Xie to the market (and to the US): Take your 2% and stop telling China to revalue!
Here is the difference between Xie and me, put simply.
Xie thinks the US is trying to get China to "artificially" push up Chinese wages.
The vast US trade deficit … cannot be solved by artificially raising Chinese wages.
I think a country that is spending $260-300 b (14-16% of its GDP) to keep its currency from appreciating is artificially holding down Chinese wages and Chinese purchasing power.
In the process, China — not just the Fed, as Xie argues — artifically holds down US interest rates. That helps the US in some ways. Certainly in the short-run. But doing so has long run costs, on both sides of the Pacific. The US is storing up a big adjustment, as resources will have to flow out of interest-sensitive sectors at some point. And resources will likely also have to flow out of China's export sector, or at least Chinese factories will have to regear to serve China's internal market. To those adjustment cost, add the massive bill China's taxpayers will get when China realizes the costs of the massive "subsidies" its central bank is now providing to China's offshore customers. Buying high (i.e. buying dollars at 8.28 RMB, or 8.11) and selling low (selling dollars for RMB at 7, 6 even 5 RMB to the dollar) is a pretty sure fire way to lose money.
And it is not obvious that China is better served subsidizing American consumption rather than putting its money to work at home. Joe Stiglitz has long defended China's peg. But he — like Roubini — worries that China might be better able to adapt to the loss of the US export market than the US to the loss of Chinese financing. Stiglitz's warning to the US needs to be taken seriously:
China could easily make up for the loss of exports to America – and the wellbeing of its citizens could even be improved – if some of the money it lends to the US was diverted to its own development. China has huge investment needs. If its government is going to lend money, why not finance its own development? Why not fund increased consumption at home, rather than that of the richest country in the world, to pay for a tax cut for the richest people in the richest country, or to fight a war which most view as anathema?
The CIA calculates that China's 2004 PPP GDP is around $7300 billion – a bit over $5,500 per person (link from PGL of the Angry Bear). At market rates, China's (2005) GDP is only $1850b, or a bit under $1500 per person. The large gap between China PPP GDP and its GDP at market value – even taking into account the fact that poor countries usually have a market GDP well below their PPP GDP – is what leads Jeff Frankel to conclude that China's currency is undervalued.
That matches my own subjective economic development smell test. Beijing looks like the capital of a country that is wealthier than say Turkey, not the capital of a country that is just starting to develop. And I don't think that is just because Beijing is the capital of a very large country.
Be forewarned – I'll probably be focused almost exclusively on China for the remainder of this week. I want to return to CNOOC (in the interim, read this from Brainard and O'Hanlon), to comment on the Wall Street Journal's excellent article on US/ Chinese dollar diplomacy – and China's internal currency politics, and to talk a bit (more) about China's reserves.