The Economist still isn’t convinced the RMB is undervalued …
Half a trillion dollars apparently doesn't get the respect it used to. Neither the author of last week’s Economics Focus column nor Morgan Stanley’s Stephen Jen think that the Chinese yuan (or RMB) is undervalued, despite annual reserve growth that would have been around $350b last year but for $100b or so of debt purchased by Chinese state institutions and that could approach $500b this year.
The Economist, for all its free market barnstorming, apparently doesn’t mind massive government intervention in the foreign exchange market – intervention that necessarily means governments will be big players in a host of asset markets.
Indeed, it often seems that the larger China’s current account surplus (it looks set to rise above 12% of China’s 2006 GDP), the faster China’s reserve growth, the faster Chinese exports growth (30% y/y in the latest data) and the more net exports contribute to growth (2-3% of GDP in q1, about the same as in 2006), the more the Economist (and, to be fair, some economists) insists that China’s exchange rate isn’t truly undervalued.
The Economist includes many different voices. This week's leader on the lessons from the 1997 crisis includes a welcome call for China to let its exchange rate move more. But I think it is fair to argue that its main editorial line consistently has emphasized that the RMB isn’t obviously undervalued even as China's trade surplus soars — while suggesting that other currencies (the Saudi riyal, the Japanese yen) are.
The Economist tends to pick up on Stephen Jen's arguments, but not those of say Nick Lardy and Morris Goldstein.
And rather than encouraging China to mark the RMB to market, the last week's Economist argues we should all mark the RMB to a model, and specifically to a behavioral equilibrium exchange rate model. Fair enough. But marking-to-model poses its own risks, not the least the challenge of picking the right model.
I cannot quite figure out what a behavioral equilibrium exchange model tells us about the currency of a country that manages its exchange rate as heavily as China. Movements in China’s real exchange rate clearly have been shaped more by central bank policy – notably the dollar peg – rather anything else.
The behavioral equilibrium exchange rate approach – at least as I understand – says that it is impossible to determine whether an exchange rate is under or over-valued based on macroeconomic fundamentals, so it is better to instead to try to find variables that help explain how the country’s real exchange rate has moved in the past:
"This [approach] does not attempt to define long-term economic equilibrium. Instead it analyses which economic variables, such as productivity growth, net foreign assets and the terms of trade, seem to have determined an exchange rate in the past, and then uses the current values of those variables to estimate a currency's correct value"
Given China’s policy decision to peg to the dollar, though, the variable that will appear to drive movements in China’s real exchange rate will be the variable that moves when the dollar moves. If a weaker dollar leads to higher net foreign asset growth (because it produces a weaker RMB), the model might argue that the even higher foreign asset growth implies an even weaker RMB.
Or, for example, if an acceleration in Chinese productivity growth happened to coincide with a fall in the dollar and thus a fall in the RMB’s real exchange rate in the past, I think a behavioral equilibrium exchange rate model would indicate that faster Chinese productivity growth should push the RMB down in real terms …
That would, for example, help explain why Jen’s model doesn’t show a current RMB undervaluation, despite a very strong increase in China's current account surplus.
Incidentally, a "world of mobile capital" doesn't pose any problems applying "fundamental equilibrium exchange rate" analysis to China. For one, China has capital controls, so it doesn't live in a world of mobile capital. And more importantly, there is a lot more money trying to get into China than trying to get out. Capital flows are putting upward pressure on the yuan. China isn't Japan, or Switzerland.
I do not doubt that determining whether or not a currency is misaligned is difficult – and different models produce different results. But some cases are easier than others. $500b in intervention does provide a bit of a clue.
Here are three graphs that explain why I remain convinced that the RMB is undervalued significantly. The first plots Chinese exports and Chinese reserves against China’s real exchange rate. It sure seems to show that both export and reserve growth picked up when the RMB fell in real effective terms in 2002.
The second chart plots the y/y increase in Chinese exports and reserves, in billions of dollars, against the real exchange rate. Both exports and reserves are rolling sums, and the change in the change in most recent 12 months against the preceding 12 months.
The last chart looks at percentage changes — it plots the y/y export growth v. the real exchange rate. It fundamentally is a different way of presenting the data presented in the preceding chart. China's export growth rate bounced up and down a lot in the 90s (that shows up in the data above as well, with its pronounced hills and valleys). But generally speaking, the rate of China's export growth was trending down in the 90s, when the RMB was appreciating in real terms, and it then picked up when the RMB started its recent trend depreciation.
