I side with China on this one
by Rebecca Wilder
Yes, the renminbi (RMB) is closer to fair value. Chinese Foreign Ministry spokesman Ma Zhaoxu states:
“Our currency, the RMB, has appreciated more than 20 percent against the U.S. dollar since July 2005, when China moved to a floating exchange rate regime,” Ma said. Before 2005, the RMB was pegged to the U.S. dollar at a fixed rate.
“The RMB exchange rate has drawn close to a reasonable and balanced level, given the international balance of payments and the market supply and demand for foreign exchange,” Ma said.
The New York Times asserts that China’s currency is undervalued by 25%-40%. The NY Times, like many politicians and media channels, is entirely too obsessed with China’s exchange rate; they fail to understand that economic fundamentals are changing.
Contrary to popular belief, the level of the renminbi has become rather inconsequential to Chinese trade flows. Why? Because despite the fact that the renminbi has been pegged against the dollar since July of 2008, imports are surging.
The chart above illustrates the 3-month annualized growth rate in exports and imports and the renminbi valued against the US dollar. I use the 3-month annualized rate, rather than the year/year rate, to remove the strong base effects from the drop-off in trade last year.
The first thing to notice is that while export growth is indeed strong, “business as usual” in China, import growth is surely breaking trend. The 3-month annualized growth rate of imports – a good proxy for domestic demand – averaged 117% annualized growth per month from April (when it turned positive) to December 2009. Compared to this period in 2006, annualized import growth is up almost 80 percentage-points, while that for exports is up just 5 percentage-points (76.2% average 3-month annualized growth in exports May-December 2009 vs. 71.7% in 2006).
It’s hard to argue that the Chinese currency is so “undervalued” if the import response is this strong.
Another myth is that China is running large current account surpluses. Given the chart above, it won’t surprise you to know that China’s current account has dropped markedly since late 2008.
The thing is: since prices in developed economies have dropped relative to those in key emerging markets (i.e., China), real exchange rates are coming back in-line with a s0-called equilibrium. Therefore, the renminbi, by definition, is closer to whatever an equilibrium would be, despite the fact that it is fixed. Thus, like Ma Zhaoxu says, it’s at a “reasonable” value.
Rebecca Wilder
Contrary to popular belief, the level of the renminbi has become rather inconsequential to Chinese trade flows.
Then why don’t they let it float and make everyone one happy?
Wow this is a bad post. Taking a zero baseline as the counterfactual? Ignoring rest of the world income?
Theoretically, the “rest of world income” would be accounted for in the trade flows and relative prices….
Rebecca
Cantab,
For one, the $value of their $2.4 tn (+ who knows how much in the banking system) portfolio of FX reserves (approximately 66% of which is denominated in $US assets).
They’ve gotten themselves into a pickle, for sure. However, if real exchange rates continue to maneuver through the peg (which I don’t believe will last much longer – Jim O’Neill at GS is calling for an unexpected and one-off 5% appreciation against the $US), eventually price pressures and stronger domestic demand growth will force the float.
But that’s just part of one case – what you ask is obviously too complicated for me to answer or even address in a paragraph.
Rebecca
wrong wrong wrong
negative real natural interest rate in the US is not a good or sustainable equilibrium.
If growth in the US ever picks up, so will the CA deficit. The problem is not solved – at all.
This whole article is just totally backwards. The peg is at the very core of the problems… all of the Finance ministers, CBers etc. are not delusional for being worried.
You should listen to Paul Krugman – he is simply far smarter than you
Rebecca,
But-but-but-but… using imports to establish a currency value is too logical. Such thinking leads to the conclusion that we have simply been trading paper for goods. This could also lead to Americans realizing that if we could get our recalcitrant dollar to devalue we could then give ourselves a discount on our conspicuous consumption while also minimizing ‘our’ cost — of our AAA fraud fiasco. Then, ‘radicals’ will question whether humanity should be made to pay for our ‘complicated’ behavior. That could cause ‘crackpots’ to even go so far as to correlate our foreign policies to those domestic policies from our past that allowed us to demonstrate to Native Americans how superior we are at land and resource exploitation. Naturally, that could insight the ‘heretics’ who will probably claim that this is nothing more than a continuation of Christian expansionism, corporations pushing our culture and all of that. So, Rebecca, easy with the logic, our behaviors of late, with so much information available, could cause the less fortunate to question whether we know what is best for them, and poor nations lending to wealthy nations, and then helping in paying the ‘bad apples’ costs, is so clearly what is best for them. Divine guidance does not come cheap — and sometimes it defies logic. ~ ray
Oh bob…we have.
http://econospeak.blogspot.com/2010/02/global-imbalances-are-statistical.html
Brenda Rosser speaks up on this issue as well. We can blame China for a lot of things, but it keeps us from looking at our assumptions and role in the issue, and avoid looking at the realities of trade flows.
