The NYT has an article today explaining how China's high dollar policy helped drive the housing bubble by keeping down mortgage interests in the United States. At several points the article says or implies the consequences of this policy could not be foreseen. In fact, it was easy to see exactly what was going on and that this pattern of growth would end badly. However, the economists who were issuing such warnings were largely ignored by the media and political leaders. Rather than telling readers that nobody expected the sort of crisis the economy is now experiencing, the NYT should be examining why people in positions of responsibility could not see a problem that should have been obvious, even when it was brought to their attention. It is also important to note that, contrary to assertions in this article, the United States does not have to persuade China to change its currency policy to get a lower value of the dollar against the yuan. The United States could unilaterally set an official exchange rate of the dollar against the yuan that is lower than the Chinese rate. For example, it could announce a policy that it will accept 5 yuan to the dollar, as opposed to the current rate of 6.84 yuan to the dollar supported by the Chinese government. This would lead to an immediate upward valuation of China's currency in world markets. Also contrary to the assertion in the article, the United States has no need whatsoever for China to buy U.S. debt. It can have the Federal Reserve Board purchase the debt. In normal times this practice would raise the risk of inflation, but there is no risk of inflation in the current economic environment. Furthermore, insofar as China's purchases of debt reduce the need for the Fed to effectively print money, these purchases are simply pushing the risks of inflation into the future. At some point, China will presumably not feel the need to subsidize U.S. consumption. At that point, it will stop buying U.S. Treasury bonds and might even sell its holdings. This would push down the value of the dollar, leading to higher import prices and higher inflation.
--Dean Baker
