Managing China’s real appreciation
The BIS computes the real exchange rate for a broad range of countries (if only the data extended backwards a bit further). The BIS data shows that China’s real exchange rate tracked the US real exchange rate pretty close through 2005. That isn’t much of a surprise: China pegged to the dollar. It actually tracked the US real exchange rate quite closely through most of 2006, even after formally moving off the peg. The initial move off the dollar peg was exceptionally timid. Too timid in my view.
Over the past year though, China’s real exchange rate path has diverged from the US path. The pace of RMB appreciation against the dollar picked up. And Chinese inflation also picked up. The two have combined to produce a meaningful real appreciation against the dollar — though not, it has to be emphasized, a meaningful real appreciation against the euro.
Chinese exporters have taken notice. Michael Pettis reports that exporters’ complaints are starting to influence the policy debate in Beijing. The influential Li Yang (a former PBoC advisor now at the Chinese Academy of Social Sciences) is now calling for a halt to RMB appreciation against the dollar.
Keith Bradsher of the New York Times reports that Chinese firms exporting to Europe now want to be paid in euros — and Chinese firms exporting to the US want to be paid quickly. Some firms have apparently gotten burnt promising to deliver goods for dollars in the future only to see the RMB appreciate against the dollar before the goods were delivered, cutting into their profits.
Fair enough. These stories explain why exchange rate moves do have an impact on trade flows, despite often made arguments to the contrary. If the rise that the RMB will rise against the dollar (or for that matter the euro) makes Chinese producers more inclined to sell their goods for RMB in the domestic market, all the better. That is what should happen: domestic demand should displace external demand as the driver of Chinese growth.
Such complaints though strike me as premature.
The graph above suggests that China’s real appreciation has only just begun. China’s real exchange rate has tracked the real exchange rates of Japan and the US — two of the countries with the worst performing currencies over the last five years. Japan and the US have much weaker economies than China, so the fact that China’s real exchange rate has tracked their real exchange rates down until recently is in some deep sense puzzling. China’s economy has been stronger than Europe’s, so the ongoing nominal and real depreciation of the RMB against most European currencies but especially the euro is a bit hard to understand on a fundamental basis.
Moreover, China’s real exchange rate remains below its level in early 1998. That doesn’t make much sense. China’s economy has been the best performing in the world over the past decade. That should translate into a real appreciation.
It strikes me as reasonable to assume that the pace of real appreciation that China experienced in the 1990s should have been expected to continue in this decade, which suggests a large gap between China’s current real exchange rate and its natural rate.
The ongoing pressure for real appreciation though is creating very serious policy challenges for the PBoC. Michael Pettis has this right. Frankly, China’s past timidity has put it in a position where it has few good options.
MORE FOLLOWS
One option is to allow the RMB to appreciate in a gradual way against the dollar. This policy has the advantage of allowing firms time to adjust. They can avoid long-term contracts in dollars, or start hedging their dollar exposure in the forward market. A stronger RMB also will tend to lower import prices — though this effect is muted if the RMB is rising at a slower pace against the dollar than the dollar is falling, and if commodity prices are still rising in RMB terms. It has the disadvantage of creating unambiguous incentives for anyone who can to hold RMB rather than dollars, particularly when Chinese interest rates are higher than US interest rates. The resulting hot money inflows can fuel rapid money growth and thus create inflationary pressures.
This incidentally is a difficult concept to explain. The stronger RMB helps lower the price of imports and thus reduces inflation (at least if the RMB were rising against something other than the dollar). But if too much money comes in to bet on further rises in the RMB, the influx of money can be a source of inflation. The overall impact is ambiguous.
One option is to avoid allowing the RMB to appreciate and to hold Chinese rates below US rates. A close variant is a policy of not letting the RMB appreciate by more than the difference between US rates and Chinese rates. This was the policy that China followed immediately after it “depegged” in 2005. But it was a far easier policy to follow back when US rates were higher than Chinese rates. Right now, such a policy would imply cutting Chinese rates so that they are below US rates even as Chinese inflation has picked up — and limiting the RMB’s appreciation against the dollar even as the dollar depreciates against other currencies. Effectively, it amounts to a policy of allowing real appreciation through inflation. Central bankers in the UAE and Argentina could even provide China with lessons.
Another option — one that many in China seem to be gravitating toward — is to hold the RMB constant and rely on other policy tools to fight inflation. The PBoC could increase domestic Chinese interest rates. At least to me, PBoC governor Zhou’s remarks recently seem to hint at such an approach. Or China could try to limit inflation by, in effect, controlling prices. China right now is holding domestic petroleum prices below world prices (and in the process encouraging Chinese demand growth) — a policy that requires China’s state oil companies use their profits from domestic production to offset losses on imported oil. Pettis reports that Xu Zhiman of the NDRC has said that “the government will not increase the price of refined oil or electricity until inflation is brought under control.”
Such a policy means continued distortions — with administered prices being only the most obvious. Moreover, it might not work. At least not in the sense of creating incentives to hold dollar rather than RMB. So long as Chinese interest rates are above US interest rates, there is an incentive to hold RMB rather than dollars even if the RMB is stable against the dollar.
Another option is a big move in the RMB — one large enough to end expectations of further moves. But such a move would need to be large in order to really end expectations of further moves. Just think how far the euro has moved against the dollar over the last give years. Any move large enough to be effective would also be disruptive. A large share of China’s economy grew up around an undervalued exchange rate, and could well have trouble competing at market exchange rates.
Isn’t that, after all, what all the complaints about the RMB’s still modest appreciation against the dollar imply?
My core conclusion is that China should have moved much earlier, as further dollar weakness and a period of low US interest rates were imminently predictable. For too long Chinese policy makers avoided making hard decisions, in part because they hoped that if they waited long enough the dollar would recover. Their problem now is that the dollar in the end only slid further. As they waited, the gap between China’s managed exchange rate and a true market exchange rate only got bigger.
China’s policy makers are often said to focus on the long-term. Here though it seems at least to me that a desire to avoid short-term pain led to a series of decisions that created a bigger long-term problem.