The peg is a problem for sure, but certainly not the key to our own policies. Now the mercantilist Chinese policies and our very own freetraders make for great profits off both country’s peoples.
MSN’s deal with bottom line on day to day business decisions and have no interest in what else a way of doing business costs if someone else pays. Until the cost is shifted to them by accident, new equilibrium, or policy choices.
Wow, wasn’t expecting this much pushback from AB readers! It’s not traditional thought, for sure, but certainly up to date!
It’s pretty simple – now that the US is seeing a fledgling recovery, the yuan is coming into the spotlight. But why? It seems that trade is re-balancing quite smartly despite the peg. Sure, the yuan is most surely still undervalued – but compared to what? Two years ago? Not fair. Long-term fundamentals are changing, eventually the yuan will appreciate. The government will be forced to….inflation.
So what do you want China to do? Revalue the yuan so that US imports suddenly become that much more expensive when the labor market has yet to improve much in the first derivative? This is a long-term proces; and no matter what Krugman says – who, by the way simply highlights the problem that we all know exists – the shift is already underway.
You all should read more current literature that cites predatory behavior on the part of the Fed vis-à-vis low real rates in the earlier part of the decade. It’s the liquidity glut – see David Beckworth’s blog for discussion.
Rebecca
bob,
Joe Stiglitz ~ “Trade deficits and foreign borrowing are two sides to the same coin. If borrowing from abroad goes up, so too will the trade deficit. This means that if government borrowing goes up, unless private savings goes up commensurately(or private investment goes down commensurately), the country will have to borrow more abroad, and the trade deficit will increase.”
So, is the peg the problem, or could it be that we simply do not produce enough? We could invest less I suppose but that would require a solution involving actual work for those who know only how to invest. They could be administrators and managers perhaps, but we already have too many of those too. Could it be that: “all of the Finance ministers, CBers etc. are not delusional for being worried”– because their competence would be in question if more people understood that the developed economies have hit a wall? Would there even be a reason to worry if an equitable solution were forthcoming? After only trading paper for actual goods for decades, ‘any’ argument one advances must be more than just a little ‘worrisome’. ~ ray
Bob,
http://roddickiverson.spaces.live.com/Blog/cns!F9F215AEA43BE3CC!2646.entry
Krugman says there is nothing wrong with such a policy (the peg) but it has to have reasonable bounds….don’t turn Krugman into a fetish until you understand what he says, and what the conditions are.
It is still a problem for our trade policy.
Keep in mind China went on a commodities buying frenzy in 2009 that accounts for a significant portion of their imports. That was based on the fear that the dollar was tanking. In hindsight they might consider that to have been a bad bet and may try to dump those commodities instead of dollars.
Trainwreck,
That is a good point. It is the mess made by piigs and the like, that keep things interesting. If I were a cartoonist, I would show hogs wallowing in Euros here:
xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx
xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx
did you actually read Krugman’s artlcle, and not just the shortened version in that link? It certainly doesn’t seem like it. This is what he wrote:
“There’s nothing necessarily wrong with such a policy, especially in a still poor country whose financial system might all too easily be destabilized by volatile flows of hot money. In fact, the system served China well during the Asian financial crisis of the late 1990s. The crucial question, however, is whether the target value of the yuan is reasonable.”
He goes on to say that it CLEARLY IS NOT.
“But China has been keeping its currency pegged to the dollar — which means that a country with a huge trade surplus and a rapidly recovering economy, a country whose currency should be rising in value, is in effect engineering a large devaluation instead.
And that’s a particularly bad thing to do at a time when the world economy remains deeply depressed due to inadequate overall demand. By pursuing a weak-currency policy, China is siphoning some of that inadequate demand away from other nations, which is hurting growth almost everywhere. The biggest victims, by the way, are probably workers in other poor countries. In normal times, I’d be among the first to reject claims that China is stealing other peoples’ jobs, but right now it’s the simple truth.”
“The point is that with the world economy still in a precarious state, beggar-thy-neighbor policies by major players can’t be tolerated. Something must be done about China’s currency.”
what part of that do you not understand?
“But why? It seems that trade is re-balancing quite smartly despite the peg. Sure, the yuan is most surely still undervalued – but compared to what? Two years ago? Not fair. Long-term fundamentals are changing, eventually the yuan will appreciate. The government will be forced to….inflation.”
