the United States the same. Of course the inflation rates were the same between the two countries. The United States and China have had almost identical inflation rates for the last 11 years. That means if I'm an investor in the United States, looking at the possibility of a Chinese investment, I have to first understand the product of the business I'm going into, and where should I locate the business. There are thousands of questions. After that, I also have to ask, if I do that [investment], is there any inflation risk in that country, or is there any currency risk in that country. Fixed rates between the yuan and the dollar make inflation risk and currency risk go away.

In the last 11 years, China had the highest growth rate and the lowest inflation rate of any major country in the world. The only reason the yuan is under pressure from the politicians, not the market, is because political pressures in the United States and in Europe are quite severe and the political leaders have a weak grip on power. The political leaders are using protectionism to keep their own power so they can stay in office. It is not a good idea to allow 20,000 textile workers in South Carolina to determine China's monetary policy. The U.S. reason for doing this is obvious. It's because of the political pressure.

Historically in the United States, the party of workers is the Democrats, and the party of owners is the Republicans. So the fact that the Democrats won power last November means that the angry worker has got his politician, and they are now in control of something in Washington. The Republicans are trying to hang on to power, and in order to hang on to power, they are becoming protectionists too. In other words they are catering to the anger of these people. That's a big danger today between the United States and China. Some of that pressure shows up in terms of the currency.

Yuan revaluation has already attracted international hot money, something that is thought to be a danger to Chinese financial stability. What are the solutions?

You have to make it unprofitable for the hedge funds to do business in China. There is a choice between the hedge fund and the direct investor. If you raise the value of the currency, you attract the hedge funds, but you drive the FDI investor away. If I were the Chinese leadership, I would invite [U.S. Secretary of the Treasury] Mr. Henry Paulson to dinner and give him a lot of Moutai (a well-known Chinese alcohol brand), and then send him home. But I would not change the currency. But they've already made the decision to some degree and it is already attracting hedge funds. That is very frightening. Next quarter, it could be $100 billion [of hedge fund money in China]. I think it's important for the Chinese Government to shut off the hot money by saying this is enough appreciation.

Chinese currency convertibility is very important. Capital market growth is much more important than the currency. What people talk a lot about is the 1.2 trillion in [Chinese] reserves, which is a target for the politicians. Every time that number is published, Americans will show up on television and say "the Chinese are bad." Last October, Chinese policy changed to allow Chinese insurance companies the ability to own stocks in foreign markets. The way to solve the reserve problem is to make the currency convertible so private companies, private entrepreneurs and private investors can build up their asset holdings. So the good story in China today is the Tianjin special zone for convertible currencies. In the very beginning of the opening when Deng Xiaoping set up special economic zones, they quickly spread around China. That was the beginning. I think the special zone in Tianjin is going to work in the same way, because it will be very successful to allow local firms to do the next one, whether it is in Shenzhen or Guangzhou. Wherever the next ones are, I think convertibility is far more important for China than the price.

The bad thing is the pressure from the United States, which is forcing the rate to change and attracting the speculators. With convertibility, speculation would be very difficult to do. So the speculation is actually delaying convertibility which will really solve the problem.

The Chinese stock market is continuing to break record highs. Do you think it's still healthy now at this stage?

I think Chinese companies are healthy. The fundamentals of the Chinese stock market are wonderful. Chinese state-owned enterprises (SOEs) have plenty of money available and they are making money. China's small and medium-sized enterprises

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