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Five myths (or half truths) about China and the renminbi

by Brad Setser
May 23, 2005

China’s exchange rate peg has attracted a lot of attention recently, in the market, among the public and in the press. (also here, here and many other places)

Alas, too much of the commentary seems to me to reflect arguments that at least to me don’t seem to be true, or seem to be only half true.

Arguments that appear often include:

1) China runs a surplus with the US, but a deficit with the world; its overall trade is close to balanced. This is a myth. China’s trade surplus with the US exceeds its trade deficit with the rest of the world. It ran a trade surplus of $32 billion in 2004. That surplus is set to widen significantly in 2005, since China’s exports are growing far faster than its imports. China’s trade surplus in 2005 could reach $100 billion or more, according to Jonathan Anderson of UBS. China’s overall current account surplus is larger as a share of GDP than Japan’s, and it is rising rapidly — it could be 7% or 8% of China’s GDP in 2005.

2) China hasn’t changed its currency peg since 1994, it therefore cannot be trying to keep its currency down. Back in 1998 there was concern that China might devalue. The last statement is true (counting back to 1998), but the rest I would argue reflects a myth — namely that so long as China is not pushing its currency down in nominal terms, it cannot be “manipulating” its currency to impedge effective balance of payments adjustment. Put simply, a lot has changed since 1994. China’s economy is far more productive. It now exports $595 b of goods, and it is on track to export 750-770 b in 2005 (One note, i previously used a Goldman estimate of end 2004 “exports” that was around $700b; Goldman’s definition of exports was very broad — goods exports are closer to $600b. My apologies.) v well under $200 b back in 94. That increase in productivity should have led to an appreciation of china’s currency in real terms, whether through higher inflation rates in China or through a rise in the renminbi’s value against other currencies. Neither has happened. One other thing has changed, particularly since 1998. From about 1995 to 2002, the dollar was generally rising; from 2002 (leaving aside its recent rally v. the euro) the dollar has been falling.

There is a reason why China’s current account surplus has been rising, and why China’s reserves are rising even faster. Lots has changed since 1994, and since 1998.

3) Chinese wages are so far below US wages (and for that matter wages in other industrial countries, and many emerging economies) that a change in the renminbi won’t have any impact. Myth. Goldman Sachs estimates that a 1% rise in the renminbi’s real value (which can come either if Chinese inflation is 1% higher than inflation in the rest of the world, or is China’s currency rises by 1% and inflation is unchanged) leads to a 1% reduction in China’s export growth rate.

It is not all that hard to see the impact of changes in China’s real exchange rate on China’s exports even without a fancy model. China’s exports to Europe are up by something like 50% in q1 — probably a reflection of the fact the the RMB has fallen substantially v. euro over the past few years. And, as I noted previously, from 2002 on, as the dollar has fallen, China’s export growth has averaged over 30% y/y; from 98 to 2001, the average growth rate was only 13.4%.

Whether a slowdown in China’s export growth leads to a slowdown in the growth in the US trade deficit or the substitution of other imported products for Chinese products is a different question — it depends on what happens to US savings and consumption along with the availability of financing to cover the US savings deficit, not just the RMB/$.

4) China is just taking market share away from other Asian economies. That was true between 2000-03. But it is also no longer true. Hence, this too is something of a myth. The element of truth: in 2003, US imports from the Asian Pacific region were exactly what they were in 2000. Remember, in 2001, overall US imports fell sharply, including US imports from the Asian-Pacific region. It took some time for them to recover. From 2000-2003, imports from China rose as a share of US GDP, but imports from the rest of Asia fell as a share of US GDP. But in 2004, US imports from the Asian Paficic region as a whole rose by 18% — and consequently rose as a share of US GDP. Even taking away China, imports from the rest of the Asia Pacific grew faster than US GDP. The same looks to be true in 2005 …

Imports for Asia as whole are up 15.5% in q1; Imports from China (even with the lunar new year effect) are up 30%, imports from Korea are up 14%, Japan 8.5% … overall imports from Asia are rising far faster than nominal US GDP.

5)China is America’s fastest growing export market. Myth. Y/Y exports to China are up 0% (q1 05 v q1 04). Exports to the Eurozone are up 8.5%, Canada 12%, South America 11%. Over a longer period of time, US exports to China have grown fast in percentage terms (in line with the very rapid expansion of China’s imports from everyone — China’s overall imports rose from $278b in 2000 to $561b in 2004). But the base was very low. In 2004, US exports to China increased by 22%, or $6.3 billion. Exports to Europe did not grow as fast, but in dollar terms, they increased by much more — $16.8 billion.

What has grown fast is US exports of debt to China — China’s reserves increased by $160b in 2003, $206 b in 2004 and look set to increase by at least $300 b in 2005. Most of those reserves are invested in US dollars, even if not all Chinese purchases show up in the US data.