But the past is the past.
Right now, I am in same camp as Wang Tao, Frank Gong and Michael Pettis: the least bad option now is a large one-off revaluation, probably in conjunction with efforts to tighten China’s capital controls. I increasingly though suspect that China will opt for a slower pace of appreciation and price controls.
Slightly off topic: how insolent can these Chinese be? Not only have they hoarded billions of US dollars to threaten us with, but now they are building up, apparently, a super fleet of nuclear submarines to run us out of Asia. Oh the wickedness, the perfidy, the cheek. LOL
http://www.telegraph.co.uk/news/majornews/1917167/Chinese-build-secret-nuclear-submarine-base.html
We in the US cannot complain too much when the PBoC/ SAFE is financing our far larger defense budget …
The Chinese government will ALWAYS manage the economy is a gradual and methodical fashion. Most of the Senior leadership in China lived at least a portion of their lives during the tumultuous Mao’s "Cultural Revolution" era. Any radical economic prescription from foreign do-gooders will ALWAYS be outright rejected. The primary consideration for the Chinese government is political stability. A large population of unemployed workers and students is a recipe for political and economic instability. Even with the one child per family rule, since China’s population won’t peak until 2050 due to longer lifespans, the Chinese government needs to find new employment for 10 million workers entering the workforce each and every year. To those concerned about the China PLA modernization, the Chinese government simply doesn’t have the luxury of global military adventurism unlike another country with a reckless Cowboy as President. As a regional military power, the China PLA naval capabilities are adequate for enforcing a blockade on Taiwan if necessary, securing the Korean DMZ if necessary, or patrolling the strategic trade routes across Southeast Asia.
Brad –
Another useful and informative post. If demand is insufficient and limits output (as in the Keynesian model), then Chinese loans will not be providing the U.S. with greater resources, but instead will be stunting U.S. economic growth and employment. I continue to think the only chance for real reform of China’s currency policies is if the U.S. and other developed countries confront them with some really, really hard choices. This is unlikely now, but may not be so unlikely if there is a real downturn here and abroad.
As for those inclined to buy euros rather than dollars, they may be in for a nasty surprise. Sure, there are huge dollar balances in foreign central banks, but the euro is about 30% overvalued right now. That is a big premium to pay – it would take quite awhile to overcome such a disadvantge with a 2% interest differential (which may shrink) plus a 1% inflation differential (which may also shrink). And if there is a real economic downturn, the euro area may discover that it is not an optimal currency area. What would happen to the value of the euro if, for example, the southern members of the currency bloc could no longer stay with the rest and opted out of the common currency? I’m surprised that more reserve holders do not prefer the yen, which is currently undervalued and should make an excellent store of value. After all, much (if not all) of the low nominal interest rate on yen-denominated assets is offset by lower inflation in Japan.
Chinese GDP to overtake US Economy by 2015 – Economist Angus Maddison
http://money.cnn.com/2008/04/29/magazines/fortune/seven_years_learn_chinese.fortune/index.htm?postversion=2008043005
A recent study by the economist Angus Maddison projects that China will become the world’s dominant economic superpower much sooner than expected – not in 2050, but in 2015. Angus Maddison’s forecast (which uses purchasing power parity) isn’t built on outlandish assumptions. He assumes China’s growth will slow way down year by year, and America’s will average about 2.6% annually, which seems reasonable. But because China has grown so stupendously during the past decade, it should still be able to take the crown in just seven more years. The world’s largest economy until 1890 was China’s. That’s why Maddison says he expects China to "resume its natural role as the world’s largest economy by 2015." That scenario makes sense. Then the Industrial Revolution sent the West on a more prosperous path. Now the world is returning to a common economy, this time technology- and information-based, so once again population triumphs
DC, although I admire your patriotism. But that forecast is pretty dumb.
Brad, as I argued before. The trade imbalance between China and U.S. had been artificially twisted by both sides. You just focus on Chinese side. What U.S. had done is prohibiting export to China. Trade is about comparative advantage. You should not blame others for your abandoning your own advantage.
bsetser: Moreover, China’s real exchange rate remains below its level in early 1998. That doesn’t make much sense. China’s economy has been the best performing in the world over the past decade.
But one can easily argue that the exchange rate in 1998 was overvalued.
bsetser: Another option — one that many in China seem to be gravitating toward — is to hold the RMB constant and rely on other policy tools to fight inflation.
There are some other options. One is not to fight inflation. If the root of the inflation is due to commodity prices and if you believe that Chinese save too much, then food inflation is one way of putting the economy back into balance.
bsetser: Or China could try to limit inflation by, in effect, controlling prices. China right now is holding domestic petroleum prices below world prices (and in the process encouraging Chinese demand growth) — a policy that requires China’s state oil companies use their profits from domestic production to offset losses on imported oil.
Since it’s been argued that Chinese corporations are saving too much, putting in price controls on companies doesn’t seem to be such a bad idea. It forces them to disgorge their savings. So if you have a situation in which you have higher food prices, but price controls are keeping the price of fuel and fertilizer low, and the difference is being made up through the savings of the SOE’s, if you follow the money, it means that you have capital flows from the SOE’s to rural farmers, which isn’t a bad state of affairs for the government.
bsetser: Another option is a big move in the RMB — one large enough to end expectations of further moves. But such a move would need to be large in order to really end expectations of further moves.
But that assumes that the monetary inflows and inflation are being driven by anticipation of RMB appreciation. One has to make a strong argument that this really is the case, because bad things will happen if there is a sudden revaluation and it turns out that the drivers of capital inflow *aren’t* RMB appreciation. The big reason I don’t think that the drivers of Chinese inflation involves people waiting for an RMB increase is this doesn’t explain why food prices are rising in Haiti and Egypt.
I think that whether a one off revaluation is in the cards depends on non-food inflation and the balance sheet of the SOE’s. If non-food inflation stays stable the the SOE’s aren’t losing money through price controls, then I don’t see a maxi-reval. If things are different then things are different.
