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Exporters keep dreaming of a buyers’ wonderland

by Kevin Rafferty

HONG KONG — It is a measure of the nervous mess of world financial markets that when the Financial Times reported last week that China was reviewing its assets denominated in euros, the markets promptly plummeted. The very next day — when China denied any such euro-review — there was a massive rally in equities and commodities and a bond selloff.

This occurred in the week when the Organization for Economic Cooperation and Development forecast returns to healthy economic growth in the rich industrialized countries of 2.7 percent for this year and 2.8 percent next. Overall global growth is expected to be 4.6 percent after a fall of 0.9 percent last year.

There are good reasons why some people are twitchy. When you look at the real economic world of 2010, there is a lack of balance. Too many countries are pursuing the same objectives in which they can’t all succeed. Indeed, in many cases there is an internal conflict between policies pursued inside individual countries. Politicians in countries as diverse as Greece, Germany, China and Japan have not realized that only in an Alice in Wonderland world is it possible for everyone to do impossible things.

Some of the pious and portentous policy statements coming from governments remind me of the encounter between Alice and the White Queen:

Alice laughed. She said “one can’t believe impossible things.’

“I daresay you haven’t had much practice,” said the Queen. ‘When I was your age, I always did it for half-an-hour a day. Why, sometimes I’ve believed as many as six impossible things before breakfast.”

China boldly chases impossible dreams. It wants to keep its exports growing so that they are the engine of economic growth and jobs, and it is reluctant to see the yuan appreciate because this will make exports less competitive. China’s foreign exchange reserves will continue to grow, but this makes their real value ever vulnerable to any fall in the value of the U.S. dollar or other reserve assets that Beijing chooses.

The fall in euro value — from $1.49 per euro in November to $1.22 today — has Beijing complaining that it has suffered a 13 percent revaluation against the euro this year, threatening the competitiveness of exports to the euro zone.

At last week’s annual China-U.S. summit in Beijing, U.S. Treasury Secretary Timothy Geithner was noticeably quiet about yuan revaluation. It is not clear whether he was sympathetic to China’s euro plight, whether he believes he has got a promise that yuan revaluation will resume shortly, or whether discretion was the better part of valor and Washington decided that it could not try to muscle China in too many directions at once and that its priority was to get Beijing to understand the perilous state of the Korean Peninsula.

China has limited options. It is tempting to ask what’s the real profit in hoarding nearly $3 trillion that is vulnerable to forex fluctuations. A few months ago Beijing was abuzz with rumors of diversifying out of U.S. dollars to the supposedly safer euro. Even if a new global reserve currency were created, say based on the so-called special drawing rights, that currency would still be a proxy for the basket of currencies of which it was composed and vulnerable to fluctuations.

The truth is that the vulnerability of the increasing reserves is part of the price to be paid for export success, but it also denies Chinese consumers the fruits of their labor locked up in the dollar holdings.

China could diversify its holdings by buying foreign assets, such as companies or buildings but that — as Japan realized not so long ago — is easier said than done and excites foreign opposition if done on a large scale. Japan was criticized for trying to buy up the Great American Dream with purchases such as the Rockefeller Center and Hollywood film studios.

Imagine the outcry if China bought wholesale chunks of the United States. It’s also too easy to miscalculate and pay too much for not assets that aren’t so good, as China and even canny operators like Singapore have already discovered.

China’s better option is to re-examine the economy and actively aim for a balanced current account most consistent with growing job creation. But that means riding the political punch of powerful exporting companies.

At least China is enjoying the challenges of success. It’s different with the so-called advanced industrialized economies. Indeed, if you look closely at the economic structures of the Western countries, the expression “advanced industrialized countries” is something of a euphemism for “aging, sclerotic and unwilling to change.”

These countries seem to have forgotten some basic principles of economics. As John Maudlin wrote over the weekend in “The Big Picture” blog, there are only two ways for economies to grow, either through population or productivity increases. On the first score Japan, Russia and much of the old Western Europe are all vulnerable, but don’t seem to understand their plight.

The euro-zone countries have an extra problem of being 16 different fiscal regimes roped together under a common currency. The difficulties of Britain, outside the euro zone, illustrate this.

The new British Conservative-LibDem coalition announced a substantial £6 billion spending cut to get the government’s unsustainable deficit of 11 percent of GDP under control. It may sound savage, but it is only 4 percent of the £156 billion deficit.

Another option is to raise the value-added tax to 20 percent, but retailers have warned that this would cost 163,000 jobs, cut consumer spending by £3.6 billion over four years and risk sending economic growth into a tailspin.

Britain has its own currency and a painful escape route. It can allow the pound to depreciate toward parity with the U.S. dollar, which will make Britain more attractive as a tourist destination and boost exports — if Britain can rediscover the art of making things as opposed to making paper financial mansions in the City of London.

Greece has no such luxury, and is competing in the euro zone with Germany where productivity has risen 30 percent since the euro started. Even if the euro gets a boost from depreciation, Greece and everyone else have to compete with superproductive Germany. Greece’s choice is willingly to go into depression or to default on its debts and leave the euro.

There is increasing recognition that the euro is an unfortunate orphan that needs greater parental political control. But none of the countries is willing to concede the control. Greek public servants are not even prepared to accept the curbs of their own elected government.

Spare a thought for the self-righteous Germans who — conveniently forgetting that they and France encouraged acceptance of deficits by not accepting the original 3 percent limit — are now saying that everyone should be like them. That’s the other impossible dream — that not everyone can export their way to economic recovery.

If China, Britain, the U.S., Germany and Japan are all furiously trying to export, who is going to buy?

Kevin Rafferty is a freelance financial writer in Hong Kong.