There are two other arguments that are often made about China’s peg that while not exactly myths, are not quite as obviously true as is often assumed.

6) China’s peg increases employment in China by stimulating its export sector.

There is no doubt that the peg, by contributing to rapid export growth, is contributing to rapid increase in employment in the export sector. 30% y/y growth creates jobs in the export sector even with rising productivity. But the overall impact on employment is much more ambiguous, since the peg also keeps China’s domestic interest rates down. With borrowing rates of 5 or 6% in an economy that is growing at 10% (and with producer prices rising rapidly), capital is very cheap in China. And no surprise, cheap capital creates an incentive to substitute capital for labor. I don’t know the magnitude of the different effects, but the peg’s overal impact on employment in China is less clear than is often asserted.

7) Changing the peg would devastate China’s banks. This is a topic worth a post of all of its own, but it not at all obvious.

China’s banks don’t have any real economic capital — they are technically insolvent, so letting them bet on the exchange rate is not without its risks. But so to is letting them lend domestically. Heads, the bank wins; tails, the China’s taxpayers face an even large bill for cleaning up the banks. Without real economic capital, Chinese banks need to be regulated tightly across the board.

Above all though, it is not at all clear to me that exchange rate stability is strengthening rather than weakening the banking system. Afterall, in 2003, rapid reserve growth was fueling very rapid credit growth — lots of new lends helped to reduce the ratio of NPLs to total loans, but if rapid credit growth leads to a new generation of bad loans, the banks are not getting better. Right now, the government has crimped credit growth with controls. As a result, the banks are buying government sterilization paper at very low rates. This too has a cost: it makes it harder to finance cleaning up past bad loans out of ongoing profits.

China’s banks generally don’t have direct exposure to a change in the peg. They generally take in deposits in RMB and lend out in RMB. No direct exchange rate risk there. Moreover, the risks of a revaluation are not the same as the risks of a devaluation: a revaluation generally makes it easier to repay dollar debt. Some of the capital of China’s big four banks is denominated in dollars because China used its reserves to recapitalize the banks, creating something of a mismatch. But the authorities know about this, and they will compensate the banks for any exchange rate changes.

A bigger concern is that a revaluation potentially hurts firms that have borrowed in RMB to invest in the export sector. Their dollar revenue falls, the RMB debt stays constant. However, there are offsetting effects — imported components are cheaper, and if Chinese firms can increase their dollar prices, their renminbi revenue won’t fall much. I suspect most Chinese firms will manage — even a large revaluation is likely to slow the growth of China’s exports, not end it.

That is why I agree with the leader in this weeks’ Economist: China should revalue, both because it is in its own interest and because it is part of the set of actions needed to generate a less unbalanced world economy.


  • Posted by SJ

    That’d be seven myths, not five. ๐Ÿ˜‰

    Seriously, though, good reading, as always.

  • Posted by glory

    hehe, this format (myth/fact) seems to be gaining in popularity ๐Ÿ˜€


  • Posted by Edward Hugh

    I don’t think Brad, many of us would disagree that China should revalue (or rather ‘flexibilise’). The issue is when, in what way, and above all what the consequences would be.

    Whatever the rest of the world wants I wouldn’t be too optimistic that the Chinese administration are going to be pushed anywhere very quickly.

    There are lots of points, but this seems to be the key one:

    “Myth. Goldman Sachs estimates that a 1% rise in the renminbi’s real value (which can come either if Chinese inflation is 1% higher than inflation in the rest of the world, or is China’s currency rises by 1% and inflation is unchanged) leads to a 1% reduction in China’s export growth rate.”

    I think one would need to see the methodology applied by Goldman Sachs (you wouldn’t have the link would you?). I mean intuitively I find this hard to accept.

    You youself yesterday were citing Greenspan about how German exporters have swallowed a 40% plus rise in the currency and still go from strength to strength.

    If Goldman Sachs say one thing, Morgan Stanley – in the shape of Andy Xie – say another. I tend to trust Andy’s intuitions on China, and they fit with mine. But it shouldn’t come down to this: we should have some way of trying to validate our intuitions.

    My reasoning would be, following Xie, that the differentials between prices of origin in China and end prices in Europe and the US are so huge that there is bags and bags of room for absorption along the line. So I don’t think that Chinese exports are likely to reveal the kind of currency sensitivities which you suggest.

    Of course there are more arguments. Firstly one could look at the excess fixed capital formation that is taking place in China. A chunk of this is going to end up in products which arrive at end users. This xcess capacity will exert deflationary pressures on prices ex works in China, and these could easily compensate for any upward movement in currency.

    Then there is outsourcing. If China is as so sensitive to currency movements then China will outsource: either into the vast interior of China itself, or, as has already been happening as wages have been slowly ticking up in China, to Cambodia, Vietnam and elsewhere. Of course, the ability to do this depends on the product profile. It depends on the level of skill input required, but my guess is that in many of the cases where China is having export success, part of the supply chain is in fact mobile.