Don: I continue to think the only chance for real reform of China’s currency policies is if the U.S. and other developed countries confront them with some really, really hard choices.
The trouble with confronting China with hard choices is that it ends up forcing the US and Europe to make even harder choices. Also calling for "reform" of currency policies suggests that Chinese currency policies are "unreformed." In fact, people forget the a fixed currency rate was the darling of economists in the early 1990’s and it took China about eight years to get itself onto a pegged currency. It’s going to take about as long to get itself out of a pegged currency. Currency policy is something that you can’t change overnight without lots of things breaking badly.
The problem with saying that the Chinese leadership made bad choices in 2005, is that I’m convinced that if they had do anything sudden, the situation now would be much worse. People aren’t rioting over the economy, and the amount of civil unrest in China has actually gone down between 2004 and today.
To me, bad options means deciding between whether or not to shoot demonstrators or have the mob take over. The options that exist right in China regarding the economy now aren’t anything close to "bad options."
Jin,
I think China’s economic policy of "gradualism" has worked very well. There is no rational reason for the Chinese government to abandon that fundamental policy tenet. The recent food inflation problem is not specific to China but engulfs the entire world. Most of the recent advice given to the Chinese by the US to massively revalue the RMB has been mostly political pandering to US "rust belt" regions during an election year. A large revaluation of the RMB would probably decrease the volume of labor-intensive Chinese exports, but it would not necessarily improve US global competitiveness. Japan and Germany are the major high-tech competitors to the US. Other than a recent rise in food inflation and a decease in exports to the US market, China’s Industrial production is booming and overall prosperity is rapidly rising for the bulk of the population. Kudos to the economic management team of Prime Minister Wen Jiabao.
China’s Manufacturing Index Expands at Fastest Pace on Record
http://www.bloomberg.com/apps/news?pid=20601089&sid=ac_GB99TkCZI&refer=china
May 1 (Bloomberg) — Manufacturing in China, the world’s biggest maker of steel and cement, expanded at the fastest pace on record, spurred by new orders from domestic customers as export demand eased. The Purchasing Managers’ Index rose to 59.2 from 58.4 in March, the highest since the index began 28 months ago, the China Federation of Logistics and Purchasing said today in an e-mailed statement. The index of new orders rose to 65.0, the highest since April 2007 while export orders dropped for the first time in three months.
DC — excess money creation fueled by excess reserve growth (or less fiscal sterilization of the oil windfall) is actually an emerging market wide phenomenon, not a China specific phenomenon. We are currently going through a period of very loose monetary policy in much of the emerging world …
@Brad
"Or China could try to limit inflation by, in effect, controlling prices. China right now is holding domestic petroleum prices below world prices (and in the process encouraging Chinese demand growth) … Pettis reports that Xu Zhiman of the NDRC has said that "the government will not increase the price of refined oil or electricity until inflation is brought under control." Such a policy means continued distortions — with administered prices being only the most obvious. Moreover, it might not work."
The main reason why such a policy might not work is seen by looking at real flows, rather than financial flows.
http://europe.theoildrum.com/node/3898
"At the end of a cold and stormy winter, the country has just 12 days of coal reserves at most power stations. Some provinces, including Hebei, bordering Beijing, have less than a week’s coal left. This is a record low, the state electricity regulatory commission revealed on Tuesday."
The key why this is happening in the face of rising Chinese coal EXPORTS was well articulated by one of the comments:
"A big issue here is the power sector. The power sector consumes half of Chinese coal production, but power prices are controlled, and prices have been frozen as part of the effort to keep down retail inflation, which has been hit particularly hard by food price increases. Power plants are balking at paying the higher coal prices since they can’t pass the increases on, so "maintenance" has become a regular occurrence as power producers avoid going further into the red. The export market offers higher prices to coal producers, and despite government measures (such as the export quota adjustment earlier this year), coal exports have risen. With many of the major coal producers such as Shenhua and Datang now listed on stock exchanges, decisions on profitability have coincided less with national interests than with corporate interests."
So, either they ban coal exports outright, or subsidize coal purchases of power plants so that the export price is paid to coal producers, or let electricity prices rise.
Brad,
Loose monetary policy in much of the emerging world is a function of US Dollar hegemony and Bernanke’s "helicopter drop" of cheap money, but given the sky-high savings rates of the Chinese population, the China PBoC can mostly sterilize excess liquidity through government bond sales and increased banking reserve requirements. At some point in the future, it may no longer be possible to finance this sterilization regime, but there are no indications that the China PBoC has reached its financial limitations. Most Hong Kong pundits are only predicting a further 5 percent revaluation of the RMB this year. Furthermore, the Hong Kong Monetary Authority intends to retain its US Dollar peg since over 75% of Hong Kong’s trade remains US Dollar denominated.
China right now is holding domestic petroleum prices below world prices, but it is hardly a disaster for state-owned Chinese oil companies. Shanghai, Hong Kong and New York-listed PetroChina Co. Ltd. (PTR) saw its net profit in the first three months of 2008 decrease 31.5 percent. But CNOOC Ltd (CEO), China’s biggest offshore oil producer, released its first quarter report, which showed that the company’s total revenue ballooned 61.8 percent year-on-year, to RMB 24.03 billion ($3.34 billion), even with price controls. So the pricing controls have impacted short-term profits, but I’m still bullish for the Chinese energy companies longer term. Writes Warren Buffett, "If the GDP of any economy is growing slowly at 2%, it is difficult for any company in that economy to grow much faster than 2% over the longterm". Likewise in a fast developing Chinese economy with 10% or higher GDP annual growth, it is easy to obtain at least a similar return on investment over the long term. Anyone not investing in China’s economy today is missing the biggest economic boom in world history. I also like and invest in Brazil.
http://seekingalpha.com/article/75037-petrochina-q1-net-profit-down-31-5-cnooc-gains-favor-with-investors?source=yahoo
Twofish:
I agree that China’s currency policy has probably not been bad for them. And realistically, I doubt if pressures for change will ever be effective. Instead, my best guess is that, if demand becomes really short and unemployment in developed economies becomes a real problem, trade protectionism will appear in its older, more distortionary form of industry-specific trade barriers.