No, your old Mundell-Fleming models don’t work on China. They proved that wrong years ago, when everyone was calling for inflation that would kill the 10%+ growth, but it never came.
Trade is only rebalancing because America has unemployment running at 10%. You try to bring that down while maintaining the peg, you blow out both the fiscal deficit and the current account deficit. It’s that or stagnation until the peg issue is resolved. The US has chosen stagnant growth and unemployment for the time being, since they don’t want to run the huge deficits necessary to keep employment up while the peg continues..
What do you mean “predatory behaviour” by the Fed?
I’m well aware of the literature on the savings glut, if that’s what you’re referring to
rl love,
Do you have to keep quoting Stiglitz. For me if they give the nobel prize to another hyper-liberal like Stiglitz and Krugman we’ll then have the three stooges of the economics world.
Hi Bob,
I am definitely referring to the “liquidity glut” – the Fed’s pumping up the money supply to fuel domestic demand in 2001-2004. They used call the current account imbalances a “paradox”. It’s no longer a paradox – just a matter of fact. Current account deficits generally are a warning signal (see Rogoff and Reinhart research). Mundell-Fleming still holds: the terms of trade are shifting.
Rebecca
Hi Cantab,
Perhaps inconsequential is not the best term because exports are coming back smartly (it is unlikely that, all else equal, the effect is purely from world growth). It’s [the peg] important, but so should be domestic policy…and that is likewise becoming increasingly more important to the Chinese. You can’t have it all, as the Impossible Trinity would say.
People always forget that China didn’t force the US consumers’ hand – they (we) are prone to such aggressive debt behavior.
Rebecca
Cantab
Rebecca,
I’m not pushing back hard on what you said. However, It seems to me that if the level of the renminbi is inconsequential to trade flows then I wonder why they would peg the value of the currency in the first place. The fact that they keep pegging their currency makes me think its actually important to the chinese and not inconsequential to them.
I think Bob is could start slower in his opposition and then work his up to it if its called for. So far I think’s he’s too aggressive out of the gate.
Rebecca,
I’m not pushing back hard on what you said. However, It seems to me that if the level of the renminbi is inconsequential to trade flows then I wonder why they would peg the value of the currency in the first place. The fact that they keep pegging their currency makes me think its actually important to the chinese and not inconsequential to them.
I think Bob is could start slower in his opposition and then work his up to it if its called for. So far I think’s he’s too aggressive out of the gate.
Is this monologue sarcastic? I think so, but can’t tell exactly. 🙂 Rebecca
“the Fed’s pumping up the money supply to fuel domestic demand in 2001-2004″
Do you mean the Fed set interest rates too low, encouraging borrowing that expanded the money supply? as in Woodford
The Fed set the interest rate low because the natural real rate of interest was depressed, due to the (mainly) Asian savings glut. The “savings glut” was mainly the byproduct of China’s peg and complimentary policies in east asia that required the purchase of US treasuries.
The rest of your response I find pretty incoherent. I’m not sure what point you are trying to make
Rebecca,
I suppose that the 🙂 means that you know that the sarcasm was not in any way aimed at you or your article, but instead in a way, meant as support. But because sarcasm can be tricky, considering how POVs play a role, let me just express myself thus: 😎 . (that was my first use of ’emoticons’, I think my blogging skills just moved up a notch) (wow, italics and bold and other stuff as well, but that is enough for one day [and I have no idea what those other symbols are for?])
Cantab’
‘For me’, Krugman writes for the flagship of the MSM and is therefore a Conservative. Naturally, I want only to please you and would do so if not for ‘my’ confusion about where to draw the lines of bias. But you complained about my positions even before I quoted Stiglitz and so perhaps you might understand my dilema. I quote Fogel some too, is he pleasing to you? :'(
Whatever else one may think of the argument here, Bob’s argument against describing current conditions as “equilibrium” has merit. Current circumstances are best described right now as “current circumstances”. We have no reason to believe that the reduction in China’s current account surplus is a reflection of secular adjustments. China has undertaken a strong and fairly successful stimulus effort, while China’s trading partners are struggling to get their economies back on their knees. Standing on our feet is a good long way off.
Often, when a bilateral trade imbalance is criticized, cooler heads not that it is overall balance that matters and that bilateral imbalances are as natural as rain. Since in China’s case, that is not so. It is pretty obvious that China picked the US as the country with which trade penetration could do the most good, and that decision has a legacy. The bilateral imbalance remains large, even though China’s overall current account surplus is falling. Since the credit pump through the current account and the US mortgage market into Chinese reserves may have had a large influence on the credit bubble, we may want to take the bilateral balance into account.