    OK, that more or less is why I think this myth isn’t such a myth.

  • Posted by anne

    Nice post and response.

    “Myth. Goldman Sachs estimates that a 1% rise in the renminbi’s real value (which can come either if Chinese inflation is 1% higher than inflation in the rest of the world, or is China’s currency rises by 1% and inflation is unchanged) leads to a 1% reduction in China’s export growth rate.”

    This simply has to be wrong. Chinese exporters and American importers are not on so tight a margin that the effect of an incrase in value of the Yuan against the dollar will not be muted by price adjustment.

  • Posted by jm

    Reading some Toyo Keizai articles about the Chinese economy this weekend, and then starting in on “Conspiracy of Fools” about Enron, I was struck by the many similarities. Though I usually compare Asian mercantilism to bubble-era telecom vendor financing by Lucent/Nortel/et al, Enron seems perhaps an even better model.

  • Posted by vorpal

    Myth: The only economically responsible response to China’s peg is to ask them to change it. No other options are available.

    There are many economically sound responses to a currency peg. Perhaps economists may disparage them as being out-of-fashion, but their net effect would be equivalent.

  • Posted by glory

    looks like they’re signs of a slowdown and paul mcculley is saying fed might be done tightening soon, esp if ISM falls to 50 over the next few months, altho richard berner does not agree, essentially saying bond markets are wrong ๐Ÿ˜€


  • Posted by Navin

    I found this shocking piece on dollar movement at Investordiaries blog run by PC ..

    “How about this scenario – a long and deep secular economic contraction finally starts to reverse the US trade deficit. Dollar demand is high due to all the outstanding Dollar denominated debt obligations that needs to be repaid. So the Dollar continues to strengthen relentlessly due to a collapsing current account deficit plus strong demand for the greenback.”

    I don’t fully understand how a “collapsing CA deficit come”. ?

    I thought strong dollar is bad for US.. as it will ruin the US exports

  • Posted by w

    jm, et al,

    You got me into looking@ some old Toyo Keizai-like stuff, July 8, 2000, Re: “At some point, Japan will have to switch its priorities from the stimulation of its economy to fiscal rehabilitation.”

    A few other old hillbilly-hilites:

    When the Hong Kong economy was in the midst of a currency crisis in 1997-98, the U.S. was in an information technology bubble. Lowering interest rates was not an option for Hong Kong despite its economy being in a moribund state. And you cannot expect Greenspan to ease monetary policy for the sake of Hong Kong. Should China peg the yuan to the yen now, its monetary policy would be largely decided by the Bank of Japan, and this may not be in China’s own interests.

    Also: “For instance, it would be extremely difficult for an oil-producing country and a non-oil-producing country to have a common currency because fluctuations in oil prices bring opposite effects”.

    Also: China needs to give up either independence in monetary policy or exchange rate stability. Between these two options, the former is unacceptable to China because it is tantamount to letting Greenspan take charge of its monetary policy.

    So, shifting into a more flexible foreign exchange system is an inevitable step that China needs to take sooner or later for its own sake, not for the sake of someone else. However, because such a move can be flattering to some other countries, China wants to choose the right timing to play this card so as to maximize chances for reward.

  • Posted by PC

    If the US economy went through a long secular contraction, consumption will collapse thereby reducing the trade deficit in a hurry.

    I think it’s interesting how the momentum in the media and the general public is now of the opinion that “China needs to do something” in order to correct the US imbalances (the power of the herd). While we discuss myths and half truths, this is the biggest myth and lie.


  • Posted by brad

    Edward —

    The Goldman paper looks at overall chinese exports/ imports, not us-chinese trade. And the basic reasons for the econometrics are pretty easy to see — China’s export growth rate picked up dramatically after the real exchange rate started to fall in 02 (along with the dollar).

    Vorpal — higher inflation in china/ lower inflation (deflation) the US is another way to bring about real exchange rate adjustment. I don’t like it, but it would work — however, right now, we are not seeing major inflation differentials, so real adjustment is not happening through that channel.

  • Posted by CalculatedRisk

    US Tells China To Revalue Yuan By 10% Vs Dollar – FT

    NOTE: No link, from a friend.

    Dow Jones News Services

    TOKYO (Dow Jones)–The U.S. Treasury has told China that it must revalue its currency by at least 10% against the dollar to prevent protectionist legislation in the U.S. congress, the Financial Times reported in its international edition Tuesday.

    Henry Kissinger, former U.S. secretary of state, is one of a number of unofficial envoys who have impressed upon China the urgent need for action, on the 10% target and on the seriousness of the threat from Congress, people familiar with the administration’s efforts told the FT.