Can anyone say Bubble?
DC, as a Chinese from NYC you support a blocakde of Taiwan, actions in the DMZ, and patrolling SE Asia. You might forget a thousand years of Chinese domination in SE Asia, but believe me, we haven’t.
Guest,
I would never advocate a war in the Taiwan Straits between the US and China. Nevertheless, I am merely stating the fact that the China PLA will definitely take military action if Taiwan were to declare formal independence, the Chinese will never allow US military forces to advance to the Yalu River if North Korea collapsed, and the Nuclear equipped China PLA Navy remains the most powerful military across the Asian Pacific Rim (ie. Japan isn’t Nuclear). Numerically, the 3 US Nuclear submarines stationed at Guam are hardly a challenge to the 50+ Diesel-Electric, AIP, and Nuclear Subs of the China PLA Navy. Even with the US F-22 Stealth Fighter, the US would run out of missiles and bullets before the 3000+ Fighter China PLA Airforce would run out of planes. Sure the US Navy has 11 Aircraft Carriers, but 6 of them are based on the Atlantic Ocean and too large to transit the Panama Canal. It takes a month to transit around South America and cross the entire Pacific subject to submarine wolf-packs. While US military forces are spread thin around the global, the three naval battlegroup fleets of the China PLA are always in the Asian region (ie. Northern Fleet – Harbin, Eastern Fleet – Zhoushan, and Southern Fleet – Hainan).
Don: if demand becomes really short and unemployment in developed economies becomes a real problem, trade protectionism will appear in its older, more distortionary form of industry-specific trade barriers.
One should note that a lot of the calls for RMB appreciation has disappeared once China agreed to a three year extension of textile export limits. I would imagine that as the deadline approaches that we start hearing more about the RMB.
I really have less objection to industry-specific trade barriers than I do with tinkering with currency regimes. If you impose a 40% tariff on auto parts, then the effects are localized. If you start tinkering with currency regimes, then all sorts of things happen, and the effects are quite unpredictable. One weird thing is that because industry specific tariffs have become so taboo, we now talk about a dozen other things that might to much more harm than specific tariffs.
I also think that industry specific tariffs are a good thing for the US-China relationship. When people talk about the RMB, then the focus becomes on China. Suppose the US imposes a 100% tariff on auto parts. Then what happens is that all of the factories move to Mexico and China exports toys. But what happens once this is discussed is that the focus no longer is on US-China relations but on auto parts.
DC: At some point in the future, it may no longer be possible to finance this sterilization regime, but there are no indications that the China PBoC has reached its financial limitations.
9% inflation year on year says that PBC has reached its financial limits. The volume of sterilization bills hasn’t grown in the last year, and the PBC is now turning to reserve requirements and currency appreciation. The debate right now is over how the PBC needs to appreciate, not whether it needs to do so.
Oh I’m sorry, so you were merely bragging about Chinese muscle and its ability to control its neighbors and now you temper in terms of your rabid dog nature against the US. Thanks for clarifying.
I assume the South koreans would stop the Americans before they did anything to the North Koreans, but then if the South Koreans wanted, how would the Chinese react? Certainly, they wouldn’t want N. Korean refugees, but the relationship between S.K and China must be of greater strategic importance to the Chinese than N.K. Or do you see that S.K would be better as a workers paradise a la N.K. You probably would.
As you state yourself, Chinese ability is limited and frankly the only benefiting from the current state of affairs are the US and China, the ones that will hurt the most, should things turn for the worse, are the same. War between the US and China is very unlikely, and neither would "win". Your constant referencing such refers to a paranoid psychosis which More B vitamins or other stimulants might address.
Chinese economy is largest economy in world in PPP. Because of last year tampering of CIA factbook chinese percapita income has decreased from 9500$ in 2008 to 5700$ in 2007 so that US remains no.1 economy in the world. Facts speaks for themselves. China has the largest power installation capacity, top consumer of all metals. Only in oil and natural gas does china lag behind. chinese car sales will exceed US in 3 to 4 years.
But i doubt world economic growth will continue for long because every country in the world except US is growing. Latin america is roaring back. Africa is powering ahead. East europe, SE-asia, south asia , ME is growing really fast. There will not be enough resources to grow at that pace. Oil has reached 120$. This is in may-june, weakest consumption period. By next winter we will be at 200$ easily when demand will be 90 mbd. But supply is at 86 mbd.
Look for crisis to come from pakistan. Its forex reserves is dwindling fast. Its going to indonesia of 2008-09.
DC: Nuclear equipped China PLA Navy remains the most powerful military across the Asian Pacific Rim (ie. Japan isn’t Nuclear).
But Japan’s non-navy navy is more advanced and powerful than China’s. The Russian navy is comparable to China’s. China *could* afford a much bigger military than it has, but one major lesson from the Soviet Union is that too much military spending can decrease national security. A second one is that hardware is useless without peopleware.
In particular, less military spending means more factories in Fujian, more business opportunities for Taiwanese businessmen, and that means that Taiwan is pretty much off the table as a major flashpoint for the next four years at least.
DC: Sure the US Navy has 11 Aircraft Carriers, but 6 of them are based on the Atlantic Ocean and too large to transit the Panama Canal.
Nimitz class carriers can transit the Panama Canal. Also the US has demonstrated that it can get nine carriers to the Western Pacific in 30 days.
DC: It takes a month to transit around South America and cross the entire Pacific subject to submarine wolf-packs.
Most PLA subs are noisy and diesel-electric subs don’t have much range. Wolfpacks are also horrible submarine tactics since putting subs together makes them easy targets for destroyer convoys. The PLAN doesn’t have much in the way of long range capability because it really doesn’t need them.
satish: There will not be enough resources to grow at that pace. Oil has reached 120$. This is in may-june, weakest consumption period. By next winter we will be at 200$ easily when demand will be 90 mbd. But supply is at 86 mb.
