A quick synopsis of the last five years.
The RMB tumbles against the euro (and most European currencies).
Chinese exports to Europe surge, growing faster than Chinese exports to the US (even though US domestic demand growth generally has been stronger than European domestic demand growth). Right now, EU-25 and Eurozone imports from China are up around 25% y/y (in euros) while US imports from China are up 16% or so.
Many economists (and the Economist) conclude that exchange rates don’t influence trade, at least not trade with China.
Apparently relative prices only matter some of the time …
Many things have happened since 2002.
- China joined the WTO.
- The final assembly of most computers shifted to China.
- Chinese productivity growth exceeded US productivity growth, increasing China’s competitiveness even in the absence of exchange rate moves (see p. 13 of Feng Lu’s presentation).
- Chinese wage growth lagged Chinese productivity growth (as the IMF notes, labor income fell as a share of Chinese GDP), further increasing Chinese competitiveness.
But, processing trade or no processing trade, the enormous acceleration in China’s rate of export growth (to the world) is clearly correlated with a change in the RMB.
From 1995 to 2002, the RMB generally appreciated in real terms because the dollar depreciated. Exports grew, but not super-fast. China ran a small trade and current account surplus.
From 2002 on the RMB has depreciated in real terms, again, because of the dollar.
The result: China’s exports are set to go from around $320b in 2002 to somewhere around $940b this year. Nick Lardy now forecasts that China will have a 9% of GDP ($250b) current account surplus, even with oil at $60. It will be bigger if oil falls back further.
China's central bank turns that surplus into demand for US dollar-denominated debt, its purchases likely finance something like 1/5 of the US currnet account deficit.
The Economist also argues that:
“Unless Americans curb their appetite for imports bought with borrowed money—and start making more things other countries want to buy—the deficit will continue to be a problem.”
That argument could be framed the other way around: until the central banks of the world curb their appetite for financing their exports to US, the US will continue to specialize at making exactly the thing that other countries really want to buy — IOUs. If not Treasuries, then Agencies and mortgage backed securities. We are rather good at it.
I’ll let the Economist in on another little secret. The RMB didn’t rise to 7.92 this week because currency traders took Mr. Paulson’s words to heart. Currency traders don’t set the RMB’s value. The PBoC does.
I am glad that the PboC is showing a bit more flexibility – even if the Economist is not.
The striking thing about the global balance of payments is that East Asia’s surplus continued to climb even as the oil exporters surplus exploded. That necessarily implies that the deficits of the world’s other oil importing regions had to rise. The US has done its part. And recently, Europe has too.
And when you look closely, it isn’t all that hard to find channels linking exchange rate moves to the savings and investment balance. The surge in Chinese business savings is one. Bernanke’s argument that low US savings is – in part — a function of high savings elsewhere is another.
Of the channels that link changes in the RMB/ Euro to China's growing capacity to finance the United States deficit. The huge surge in China’s bilateral surplus with Europe since 2002 sure seems to have contributed to China’s growing capacity to finance deficits elsewhere in the dollar/ RMB zone.
If you think global imbalances are a problem – and I think the Economist generally does – then both deficit and surplus countries have to adjust.
Adjustment means things have to change, and those who have profited from the cheap Chinese goods for over-priced Treasuries and Agencies trade won’t do so well. I understand that. I also understand that exchange rate moves are not a panacea — and many other adjustments are needed. I have never argued that adjustment process will be painless. In any adjustment scenario, US demand growth has to slow. That means US consumption growth has to slow, even if US income growth doesn't. Ted Truman makes this point clearly.
But does the Economist seriously think China’s current growth model can continue unchanged? Or that global adjustment will become less risky if adjustment is postponed for another couple of years, while China’s surplus rises and the US (or perhaps Europe’s) deficit rises? China’s goods exports are on track to reach $940b in 2006. To keep up a 25% growth rate over the next four years, China’s goods exports would need to rise to around $2300b. China already exports about as many goods as the US. Can it really manage to export twice as many goods as the US?
Sorry about the rant – but the Lex/ Economist/ breakingviews/ City of London financial press consensus that Chinese export growth is unlinked to exchange rate moves gets under my skin. Particularly since most such arguments are made without noting that Chinese exports did respond as one would expect to the big move in the RMB/ euro.
I can understand the arguments that the huge surge in Chinese exports (and shift in assembly) since 2002 has been a net gain to the world. But I have trouble with arguments that claim China's trade is not sensitive to exchange rates moves that do not even bother to note that the surge in China’s export growth rate is rather clearly correlated with the RMB’s post-2002 real depreciation.
The FT wrote on Friday of England’s “enduring popular suspicion of most things European.” Right now, I have a feeling that the UK's financial press shares that suspicion. At least when it comes to looking at the eurozone data. Maybe I should try to dig up data on how Chinese exports have responded to changes in the RMB/ pound? Or just give up.