    As well as the minimum 10% target revaluation, Kissinger was briefed by the Treasury on the need for other measures, such as a shift to a currency band against the dollar or a basket against a number of currencies to replace the peg.

    Bill Rhodes, senior vice chairman of Citigroup Inc. (C), and Brent Scowcroft, national security adviser to former U.S. President Gerald Ford and former President George H. W. Bush, have also acted as unofficial envoys on behalf of the administration, the FT said.

    Rhodes declined to comment on talks with Beijing but said: “Apart from any external pressure, I think it’s in China’s interests in the coming months to move towards a market interest rate regime, accelerate the opening of the capital accounts, and move to a more flexible exchange rate system,” according to the FT.

    Tony Fratto, U.S. Treasury spokesman, refused to comment on the 10% minimum target. “We have made it clear that the interim step should be of sufficient magnitude and flexibility to quell speculative financial flows,” he said, according to the FT.

    On the missions of Kissinger and others who have spoken to Beijing, Fratto said: “Without commenting on particular individuals, I would say it is important for the Chinese authorities to hear from respected individuals who can provide an accurate analysis of the American political environment.”

  • Posted by MTC

    “At some point, Japan will have to switch its priorities from the stimulation of its economy to fiscal rehabilitation.”
    – Dr. Sachio Konishi, Kansai Gakuin University

    “For instance, it would be extremely difficult for an oil-producing country and a non-oil-producing country to have a common currency because fluctuations in oil prices bring opposite effects.”
    – C. H. Kwan, RIETI

    I am not sure I understand the points you are trying to make in offering these quotes. Could you be more expansive in explaining your thoughts on these matters?

    Konishi is probably one of the more asiduous analysts of prefectural and municipal fiscal policies. I am worried that he skates close to the edge of equating national fiscal policy with the sum of local fiscal policies.

    Kwan is a wonder. It is a shame he has stopped posting his occasional research note “China in Transition”

  • Posted by MTC

    My above comment should have been addressed to w.

    Q: Are Japanese insurers, borrowing PC’s turn of phrase, starting to “think” or “see”?

    Meiji Yasuda, Sumitomo Life May Sell Treasuries, Buy Yen Bonds

    May 24 (Bloomberg) — Meiji Yasuda Life Insurance Co. and Sumitomo Life Insurance Co., Japan’s third- and fourth-largest life insurers, may sell U.S. Treasuries and buy Japanese bonds, reversing a strategy used last year to boost profits…

  • Posted by aeolius

    Renminbi and dollar
    Yapchongyee Updated: 2005-05-18 10:43

    China need not revalue her yuan/renminbi. The US$/renminbi peg is not any bilateral agreement, and the USA can if they want to sell to China cheaper devalue the US$. No one is forcing the USA to hold their exchange rate as they have today. They can do what is asked of China and devalue; this is common sense and the USA has no strings to pull.

    The USA cannot dictate to China. What will the USA do if China asks the USA to devalue ? Why must China suffer ? Why not the USA suffer ? The problem with the USA is that she can only see what others can do for the USA and not what the USA can do for others. There is no commonsense that China has to sell “expensive” when it is to the advantage for China to sell “cheap.” The USA can also sell “cheap” if they can but they cannot because the Americans want to live at a level that is 100 times better than the people of China; Therefore why should the Chinese make life better for the Americans by 100 times better than their own ? Why is it not the responsibility for the USA to live 50 times lesser than the Chinese instead of 100 times better than the Chinese ?

    Competitiveness is about achieving effenciency; if the USA is what they say they are (the most competitive society)then they should be able to beat the Chinese at what the Chinese are ding so well. The USA must be able to sell much cheaper than the Chinese. Having said that the USA must compete better and become better than the Chinese. What is the worth of the WTO if it is not aimed at producing at the most efficient and therefore at the cheapest ?

    CHEAP LABOUR IS CHINA’S COMPETITIVE ADVANTAGE AND IF CHINA SURRENDERS THIS ADVANATGE THEN CHINA WILL BECOME ANOTHER THIRD WORLD PRODUCER AND AT THE MERCY OF THE USA> I say to our leaders in Beijin not to revalue at the demand of the USA. The Americans will have to find their own solutions and not depend on China to take the fool’s “ROAD”

  • Posted by DOR

    Interesting post.

    I’m having a bit of trouble with the math.
    China’s exports, 2004: US$593.37 billion, exports to the US: $124.95 billion, exports to the Rest of the World: $468.42 billion

    China’s imports, 2004: $561.42 billion, imports from the US: $44.68 billion, imports from the ROW: $516.74 billion

    Balance with World: +$31.95 billion, balance with US: +$80.27 billion, remainder: –$48.32 billion.

    Isn’t that a deficit with the rest of the world?