In a lot of ways though, what is most distinction about China's recent export boom is that it has been all boom and no bust. Export growth rose to 30%, fell to 20% and now has picked up again. That is a far cry from the pronounced boom/ bust cycles China experienced in the 1990s. Sure, the strong global economy helped. But so did the weak RMB.
Suffice to say that if either Morgan Stanley or the Economist trust their model and want to sell RMB five years forward at its current price, I would be a happy buyer. And if China ever lets the IMF publish the results of its core model for assessing fundamental equilibrium exchange rates, I am pretty confident that model will show that the RMB is somewhat undervalued in real terms.
Along with the yen, the Saudi riyal and no doubt other currencies. I am not sure if the yuan is more undervalued than the Saudi riyal. But I am pretty confident both are significantly undervalued.
From Asia Times Online:
National Bureau of Economic Research (NBER) declares Chinese Yuan not undervalued
http://www.atimes.com/atimes/China_Business/IB15Cb03.html
National Bureau of Economic Research (NBER) Working Paper No. 12850 issued in January 2007 reports that relying upon conventional statistical methods of inference and a framework built around the relationship between relative price and relative output levels, once sampling uncertainty and serial correlation are accounted for, there is little statistical evidence that the RMB is undervalued.
NBER is a prestigious and highly respected private, nonprofit, nonpartisan research organization where Simon Kuznets’ pioneering work on national income accounting, Wesley Mitchell’s influential study of the business cycle, and Milton Friedman’s research on the demand for money and the determinants of consumer spending were among the early studies done. Sixteen of the 31 US Nobel Prize winners in Economics and six of the past Chairmen of the President’s Council of Economic Advisers have been researchers at the NBER. The more than 600 professors of economics and business now teaching at universities around the country who are NBER researchers are the leading scholars in their fields.
Hedge Funds are the real Currency Manipulators
Hedge fund assets have doubled globally to more than $1.4 trillion in the last five years betting on notional values in the hundreds of trillion. Notional amounts of all types of OTC contracts stood at $370 trillion at the end of June, 24% higher than six months before. Growth was particularly strong in the credit segment, where the notional amounts of outstanding credit default swaps (CDS) increased by 46%. Rapid growth was also recorded in other market segments. Open positions in interest rate derivatives rose by 24%, while those in foreign exchange (FX) contracts expanded by 22%.
The pace of trading on the international derivatives exchanges also quickened in the first quarter of 2006. Combined turnover measured in notional amounts of interest rate, equity index and currency contracts increased by one quarter to $429 trillion between January and March 2006.
The derivative market has been described as a financial weapon of mass destruction. It makes the Chinese currency exchange rate issue seem like a small harmless firecracker.
Brad,
I found the Economist column as annoying as you did. One might argue that reserve accumulation is an effect of something other than government intervention to manipulate a currency, but one should simply ignore a half trillion dollars.
But aren’t you also ignoring an important statistic: the Chinese savings rate? Is high savings an effect of currency intervention or a cause?
Brad,
How is it in the end that : China, Japan, Saudi Arabia have undervalued currencies ?
Why not write for a start a paper on the OVERVALUED dollar.
In what ways is the present US dollar situation different from the pound situation in 1929 ?
WHy Doesn t the federal bank flood the markets with dollars. It could technically force the dollar down by accepting some inflation. Simply by indicating that it wants a lower dollar against all the above mentioned currencies it could achieve some results by influencing anticipation.
I would like to play “Wang”, and ask, gee, who’s getting free stuff financed by the others ? Who s letting all this happen ?
Why care about chinese currency manipulation and not about the US implicit agreement with those by not doing anything.
If its so easy to devalue ones currency what are the US waiting ? Why aren’t they adding Yens, RMBs and Saoudi Ryals to their reserves ?
I know I ve already said much, but I d like all of us to ponder. If say the dollar exchange rate is 20% overvalued : what does it say about recent productivity growth ? Could it be that higher price for imports could wipe out in one swift move productivity gains obtained by shifting productions abroad ?
If this is the case the US economy at large is seriously overrated and the Chinese economy underrated. BTW you don’t mention purchasing power parity, i know I ve some time ago read articles clearly stating that if exchange rate were fixed to power purchase parity the chinese RMB would be reset much higher (and the dollar lower).
