Home' Trinidad and Tobago Guardian : September 10th 2015 Contents BG20 INTERNATIONAL
BUSINESS GUARDIAN www.guardian.co.tt SEPTEMBER 10 • 2015
The recent meeting of the G20
group of countries sounded
a relatively optimistic note
on the global economy, in
sharp contrast to the recent
price falls in world asset mar-
So who is right: the markets or the min-
isters? The swing factor between a continuing
stable but uninspiring global recovery and
relapse into a global downturn is China.
The big question is: how steep is China s
economic slowdown? Those looking for an
answer have pointed to China s surprise deci-
sion to devalue its currency in early August.
Does this suggest that policy-makers are
panicking and trying to boost exports?
The fundamental problem that China faces
is that its economy is deeply unbalanced---
both internally and externally---at a time that
it is also slowing.
Economists tend to look at an economy
for internal balance (a state of affairs in which
neither employment nor inflation is too high
or too low) and external balance (a situation
in which a country s current account (its
borrowing or lending to the rest of the world)
is neither too high nor too low.
China is currently struggling to achieve
both kinds of balance.
Chinese policy-makers have a tricky task
ahead but not unmanageable one.
It s a challenge that could be made much
easier by some global policy co-ordination
At the heart of China s problem is the
"impossible trinity" of international macro-
The impossible trinity---or trilemma---is
the idea that it is impossible for a country
to have three things at the same time: a
stable currency, the free movement of capital
(ie the absence of capital controls) and inde-
pendent monetary policy.
A country can instead choose just two of
the options from this policy suite.
The UK, in common with most developed
economies, has free capital movement and
an independent monetary policy - but not
a controlled exchange rate.
The Bank of England sets interest rates at
a level it thinks is right for the UK economy
and---as capital can flow into and out of the
UK at will---the exchange rate is determined
by the market.
Change in outlook?
If, as in the late 1980s and early 1990s, the
UK wanted to retain free movement of capital
but have a stable exchange rate then it would
cease to have an independent monetary pol-
icy.Instead of being set as appropriate for UK
domestic conditions, the interest rate would
have to be set to maintain the value of sterling
against other currencies - in effect monetary
policy would be outsourced.
China s policy mix has been to have an inde-
pendent monetary policy and a controlled
exchange rate, which has meant restrictions
of the free movement of capital.
In reality the situation is a bit more com-
plicated. China s capital controls are porous,
money does flow in and out of the country
and the renmimbi has been semi-pegged to
the dollar, rather than straight-forwardly sta-
ble.But things are changing. China is currently
pushing for the renmimbi to be formally
included in the International Monetary Fund s
list of reserve currencies.
Part of that process involves dismantling
its capital controls bit that exposes its own
central bank, the People s Bank of China
(PBOC), to the trilemma.
The slowing domestic economy suggests
an easier monetary stance is required and that
an easier monetary stance, coupled with freer
movement of capital, suggests that a weaker
renmimbi lies ahead.
But as Karthik Sankaran of Eurasia Group
has convincingly argued this wouldn t be ideal
either for China or for the global economy.
Domestically, a weaker currency would tight-
en financial conditions for any Chinese com-
pany that has borrowed in dollars at a time
when the PBOC was trying to ease them. But
the international spill-overs of a weaker Chi-
nese currency matter more.
What China needs
Before the financial crisis of 2008 China s
economy was far from externally balanced.
Indeed it was a major driver of global imbal-
ance, with a current account surplus of 10 per
cent of GDP. That s now down to around 2%,
but a weaker currency could force it back up.
At a time when disinflationary factors, such
as lower commodity prices, are at work and
when Western inflation is stuck around zero
per cent, then the last thing the world needs
is a Chinese devaluation which would risk
turning a still benign period of low inflation
into a damaging spell of deflation.
China needs easier monetary policy and the
world could do without a much weaker ren-
Thankfully that is an achievable mix. But
it requires Chinese capital controls to stay in
place for longer than intended; giving China
the ability to both have an independent mon-
etary policy and a stable exchange rate.
The IMF was once regarded as fairly dog-
matic on the need for countries to sign up to
the free movement of capital.
But during the crisis that attitude shifted
and the Fund recognised that there are times
when capital controls might be appropriate.
China right now feels like one of those times.
If China can keep its capital controls while
moving towards reserve currency status---even
for a while---it may be better placed to seek
It s very easy to attack China s economic
policy missteps of the past few years.
Propping up an overvalued stock market
and surprising the market with currency
announcements are just the latest examples.
But the bigger criticism is usually over the
nature of the post-2009 stimulus package
which kept Chinese growth high by going on
a credit and investment binge driven by state
owned enterprises, state owned banks and
That s left the Chinese economy with a seri-
ous mal-investment problem (the often men-
tioned empty ghost cities) and high level of
But, for all the criticism, the counterfactual
is rarely stated. What would global growth
have looked like without it?
At a time when the world was desperately
short of economic demand, China stepped up
and provided some.
That stimulus package helped prop up global
growth during the crisis but left China s econ-
omy dangerously out of balance.
Helping China make the transition back
towards balance needs to be a central aim for
China's impossible trinity
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