    * * *

    I still can’t get to 7-8% of PRC GDP current account surplus without holding nominal GDP growth to 5% and doubling the currant account surplus to over US$137 billion (or, some variation thereof).

    Last year’s trade balance (current-account basis) was 85.9% of the current account balance. If the ratio holds, that implies a US$118 billion trade surplus to reach 8% on 5% nominal GDP growth.

    * * *

    The point about China’s share of US imports from Asia seems to be using one data point (2004) to refute the pattern. Since the pattern is a decade old, perhaps we need a few more data points before we can conclude that China is indeed creating new market share, rather than taking it from others. Further, the point I have made about this phenomena isn’t about China’s share of imports as a share of US GDP (which would have more to do with US growth and inflation). It is about substitution.

    * * *

    According to Chinese figures, imports from the US rose 34.1% in 2004, or by $11.4 billion. Imports from the EU grew 33.6%, or $17.6 billion.

    China’s exports to the US and Europe are up very strongly in the first quarter of 2005. Not as strongly as in Q-4 2004 (41.2% vs. 47.6%), which is also true of sales to the US (36.9 vs. 40.7%). Why the slow-down?

    * * *

    The Lunar New Year effect always, always hits in the first quarter. Hence, there is no effect on quarterly data.

  • Posted by w


    Re: I am not sure I understand the points you are trying to make in offering these quotes.

    The overall point was to link economic thinking from the past, to the currency issue at hand, i.e. Dr. Konishi simply made a point that Japan needed to focus on fiscal rehabilitation, versus synthetically attempting to stimulate a failing economy already weakened from derivative manipulation gone awry. That period has also been linked to asset pricing inflation and thus similarities are worth thinking about in regard to our current global un-pop able housing bubble — which of course is connected to new improved derivatives and a “stronger” house of cards.

    As for the Kwan quote related to oil, it connects to the following out-take and further demonstrates the growing danger of hedge fund trading, i.e., oil, currency, bonds, etc.,:

    (2001) explained, from the practical viewpoint, that large and liquid
    international capital markets make it more difficult for national authorities
    to support a shaky currency peg, since the resources of the markets far
    outstrip the reserves of even the best-armed central banks and

  • Posted by MTC

    aeolius –

    It would not be out of place to note that the text you have posted is a Letter to the Editor.

  • Posted by Stormy

    After tirelessly reading about the tireless Chinese, I guess they are going .

    Thanks, movieguy.

  • Posted by Fred

    Re: Movie Guy’s list –

    Could China be looking frantically for new markets because it expects the US consumption binge to end? At some point we will have extracted all that we can from the housing bubble and spending will plunge or decrease anyway. But then who will buy our treasuries particularly with declining tax revenues?

  • Posted by Stormy

  • Posted by Stormy


  • Posted by Movie Guy

    A bit more clarification on MTC’s valid point…

    The article/letter cited by aeolius in a previous post was written by Yapchongyee, one of eleven (11) “Forum Columnists” listed by name in a header column under the Reader’s Voice opinion section in the China Daily.

    The other “Forum Columnists” have authored a number of Reader’s Voice “Forum Columnist” opinion letters. One author, Bossel, is credited with only two such opinion letters, but the majority have written quite a few pieces. By appearance and recognition by China Daily, these opinion letters represent more than routine letters to the editor. One follow up poster commented that Yapchongyee is paid for his opinion pieces. The “Forum Columnist” letters are listed separately from the general letters to the editor.

    The opinion piece under discussion is Renminbi and dollar, opinion by Yapchongyee, Updated: 2005-05-18 10:43.

    Yapchongyee, identified in a subsequent comment post as an attorney, is the author of eleven (11) opinion letters. Access to the other opinion letters by Yapchongyee is available here.

    Yapchongyee offers additional remarks in the follow up comments posted under the article. There are twelve pages of such comments. Additional views of the author are shared on page 4 and
    page 8.

    Anyway, it’s interesting to note such viewpoints from persons in China.

  • Posted by Movie Guy



    I believe that the Chinese government and corporate leadership are going global in a big way. And, of course, have been for some time.

    But most Americans won’t note such news because the loud and amateur U.S. news media generally fail to capture the overall efforts of China as it moves forward on numerous governmental and commercial fronts.

    It’s difficult to paint an accurate picture if you don’t know the size of the canvas. Many in the U.S. news media have no clue, and they take the sound bite shortcut to fill air, print, and internet space.

    If you are playing chess, see the whole board.

    China sees the whole board.

    I am not so confident about Team USA’s ability to do so.

  • Posted by Phil

    Brad, per this comment: “The Goldman paper looks at overall chinese exports/ imports, not us-chinese trade. And the basic reasons for the econometrics are pretty easy to see — China’s export growth rate picked up dramatically after the real exchange rate started to fall in 02 (along with the dollar).”