And once you hit 200$ then it becomes profitable to mine Alberta tar sands and bitumen from Venuzuela. If you hit 300$ then coal liquification becomes viable.
Also, about North Korea. I remember reading a paper from a seminar about North Korea in which the PLA representatives said that they really weren’t worried about the US invading North Korea. The thing that keeps them up at nights is the possibility that North Korea will collapse and you will have millions of starving refugees streaming across the Yalu. This has some impact on US foreign policy because it means that both the PRC and SK are very much against any US efforts to destabilize NK.
China has long had ex-patriot colonies in SE Asia that effectively dominate economic life there, so it is a given that China will run the economies of SE Asian nations. If it grows its military might, it would not have to go to war with the US. The threat would be enough to detach Japan, perhaps even Taiwan, from the US and steer them toward submission to Chinese hegemony. The US attempts to remain the Great Power in East Asia are doomed to long run failure. As the US presence declines, that of China will rise. Only the US warmongers haven’t gotten the message yet.
Nimitz class carriers can transit the Panama Canal. – Twofish
No they can’t. The Marine Amphib Carriers can fit through the Panama Canal, but not the Nuclear powered Nimitz Supercarriers. Sure you can get 9 Carriers to the Far East fast, but half the Carriers have to sail from the Middle East region. The new Chinese Type-093 Attack Submarines are quieter. Most US Submarines are the 1970’s technology Los Angeles Class submarines. Don’t you think that even Chinese submarine technology from 2008 is better than US technology from the 1970’s.
Twofish,
The new Chinese Submarines pack a bigger punch than Western military analysts think. Chinese Navy has been modernizing its conventional submarine fleet, with the introduction of Russian Kilo class SSK and the indigenous Song class SSG. Meanwhile, Chinese are also building their next generation SSNs and SSBNs, as the nuclear submarine fleet has always been enjoying higher priority than the conventional submarine fleet. The Chinese are also developing their next generation SSG after Yuan which is similar to German Type 212. This new 4,500t class sub will feature AIP (magnetohydrodynamic drive) and 4 diving planes arranged in "X" shape.
http://cnair.top81.cn/han_xia_kilo_song.htm
Twofish:
"I also think that industry specific tariffs are a good thing for the US-China relationship. When people talk about the RMB, then the focus becomes on China. Suppose the US imposes a 100% tariff on auto parts. Then what happens is that all of the factories move to Mexico and China exports toys. But what happens once this is discussed is that the focus no longer is on US-China relations but on auto parts."
You may be right about the political ramifications of an anti-China tirade as opposed to discussions of industry-specific trade restraints, but the trade-off comes at a real cost. For example, the economic cost of a tariff increases with the square of the rate – that is, doubling the tariff quadruples the cost. The same goes for other distortions, including subsidies created by an undervalued currency. So, hitting only a small part of trade hard is much more costly than a milder medicine that is spread over a larger base.
Guest: China has long had ex-patriot colonies in SE Asia that effectively dominate economic life there, so it is a given that China will run the economies of SE Asian nations.
No it’s not because SE Asia also has a lot of overseas Indians and a lot of people that don’t want Chinese dominance. The other point is that there may be differences in goals between overseas Chinese and homeland Chinese.
Guest: If it grows its military might, it would not have to go to war with the US. The threat would be enough to detach Japan, perhaps even Taiwan, from the US and steer them toward submission to Chinese hegemony.
Why? It seems more likely that as China’s power grows, that the other nations in the area will increase ties with the United States and India. This is why China has to be careful in how it interacts with its neighbors. An overly aggressive China will lead to a containment policy. The other point is that there is no real strategic need or ideological justification for China to economically or politically dominate its neighbors, even if such a thing were possible.
What incentives does China have to militarise, that France, Germany and Japan didn’t have?
The US military seems pretty willing to defend the interests of multinationals of all nations. The Dutch don’t need a huge military when the US is just as willing to protect the overseas assets of Shell as the overseas assets of Exxon and the Japanese don’t need a huge overseas presence when the US will protect the overseas assets of Toyota as much as the overseas assets of GM.
Since the shares of these multinationals are traded internationally too, US pension funds have about as much interest in the defense of Toyota assets as GM’s, Exxon’s or Shell’s. Similarly, since the pension funds in Japan and Europe can buy any of these assets, they too have no interest in funding one nations champions at the expense of anothers.
The expansion of the Chinese military seems like a collective action problem for the world’s multinationals. If the US and China both have huge military establishments then, taxes worldwide will go up to fund that arm’s race. More importantly, the assets of the multinationals will be less secure because there will be two governments that the multinationals have to pay tribute to and the third world client states can try and play each of the two off each other.
I guess I am wondering what is in it for the Chinese to establish a huge military establishment? Why not freeride on the US militaries willingness to defend the assets of multinationals worldwide – like every other advanced nation does? Then you have the soft power of not being an imperialist, and can afford to have either lower taxes or more money for social programs at home.
In short what is in for the Chinese to build up a huge military?
To DC: You are right about the carriers. The upgrade in locks in the Panama Canal is partly to accomodate Nimitz carriers. In any event, suppose it does take a month to move nine carriers to the Western Pacific, what then?
I have noticed one difference between professional military and amateurs. Professional military people constantly think about how they can lose a war rather than how they are likely to win it. The problem with being overconfident in one’s military is that it leads on into bad situations. In actuality, there is enough randomness in war that no rational general would want to start one.
Also the hulls of capital ships may be from the 1970’s but the sensors and electronics are not.
don: You may be right about the political ramifications of an anti-China tirade as opposed to discussions of industry-specific trade restraints, but the trade-off comes at a real cost. For example, the economic cost of a tariff increases with the square of the rate – that is, doubling the tariff quadruples the cost.
That may be true, but the issue is then cost to whom? There are good economic arguments that removing tariffs increases overall national wealth, but that’s little comfort to the person that loses his job. The operating assumption over the last decade and a half has been that if you make the pie bigger than figuring out who gets what piece doesn’t matter, but I think that is now questionable.
don: The same goes for other distortions, including subsidies created by an undervalued currency. So, hitting only a small part of trade hard is much more costly than a milder medicine that is spread over a larger base.