There are no legitimate tools for dealing with the legacy of China’s decision to target the US other than the exchange rate. So while by standard metrics, it may be possible to argue that China’s exchange rate is near equilibrium (in what is very likely not anything like global macroeconomic equilibrium), I don’t thenk that does much to rebut calls for China to move away from its continued peggish sort of arrangement with the dollar. There are certainly complications in making any such move, but that doesn’t overturn the argument again the peg. It just means any solution must be undertaken with care.
Not “not” but “note”, as in “cooler heads note that” … sorry.
***Then why don’t they let it float and make everyone one happy?*** Cantab
That’s a really good question. I think the answer is that the Chinese system is largely free market capitalism within the framework of a managed economy. They seem to be really good with that “managed economy” thing. My guess would be that managing their economy is tough enough without the additional variable of a currency whose value is set by who the hell knows what.
But the free market produces the optimum results? Hogwash. The free market is — as it always has — causing the world to stumble from crisis to crisis. I doubt any pragmatist trying to develop a huge country with a quarter of the population of the world in an orderly manner is going to consider letting the free market set their currency rate. The evidence suggests that the Chinese are far less lazy and incompetent than US-European economists, businessfolk, and politicians.
The next question would be, is there any such thing as a “Fair Exchange Rate”? I’m inclined to think not. Could be convinced otherwise.
What the Chinese are going to want is the exchange rate that optimizes current and future good to China. I can’t think of any reason why that would be the same exchange rate that optimizes current and future good to the US, the EU, Australia, Tonga or Mauritania. Nor do I think there is a single exchange rate that accomplishes that for all those countries.
Finally, I would point out that in the past 36 months the price of the same damn barrel of oil has varied from $135 to $35 and back up to $78. Gold from $720 to $1214 and back to $1100. The US-Canadian exchange rate has varied by 30%. The US-Euro exchange rate has varied by 23%. Why — other than a death wish — would any economic manager subject their efforts to forces that volatile?
I don’t think I really understand this. But I’m skeptical that anyone else does either.
bob,
Not to suggest that Krugman is other than all knowing, but I offered another explanation regarding the global aggregate demand issue here: http://www.angrybearblog.com/2010/02/globalizationlifted-from-comments.html#comments
Codger,
Yes, yes, yes and yes. The Chinese are proactive as opposed to reactive. And they understand what The Plaza Accords did to the Japanese economy etc.. kharris made a good point about the Chinese entering into this knowingly, but they also know that they are in the lion’s den.
I understand that quite clearly. What is US industrial policy response? More of our same
Hi Bob,
I was responding to this remark: “They proved that wrong years ago, when everyone was calling for inflation that would kill the 10%+ growth, but it never came.”
It seems that these crises take time to build (i.e., the “paradox” remark above). One cannot rule out Mundell-Fleming just yet – the Chinese will not be able to maintain the peg forever. If indeed the recovery in the developed world is as weak as the IMF suggests, it would be difficult for China to maintain strong growth rates on the classic export growth model alone.
I digress: Menzie Chinn and an ECB paper.
Rebecca
rl love,
Krugman writes for the flagship of the MSM and is therefore a Conservative.
Most lefties are conservative, Krugman is very conserative.
On the Stiglitz (aka Curley) quote it seems like he’s punting by alluding to trade accounting identity truisms (capital accout surplus means a current account deficit).
How about if we run this by Curley (he can consult with Moe). Let the renminbi float, a higher renmindi with reduce our trade imbalance, less trade imbalance means less borrowing to maintain the identity (missing one term): Balance of payments = Capital Account +/- Current Account=0. The cost of external funds my rise so we’ll have to reduce our deficit. Curley and Moe won’t like this but the best way to do it is to reduce government spending 😎
VtCodger,
In most countries around the world both private and state owned businesses deal with fluctuations in commodity prices, whether it be the one they’re selling or purchasing as input and the deal with changes in exchange rates. The Chinese are not dummies so I think they can figure out how to perform this function. So we’re back to them seeking and self centered trade policy.
fluctuation
rl love,
Yes, yes, yes and yes
Let me guess, you’ll have what the chinese are having.
VtCodger,
In most countries around the world both private and state owned businesses deal with fluctuations in commodity prices, whether it be the one they’re selling or purchasing as input and the deal with changes in exchange rates. The Chinese are not dummies so I think they can figure out how to perform this function. So we’re back to them seeking and self centered trade policy.
VtCodger,
In most countries around the world both private and state owned businesses deal with fluctuations in commodity prices, whether it be the one they’re selling or purchasing as input and the deal with changes in exchange rates. The Chinese are not dummies so I think they can figure out how to perform this function. So we’re back to them seeking a self centered trade policy.