    Seems to be it might be more valid to measure FDI versus exports, since FDI (much of which is destined for export facilities) was increasing at a $50-$60 billion rate in the years Goldman mentioned.

    I’m no economist, but extrapolating that exports will decline X amount if the currency rises Y amount, just because exports gained a certain amount while the relative value of the currency fell, is pretty shoddy economics. Especially since exports were also rising quickly in the previous years when the currency was relatively stable. I would bet a study of FDI versus exports would more closely correlate with the facts than relative currency values.

    Here’s a paragraph on this issue from a research paper I found from a quick Google on FDI effects (

    “China has realized benefits from the rapid increase in total exports from about $10 billion in 1978 to over $125 billion in 2001.[6] The value of China’s exports currently ranks 10th in the world. Much goes to the “foreign-owned” manufacturing enterprises for this export growth (Economist Intelligence Unit, 2002b). A large portion of FDI is for establishing manufacturing facilities to produce goods for export. Exports from Nokia’s eight joint ventures alone accounted for about $2.3 billion in 2001, making it the largest foreign-investment exporter in the country’s communication sector (Li, 2002). Job creation has been significant. For example, Nokia has invested heavily in China, and one new manufacturing facility located in the Beijing area has created about 15,000 jobs (Li, 2002). Foreign-owned, export-oriented enterprises have raised income and benefit levels since foreign firms tend to pay more and offer more comprehensive benefit packages than mainland Chinese-owned firms. Another benefit from rapid export growth has ensued from its contributing to China’s very positive balance of trade. the IMF projects the overall balance of payments will register a surplus of at least $15 billion in 2002. In the process foreign exchange reserves have grown consistently to over $210 billion by the end of 2001, more than double the 1995 level (IMF, 2001). As a result, China has been able to maintain the Yuan’s value relative to the dollar at very close to a $1 = Yuan 8.28 for the past five years. This stability has served to maintain high foreign investor confidence, thereby promoting FDI in China.”

  • Posted by MTC

    Movie Guy –

    Thank you for the research on the China Daily’s “Forum Columnist” Yapchongyee.

    Paid-for letters to the editor…hmmmm…I would have never thought of that.

    Once at a party I was attending in Sonoma County an acquaintance remarked, “What is great about California is that no matter what you do, someone is willing to pay you to do it.”

    It would seem that this once exclusively Californian proclivity is now a worldwide phenomena.

  • Posted by Edward Hugh

    “China’s export growth rate picked up dramatically after the real exchange rate started to fall in 02 (along with the dollar).”

    Just two points here Brad: Firstly these things are not necessarily symmetrical – you may react differently to an opportunity than you do to a threat, it is easier to hire workers and buy equipment than it is to fire and ‘decomission’ them. ie once you’re in for the fixed costs, the economics of decision taking are different.

    Secondly, there is the cause/effect problem. ie was the important point here a cheap renminbi, or a high euro. My feeling is that you need to start from the latter, and its impact on re-structuring in Europe.

    Prior to 2002 China outsourcing was very much a US thing, probably driven by the high dollar and the need to sell to Europeans and Japanese (we need some trade theory as well as econometrics here). So post 1995 the US corpration increasingly reaches out globally to extend supply lines, and discovers China. The EU response – as with IT – comes later, and post 2002 there is a major push into Central Europe and China.

    So the methodological question is what is driving what here. As I say, given the capacity expansion in China, any obstacles to trade are just going to drive prices down there.

    The point maybe is this:

    “leads to a 1% reduction in China’s export growth rate”.

    Now is the export growth rate being driven primarily by the value of the currency, or by the increase in fixed investment, which may be rather responding to other factors? All I am really saying is that this problem is a fairly complex one, with a lot of inter-connections, and I still am not convinced that the Goldman Sachs argument gets us very far.

    Also, of course, if the myth is that a revaluation ‘won’t have any impact’ then clearly it is a stupid one: some impact there will be (so it’s a trick question ๐Ÿ™‚ ). The question is: will a renminbi revaluation have the consequences that its most vociferous advocates assume it will? I think this is much more open to doubt.

  • Posted by jm

    “… the myth is that revaluation ‘won’t have any impact’…”
    “… given the capacity expansion in China, any obstacles to trade are just going to drive prices down there …”

    It’s often said that Chinese living costs are only a tenth of those in the US. And wages are less than a tenth. Why? Because the government sets the exchange rate by fiat. In the early ’90s it was about 5.7 yuan to the dollar, but they decided to devalue to 8.2. Some commentators trace the Asian financial disasters of the ’97 timeframe back to the effects of that devaluation.

    Because their totalitarian government denies Chinese labor the right to trade its labor with the rest of the world at market prices, the favored who are able to exploit that labor see a potential for enormous profit. They have responded by building capacity for production of exportable goods that greatly exceeds what demand for those goods would be if Chinese workers could get free-market prices for their labor.

