With the Treasury’s verdict on global currency manipulators coming up on April 15th, the debate on the Chinese renminbi has not just been increasingly heated; it’s also turned ludicrous.
The ludicrous took center stage last week after a key figure in the Chinese leadership suggested that the renminbi is not undervalued.
Shortly after, two of the most loyal Ambassadors of Ludicrous—top economists at a couple of brand-name investment banks—argued that “the renminbi is not particularly undervalued…. China is importing a lot”; or that the US should mind its own business and save more.
Needless to say, these claims are, well, ludicrous.
Starting with the US savings argument… Since the third quarter of 2006, the US trade deficit has declined by almost 3% of US GDP—i.e. US national savings have risen by as much. And yet, the bilateral trade deficit with China has NOT. MOVED. (in US GDP terms). All the adjustment in the US external imbalance has been borne by other countries, notably oil/commodity exporters, Japan and the eurozone. China’s own contribution has been practically zero so far.
On top of that, most people refer to the global imbalances as a US vs. China problem. Not true. The eurozone, which has been running a trade surplus, has seen its trade deficit with China rise almost uninterruptedly for years now. Indeed, the increase in the bilateral deficit with China accounts for 70% of the deterioration in the eurozone’s trade balance since end-2001 (when China joined the WTO) and for one third of the deterioration since mid-2005 (when China began to appreciate its currency).
Both these examples show that the “need for higher savings” argument is bogus. No, I’m not saying that the US does not need to save more. The point here is that despite the recent rise in US savings, China has yet to bear the brunt of this adjustment, instead displacing other exporting countries, many of which are as poor or poorer. Yes, China is “importing more”. But clearly not *enough*. And a prompt and meaningful real exchange rate appreciation is a critical policy tool to make “enough” happen.
Then you have those who say that a renminbi appreciation won’t be of much help in reducing the bilateral deficit with the US. To support this, they point to the currency’s 21% appreciation vs. the US dollar since July 2005, which, seemingly, had no impact on the US deficit with China (the deficit kept increasing in dollar terms until the crisis escalated at the end of 2008).
This argument is equally bogus for at least two reasons: First, it ignores the role of domestic demand growth as a driver of imports. But more importantly, even a 20% change in the exchange rate means very little when the price and wage levels start from an extremely low base.
Chinese wages remain a tiny fraction of wages in the advanced world when measured in US dollar terms. They are also much lower than many of China’s developing-country competitors in global markets for, say, textiles or manufactures (e.g. see Peru, Turkey, Mexico, Romania). Meaning that even a further 20% or 30% appreciation may not be enough to bring wages to par with competitors.
Incidentally, for a country with a stated objective to reorient growth towards domestic demand, raising real wages would be an obvious starting point.
But it goes beyond that. Recent press reports cite that stress tests by China to assess the resilience of its exporters to renminbi appreciation found that some firms would be very sensitive and probably go out of business. In other words, many Chinese exporters only exist because of, effectively, a subsidized exchange rate level. Apart from being unfair in the context of a global competitive landscape, it’s also detrimental for China’s own efforts to move up the value-added chain, by fomenting complacency among its firms.
Finally, it’s amazing to suggest the renminbi is not overvalued when China has continued to accumulate FX reserves at a rate of $50 million an hour throughout the crisis! And don’t tell me it’s insurance!
After correcting for (an estimate of) valuation effects, almost half of that accumulation in 2009 was accounted for by the trade surplus—no need for insurance there. Another 20% can be accounted for by foreign direct investment flows—the most stable form of foreign investment with little need for precautionary reserves. Even if all the remaining flows were “hot money”, insurance does not involve covering 300% of those flows with reserves, esp. when you already have another $2 trillion in your coffers!
China’s exchange rate policy is a major distortionary force in global trade and also a key impediment for the smooth functioning of global capital markets and the conduct of monetary policy everywhere (including in China itself). As we speak, there are emerging market countries whose stage in the business cycle demands a tighter monetary policy. And yet, they don’t move because of fears of an exchange rate appreciation that would ruin their competitive edge in major markets.
China, along with every major economy interested in participating in, and profiting from, an increasingly globalized world, has a duty to take policies that foster stability in trade and capital markets. In China’s case, exchange rate policy is the number one issue. It’s irresponsible for anyone calling him/herself an economist to claim the contrary.
Originally published at Models & Agents and reproduced here with the author’s permission.