Again the question is "costly to whom"? Also it’s far from clear that a 100% tariff on cotton underwear is worse than a 5% tariff on everything. In any case I think that the era of trade liberalization through negotiations has pretty much ended with the Doha round being stalled. Interestingly trade liberalization seems dead, but trade has expanded enormously sense 2001, largely because of technology.
I think we really are reaching the limits of the Thatcher/Reagan/Friedman project of minimizing the role of the state in favor of the market. The politically easy ways of getting rid of unproductive state control have been gotten rid of, and the easy productivity gains from marketizing things have been made. What’s left are areas in which people can really argue the state should intervene in and areas were there aren’t obvious economic benefits relative to the political cost.
The framework that a lot of economists have had for China is that it is in a "transition" between an old bad centrally planned economy and a new capitalist utopia. However it’s really getting harder and harder to argue that this capitalist utopia exists, and if that is the case, then seeing the Chinese economy as a transition between two states is probably not a good paradigm. The way I think about it is a blind man stumbling through a dark field trying to pick up pieces of gold that seem to be there.
Brad, I have a question about the weakness of the Japanese economy. There is the domestic economy and then there is the export economy, much of which has been offshored. The domestic economy may be weak, but Japanese corporate profitability has risen rapidly since 2003, suggesting that the export economy is pretty strong.
There’s a lot of rivalry in Asia. No one wants to unilaterally appreciate their currency. My feeling is that Japan is "leading the way," allowing its currency to appreciate to encourage the Chinese to do likewise.
Your response?
Central bankers hate to have their hands tipped. For them, it is worse than making love in open broad daylight. Once the RMB appreciation becomes a one way bet, the appreciation itself becomes a "death-march".
Beijing understands the problem. Ms. Wu Yi complained in private that "there were 300B USD hot money" in China, and she said that in —2004—! before the appreciation started.
The international club also understands the problem and proposed sharing the pain with Beijing. The concensus was communicated to Beijing 2 years ago. So far, Beijing hasn’t taken up the offer. So. you can see they are still quite confident running the show at this point.
EU and China is running an experiment now, in textile,— tracking and liscensing at both ends. It is quite easy to flip this setup to be "diectional & differential" export tax, in which "made-in-China" will be more costly only to the consumers in the US and EU, but not to other countries.
Personally, I don’t buy any theory or conclusion about trade adjustment, not yet. The only candidate that everyone is hoping and expecting to take China’s place is Vietnam. Vietnam has the right DNA, but it still looks to be 4 or 5 years away. In the mean time, the "digital covergence" and electronic miniaturization will keep on driving the supply chain to China. End story.
Is domestic asset price inflation considered in measuring or interpreting the real exchange rate (as opposed to domestic goods and services inflation)?
Asset price inflation does NOT enter into the calculation of the real exchange rate.
Anonymous ibid — I don’t Japan is leading the way, b/c I don’t think Tokyo was pushing the yen to appreciate. The yen appreciated b/c the interest rate differential with the US fell and some carry trades got unwound during a period of risk aversion. Japan didn’t fight this by intervening, but it hard led — and, as the chart above shows, the yen is still pretty weak in real terms. I would put more emphasis on China creating the conditions through faster RMB appreciation where others in asia (malaysia, thailand) were more comfortable with a bit more appreciation.
Just when the US trade deficit is actually adjusting with China but not the Middle East (ie. oil), the US politicos are back on the China bashing bandwagon. This year’s Guangzhou Trade Fair that is attended by most national US retailers portends a further drop in Chinese exports to the US over the coming year with the value of contracts plunging a reported 13 percent.
Obama, Clinton back Senate trade bill on China currency
http://www.reuters.com/article/marketsNews/idUSN0144032720080501
WASHINGTON, May 1 (Reuters) – Democratic presidential candidate Barack Obama said on Thursday he supported a Senate bill to offset China’s "currency manipulation," one day after his rival Hillary Clinton added her name to the list of legislation’s co-sponsors.
Twofish,
Unlike the United States which plays the Supercop role around the world, the China PLA military objective is more limited. Defense should only mean Defense for any nation and absolutely not any global hegemony objective. For defending it’s territorial sovereignty, the assymmetrical weapon systems developed by the China PLA are more than adequate to deter US interference around the Taiwan Staits. Today’s modern Diesel-Electric submarines are extremely capable. New Fuel-Cell Electric submarines with Air Independent Propulsion (AIP) can remain submerged for a couple weeks at a time. The new Chinese Type-040 submarines utilize AIP technology from Germany. For regional waters, Diesel-Electrics are more capable than Nuclear subs since the Electric motors are almost completely silent. In exercises with the Australian Navy Subs, everytime the US Navy Aircraft Carriers were sunk in the warfare simulation. It was so bad that the US Navy has leased a Swedish Diesel-Electric submarine in San Diego. The Chinese submarines are equipped with supersonic Anti-Ship cruise missiles for long range attack. The recent destruction of a Chinese weather satellite with an ASAT weapon also stunned the Pentagon. The preeminent Asian military power in the Western Pacific is China. Japan doesn’t have Nuclear bombers, Nuclear cruise missiles, Nuclear Submarines, or Nuclear Ballistic ICBM missiles.
The trouble is, low rates are treating the symptoms of the U.S.’s problems, not the underlying sickness. What ails the U.S. is too much consumption, too much debt, too little household savings and a financial system that’s more vulnerable than once thought. Fixing these imbalances will require strong action from lawmakers and economic officials — not more liquidity. Japan squandered a decade believing low rates would restore its economy to greatness. The longer it takes the U.S. to heed those lessons, the more Asia may pay the price.
http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_pesek&sid=acrUvNUAIYX4
The United States is afraid of China’s rise to world superpower status and is determined to contain it if possible.
DC: Unlike the United States which plays the Supercop role around the world, the China PLA military objective is more limited.