  • Posted by DOR


    Chinese exports vs. FDI, average annual percent change 2000-04:
    _ _ _ _ _ 1995-99 _ _ _ 2000-04
    Exports _ _ +10.0% p.a. _ _+24.9% p.a.
    FDI* _ _ _ +3.6% p.a. _ _ _ +8.5% p.a.
    * utilized.


    I’m curious where you get the notion the Chinese government denies Chinese labor the right to trade its labor with the rest of the world at market prices. Given than 57% of Chinese exports are from foreign-invested enterprises, that seems to me contradictory. Eliminate foreign-invested enterprises, and you get massive unemployment, social unrest and regime change. Oh, and probably a distracting war, to boot.


  • Posted by DOR

    Sorry. I threw in the 1994-99 data without changing the title.

  • Posted by satch

    Chinese bank exposure to the Dollar is more substanial than you indicate. On the asset side of the Liability side of their (collective) balance sheets are a large proportion (20% by memory) of Dollar denominated deposits. Also on the liability side is the capital that the PBOC injected two years ago and then early this year. This capital I believe is denominated in Dollars, and does double duty continuing to be counted in the International Reserves while also helping recapitalising the banks in anticipation of their sale on international stock markets this year. This represents a couple of percent of the Balance sheet. By contrast most of the asset side of the balance sheet (ie Bank loans and Government Bonds)are denominated in RMB. A small change in the currency has substanial affect on the already parlous capital position of banks because of this Liabilty/Asset Currency mismatch.

  • Posted by jm

    DOR: I didn’t write that they can’t trade their labor, I wrote that they can’t trade it at market prices. The pegged yuan/dollar rate denies them that right.

    I am not referring to workers in the export industries — in terms of local buying power, they are being subsidized along with the factory owners (though nowhere nearas much) — the international buying power of everyone else in china is being held down to perhaps a fifth or tenth of what it might be in the absence of the peg.

    Do you think this is good? From the tone of your post I gathered that you believe in the glory of free markets.

    If the current yuan/dollar rate were anything like the rate that would exist in the absence of the peg, why the refusal to remove the peg?

  • Posted by jm

    DOR: Having a few minutes more…

    You write, “Eliminate foreign-invested enterprises, and you get massive unemployment, social unrest and regime change.”

    Although allowing the yuan/dollar rate to adjust to free-market levels would not eliminate all foreign-invested enterprises, it would certainly reduce the scope of their operations, and so indded might lead to “massive unemployment, social unrest and regime change.”

    But why? Would employment in the exportable goods industries shrink if it were not currently at a level above where market prices would place it in the absence of the exchange rate manipulation? If it is at such a level, what right does the Chinese government have to place it at that level?

    And if the consequences of the resulting trade imbalances are that punitive tariffs are voted into place in the US and Europe, and we descend again into the world of Smoot-Hawley, will this consequence of the “rational planning” of the Chinese government have benefited even its own people?

  • Posted by DOR


    Yeah, I kinda like free markets. Never met a bureaucrat or politician who could set prices worth a damn, and I’ve met a lot of bureaucrats and a lot of politicians from a lot of countries.

    You assert a Chinese worker is unable to trade her labor at market prices on the world economy. If she could, would her income go up or down in real terms?

    How is this different from in Anguilla, Antigua and Barbuda, Aruba, the Bahamas, Bahrain, Barbados, Belize, Bermuda, Burma, the Cayman Islands, the Democratic Republic of the Congo, Cuba, Djibouti, Dominica, Grenada, Hong Kong, Iran, Iraq, Liberia, Montserrat, Netherland Antilles, Nigeria, Oman, Panama, Qatar, Saudi Arabia, St Kitts and Nevis, St Lucia, St Vincent and the Grenadines, Syria, Turkmenistan, or the UAE?

    They all fix or hold closely the local currency’s value to the US dollar, but only China gets bashed.

    You assert that Chinese consumers are having their international buying power restricted by the peg. But, Chinese consumers don’t consumer foreign products. OK, some do, but we’re talking about a small percentage of the urban coastal population and none of the one billion farmers.

    If the renminbi exchange rate wouldn’t move, on economic grounds, if it were depegged, why depeg? All you do is open yourself to currency speculators out to make a quick euro before lunch. There are enormous costs in terms of uncertainty, best measured in the cost of hedging. Why bother?

    On foreign investment, is there a reason why it would be wise to test social stability by playing around with the exchange rate? Or, are the potential costs so wildly out of line with the potential benefits that no one wins?

    What right does the Chinese government have to determine the value of its currency? Sovereignty. Nothing more, nothing less.

    If the US does something incredibly stupid like Smoot-Hawley, something that undermines both the global trading system and US consumers buying power, is it the Chinese’s government’s fault? Should the PRC hurt itself to prevent the US from hurting itself?

