Brad Setser

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Back to the future: Is China’s new RMB policy China’s old RMB policy?

by Brad Setser
July 31, 2008

The odds that the US slipped into a recession around the turn of the year have increased. Nouriel Roubini is convinced. Jim Hamilton isn’t. The risk that US growth may slow later the in year are rising. So far, US export growth has remained robust – supporting growth. The pace of export growth hasn’t risen recently — if has been strong for a long time — so much as the pace of import growth has slowed: Imports have contributed positively to growth for the last three quarters, meaning real imports fell (see Dean Baker for more). But there is a growing risk that export growth will slow with a slowing global economy.

Signs of trouble are now visible in Europe. And not just in housing and finance-dependent economies like the UK – where consumer confidence has really plummeted. Anything that includes the phrase “worst since 1974” cannot be good. Europe, writ large (i.e. counting “new” Europe) has been a more important engine of global demand growth that the US since 2005, so a European slowdown matters for the world. Especially if Europe slows before the US resumes sustained growth.

Japan hasn’t had much momentum for a long-time. It isn’t likely to find new momentum now.

Of all the major economies – and with a $4 trillion GDP and $1.4-$1.5 trillion in goods exports this year, China is far too big to be considered anything other than a major economy – China has by far the strongest growth.

Its exports have held up quite well as the US – and Chinese exports to the US — slowed. Thank Europe – and booming sales to India and a host of other emerging economies. Many emerging markets fear cutting tariffs on Chinese goods far more than cutting tariffs on US and European goods. But forward looking indicators* suggest a broader slowdown in exports. Chinese manufacturers and policy makers are worried.

And it increasingly seems like China took a policy decision to slow the RMB’s appreciation against the dollar (and thus to slow the RMB’s likely appreciation against all the other large oil-importing economies) in order to support China’s export sector. That decision came even though China has the strongest domestic economy and the largest current account surplus of all the large oil-importing economies.

China has a larger export sector — and probably more value-added in its export sector, as China’s domestic value-added has increased sharply during China’s boom – than most other big economies. And it has relied more on exports to support its growth (exports contributed over 2% to China’s GDP growth in 2005, 2006 and 2007) than other big economies. So a slump in China’s exports will undoubtedly have an impact on China. And unlike in 2007 – when most emerging Asian economies appreciated by more than China – in 2008 China’s currency has appreciated not just v the dollar but against a host of smaller Asian economies.

Still, I would rather see China – which has a strong fiscal position (it ran a surplus in 07) and the largest current account surplus of the major economies – support its growth by taking policy steps to support domestic demand, not try to support its growth by slowing the pace of RMB appreciation to support its exports.

A chart of the RMB v the dollar (since 2005) shows the various phases of China’s RMB policy.


The initial revaluation was followed by a long period of almost no appreciation. China genuinely seems to have worried that even a small move would hurt its exporters (remember all the stories about their razo-thin margins). It took about two years for the RMB’s value to increase by a cent, from 12.5 cents to 13.5 cents.

As the US slowed, the dollar started to depreciate and inflation in China began to pick up, China started to allow the RMB to appreciate more. Last fall, it allowed a meaningful appreciation for the first time.

But that created problems of its own – not the least hot money inflows, as the RMB was appreciating and Chinese rates were above US rates.

And now China seems to have decided to pause the RMB’s appreciation, at least for a while. Export interests have reasserted control over policy. Special interests aren’t just a factor in trade policy – there are a host of industrial sectors in China that have been “protected’ by an undervalued exchange rate.

Slowing RMB appreciation – the non-deliverable forward suggests an appreciation over the next year of only a bit above 4%, a pace last seen in 2006 – might reduce hot money inflows. But if China really wants to make its monetary policy consistent with its exchange rate policy, it also needs to reduce domestic interest rates.

Ending appreciation, cutting rates and relaxing lending curbs would certainly support growth. It also would risk pushing Chinese inflation up to the levels seen in the Gulf.

While I would prefer that China allow its currency to appreciate (helping the global economy) and use domestic policies to support growth (also helping the global economy), if China is going to slow the pace of RMB appreciation, I certainly would hope that such a policy isn’t accompanied by policy steps to curb demand growth (like tight fiscal policy) in order to limit inflationary pressures. China tried that policy before, back in 2004. It led rather directly to China’s big current account surplus. The last thing a slowing global economy needs now is a Chinese policy that supports the export sector by limiting RMB appreciation while restraining domestic demand growth to limit inflation.

