Robert Mundell

Editor's Note:

Financial reform is one of the top items on China's development agenda, with cautious moves toward opening up exchange rates and allowing more flexibility for markets. Should China be cautious of too much openness? Is the global financial future bleak? Wang Wen (Wang), executive dean of the Chongyang Institute for Financial Studies at Renmin University of China, talked to Nobel Prize-winning Canadian economist Robert Mundell (Mundell) about these issues.

Wang: Many people call you "the father of the euro," but now Europe is going through a crisis of debt. What's the euro's future?

Mundell: I am happy to say that the euro itself has been a great success. But you know, one of the necessary conditions for any countries going into a monetary union or even a fixed exchange rate is that they have to have fiscal stability.

They automatically give up monetary stability, but they definitely give up control over the exchange rate, so that's taken out of their hands, so it's even more important for a country ordinarily with a fixed exchange rate to have fiscal stability.

The countries, when they moved into the euro and locked themselves into that exchange rate, they should have been super cautious about their fiscal balances, but they weren't. Many countries fudged on their commitments and got into trouble.

But I don't think there is any serious chance that the euro is going to go away. Even the case of Greece, I think it is fairly optimistic it will stay in the euro. Last year I said that my expectations of the Greece going out of the euro were less than 25 percent, but perhaps they're a little higher than that. They might leave the euro, but I don't think any of the other countries will.

Wang: Should we fear competitive devaluation between countries?

Mundell: Well, I think by and large that's not a problem countries have to worry about today. In the 1930s, people worried about beggar-thy-neighbor policies, because there was a lot of mass unemployment, and countries were depreciating their currencies. But it turned out, because back then most countries were on the gold standard, if it depreciated it would have brought an increase in the price of gold sooner.

In the US, the price of gold was more than $20 an ounce. If they had devalued sooner, it would have saved the world, even it was competitive devaluation. It would have got the world out of the great depression. When countries move forward with devaluation against gold, it increases the money supply and gets the economy out of depression and deflation. 

Now today you don't have that. You have exchange rate changes, but if a country increases its money supply under flexible exchange rates, then its exchange rate will depreciate. If China wants to have a lower yuan exchange rate, it can easily have it with a more rapid rate of monetary expansion.

But this hasn't been a good policy for Japan at all. They tried it again, for the second time, they tried it in 2008 and it didn't work, now they are trying it again to have a more expansionary monetary policy. We can just hope it will be of some use. That will help make Japan's currency more competitive, and its products more competitive.

What we would see then is that in a world of stagnation and deflation, countries can expand their money supplies to partly meet that. It's true that if Japan was really aggressive in pushing the yen down, in a serious way, China would want to compete and let the yuan go down against the dollar, but not so much that would cause too much inflation in China.   

Wang: What would be your suggestions for China's financial reforms?

Mundell: I think it would be a very good idea for China to utilize the international resources that exist for credit ratings to improve its own system. The credit rating agencies in the US and Europe are not perfect and they made terrible mistakes during the great recession. But that is one direction of reform China should take.

I wouldn't support moving to a flexible exchange rate. I said at Renmin University of China in 1995 that the best policy for China would be to give up depreciation, and to have a fixed exchange rate, and just let that be the monetary policy.

The important thing would be to move as rapidly as you can toward a more convertible currency. The changes that are being made in Hong Kong and Guangdong to further that are good. I would not do that all at once, but just as it seems comfortable to do it, so as not to create too much shock to the market.

Wang: In recent months, there has been a big debate between economist Justin Yifu Lin and the central bank about opening capital accounts, which Lin is cautious about and the central bank seems to approve. What's your view?

Mundell: I think you can move in the direction of more and more openness. Don't do it all once. There can be fixed amounts, let's say people can change a certain amount every day or every week or every month. So now we can just gradually increase those. China has ample reserves; it's not going to have an inflationary monetary policy, and the central bank it has made clear that it will not have much inflation.

There is going to be demand for the yuan, because in order to buy things you are going to need yuan. The demand is there. There is not going to be an increased supply of it, but there can be some shift of deposits where some people inside China with bank accounts in yuan will want to move a part of that abroad in foreign currency. There might be an initial large amount going out, but it will come back. 

I don't think there is any risk. But I'm not saying it is easy. In 1945, after the war all the European countries had exchange controls. The UK in 1947 tried an experiment with convertibility and that went wrong. China has had a strong surplus in the balance of payments for 15 years and it has large reserves, so I don't think there is much risk. I think the gains from a new market, an open market, would be much better than the current system.