I’m not ruling out M-F, I’m just using a modern version of it, not a simplistic undergrad model from the 60’s.
The crisis already happened in case you didn’t notice. Undervalued pegs can result in inflation within the pegging country OR (OR!) deflation in the country to whom they are pegging
Think about this: is it possible, through CB operations and targeted capital controls, the Chinese could keep the domestic price level stable? By blocking the normal sources of inflationary pressure, did they actually introduce deflationary pressures into the US economy?
Think about that for a while.
If that means I put justice and truth above patriotism, then, yes, is my answer. But I also believe that the US will benefit as well on levels other than economic ones. And like the Chinese, I am an ex-Communist. So their POV and mine are similar.
The US is wasting one of history’s great opportunities to achieve significant progress. So others must lead.
“History never repeats, but it does rhyme now and then” ~ Mark Twain
Ah Cantab, but most countries either don’t manage their economies or fail dismally when they do. The Chinese, like the Japanese before them, are doing well with their managed economy. Japan didn’t really get into trouble until they eased off on managing things — although I don’t think that was the major factor in their explosion in 1990. I’m quite sure that the Chinese studied Japan at length before they set forth to conquer the world economically. And my bet is that one of the things they learned (and Alan Greenspan didn’t) was “keep your bubbles under control” Their controlled exchange rate is one of their tools for doing that — I think.
Anyway, you asked why they don’t float their currency, not whether their failure to do so was something of a problem for other — possibly more ineptly managed — countries.
My own opinion is that the fixed exchange rate is modest problem, but that the failure of most (all?) G7 countries to run their own economies conservatively is a much bigger problem. Further, I think that economists who think that revaluing the renminbi is going to somehow rescue the G7 economies from the consequences of current and past excesses would be in for a surprise if the Chinese revalued or floated. Which, I’m guessing, they won’t in any meaningful manner.
Well, if the Chinese re-peg one time 2010 US exporters will cheer.
In answer to Cantab’s question, the employment situation within China is volatile, involving millions of ‘migrant’ laborers. Any shift to more domestic consumption needs to avoid severe disruption, so my guess is the peg is the last ditch effort to manage and keep the export based jobs going for now.
The Project 863 and others have invested billions in high speed rail (7000 miles this decade), advanced electrical grid, green tech, and research facilities and shared work experience for Chinese grads to work both in China and the US.
The US problem is what jobs other than finance can support regular folk, and how it can reduce (grow out of or reduce) debt both public and private. Our finance industry appears to feel their products are productive for regular folk….I don’t see it. We have a jobs program upcoming and might have a chance, and some stim spending, but our overall policy is unclear…re-valuing currency is par tof the deal for our own sake, but we have less control over that don’t we. Other Chinese policies are as important.
I have repeated stated the chinese beat us at our own game, WTO and all. Time for us to shape up.
Some excellent points Codger.
I laughed out loud when Cantab suggested that China should just do what everyone wants them to do and just float their currency. I wonder how he would respond to anyone suggesting the US should do what everyone wants them to do.
I really think we should just sit back and enjoy it. Receiving real stuff for little bits of paper is much better than actually giving real stuff away for little bits of paper. We have plenty of other ways to really change our economy rather than worrying about Chinas currency value.
http://www.nytimes.com/2010/02/08/opinion/08krugman.html
Then, there is of course, ability to govern.
Rebecca:
It is interesting to see the Yuan at 6.98 – 7.00 to $1. They have definitely come a long way from when I used to travel to China and it was at 8.2 to $1. Not quite a 20% devaluation; but, it is a significant movement.
Holding it steady at 7.00 to $1 does open doors to other countries
Greg,
I wonder how he would respond to anyone suggesting the US should do what everyone wants them to do.
If everyone wanted us to float our currency I would say as you wish, as it’s done. And all the Chinese bastards would raise their glasses and say three cheers for the Americans, what fine fellow they are.
Actually, I should think that if China plans to continue 8-10% GDP growth, their next problem is how to stimulate domestic consumption WITHOUT shrinking exports.
Surely, from their point of view, it’s internal consumption AND exports, not internal consumption OR exports.
I suspect that what you are seeing is driven much more by the world economic cycle rather than exchange rate considerations.
World trade and imbalances have collapsed because of the recession and it is logical to see China’s trade balance contract along with everyone elses balances.
Export prices are up to ten times domestic prices for many items. Which market would you choose given your druthers? Internal consumption is a key part of the plan, and given infrastructure improvements becomes more and more possible. Imagine that GM is saved by the Chineses car market.