Lest we forget, the RMB has fallen by something like 30% against the leading currency of its most important trading partner since the turn of the century.


The recent appreciation that Chinese exporters have complained so vociferously about hasn’t even pushed the RMB much above its late 2004/ early 2005 lows against the euro. The RMB was down 30% v the euro (from late 2000) in early 2005. It is now only down 26-27% …

China has enjoyed one of the biggest export booms in modern history. Exports are on track to from around $250b in 2000 to $1.4-$1.5 trillion in 2008 now. China’s exporters don’t have much to complain about. In the 1990s, export booms were followed by periods when exports hardly grew at all. The trend wasn’t uniformly up. Realistically , China cannot expect to be able to continue to rely as heavily on exports for growth as it has. It has the policy tools available to do shift the basis of its growth. The political will to do so, though, seems lacking. At least for now.

Update: Michael Pettis and Victor Shih are reporting that the PBoC has created a new Department for exchange rate policy. Exchange rate policy was previously handled by a bureau in the monetary policy department. I have no idea if this means that China is more or less likely to allow more RMB appreciation. I do, though, think that if China wanted to organize the PBoC in a way that reflects its existing policy, it needs to go a bit further: Shouldn’t the monetary policy department report to the exchange rate policy department, as China has decided to subordinate its monetary policy to its exchange rate policy?

* Stephen Green of Standard Chartered has a good research report on this.


  • Posted by Twofish

    Rich: Why should the EU and US just open their populace to a loss of jobs when there are more FDI restrictions in China then elsewhere?

    Because at least in the US the argument that “China is costing Americans their jobs” doesn’t work everywhere. It works in Michigan and North Carolina. It doesn’t work in California, Texas, and New York where you have entire industries (shipping, semiconductors, computer hardware/software, and finance) that are dependent on Chinese trade.

    I don’t know about the politics of Europe, but lot of the “loud calls for protectionism” strike me as politicans that are making loud noises that they are planning on doing something so that they don’t have to do it now.

    Rich: If China listens to the will of the people, most assuredly the US hasn’t (about jobs) and the EU is not going to tolerate this much longer.

    The problem here is that people are saying different things. If there was a national consensus to limit trade with China or cut the trade deficit, it would have happened years ago. There isn’t since there are just too many people in the United States making too much money with Chinese trade, and that is just political reality.

  • Posted by Twofish

    bsetser: Corporate America doesn’t mind government intervention that helps their bottom line.

    Nobody objects too strongly to government intervention that helps their bottom line. That includes Corporate American, farmers, average people, everyone. If they get a benefit from the government, then government intervention is wonderful.

    When people complain about corruption and welfare, it’s usually because they aren’t getting any of it.

  • Posted by Twofish

    Huizer: But I doubt that the 1.2 billion cars in the plateau stage of Mankind’s sunset period will include many Indian cars. They missed the Bus.

    China has missed eight or nine busses over the list four hundred years, so whatever economic mistakes India is making can be corrected. I’m fascinated with the Indian economy, because it is so different than the Chinese economy. Just about everything that India does is completely different from what China does, yet it all manages to more or less work at generating economic growth. Some with Vietnam, there are a lot of differences between Vietnamese economic policy and Chinese economic policy, but it seems to be working in Vietnam.

    Also changing technology doesn’t eliminate the problem of resource use. Suppose China were to use electric cars. Great!!! Less demand for oil. More demand for coal, copper, and battery metals. Right now, I’d be very interested in the economy of Zambia.

    Suppose China were to create 100 million hyper-efficient cars. They may use a lot less resources, but they are going to be using something.

  • Posted by Rien Huizer


    One does not have be neo-malthusian to accept that the relatively sudden increase in the production of energy consuming hardware for personal transport where previously there was no such need, to the tune that the world’s stock of cars would double in say 10 years would meet a few resource and environmental constraints, if all these cars were as heavy, thirsty and dirty as the world’s current average one (it does not have to be, there is a relatively roomy 4 seat Audi diesel hatchback that seems to get 75 miles p g, Three of those would consume as much as my SUV and use about half the weight in materials).