  • Posted by Movie Guy


    It’s not very realistic to compare the economic impact of China to the countries and islands that you listed, with the exceptions of Saudi Arabia and perhaps Qatar and/or UAE.

    But as long as you are identifying those pegged to the U.S. dollar, add these:

    East Timor

    El Salvador

    Equador (uses U.S. dollar now, but was pegged previously)


    Macao (Macau)



    North Korea


    Plus the other U.S. territories and islands actually using U.S. dollars:

    American Samoa

    British Indian Ocean Territory – mostly us dollars used

    British Virgin Islands


    Midway Islands

    Puerto Rico

    Samoa (America)

    Turks and Caicos Islands

    Virgin Islands

    Wake Island

    Western Samoa

  • Posted by PDR Veteran

    Have to take issue with your refutation of Myth #3. Key is Chinese value added to exports. For many of its largest exports such as electronics (including electronic toys) the components are imported. Chinese valued added comes from assembly, which takes advantage of cheap labor. As a result, estimated value added for Chinese exports is just 20-30%. That means a 20% appreciation of the Yuan yields a 4 to 6% increase in the export price. Maybe Walmart consumer elasticities are pretty high, but that $30 dollar DVD player still looks attractive at $31.50.

  • Posted by brad

    pdr vet —

    the transfer of assembly production to China is an easy way to generate very rapid export growth — it presumably explains a portion of recent Chinese export growth. unless that process has already run itself out, a revaluation would at the margins reduce the incentive to transfer additional assembly work to China, and thus slow China’s export growth rate.

    I think the evidence that the real depreciation that started in 02 has led to an acceleration of China’s export growth rate is pretty clear; i suspect a revaluation would lead to some deceleration (on top of the deceleration that almost certainly has to happen simply b/c 30% y/y gets harder as the base gets bigger — see microsoft, others). I am open to alternative explanations for the acceleration that started in 2002, but i think any argument that “revaluation” won’t have any impact has to look at how China’s exports have responded in the past to real appreciation (98 on) and to real depreciation …

    right now the incentive to shift assembly production from elsewhere in Asia/ Europe/ even US to china seems quite strong — unsustainably strong.

  • Posted by Ted

    I’m no economist but I’ve always wondered about looking at just the net trade numbers.

    I’d gladly allow my competitor to have twice the textile business at his 10% margin than at my 30% margin machinery company.

    What I really worry about is his ability to build the infrastructure and experience required to build a competitive margin company.

  • Posted by sun bin

    great article. i agree with your conclusion that RMB should worth more that it is now, which is also for the benefit of the hardworkinhg Chinese people. knowing very little about economics, my reasoning is actually quite simple:

    these workers are making some 1/20 of their counterparts in US make, don’t they deserve a raise? china has been able to keep the wage low because there were virtually unlimited supply of cheap labors coming from the countryside for the past 25 years. Now this supply has come to an end, from last year it has been reported that it is getting more difficult ro recruit workers in Guangdong, and wages are finally rising. This shows the unlimited labor resource has come to an end. it is time for China to raise the price of its products because supply can no longer meet demand now. the “price” to raise is RMB’s exchange rate.


    “from 2002 on, as the dollar has fallen, China’s export growth has averaged over 30% y/y; from 98 to 2001, the average growth rate was only 13.4%.”

    i have some trouble understanding this point. isn’t the relative exchange rate RMB/USD the same between 2002-2005 and 1998-2001?

    i would tend to think that part of the reason that Euro-zone lags US in buying Chinese goods is due to the complexity and fragmentation of its market. so it is hard to use price elasticity alone to compare the difference in export vs change in X-rate during the past few years.

    myth 4: the intra-asia comparison.

    don’t these figures also serve to show that export to US still grows dramatically from Rest of Asia DESPITE the devaluation of USD to their currencies? therefore, devaluating RMB may not actually change the overall import to US? hence it supports the ‘myth’ that the most noticeable change is the relative market share between China and rest of asia (and mexico etc)?

    myth 5) absolutely.
    but what about the non-goods ‘trading’, i.e. services and earnings from the morgan stanley’s and BCG’s? and repatriated profit from the GM’s and P&G’s? i guess these are the US companies who will benefit and the profit will be spent in US?
    so i would like to change the myth/fact into
    “China is America’s fastest growing business opportunity”

  • Posted by Guest

    Dear Movie Guy
    Why the heck are you talking about California, and people who live there, like that? What are you trying to tell people? What you said about California is NOT TRUE so please just STOP spreading lies like that!!!!!!!!!!!! I’m a person who lives in California and what you said about California is just a lie. Did you know that most people are poor in California and don’t even have homes? You should be ashamed for saying things like that. I bet you have never even been to California and you don’t know anything about it except the things people tell you!!!!!!!!!!