DC –
I think you are referencing the Menzie Chinn paper (i have linked to the key graph in the past), which, in my reading, actually shows that the rmb was very very close to meeting statistical tests for undervaluation back in 05 (if memory serves), and given the growth in china’s current account surplus/ growth in chinese productivity, i doubt that has changed. the statistical test is very demanding — and the rmb was jsut inside the confidence ban. I am not a big fan of the title menzie and his co-authors choose for that reason — it implies that they didn’t find any evidence of undervaluation, when my read of their data is that it shows the rmb is undervalued, but jsut not quite undervalued enough to meet standard statistical tests for undervaluation — i.e. i don’t think it fell out of the confidence intervals, but it came really, really close. i try to dig up the link, as i have done in the past, but i would appreciate it if you would reference my critique of the way this paper is being spun the next time you reference it!
Oops, I read the article and PPP was mentionned only to be stupidly discarded. It s long term… You bet, that’s what is important. ANd who cares about financial markets, cross border movement of capital should never have been allowed the way they have anyway.
BUt I can t believe they wrote this :
First, a large current-account surplus does not necessarily prove that a currency is unfairly cheap; it may just reflect countries’ different savings and investment rates.
COme on !!!! As if the saving-investment rate had nothing to do with the current account surpluses … I could well be that those rates reflect their current account surpluses. Why save if free money is coming in from asia, better borrow and if your revenues are stagnating. How not to save in Asia if your revenues are booming.
The excessive fear of protectionism will lead us right into the worst protectionism era ever. If you can’t act against asset bubbles and currency manipulation, well give up your economists jobs, and give them to those who will be glad to restore some plannification somewhere.
Aaron — you are right. to keep my comments (relatively) short, i didn’t take on the “high savings generates a weak rmb argument”. I buy martin wolf’s argument that the recent rise in chinese savings (and esp. business savings) is the effect of a weak rmb, not a cause. note that china’s recent savings surge, whcih took savings from @35% of GDP to above 50% of GDP, coincided with the rmb’s real depreciation. and the rise in savings comes from business (including SOEs that do not pay dividends) and the government, not a rise in household savings. consequently, i think it is easier to explain it as a result of rmb undervalaution not a cause of it. I certainly have not heard a persuasive explanation for why chinese savings started to soar in 2003 — which seems to me the key fact here — that is totally independent of the rmb.
household insecurity explains high household savings, but it is impossible to attribute the recent rise in the savings rates to a rise in household savings, and households didn’t suddently become more insecure between 03 and 07.
DC — please look at figures 3 and 4 in the chinn paper (latest version). the data only goes through 04 — i.e. it doesn’t pick up the most recent surge in china’s current account surplus. and it is true that i interpret these graphs in a way that is different than the authors — to me, they suggest the rmb was (even in 04) undervalued, even if the rmb didn’t wasn’t qutie two standard deviations away from where one would expect based on the model. obviously, the author’s own interpretation matters — this is one rare case where i disagree with dr. chinn. but my own reading of that data puts less weight on the statistical test and more on the plot — it shows the rmb well below where one would expect, all other things being equal. and i don’t think any of their tests really suggested that the rmb might be overvalued — only that it didn’t (and in some cases didn’t quite) meet standard statistical tests that would consistitute “economic proof” of undervaluation (i.e. the rmb’s value was outside the 95th confidencen interval). and that was in 04 - the case for rmb undervaluation has grown since then.
data is in:
http://www.ssc.wisc.edu/econ/archive/wp2007-01.pdf
Any believer in the signalling of markets through prices would have a hard time arguing against the simple idea that if a currency requires simply immense intervention to stabilize its value, the market clearly thinks it’s immensely undervalued.
RN - thx!
Brad,
You should also show the import growth in your last chart.
Sure, the growth since 2002 is not as much as that of export, but the import growth vs RER chart can be disturbing for the “exchange rate does matter” conclusion.
Conventional wisdom may suggest a depressed import growth, when a currency is significantly undervalued.
The myth of market efficiency propagated by the academic manadarins of modern portfolio theory may have been useful in advancing many academic careers and spawning a conceptual ideological empire. The reality, however, as is evidenced by past and recent current events, the latest being this curent sub-prime debacle, certainly suggests otherwise. It would appear that markets may be extremely inefficient in incorporating information into realistic market prices. The revelations that there is no high degree of certainty with regard to the appropriate valuations of CDO’s is a glaring example of trillions of dollars of global asset value being based upon dubious, and probably arbitrary, criteria.
