To rein in China’s conquest of world markets, the United States and Japan have been pressuring her to raise interest rates and thus strengthen the yuan’s foreign exchange rate. That would slow down Chinese exports. That, however, is what China is determined not to do. From Japan’s brilliant reconstruction after World War II, she learned that a low currency can be the best shooting iron in the trade war, and a means of turning around the Washington Consensus to goose the superpower. With a couple of hundred million reported unemployed and underemployed she feels impelled to conquer foreign markets. Exploiting Washington’s need for Chinese diplomatic backing in the Near East and in North Korea, she has been bargaining successfully to obtain Western technology as the price of access to her vast, potential markets.

In a most undiplomatic statement the People’s Bank of China responded to a public statement of the US, the EU and Japan suggesting that the exchange value of the yuan be raised. The figure 40% was cited in the world press as the extent of the yuan’s under-valuation. The Wall Street Journal of 25/08 reported the Chinese central bank’s declaration that "the banks are sitting on too much liquidity." It blamed "inappropriate comments on the Chinese yuan exchange rate and unreasonable expectations of the yuan’s appreciation among the international community" for the influx of hot money into China. "The central bank’s comments were unusual both for their vigor and their acknowledgement that it has the tools to absorb foreign currency without having to adjust the value of the yuan."

As a sample of the alternatives open to it, Beijing announced that it will increase the percentage of deposits that commercial banks must hold on reserve to 7% from 6% as of September 21^st. This means that Chinese banks will not be able to lend out as high a multiple of their cash reserves as in the past. They will therefore have to call in some of the loans already out. But even more than the strong language, the central bank’s riposte seemed to flaunt the fact that it was applying the very tool that Washington and most Western central banks had renounced. In the early 1990s they proclaimed higher bank overnight rates the sole blunt tool against "inflation." That policy was the very core of the bailout of the their distressed banks in the early nineteen nineties. Up to then governments had financed much of their needs through the central banks on a near-interest-free basis, since almost all the interest paid on their debt held by the central bank reverted to them. Today governments do almost all their financing through the private banks. The interest on government debt held by private banks does not come back to their government. Governments in general and Washington in particular are thus paying many billions in interest on debt that they had previously financed on a virtual interest-free basis.

Both the Nazis and the Allies used rates of interest rigged low to finance WWII – in the case of the US somewhere between 2% and 3%. Financing of government loans was done largely at quite nominal rates, and indirectly much of it through central banks. Without that the Allies might not have won, nor could they have carried out the post-war reconstruction with such dispatch.

It would be a tremendous disadvantage for Washington to continue using interest rates as its one blunt tool, while the Chinese followed the American example during WWII and the postwar period. Nor could the Chinese not have been aware of the delicacy of the subject raised in their reply. The chances of the Fed daring to debate the matter publicly are low indeed.

Particularly notable is the detail that even the best-informed commentators in the media, either didn’t know what was involved, or pretended such ignorance. Thus The Wall Street Journal repeatedly spoke of the Chinese requiring that the banks put up more capital reserves with the central bank. That would have been no effective weapon against inflation, since the banks’ capital would include its bad investments. It is cash reserves that are involved.

High time that the West disinterred its own successful record in using its central banks in war and in peace. Of course, we prefer that it be done to make possible a productive, friendly collaboration amongst nations. However, what is likely to cut more ice in the world as it is spun these days is its ghastly relevance to financing wars.

— from Economic Reform, October 2003

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