The dollar question

A Chinese call for financial reform is a challenge to the west. Howard Davies reviews ‘Against the Consensus’, by Justin Yifu Lin

Ben Bernanke arrives at the Great Hall of the People in Beijing for US-China talks in May 2010

Against the Consensus: Reflections on the Great Recession, by Justin Yifu Lin, Cambridge University Press, RRP£20 / $29.99, 280 pages

My first thought on opening a book on the Great Recession is – do we need another one? My second thought is on similar lines, I fear. Even though the consequences of the financial crisis of 2008 are very much with us, the first drafts of history are in and the long view, recollected in tranquillity, is still not accessible.

But Justin Yifu Lin is a special case. A scholar with roots in both Taipei and Beijing, he was the first Chinese citizen to hold a leading position in an international financial institution, serving from 2008 to 2012 as chief economist at the World Bank. His perspective is unusual, and unusually well informed. He also writes punchy, crystal-clear prose, and uses a wide range of data convincingly. So Against the Consensus should certainly have a place on your crisis bookshelf.

It is, however, constructed on the model of a Chinese official banquet. Courses come thick and fast. Barely has one had time to savour his views on the euro crisis than one is plunged into a discussion of China’s growth strategy, then just a few pages later we wrestle with the infrastructure problems of Africa, before being catapulted into a complex discussion about proposals to reform the international monetary system. As is the way with banquets, some of the courses taste remarkably similar to what you had at lunch, so my strategy is to pass over some, and leave time to eat all of the dishes I fancy before an eager waiter whisks them away.

Applying the same discipline to Lin’s economic buffet, I identify three courses of particular interest, which repay careful digestion. First, he rejects the notion that global imbalances, driven by an undervalued renminbi, were a powerful contributory cause of the crisis. That thesis has been developed in a series of speeches by Ben Bernanke, the Federal Reserve chairman. Lin will have none of it. For him US domestic policy was largely to blame for global imbalances and the country’s property bubble: “The loose monetary policy introduced in 2001 in response to the bursting of the dotcom bubble, magnified by financial deregulation and innovations in financial instruments, resulted in a boom in the US housing market.”

Well, he would say that, wouldn’t he, might be one response. The Chinese government has been firm in its rejection of any charge of exchange rate manipulation. But Lin is not in fact an apologist for Chinese policy towards the renminbi. His argument is more subtle, and more interesting. Indeed, an intriguing analysis of Chinese policy is the second tasty course he offers.

As he sees it, China’s massive current account surplus was principally caused by a very high corporate saving rate. While household savings in China are high, at around 20 per cent of gross domestic product they are comparable to those in other Asian countries at a similar stage of development. But corporate savings are also around 20 per cent of GDP, twice the share in the US or western Europe. That high rate of corporate saving is driven, in turn, by a very generous tax regime for state-owned enterprises, and by subsidies to companies through a low cost of credit, effectively financed “mainly by people who have deposits at financial institutions but who cannot borrow from them – the relatively poor”. Savers in banks have been paid below the inflation rate for several years.

If we add to this financial repression the very low royalties paid by natural resources companies, there is a very big “transfer of wealth from the nation to the wealthy few”. Lin concludes this section with a series of recommendations designed to correct these imbalances, to improve the financial position of Chinese households, and therefore to increase Chinese domestic consumption. This recipe will slip down nicely in the west. While the analysis is driven by concerns about the stability of Chinese society, the response would have the effect of reducing China’s external surplus.

His third course requires far more chewing, and is much less likely to be palatable in Washington. Lin believes that the international monetary system is fundamentally unstable. In his view the dollar cannot any longer act as a firm anchor for the world. The dollar became the de facto global reserve currency when the US accounted for 50 per cent of global GDP. Yet a multicurrency reserve system, to which we are edging, may be even less stable. He sees little chance of the US, EU, China and Japan achieving the tight policy co-ordination needed to make a multipolar system work effectively. They each face such different domestic policy challenges, which dominate any concern for the global system. We can see that Group of Eight summits now concentrate on Syria or tax havens, not on constructing a replacement for Bretton Woods.

His route out of this dilemma is the creation of a new global reserve currency called paper gold (p-gold). It is a great-nephew of Keynes’s bancor, put forward at Bretton Woods but rejected. National currencies would be obliged to maintain fixed rates against p-gold (though with the possibility of agreed devaluations or revaluations) and would hold p-gold as reserves. The consequence would be a return to stability, resolving the conflicts inherent in using national currencies as reserves.

It is a beguiling argument, but the US administration, and successive leaders of the International Monetary Fund, have shown little appetite for fundamental reform. For now, I suspect that p-gold will be left on the side of the plate by the various Gs, 7, 8 or 20, like those sea-slugs the Chinese love but which are not to western taste. Nonetheless, Lin’s challenge to the prevailing orthodoxy is timely and worthy of further debate.

Howard Davies is a professor at Sciences Po in Paris and former deputy governor of the Bank of England

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