While a rational analysis may lead to the exploitation of market inefficiencies, the prevailing driver of market asset values appears to be little more than sentiment, at least in the short, and possibly medium term. If anything, current affairs seem present strong evidence that markets are onlly efficient to the extent that its participants continue being deluded enough to continue being participants. On the other hand, rationale analysis, unbound by prevailing dogma, does appear to provide the opportunnity to penetrate the shroud of foolishness permeating the general market viewpoints and, consequently, establish positions to capitalize on the “madness of the crowds”.
Ryan Darwish
Author of “The Emperor’s Clothes: MegaTrends Affecting Your Financial and Investment Decisions”
http://www.investmentmegatrends.com
Chinese official recorde global trade surplus $177.5 billion in 2006, up 74% from the previous year. But take away $73 billion of capital inflow and $60 billion in returns on foreign capital, China net trade surplus is only about $40 billion in 2006. By comparison Japan’s trade surplus was $168 billion and Germany’s trade surplus was $146 billion in 2006. One might argue then that the Euro and Yen are even more undervalued based on trade statistics. Moreover, if the US reduces its trade deficit with China, China will reduce its own trade deficit with its other trading partners, without much impact on the US global trade deficit.
um, i think it’s been established that the yuan (and riyal) is ‘misaligned’, and so (as BS has so finely ground his axe, i feel like grinding one here) why not adopt baucus-grassley-schumer-graham?
indeed, it has a reasonable chance of (veto-proof) passage… so assuming it is enacted and (with a six-mo lag) ‘anti-dumping’ sanctions are imposed [escalated to the WTO after a year, including remedial action req. treasury to buy RMB (and riyal) if nothing is done] will that satisfy the ‘XR flexibilists’?
i mean if Somthing Must Be Done, and china (and/or GCC) isn’t doing it, then this bill — it seems to me — is your best shot and you should be backing it to the hilt. otherwise, it’s been all (mostly
empty (but fun and educational!) rhetoric.
I agree the RMB is undervalued, but I also think we (as outsiders), tend to underestimate the (increasing) political costs of pegging to the dollar. I was very surprised to hear many voice unhappiness with large purchases of US debt. However, the discussion always ended when those who favored the current system ask, “how else can we improve the livings of the 800 million poor farmers?”
I think there is movement to get away from the export driven growth and the adjustments to export subsidies are a start, but to make a case convincing, we’d have to first estimate what are the impacts to the 800 million people. Is it as large or dire as the proponents of current system would argue? What number (is it $400B per year?) will it take to insure that GDP growth remains robust? It seems to me that no one has good answers to that right now (and it might be an un-answerable question).
From British Telegraph,
http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2007/06/26/cnusecon126.xml&CMP=ILC-mostviewedbox
The United States faces a severe credit crunch as mounting losses on risky forms of debt catch up with the banks and force them to curb lending and call in existing loans, according to a report by Lombard Street Research.
“Excess liquidity in the global system will be slashed,” it said. “Banks’ capital is about to be decimated, which will require calling in a swathe of loans. This is going to aggravate the US hard landing.”
Charles Dumas, the group’s global strategist, said the failed auction of assets seized from one of the Bear Stearns funds by Merrill Lynch had revealed the dark secret of the CDO debt market. The sale had to be called off after buyers took just $200m of the $850m mix.
“The banks were not prepared to bid over 85pc of face value for CDOs rated “A” or better,” he said.
“God knows how low the price would have dropped if they had kept on going. We hear buyers were lobbing bids at just 30pc.
“We don’t know what the value of this debt is because the investment banks shut down the market in a cover-up so that nobody would know. There is $750bn of dubious paper out there in the form of CDOs held by banks that have a total capitalisation of $850bn.”
LC -
Interesting points.
China is trying to “engineer” a hyper-accelerated metamorphosis of a 3rd world nation into a 1st world one. To do this they are facilitating $40/month jobs for workers from the countryside who bunk up in state dorms and eat 3 state meals a day, and then after they’ve earned enough, they return to their village “enriched”.