The PLA’s military objectives involves increasing the costs of a US military intervention in Taiwan thereby deterring US support for a declaration of independence. If the PLA has to use military against the US, then it’s already failed its primary objective.
DC: The preeminent Asian military power in the Western Pacific is China. Japan doesn’t have Nuclear bombers, Nuclear cruise missiles, Nuclear Submarines, or Nuclear Ballistic ICBM missiles.
I’d argue that Japan has a stronger navy than China. Right now domestic politics keeps Japan from expanding its power, but domestic politics could change. This is why I think it is a bad idea for China to try to push the US out of the West Pacific since the US keeps Japan under control. Without US presence, Japan could be nuclear within a year (it has plutonium stocks), and that is very frightening.
In any case nukes would be mostly useless in an actual confrontation over Taiwan. The scenarios during the Chen administration involves deterring Chen from pushing the limits and deterring the US from helping him. Nuke were useless. Low cost mortgage loans did more to change US foreign policy than nukes ever code. That’s been settled, and its interesting to think about what the new military scenarios are, now that Ma is in power. Personally, I think the most likely scenarios are "war by accident."
Guest: The United States is afraid of China’s rise to world superpower status and is determined to contain it if possible.
And China’s goal is to make it not possible. The problem with a containment policy is that it requires the cooperation of Japan, India, and Russia, none of whom have any particular desire to contain China and all of whom have their own issues with the US. This could change if China behaves badly.
The interesting statistic is that China spends more money to finance the US military than it does to finance it’s own.
"If the PLA has to use military against the US, then it’s already failed its primary objective." – Twofish
The China PLA will move against Taiwan if a formal declaration of Independence is undertaken. The US Military has declared it will declare war on China if the Chinese military takes action on Taiwan. Do you think it would be better for the US Military Superpower to dismember China into subserviant Balkinized states in order to avoid a confrontation? The US Central Intelligence Agency has been financing and organizing the Tibetian separatists. The Dalai Lama himself is on the CIA payroll with a $15,000 per month salary. A huge cache of automatic rifle weapons, fake Chinese passports, and encrypted satellite transmitters provided have discovered by Chinese State Security in the Tibet region. Just where would Tibetian separatists obtain deadly sophisticated weapons and satellite communication equipment. While the organized Tibet riots burned down parts of Lhasa, they don’t seriously threaten the Chinese government hold on power, but merely serve to blacken China’s image on CNN and FoxNews, thus the Chinese government mostly ignores these provocations and grow its economy to Superpower status. If the goal of the Chinese government is to prevent US interference in China’s internal affairs, I am afraid that you are correct that Sino-US diplomatic relations are a abject failure.
"I’d argue that Japan has a stronger navy than China." – Twofish
In case the Japanese military supported Taiwan’s Independence, New Chinese Type-093 Nuclear Attack Submarines permit extended range blockade of Strategic Energy trade routes across the Western Pacific which cannot be countered by Japanese Diesel-Electric Submarines. Especially in the Western Pacific with multiple temperature layers that almost completely reflect sound waves, really the only way to kill a Submarine is only with another Submarine. I’d still argue that China has a stronger overall navy than Japan. And the US Navy only has 3 submarines permanently stationed in the Far East region.
2fish — glad you noticed my fun stat!
incidentally, if asia wants the US to fix its own problems, it should stop providing the financing that allows the US to avoid confronting those problems. Why cut back if you have a close to unlimited credit line available at very attractive rates …
Brad, Here’s an Article for you
Blaming the Chinese Yuan for the US Trade Deficit with China
http://www.counterpunch.com/behzad05012008.html
Conceding to American pressures, China relinquished its decade-long policy of pegging the yuan to the dollar in July 2005. The yuan rose by more than 5% in the first year, 12% by the end of 2007, and 14.13% by March 2008. Meanwhile, the trade deficit with China continued to swell by more than 15 percent, from $201 billion in 2005 to $232 billion in 2006; it reached $256 billion by the end of 2007. The American policy makers had gotten the story of China and its role in the U.S. economy all wrong.
Even the educated Chinese with years of work experience are deprived of what China has been supplying the rest of the world. Helping me as my interpreter, a university educated English teacher lamented about her $260 monthly income after 20 years of teaching. She is not potential buyers of American exports, at least not in the foreseeable future. For the most part, their consumption is largely unaffected by the revaluation of yuan. However, their appetite for basic consumer goods is a source of future growth for the domestic market in China.
China’s celebrated capitalism enriched many American firms through investment, and subcontracting agreements with local manufacturers. The same economic model, and its resulting income inequality, is limiting America’s exports to China. The US trade deficit will continue to soar. Trying to correct this with a revaluation of yuan is an exercise in futility. The chickens have come home to roost.
DC — do you ever look at the data links that I include in my posts? You might want to compare the jan/ feb 08 us trade deficit with the jan/ feb 07 deficit. i think you will find that the US deficit with China is no longer growing. The US slowdown played a role. but so did the rmb’s appreciation. the bradsher nyt article that i think you posted included a lot of anecdotes that suggest exchange rate adjustment is having an impact …
Brad,
Why don’t you just delete the more superflous of these military/political comments as a disincentive to posting them? There must be other blogs where this kind of debate belongs.
Twofish: You need to read this re Chinese economic elites and their dominance in SE Asia. You are quite wrong on the subject.
http://news.bbc.co.uk/2/hi/asia-pacific/1514916.stm
Here is the paragraph you need to see:
Today, they (ethnic Chinese) are effectively the region’s business class, controlling the bulk of listed companies in the region’s stock markets – more than 80% in Thailand and Singapore, 62% in Malaysia, about 50% in the Philippines. In Indonesia, they control more than 70% of corporate wealth – although some dispute this figure.
As for Chinese military and political dominance I will have some more info for you shortly.
