I was about to post a review on this article - which is well worth reading - when I noticed that Navarro had an letter to the FT published today which also makes excellent reading on the whole "China Surplus" and what to do with it question. A brief article review is now included below.
FWIW I tend to agree with this letter wholeheartedly.
China: purchases of yen not a real option
Sir, Fred Bergsten's recommendation that China should diversify its foreign currency reserves into the Japanese yen shows a fundamental misunderstanding of the current monetary policies of both the Chinese and Japan ("The yen beckons China's dollar billions", March 13).
China directly manipulates its currency by maintaining a fixed dollar-renminbi peg through the recycling of large sums of US dollars back into the US bond market. The broader goal is to sell as many exports as possible to the US so as to create jobs in China, where the unemployment rate remains stubbornly high. As a defensive measure, Japan, as well as Taiwan and South Korea, must likewise manipulate their own currencies in order not to lose competitiveness or market share to China. However, in a floating exchange rate system, Japan achieves manipulation indirectly through maintaining artificially low short-term interest rates and tacitly supporting the so-called "carry trade", which helps to keep the yen low.
Any attempt by China to prop up the yen through currency purchases would be interpreted as a wildly provocative and mercantilist act by the Japanese as it would enhance China's ability to take US market share from Japan. The more likely scenario is that China will increasingly use its foreign currency reserves to buy equity shares in US companies and, over time, the US companies themselves. By gaining control of US companies, China will therefore gain more control over the decisions of US companies to offshore and outsource to China. Such a strategy will also accelerate technology transfer from the US to China.
Where Dr Bergsten does get it right is in his insistence that China let its currency "rise to a level that would no longer require intervention". In the absence of such a policy shift by the Chinese, the road ahead will be bumpy for both the US and Japan.
Navarro also has a project looking at the China Price - HOW can China undercut most other manufacturing countries by up to 50%?. This is something I want to return to, suffice to say, they identify 8 drivers of the Chinese low price for manufactures:
1. low wages (a large, disciplined (crucial) and generally well educated population).
2. network clustering
These 2 alone account for 55% of the China - US cost difference. So where does the rest come from?
3. export subsidies (17%)
4. undervalued currency (11%)
5. piracy (9%)
The rest include lax environmental regulations and health and safety (small effect perhaps surprisingly so) and FDI.
The surprise perhaps is the extent to which piracy is playing such a large role whilst the currency effect may not actually be that large - even if the currency were allowed to appreciate it suggests that China's comparative advantage would remain a strong one.
The West and the rest of Asia should therefore stop fixating on this issue and to try and address some of the other points - such as the positive clustering affect and the education of its population.
A full PDF of the report can be found here:
China Price Project
Peter Navarro's website is here (a bit of an ugly entrepreneurial site though).