I don’t think we in the west can begin to fathom the myriad forces at play in such a situation. But I do think we can understand one of China’s motivations: as babies in financial management dealing with historically unprecedented amounts of trade flows, as well as the “starve or eat” fortunes of hundreds of millions of familes, certainly they want to take things slowly.
When the free market can crush as sophisticated a player as Bear Stearns like a knat, it’s hard to imagine China allowing full exposure to the storms of the free market quickly, if ever. And yet the other head of the dragon knows the free market is the only way to prosperity.
But China must understand that as it wants its own citizens fed through economic growth, if US citizens go hungry, and they think it’s because their jobs are now being done by Chinese, they will pressure their representatives in Congress to take off the dragon’s head. And Congress will do it.
China had better be ready to deal with the aftermath. Assuming China “retaliates”, the aftermath in the US would likely be higher interest rates, a pullback in consumption and increased savings.
Sounds to me like just what the doctor ordered.
Over the last year the CNY has appreciated 5% against USD in nominal exchange rate. Past two monthes (27Apr to 27Jun) have seen a 8.6% annualized appreciation.
As I said some monthes ago, within 1-15 years the exchange rate will cross its equilibrium point with smooth yearly changes in the 5-10% range and then the PBoC might let the FX be set a bit more by foreign central banks.
This rate of change is entirely appropriate given a long term view point, going faster or having brutal moves would attract way too much speculation in a world completely flooded by liquidity (from irresponsible central banks other than the PBoC). It would just be suicide for the chinese economy and it just won’t happen.
I still do not understand why western macroeconomists focalize on this FX when the USA and other rich countries have so many other own imbalance they’re unwilling to tackle (energy over consumption to start with).
Driving up prices of farm products could do a lot for the race-to-the-bottom wage pressure and add greatly to Chinese domestic consumption. Structural changes to bring up labor incomes and resources pricing inside China will do more to address the imbalance. A large re-valuation would make the structural reform much harder to do.
We are seeing this happening right now: as China grows tiresome of accumulating reserves, many preferences for exports are being removed (cuts in VAT rebate, equalization of corporate taxes), resources are being repriced (two-tiered pricing for electricity, pollution charges doubled), farm payments are raised and the recent surge in food prices will help too. All these help rationalize the Chinese economy which I fail to see how an adjustment in exchange rate alone could achieve.
“But China must understand that as it wants its own citizens fed through economic growth, if US citizens go hungry, and they think it’s because their jobs are now being done by Chinese, they will pressure their representatives in Congress to take off the dragon’s head. And Congress will do it.”
But that is such a zero-sum view of the economy. If U.S. citizens go hungry, pray tell what China can sell to them to sustain the trade imbalance? China doesn’t run large surpluses with the poorest countries of the world or does it?
U.S. has an income distribution problem on hand but blaming China isn’t going to help much. If anything if a re-val forces China up the food chain the conflict in jobs will be stronger not weaker.
Notational values are bogus. I bet one dollar that the price of gold will rise from $500 to $600. The notational value of that derivative contract is $500, which is a number that doesn’t mean anything at all.
Also $850 billion for valuation of CDO’s seems about two orders of magnitude too high.
Laurent — i got burned thinking that the past acceleration in the rmb (last fall) would be sustained. china then slowed the pace of appreciation to a crawl. i wouldn’t project the recent change out — it picks up a big change around the time of the paulson-wu strategic economic dialogue.
I do think the US should address its energy deficit as well — but i don’t think that addresses the us deficit with east asia. indeed, the big puzzle is that the us deficit with asia (and globally east asia’s surplus) has increased along side the us energy import bill. normally, you get penalized for being an energy glutton and are forced to either import less to buy so much energy or forced to export more to pay for your energy. the us just basically borrowed more.
jye — b/c of the processing trade, higher export growth tends to be correlated with higher import growth, which is why i didn’t plot it. most studies argue that the rer impacts exports not imports.
