Money and the Middle Kingdom

Bret Swanson
Gilder Technology Report
September 24, 2003
Last week George Gilder and I attended the Forbes Global CEO Conference in Shanghai. As we peered out from our windows in the tallest hotel in the world, we saw a once-great cosmopolis rapidly regaining its status as a giant in world commerce and innovation. We had heard that 90 percent of the world’s tall cranes were at work in China, but it was still a surprise to witness the tens of stunning new skyscrapers and thousands of other tall buildings, all at various stages of construction, piercing the coastal haze.

As we met with Jack Ma, the founder of the Chinese Internet, toured a Siemens mobile handset plant and the GE global research center, rode one of the world’s fastest trains, the 430-kilometer-per-hour MAGLEV, and drove by many of the numerous semiconductor fabs that will overtake the U.S. in chip capacity by the end of the year, we saw and felt the entrepreneurial energy pulsing through a society that had been closed off and repressed for the last 500 years.

The mayor of Shanghai kicked off the Forbes conference with a speech full of praise for businessmen and entrepreneurs, confirming the simple but startling conclusion we had already reached many months ago: the Chinese Communist Party is now far more capitalistic than the U.S. Democrats and many of our Republicans, too.

U.S. Treasury Secretary John Snow had been in country the week before offering advice to China’s monetary authorities, implicitly blaming them for the slide in American manufacturing. The suggestion is that China is stealing jobs and growth through predatory foreign exchange gymnastics. Now, we know contortions when we see them—the City of Shanghai threw a dinner for us, complete with opera singers, three-year-old dancing pixies, a virtuoso violinist, and, yes, two ultra-limber death-defying contortionists. But the Chinese miracle of 10 percent growth for 25 years is not the result of clever currency manipulation. Since 1994, China has pegged the yuan to the dollar, quite the opposite of exchange predation. As David Malpass of Bear Stearns notes, much of China’s success has come from its explicit commitment to a “strong and stable currency.”

Were Karl Rove merely scapegoating China to curry rhetorical favor with a few rust-belt constituencies, the suggestion would pass without a note from the markets, or us. Rove and Snow are right to view China as America’s biggest strategic challenge. But Sec. Snow’s official call for free-floating exchange rates threatens to extend a string of serious monetary blunders at Treasury stretching back to the Clinton Administration—and to break the momentum of stable money developments around the world.

Just a few years ago, the major European nations took a major step toward stable money when they adopted a common currency known as the Euro. It was designed to make the travel of goods, services, capital, and people more efficient. The Euro eliminated numerous central bankers working at cross-purposes and put a stop to constantly fluctuating exchange rates. European companies could now make decisions based on business strategy, not the unpredictable political actions of a dozen neighboring nations.

The father of supply-side economics, Robert Mundell, won the 1999 Nobel Prize for his work that led to the Euro’s adoption. But his idea was not entirely new. The U.S. had essentially adopted this strategy at its founding when Alexander Hamilton successfully argued that a common money would facilitate commerce among the states. Nonetheless, the Euro was the most significant endorsement of fixed exchange rates and stable money since the Bretton Woods regime fell in 1971.

Last weekend at the G7 meeting in Dubai, however, the U.S. and Europe renounced the very concept their member states practice at home. Instead of urging a stable value of money across geographic regions, the U.S. and Europe set another standard for the rest of the world, calling for “more flexibility in exchange rates ... to promote smooth and widespread adjustments in the international financial system, based on market mechanisms.”

But money is a standard of measure, like a yardstick or a clock. Would the U.S. Treasury promote “widespread adjustments” of the yard or the hour “based on market mechanisms”? Would it encourage Nevada and Arizona to float their own currencies—and then deflate them—because California is losing businesses and jobs to these neighboring states? No. If exchange rates are stable, we know the movement of capital and jobs is happening because other costs like taxes, regulations, and wage rates vary between regions. These movements offer useful feedback, telling governments what they must do to be more competitive. With dollar-yuan stability since 1994, the divergent U.S.-China growth rates tell us that China is providing a better economic environment for its entrepreneurs.

The weekend G7 communiqué sent the dollar falling and startled world equity markets, which had been on a tear all summer. The Nasdaq, for example, lost 3.33 percent the first three days this week, and in so doing reinforced Professor Mundell’s essential thesis: “Whenever the exchange rate overshoots it affects the real value of taxes, the value of all financial assets, the domestic price level and eventually wage rates. An unstable exchange rate means unstable financial markets, and a stable exchange rate means more stable financial markets.”

We fervently hope Snow, Rove, and President Bush get the message that global markets—and the U.S. economy—aren’t fond of protectionist policies, no matter how well they poll during a “jobless recovery.” But the administration has been all too willing to match much-needed domestic tax cuts with destructive international tax increases (think steel tariffs). Where it has finally come to rely on supply-side pro-growth policies at home, it views the international arena as a zero-sum game, where either China or the U.S. can grow, but not both.

Luckily, the Chinese are not playing that game. Back in Shanghai, Steve Forbes made the front pages of all the newspapers with his advice to ignore the U.S. and the G7 on currency matters and keep the yuan stable. And this week Chinese officials insisted the value of the yuan is an “internal” matter, implying the “strong and stable” policy is here to stay. This suggests the Chinese boom will continue, and whether the White House knows it or not, a Chinese boom is good for America.