    Possibly this could lead to a more or less 19th century type of competition for raw materials etc that would be difficult to handle for the existing international institutional features (assuming no one would be willing to invest in something that could do multilateral rationing…

    My idea of India missing the Bus is based on the fact that there is just not enough infrastructure for rapid expansion of car ownership like China’s right now. India has severe domestic political obstacles to any form of infrastructure development. So, it would take quite while for India to reach the rapid growth phase in the logistics curve where China is currenly. Before it gets there, we may well be living in a different sort of international environment, with China an increasingly important stakeholder in a new form of stratification.

  • Posted by Rien Huizer


    For some reason I missed the significance of the alleged new POBC department in your post. Must be because I was also listening (after having walked way from the video) to a Turandot performance apparently recorded in the People’s Palace Museum in Beijing. Bombast drowns out meaning.
    I think that it simply means that the POBC has reached a level of enlightenment previously reserved for the Monetary authority of Singapore. This is becoming serious: 1.3 billion people mimicking the policies of my beloved and exemplary City State. If you want to manage the exchange rate (for what? control inflation? make sure buddy’s factory stays competitive? suggesting to laobaixing that gvt is looking after his interests?) you cannot, according to standard undergraduate theory, manage interest rates independently, and, if you are Spore with a wide open economy, why would you want to have a monetary policy anyway. But what if you have an economy open only selectively and it is a bit large? Good Grief. Looks like the End is nigh.

  • Posted by Twofish

    Huizer: My idea of India missing the Bus is based on the fact that there is just not enough infrastructure for rapid expansion of car ownership like China’s right now.

    China built its first freeways in 1989. It’s not that difficult to create a massive network of highways, if that is what you want to do, and whether India should have massive networks is something that I’d be interested in hearing Indian perspectives on.

    Huizer: India has severe domestic political obstacles to any form of infrastructure development.

    So did China, but the political obstacles were worked around. The big political obstacle is funding, but on the other side, infrastructure creates lots and lots of jobs.

    Something that I find amusing is that one of the few cases in which the Communist Party leadership got their hand slapped on was the fuel tax. The State Council and Politburo wanted to create a US style trust fund system in which highways would be funded by a gas tax, and the National People’s Congress said no since any gas tax could hurt farmers. The way that freeways in China are funded is by state owned corporations which charge tolls.

    Huizer: So, it would take quite while for India to reach the rapid growth phase in the logistics curve where China is currenly.

    India has been having sustained growth rates of 8-9% over the last decade. It has a much different economic and political model which is why no one seems to notice. One question that I find interesting is “why do we always seem to be talking about China so often when India is growing so quickly?”

  • Posted by Rien Huizer


    Why do we always seem to be talking about China ..?

    Good question. Personally, I think that GDP is far from perfect as a comparison tool, both level and delta. Much of my knowledge of both countries is anecdotal, but if I had to make a bet, it would not be on India, and I guess that goes for many people.

    India has very poor initial conditions (it would take at least 1000 words to elucidate this) and only perhaps 200 million people who are highly socialized, artciculate and educated. Many of those work in (developmentally) wasteful professions like law, religion, arts and finance. If you take Japan from the Meiji period till say 1985 as the gold standard for industrialization (and please include that remarkable performance in Manchuria as well, anyone with an open mind, even a Chinese, should, remember Deng’s cat), India’s in vestment of elite human capital is completely wrong for a low-GDP country. In addition, many of its best minds work abroad. The higher levels of society sem to have a vester interest in keeping the rest poor (the scourge of Latin America). In the Japanese playbook the state beats the law often and the state listens to successful entrepreneurs but not to industry lobbyists. They kept the farmers (who grow food) on the land until needed them, had them socialized (women too), gve them tough military service and you would balance the urban and rural population and their diets in such a way that the rural produces a surplus and that the cities do not waste it.
    You keep this up for say 50 years and then you can start worrying of what to do next..You may need different people for he country you’ve created..

    I am not so sure that China can do something similar (or invent an even better mouse trap), but I strongly doubt India can do it. Both countries have one handicap: human noise in the industrialization process. In fact, some people call that democracy.

  • Posted by bigdog


    Michigan and North Carolina have been fairly aggressive in seeking foreign investment.

    Don’t stereotype them just because one is the home of car manufacturing and another a state where historically the textile industry was big. There is a lot more to the economies of both states – North Carolina is the home to probably the best and highest concentration of biotech and medical research in the Research Triangle. And other southern states – SC, Alabama, etc have been very prominent in soliciting foreign manufacturing investment.

