For long, this episode of rising reserves in till-recently poor countries appeared almost conspiratorial, because these reserves were being invested in dollar denominated assets including government securities in the US and played an important role in financing the burgeoning current account deficit in the US (Chart 3). The choice of US assets was, of course, determined by the facts that the dollar still is the world's reserve currency and the US the world's sole superpower, both of which engender confidence in American, dollar-denominated assets. The direct benefit for the US was obvious. With America experiencing growth without the needed competitiveness, that growth was accompanied by a widening of the trade and current account deficits on its balance of payments. Capital inflows into the US helped finance those deficits, without much difficulty. For example, UBS estimates that in the second quarter of 2003, the central banks in Japan and China bought $39 billion and $27 billion of dollars respectively. If these are invested in American assets they would finance close to 45 per cent of the estimated $147 billion US current account deficit in that quarter. They indeed were. Central banks, mostly from Asia, are estimated to have financed more than half of the US current account deficit in the second quarter.
Chart 3 >>

The indirect benefits of this arrangement are even greater. For more than a decade now, the US has benefited from a long period of buoyancy, so much so that it has accounted for 60 per cent of cumulative world GDP growth since 1995. That buoyancy came not because the US was the world's most competitive nation in economic terms. Rather, till the turn of the last decade growth was accounted for by a private consumption and investment spending boom, spurred by the bubble in US stock and bond markets (Chart 4) that substantially increased the value of the savings accumulated by US households. The money market boom was encouraged by the flight of capital from across the world to the safe haven that dollar denominated assets were seen as providing. Investment of reserves accumulated by the Asian countries was one important component of that capital inflow. With the value of their savings invested in stocks and securities inflated by the boom, consumers found confidence to spend.
Chart 4 >>

To be sure, when the speculative boom came to end in 2000, triggered in part by revelations of corporate fraud, accounting scandals and conflicts of interest, this spur to growth was substantially moderated. But the low interest rate regime adopted by the Fed still encouraged debt-financed consumer spending. Together with the return to deficit-financed spending by the American state (Chart 5), justified by its nebulously defined war on terror, America is once again witnessing buoyant output growth even if this has not improved the employment situation significantly. In fact, 2.6 million manufacturing jobs have been lost in the US since Bush assumed office in 2001.
Chart 5 >>

The only threat to US buoyancy throughout this period was the possible unsustainability of the widening current account deficit in its balance of payments. But the boom was not aborted, because the rest of the world appeared only too willing to finance those deficits, even if at falling interest rates in some periods.

Unfortunately, few other countries benefited directly from this chain of events. They did not because they did not have the military power to create the required confidence in their currencies, even if sheer competitiveness warranted a decline in the dollar. Some countries benefited indirectly: China, for example, because of the export boom to the US; the UK because, among other things, of a boom in services, including financial services. But overall, to use a phrase popularized by former US Treasury secretary Lawrence Summers, the world economy was flying on one engine.

Within the imperial order always fearful of a "hard landing", this has created two imperatives. First, in the medium term, the world needs other supportive engines, which must be from within the developed economies. Second, till that time, and even thereafter, US growth must be sustained. The new discovery that Asian currencies, particularly the Chinese renminbi, is under- and not overvalued, stems from the second of these two concerns. With the US current account deficit expected to exceed 5 per cent this year, there are few who are convinced that it would find investors who would be confident enough to continue financing that deficit. This is becoming clear from the fact that the share of the deficit financed by central bank investments is rising, as private investors grow more cautious. Thus, if the dollar is not to collapse, the US current account deficit must be curtailed and reversed.

However, this cannot be ensured by curtailing US growth and therefore the growth of US imports. It is necessary to boost exports, so that growth can coexist with a reducing trade and current account surplus. This is where China and the fact that it notched up a record $103 billion trade surplus with the US last year comes in. Ignoring the fact that simultaneously China had recorded a trade deficit of $75 billion with the rest of the world, the surplus with the US is seen as a direct consequence of China's undervalued exchange rate, which has been pegged to the dollar since 1995 despite rising capital flows and reserves. Thus, the story goes, if China revalues its currency vis-à-vis the dollar by anywhere between 15 and 40 per cent, depending on the advocate, China would absorb more imports from and be able to export less to the US, correcting the trade imbalance between the two countries.

But that is not all. If China revalues its currency, it is argued, Europe would improve its competitiveness lost as a result of the appreciation of the euro vis-à-vis the dollar and therefore the renminbi, allowing it to register higher export growth. Further, China's revaluation would reduce the need to pressurize Japan to revalue the yen, despite its own surpluses with the US and the high level of its reserves. This deals with the danger that yen revaluation might abort the feeble recovery that Japan is experiencing after a decade of stagnation. These benefits could possibly yield the supportive engines needed to keep the world economy in flight.

