Dan Alpert's Two Cents

On China and the Yuan

China’s announcement of its intention to resume Yuan exchange rate flexibility is very good news for China, welcome news to President Obama and Treasury Secretary Geithner, and almost completely irrelevant to recovery of the U.S. economy.

To achieve equilibrium with emerging markets (over anything shorter than a generation’s growth timeline), sufficient for the developed nations to be competitive with the low cost BRIC countries – four times more populous – would require either massive appreciation in the value of the currencies of those nations (which the Chinese, at least, will not permit) or relative deflation in the wages, the prices of goods and services, and the real assets of the developed nations. The latter still appears more likely than the former, despite this past weekend’s announcement.     

Even ignoring the fact that the move by the People’s Bank and the Finance Ministry was almost entirely a political gesture towards a U.S. administration that has been nearly begging its friends in China for some gesture of exchange-rate rationalization in order to fend off rabid protectionist sentiment in congress, the economic reality of this very minor action is nearly entirely in China’s self interest.

China’s need to tamp down domestic inflation, accelerate its transition towards consumerism, and pay some degree of lip service to its distressed trading partners in the developed world (we should start calling Japan, North America and Western Europe the re-developing world…..more sympathetic) is clear.  Allowing the renminbi to appreciate against the major reserve currencies is a good way to do that.  But to have any major impact, the Yuan would need to appreciate far more than it is domestically palatable for China to permit except over the longer run (between two and five years from now we expect to see much more meaningful realignment, barring the renewal of severe economic contraction in the west).  Similarly, to have any meaningful benefit to western economies, employment and exports, Yuan appreciation would need to be in the 10% to 20% range, not the 1% or 2% range anticipated by currency futures markets.

The entry of the BRIC nations’ into the competitive capitalist economies is an unprecedented conundrum for the developed nations, given the enormous gaps between the two groups in wage rates, standards of living, and savings vs. consumption behavior.  To level the playing field (as best we could) for the decade since the emerging factory economies have come to full strength, we borrowed and they lent. We maintained our wages and living standards, and wend into debt to a level that has proven unsustainable. We inflated assets with the cheap money that piled up overseas and was lent back to us, only to see those assets tumble back to earth in the absence of real across the board inflation to match off against financially engineered asset inflation. 

In short, the Yuan revaluation anticipated by China’s announcement comes nowhere near what will be required to balance the global economy – a serious issue indeed, because all prior historic precedents for the present imbalance have led to conflicts among nations that have ranged well beyond trade wars.

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