LC — spending the money (5% of GDP by my calculations, assuming 15% of GDP fx intevention and a 33% eventual capital loss) china now spends subsidizing urban factory workers subsidizing the rural poor might be a good way to start! it also generates positive externalities for the world. but that spending woudl be on budget and seems to be considered welfare for corrupt and backward rural areas — while using the currency to provide an export subsidy doesn’t show up directly in the fiscal balance and it rewards the more productive, modern urban sector …
DC. “Chinese official recorde global trade surplus $177.5 billion in 2006, up 74% from the previous year. But take away $73 billion of capital inflow and $60 billion in returns on foreign capital, China net trade surplus is only about $40 billion in 2006.”
on this, you are wrong. the capital inflow is on top of the $177.5b trade surplus. and the returns on foreign investment in china (along with the returns on chinese investment in euros/ the dollar) show up in the income balance, which also is on top of the trade balance. china’s net trade surplus really is $180b or so .. and it will be maybe $250b this year.
it is possible some of this is disguised capital inflows. but stephen green now thinks most of it is real, and i trust him. basically, the math here is clear — the numbers you substracted shoudnot be subtracted in classic bop analysis. sorry.
re: CDOs & co.
no question spreads are widening across the board (if not as much in the cash market, yet…)
http://markit.com/information/affiliations/abx
http://markit.com/information/affiliations/cdx
http://markit.com/information/affiliations/lcdx
but it’s more a ‘normalisation’ (they’re still pretty low relative to historicals) so the cataclysm that’s being predicted (parlayed?) is only a pretty orderly unwind at this point — nevermind the _three_ wsj articles today on the (potential) end of credit derivatives/LBO activity. moreover, deals that shouldn’t have been done anyway aren’t anymore (which btw says nothing of the ones that were so there could potentially be a subprime-equivalent debacle hiding in the corporate loan market, but that could be a ways away still), whereas deals that do make ’sense’ are, correctly, being priced thru — imagine that — hardly the stuff of a “credit crunch” (gross’ citation of $1200bn in arm resets over 200bps in the next two years notwithstanding!)
that said, no doubt creditors to bear stearns’ ‘enhanced’ hedge fund are sitting on unrealised losses so they can try to work thru their ~$250bn junk & loan issuance pipeline over the next few months, but already deals are being pulled, delayed or restructured on stricter terms — a good thing, imo (discernment). so altho bear’s creditors will prolly need a bath and a haircut (and make less money than last year) i think they’re capitalised (and collateralised) enough to weather a downturn and a hedge fund blowup (altho not much more than one!); again, it doesn’t look as if capital markets are about to seize up. besides china could always step in
http://www.portfolio.com/views/blogs/market-movers/2007/06/26/will-china-prevent-the-cdo-meltdown
call it a wall street cartel or “cover-up” if you will, even with bush starving the SEC, they _are_ being investigated — personally, i think the ratings agencies have been the biggest ‘enablers’ and suffer from large conflicts of interest and could be liable, cf. http://www.nakedcapitalism.com/2007/06/worries-on-valuing-repackaged-debt.html — but, more than that, when people smell something rotten in denmark they usually act accordingly, which is exactly what seems to be going on; markets got a whiff of something they didn’t like, so they aren’t going there no more (or, at least, not as much).
so to those gleefully awaiting to dance on the grave of blackstone, et al, i say… i dunno, i just wanted to say that; i don’t really care — dance away
cheers!
Brad - let’s face it! You just love to go head to head with The Economist like “ying/yang, protagonist/antagonist” - it takes two to tango or the epic will end or be bored beyond debates. Thanks to The Economist, I discovered your enticing weblog community.
Laurent Guerby - I agree slow is good for China and all nations and taking care of business at home should be the utmost first priority!
RN - Congress are “old vote-getting geezers” who can’t even solve the illegal immigration issue here at home. If US citizens go hungry, they have to first eat off their own body “fat” before even thinking of taking a bite at China (don’t know how long Americans can stand eating rice and noodles all year long). BTW, unlike the bald white eagle (just recently declared “not endangered” - it’s hunting season!) the dragon is a mythical creature 5,000 years old (potent and precious - if I may!) still going and growing, can just grow back its head — the only similar thing Congress has with the Chinese is their “iron rice bowl” for holding their seats in office so profusely long.
And thanks to the overpaid US doctors, employers’ group health costs are growing “out of control”, not to mention the ever broken Social Security and Medicare system.