    California is home to some of the most right-wing, anti China neo cons and Texas is – well Texas.

    The US is too diverse to make these type of assumptions, but of course the politicians do and pander to the voters (and unions) that way.

  • Posted by ThreeFish

    I cannot understand why Dave Chiang seeks to defend China so aggressively at every turn. The downturn in manufacturing in southern China, such as it is, is the direct result of a conscious Chinese government decision to try to reduce reliance on high-polluting, low-margin exports. The screams of pain that he says the central government is now taking notice of come from the bosses – who want to keep paying the workers as little as possible – and not the ‘working class’ he talks about. The workers actually want the higher wages which their bosses – and the multinationals (yes, the horrible foreigners) are complaining about. Earlier, Dave said the foreigners pushing RMB appreciation on China didn’t care about Chinese workers. Let me ask him – did Zhu Rongji et al care about Chinese workers when they put tens of thousands of them out of work with state sector reform in the late nineties? Yes, they did, but they also understood without a policy change, the jobs would have disappeared anyway. The same applies now – the current model is not sustainable and the central government in Beijing recognises that, even if Dave does not.
    And finally, on IPR, Dave is wildly out of touch, probably because he doesn’t live in China. Very few of the great range of DVDs on sale in China can be bought legally in China, because the Culture Ministry does not approve them for release. This is a FACT. China has solved nothing in this area, except to give people like me incredibly cheap and plentiful DVDs. It is great for us consumers…………

  • Posted by Rien Huizer


    Excellent comments!

  • Posted by Twofish

    bigdog: Michigan and North Carolina have been fairly aggressive in seeking foreign investment.

    Great!!!! So it looks like “China is costing US jobs” doesn’t even work there.

    bigdog: The US is too diverse to make these type of assumptions, but of course the politicians do and pander to the voters (and unions) that way.

    Which was my point.

    Also in the end a politician has to vote one way or another, and you can tell a lot about how a politician is going to vote by looking at their district. They are usually under competing pressures which means that the way they vote can be surprising and not easily categorized.

    One other thing, politicians often intentionally seem a lot more stupid than they actually are. About anything that involves re-election, they tend to be very sharp.

    At the end of the day you add together all of the votes and see if you have enough support for what you want to do, and there isn’t support for large scale tariffs on China.

  • Posted by Twofish

    Threefish: I cannot understand why Dave Chiang seeks to defend China so aggressively at every turn.

    I find it odd how he defines “defending China.” I tend to “defend China aggressively at every turn” in the sense of supporting policies which I think are in the Chinese national interest. The difficulty here is defining “national interest” and once you have defined it then figuring out what policies advance it.

    One thing that is the case about China is that there is no one definition of “national interest” and hardly a consensus in China about what policies support the national interest. This is what happens when you have a large nation.

    Threefish: Very few of the great range of DVDs on sale in China can be bought legally in China, because the Culture Ministry does not approve them for release.

    But this points out how specific industry concerns are. The IPR and politics issues with entertainment DVD’s are not the same as the IPR issues with industrial software or consumer software, which means what happens with DVD’s may have nothing to do with what happens with oil production software.

    IPR protection isn’t a huge issue for the people I know that sell industrial software since the high margins come with training and support, and the software is useless without those.

  • Posted by ThreeFish

    Twofish, I agree with you. There are many diverse opinions in China. Many policymakers here do NOT support caving into the demands of the manufacturers on RMB appreciation. Such a policy is not a western plot. The ritual abuse regularly handed out by Dave on behalf of ‘China’ does not in fact reflect the diversity of Chinese views. He only speak for himself.
    Re piracy, I was referring to DVDs. Of course, it is a complex issue and not one I am trying to address at length here.

  • Posted by Judy Yeo


    aaah, finally a male who admits that the legend of men and tools are really just that, legend. Calling in the experts do not neuter the male, at least not to sensible psyches :p

    but seriously, ill feeling perhaps but then again, you would expect that of certain elements in every society whatever the colour of their necks but violence over consumerism and wealth in a world tearing itself apart over other vicious issues, would that really happen, are the various sides in this violence you picture really for war or violence, war tends to make people poorer unless one happens to be in the defence business. Sigh and one would have thought bthe luke skywalker/darth vader obsession went away with the star wars prequel.

    incidentally, just how young are you? why the focus on younger people? was just thinking about some of the views expressed by some of the regular bloggers really doubt if they fit in your category of young?!