This should dispel any notion that the Chinese are not ousting the US from the SE Asia region. They are. Further, although this is of course opinion, I have no doubt that the rest of Asia will increasingly fall under Chinese influence, especially as US economi power declines and its will to empire fades. SE Asia is NOT a vital US interest. It is a VITAL Chinese interest.
http://www.hoover.org/publications/policyreview/2920211.html
Dave:
Ever hear of expropriation and read Amy Chua’s "World on Fire". Perhaps, you should. You are a disappointing example of an Overseas Chinese who does little service to the interests of China. You should watch yourself. You seem not to have acquired the best that your culture has to offer. Attitudes like this is why, not whether, there has been moves in the region to contain China (and not by the US so don’t start ranting), and were these same attitudes to be spoken more loudly (by domestic Chinese) there would be a serious problem for China in the offing. You should listen to yourself.
Thanks for the Amy Chua reference. She was the source I was seeking for the info to refute Twofish. She makes it clear that the Chinese minorities (not the Indian) in SE Asia control in effect the economies of those nations. As for DC, I see nothing he needs apologize for. Japan won’t get very far "containing" China, nor will the USA. So they might as well forget about it. Won’t and can’t happen.
It will be interesting, from a historical and political perspective, to see China make its final move to democracy (a.k.a. capitalism) by allowing a true floating exchange rate. Jeez….globalization makes one country’s economic analysis look simple.
Brad,
it’s just a guess of someone who doesn’t know a lot ( the story of my life) but chances are the Chinese government will adopt a 3 prong movement; high interest rates (which ironically worsens the hot money problem), gradual appreciation and price controls/subsidies. Could we see a very ironic situation develop – where local speculative flows are locked in, hot money then becomes the most vulnerable to a bust up scenario, should the government then do a volte face and impose capital controls overnight, speculative flows might well be caught in a really hard place.
The Chinese government was praised for not devaluing in the face of the asian crisis, this may well show a propensity for adopting inaction where there are doubts or an immeasurable balance of pros and cons.
Written by Guest on 2008-05-03 15:57:45
Thanks for the Amy Chua reference. She was the source I was seeking for the info to refute Twofish. She makes it clear that the Chinese minorities (not the Indian) in SE Asia control in effect the economies of those nations.
I seriously doubt if you are Chinese or at least a chinese who’s ever lived in that part of the world for a significant amount of time. What you’ve just said is a very touchy issue which has brought more grief to the chinese in those regions than foreigners can imagine. Everytime there’s economic or social turmoil, the Chinese minorities are targetted, you don’t need to look too far back in history to know that, 97/98 provides enough examples. As for Japanese containment of the Chinese "threat" history is full of those attempts for example, in the 19th and 20th
centuries policies and outright war all aimed at "reducing" the threat of the Chinese were adopted. Incidentally, in the former colonial territories in SE Asia, the Japanese implemented "divide and conquer" principles during the war and occupation, which only worsened the social divide. No prizes for guessing which ethnic minorities were the most targetted. That might well explain why American- Japanese alliances breed unease in the region, as long as Japan doesn’t dispel suspicions (for example, recognise in full its militaristic past ) they will remain targets of paranoia in every dispute.
Judy: No I am not Chinese. But my point was that Twofish was wrong when he denied that ethnic Chinese control the economies of SE Asia. This may have caused many problems, etc., I don’t doubt that, but that was not the issue. The issue was the fact of Chinese dominance. I further think that the Japanese/US alliance is not rock solid and that either the US could desert Japan or Japan decide it would be wiser to cooperate with, rather than oppose, China and that would make the US alliance unnecessary. I doubt the US will remain a major player in the Far East forever.
Twofish was wrong when he denied that ethnic Chinese control the economies of SE Asia. Written by Guest on 2008-05-05 02:15:29
Guest: have you heard about the "positive discrimination" policies in Malaysia? That’s part of SE Asia as far as I know! Not to be snide, but in certain SE Asian countries, control over industries started off with Chinese willingness to take risks and has come with the price of being forced to give up more salient features of their culture; be those Chinese names, language or culture, is that real control? Debatable don’t you think?
Control of the economies of SE Asia is probably large brush strokes, large enough to paint over the fact that much of those Chinese minorities are living similar lives at similar standards to ethnic majorities. The example most often cited by writers such as Amy Chua is Indonesia, but if you visit Indonesia or are familiar with its situation, the number of ethnic Indonesians (non-Chinese) who control industries vitalto the economy aren’t exactly that much smaller than Chinese Indonesians; it’s a feature of the Suharto era that concentration of power was in the hands of a few , and those few comprised both Chinese and non-Chinese, just a matter of politics and power going hand-in-hand rather than any ethnic bias. Visit any Chinatown in SE Asia and you’ll find plenty of local Chinese living very ordinary lives , far from any significant corridors of power. Singapore is an exception not merely ‘cos the Chinese formed a majority from the early days of independence but also because of its meritocratic principles.
Give up their culture? Well Jews in Hollywood had to disguise their Jewishness or thought they did, but that hardly changed the fact that Hollywood was primarily Jewish. Local elites control things along with Chinese elites? Chua never said Chinese controlled everything. But their control is crucial and striking. The percentages cited in the BBC story I referred to earlier are clear on that point. SE Asia is not unique. Portugal was economically largely under British control until recently. The Port wine companies, the transport companies, the telephone company, etc., were all British controlled and run.
perhaps you read the wrong book guest, but she, Chua, also argued, any such control was tenuous, at best. Anyone who lives in the region, as I do will note movements, that do not highlight the US at the center of some containment, yet movements from Japan, SK down to Indo and across to India, where China curries favor from Burma to Pak and Sri Lanka. This is a purely Asian effort, whether America is allied with Japan or not, like in Vietnam, the American war takes abcakseat to a thousand years of Chinese domination, and Japanese war transgression are far less relevant in this light than they migh be in China. This is not the Evil American empire, this is a practical, relevant strategy to counter historical Chinese domination. Where the case of Tibet is relevant, on the grounds as stated, it also might be that many smaller regional nations could be subsumed by such logic from the Chinese, Not that the Chinese would use similar logic to deprive commonly accepted soveriegn nations of their soveriegnty, but historical Chinese domination in the region would demand some counter to that weight, and is in their interest of nations to develop it. No need for an American conspiracy theory here, nations need only rely on their history.