LC — spending the money (5% of GDP by my calculations, assuming 15% of GDP fx intevention and a 33% eventual capital loss) china now spends subsidizing urban factory workers subsidizing the rural poor might be a good way to start! it also generates positive externalities for the world. but that spending woudl be on budget and seems to be considered welfare for corrupt and backward rural areas — while using the currency to provide an export subsidy doesn’t show up directly in the fiscal balance and it rewards the more productive, modern urban sector …
Brad: agree with your point, but I think part of the difficulty (at least from Chinese point of view) is whether the cost is 5% of GDP. When exports are reduced and workers are out of jobs, does the cost go up? Where will the money come from if this model were suddenly changed? Finally, how much money does it take to buy happiness and satisfaction for the average Chinese farmer? The Chinese are trying to figure this out while at same time hoping that steps taken to reduce export incentives (via tax rebates) can address some of these issues.
HZ and Asian Man -
I don’t disagree. And there’s plenty of blame to spread around if you want to do that.
I just think it’s remarkable how little the parties seem to understand each others’ thinking and realities.
Check that. It wouldn’t surprise me if someone who knew well told me the Chinese are plenty aware of how things go over here. I just don’t think they’d have gotten themselves into quite this bind if they did. I worry it’s getting too late to avoid a trade conflict escalation, and I think both sides will be unhappy if it comes to that. On the other hand, it could be a situation where some (-any-) thing that starts an adjustment process happening sooner than later is a good thing.
Certainly if China were to simply speed up the pace of RMB adjustment, it’s hard to see how that’s not better for everybody at the table. They could still control overinvestment through other means.
“I worry it’s getting too late to avoid a trade conflict escalation, and I think both sides will be unhappy if it comes to that.”
I think that depends on how things evolve. It is within the US’s right to reduce the imbalance through either tariff or a final consumption tax. It could be a political decision (like the steel tariff) depending on the relative powers of the producers and the consumers in particular sectors or it could be an across the board tax. So long as it is non-discriminatory I don’t see why China would object or would have the right to object. It is a matter of MNC’s interest vs labor’s vs consumers’, i.e. a rather domestic affair. And with a giant USD denominated reserve holding China’s interest is rather aligned with US balancing.
On the flip side of the same coin, China’s course will largely be dependent on balancing its own myriad of domestic interests.
And US needs to be prepared of the consequences of rebalancing. One thing I see high likelihood of happening is that boosting Chinese domestic consumption will mean boosting its energy consumption and its imports of oil/gas and other basic materials. The rise in US oil bill could cancel out any gain of less imports from China.
Asian man — I enjoy debating Dr. Jen, the whole yen/ yang thing. I don’t always agree with him (or even often agree), but he is creative/ interesting (is great funneling hypothesis for the yen was quite interesting, and i think probably correct — the absence of “official” demand for yen is one source of yen weakness). the economist by contrast is literally read my millions, and when they consistently take the line that the rmb isn’t undervalued, that shapes a lot of informed opinion. so in this case, i would much rather not have a foil.
Brad - if you may be able to share any insights as to why The Economist’s anonymous writer(s) might want to defend that position which can be seen as - British? - or something else.
…and if someone could tell your friend that there are still a few quality economists, journalists and analysts out there, but he won’t find them by reading the stuff under the trashy, supermarket tabloid style headlines which he finds so appealing….
RN:
It wouldn’t surprise me if someone who knew well told me the Chinese are plenty aware of how things go over here. I just don’t think they’d have gotten themselves into quite this bind if they did.
Reply:
Contrary to the Western centric thinking of US Economist pundits, the Chinese leadership has more than enough internal domestic problems before even considering the self-serving views of Washington. While the Chinese economy is experiencing fast growth, it is not nearly fast enough to absorb the surplus labor force. Unemployment is rising even among the skilled and educated with only half of recent university graduates able to find employment. The largest human migration in world history is taking place today with urbanization expected to account for 60% of China’s population by 2020. The economic perspectives of the Washington Consensus are irreverent to the myriad problems facing the Chinese leadership. It is rumored that Prime Minister Wen Jiabao may resign, not because of an internal power struggle, but because of physical exhaustion from his job of working 12-14 hour days.
DC - i think you just hit on something important. the great chinese export machine hasn’t been a great job creation machine, and hasn’t done a great job of absorbing that human migration. among other things, low rates and high (business) savings have encouraged the substitution of capital for labor …
china will soon need to find another model for generating employment. i don’t think it is possible for the export machine to keep cranking out 30% y/y growth off a 1.25 trillion base.
incidentally, if you depend on the rest of the world to absorb your output/ generate export jobs, don’t you have to take the rest of the world into account? China’s solution to its domestic problems ironically enough has been american and european demand … which means america and europe have a say.
