Chinese trade officials are reluctant to change China’s dollar-peg currency policy, citing concerns over the fate of exporters. Vice Commerce Minister Zhong Shan has argued that exporters will fail if the currency appreciates because profit margins are often less than 2%. However, when China International Capital Corporation (CICC) performed an analysis evaluating the effect of a hypothetical 5% increase in the value of the RMB against the dollar, by comparing decreases in revenue with the cost savings from cheaper imports, they found that most manufacturing sectors’ profitability actually increased. But as Chen Deming, the Minister of Commerce, has said, ‘we also have our own employment and stability to think about.’ Decreases in revenue suggest reduced employment, which Chinese officials appear unwilling to accept. Maintaining the peg can also, at least temporarily, prop up facilities that would not be profitable at a higher exchange rate. Supporting ventures that are unprofitable at equilibrium exchange rates will not, however, foster economic growth over the long run. Read more »

Because foreign currency reserves are viewed as a form of insurance, the risks of excess reserves are often overlooked. Japan holds reserves equal to 20% of GDP, more than it could possibly need for insurance purposes. These holdings make up a foreign asset portfolio that is subject to exchange rate risk. However, this risk is hidden because Japan’s reserves are primarily held in U.S. dollars and their value is reported in U.S. dollars. So as the local and global purchasing power of the dollar falls there is no change in the reported value of the reserves. As shown in the chart, Japan’s reserves increased by over $100 billion since June 2007, but fell by nearly ¥20 trillion when measured in local currency terms – over 4% of GDP. The risk of large losses in national wealth is even greater for China, whose reserves make up 50% of GDP. This risk will become apparent as and when China allows the renminbi to appreciate, in line with market pressures. Read more »

Global imbalances, as reflected in the current account deficits and surpluses of the world’s major regions, fell with the collapse of trade and oil prices in 2008, but should rise again as both recover. This chart shows that global imbalances are driven primarily by the U.S. and China. Absent significant macroeconomic policy changes in one or both, the likelihood of a sustained, significant improvement in global imbalances, without another crisis, is small. Read more »

Over the last decade, Asia has developed into a major manufacturing base for the developed world. This relationship has provided mutual benefits: the West has received cheap goods while the East has developed its production capacity more quickly. China, to a significant extent, has been the assembler nation, importing raw materials and intermediate products from the rest of Asia and exporting finished products to the West. This relationship is illustrated in the chart above, which plots China’s imports from Asia and its exports to the U.S. and Europe since January 2000. Recently, however, this relationship has weakened slightly — China is providing more demand for Asian exports than the West is providing for Chinese exports. An important question is whether the strong Asian recovery can continue without a robust recovery in Western demand for Chinese goods. Read more »

China has accumulated a massive stock of U.S. dollar reserves in recent years. Statements of concern from China regarding the risk that U.S. economic policy might undermine the future purchasing power of these assets has fuelled the market’s concern that China may shift away from dollar purchases. Yet the chart shows that over the 12 months ending in July 2009 China accumulated more dollar-denominated assets, mainly U.S. Treasuries, than foreign assets in total. Despite its rhetoric, China has thus far taken no actions to wean itself off of the dollar. Read more »