In this assault on the less-developed nations, involving a complete reversal of the argument regarding the currency regime in developing countries, the US and its allies are finding strange supporters. Trade unions and manufacturing companies located in the US who have experienced job and market losses have joined the chorus through organizations such as "The Coalition for a Sound Dollar". They are even threatening to take the Chinese to the dispute settlement body of the WTO on the grounds that it is manipulating the exchange rate to win unfair gains from trade. There effort is ostensibly aimed at invoking a provision in the World Trade Organisation that bars countries from influencing exchange rates to "frustrate the intent" of WTO trade agreements. In practice, the clamour is all intended to get the US government, in a pre-election year, to increasing pressure on China to float its currency.

However, not all of American business supports this effort. Calman Cohen of the Emergency Committee for American Trade, which represents many large US companies doing business in China, is reported to have said that while the renminbi may well be undervalued, it was not the main cause of the industrial problems facing the US. His principal and well-founded fear is that action against China would adversely affect US companies that as part of their competitive strategy are sourcing their products from countries like China.

Not surprisingly, Rob Westerhof, chief executive of Philips Electronics North America and former chief executive of Philips Electronics East Asia, argues: "A free float or sudden revaluation would be bad for China and bad for business. Instead, Beijing should maintain the peg for now and aim for a gradual revaluation of about 15 per cent over the next five years. Free- floating the renminbi can be considered only when China has a well established financial system. That will take at least another 10 years." He made it clear that "business prefers a stable renminbi-dollar exchange rate. A sudden revaluation of the renminbi would disrupt results for the many multinational companies (Philips included) that supply American and European retail chains with goods made in China. Currently, hedging against exchange rate fluctuations of a free-floating, unpredictable renminbi would be very costly for those companies."

Unfortunately, some Asian countries, particularly those that have been experiencing an appreciation of their currencies from the lows they reached after the 1997 financial crisis are supporting the demand with the hope that they would benefit from the loss of Chinese export competitiveness that a revaluation of the renminbi would involve. Interestingly, Japan too is part of this group, even though it is itself intervening in currency markets to prevent the yen from appreciating too much against the dollar.

Thus at the end of September, the dollar recovered sharply against the yen as a result of Bank of Japan intervention, conducted through the New York Federal Reserve. This help reverse a prior downward lurch of the dollar vis-à-vis the yen. According to information released recently by the Japanese Finance Ministry, the government and central bank have spent a total of $ 40 billion between August 28 and September 26, taking the total amount spent on supporting the yen in the first nine months of 2003 to well above $100 billion. This willingness to intervene openly is partly explained by the fact that the G-7 has accepted that any excessive appreciation of the yen could abort a recovery which has come after a long while and which is seen as crucial for overall global growth. This support for action against yen appreciation goes against the G-7's own recent statement that cam out in favour of exchange rate flexibility in the world, which it is now clear was aimed at developing Asia in general and China in particular.

Despite its own actions, the Japanese government has been willing to go along with the demand that the Chinese and other developing Asian countries should revalue their currency by opting for a float. Once again the fact that the developed countries believe that developing countries should do as the G-7 says and not as it does has been brought home.

The flaws in these arguments are obvious. A revaluation of the renminbi may reduce China's trade surplus with the US, but it is unlikely to trigger either export or output growth in the US. Rather, the space vacated by the Chinese in US markets would be occupied by some other trading country such as Vietnam, Korea or the Philippines. Further, those Asian countries that expect to gain from the renminbi's revaluation would soon find that their current account surpluses and reserves are seen as grounds for identifying their currencies as undervalued and provide the basis for a revaluation demand. India, with less than $90 billion of foreign exchange reserves is already being targeted. Whatever gains would occur from China's revaluation would be shortlived.

Further, if China and other countries, like India, with rising reserves are deprived of those reserves on these grounds, the capital required to finance the current account and budget deficits accompanying US growth would soon dry up. This would drive up interest rates in the US, cut consumption and investment spending, make the current account deficit unsustainable, and ensure the collapse of US growth and the dollar that the revaluation is expected to stall.

In sum, the whole episode indicates that the desperation to protect the current imperial order is yielding a number of scatter-brained proposals. Economics has been reduced to deformed ideology, devoid of consistency and rationality. Fortunately, the Chinese have thus far stood their ground and refused to yield. Hopefully, other developing countries would also see where their best interests lie.