Brad,
If the US government was willing to dump the ideological dogma and restrictions on high-tech products, the Chinese have enormous infrastructure requirement that would generate huge, capital intensive revenue exports for the US economy. For instance, Vice President Al Gore’s opposition to the Three-Gorges Hydroelectric project on the Yangtze river, terminated General Electric’s Power turbine and transmission contracts. The Clinton Administration killed any prospects for US export participation in Hydropower and Nuclear power development in China. The Three-Gorges Hydropower project was built anyway despite the US government veto of any World Bank financing for electrical power development. The Washington Consensus would rather have China remain as an underdeveloped nation to bully around.
Regards,
if the DC consensus wants to keep China underdeveloped, it has failed miserably …
in general, my sense was that the guardians of dc consensus orthodoxy have been rather keen to adopt china as a success of dc consensus policies (openness to trade, macro stability, low inflation) despite its deviations from orthodoxy (absence of clear land title, massive state banks, big state enterprises and the like). DC consensus on XRs has never been consistent — for a while pegs to avoid inflation were part of it, then it become your choice as long as it fits the impossible trinity (currency boards were ok, soft pegs not so much) and now perhaps there is more desire for flexibilty, but it is quite clear that the global XR system is becoming less flexible not more …
if there is going to be a trade war…..its definitely because there is a election in USA…..and every old hag politician needs a platform to make himself look bigger than the rest.
I wonder why china is not getting creative with ideas like social security, free medical care, free housing etc….. after all what does one need for a healthy economy……..confidence and secure, spending consumers……and that confidence can be created by short term spending….(false promises of secure future, say everyone gets social security after 5 years….no need to save for emergency..)
or maybe china is not as efficient and smart as we assume it to be, it maybe same as india….hundreds of corrupt,selfish politicians fighting for the kill….so busy that they dont know that they are missing opportunity to create enough for everyone in future.
i dont beleive that energy consumption in the same scale as usa is required for a efficient economy……since china and india are highly populous……they can easily live/work within 15 miles radius…..served by efficient public transportation….
Wrong lessons
Hey brad, don t you think the economists journalists should talk one to another.
Here s an excerpt from Roubini’s blog. Seems other journalists from the economists are agreeing that china has kept its currency down through massive reserve build up.
Could China be the source of the next crisis? China was less affected in 1997-98, thanks to strict capital controls. Indeed, by not devaluing its currency it helped to prevent a worsening of the financial contagion. But China, more than its neighbours, may have drawn the wrong lesson—namely the need to keep its exchange-rate stable and to build up massive reserves. China’s monetary policy has been overly lax and low interest rates on bank deposits have encouraged a huge shift of money into its stockmarket. Thus Mr Roubini’s diagnosis of Asia does apply to China.
The economist has several different writers who write about the global economy, and i presume several different leader writers as well as several writers for the economics focus column — i agree that the asian crisis retrospective had a different tone than the leader that accompanied the “panda” cover, or the economics focus column.
“the great chinese export machine hasn’t been a great job creation machine, and hasn’t done a great job of absorbing that human migration. among other things, low rates and high (business) savings have encouraged the substitution of capital for labor …”
I don’t think creating more jobs in the manufacturing sector at the price of capital deepening and efficiency is the answer. I’d say just the opposite: the more efficiency the better. Where China failed is to sufficiently promote the service sector. It came from a history of acute lack of material comfort for the general populace. Lack of a social safety net and political freedom are the main hindrance to the development of its service sectors.
re: don t you think the economists journalists should talk one to another.
“Propaganda is the deliberate, systematic attempt to shape perceptions, manipulate cognitions, and direct behavior to achieve a response that furthers the desired intent of the propagandist.” Source: Garth S. Jowett and Victoria O’Donnell, Propaganda And Persuasion, 4th edition, 2006.
Another data point: historical one month sliding volatility annualized (textbook formulae) for USD_CNY has increased from 0.5% to about 2% from Sep2005 to now, and seems to be following a trendline. For reference USD_EUR volatility went from 10% to 5% over the same period and USD_JPY from 8% to 5% (with a jump at 15% in Mar2007).
It means that PBoC is likely controlling volatility evolution and let it increase progressively. Within 1-5 years of this volatility trend USD_CNY volatility will be in the same range as other FX.
Also not unreasonable.