Saturday, February 6, 2010

I have to side with China on this one

Yes, the renminbi (RMB) is closer to fair value. Chinese Foreign Ministry spokesman Ma Zhaoxu states:
"Our currency, the RMB, has appreciated more than 20 percent against the U.S. dollar since July 2005, when China moved to a floating exchange rate regime," Ma said. Before 2005, the RMB was pegged to the U.S. dollar at a fixed rate.

"The RMB exchange rate has drawn close to a reasonable and balanced level, given the international balance of payments and the market supply and demand for foreign exchange," Ma said.
The New York Times asserts that China's currency is undervalued by 25%-40%. The NY Times, like many politicians and media channels, is entirely too obsessed with China's exchange rate; they fail to understand that economic fundamentals are changing.

Contrary to popular belief, the level of the renminbi has become rather inconsequential to Chinese trade flows. Why? Because despite the fact that the renminbi has been pegged against the dollar since July of 2008, imports are surging.

The chart above illustrates the 3-month annualized growth rate in exports and imports and the renminbi valued against the US dollar. I use the 3-month annualized rate, rather than the year/year rate, to remove the strong base effects from the drop-off in trade last year.

The first thing to notice is that while export growth is indeed strong, "business as usual" in China, import growth is surely breaking trend. The 3-month annualized growth rate of imports - a good proxy for domestic demand - averaged 117% annualized growth per month from April (when it turned positive) to December 2009. Compared to this period in 2006, annualized import growth is up almost 80 percentage-points, while that for exports is up just 5 percentage-points (76.2% average 3-month annualized growth in exports May-December 2009 vs. 71.7% in 2006).

It's hard to argue that the Chinese currency is so "undervalued" if the import response is this strong.

Another myth is that China is running large current account surpluses. Given the chart above, it won't surprise you to know that China's current account has dropped markedly since late 2008.

The thing is: since prices in developed economies have dropped relative to those in key emerging markets (i.e., China), real exchange rates are coming back in-line with a s0-called equilibrium. Therefore, the renminbi, by definition, is closer to whatever an equilibrium would be, despite the fact that it is fixed. Thus, like Ma Zhaoxu says, it's at a "reasonable" value.

Rebecca Wilder


  1. RW, there are other possibilities as well:

    China is converting a lot of its dollar holdings into assets, imports and the like. Therefore it needs to secure other under-valued currency assets before dollar loses its purchaisng power. So mining, raw material, food grains etc. should account for some higher imports.

    A currency equation always has two sides. If one is fixed (RMB) then you can adjust the other (USD). The question is should you adjust using deflation or revaluation. China's peg is forcing a US deflation.

    This does not mean US will be quiet. It will print as much dollars as it can forcing China to buy them because China committed to the peg in the first place.

    China, in my view, does not get the full extent of this game. US can pull out of this as winner and under-dog both at the same time. China seems to be making itself into a villian without reason.


  2. It will be at a reasonable value when it is not pegged.

    The peg exists to keep it from a reasonable value.

    If it were at a reasonable value now, they would let it float.

    China's imports reflect its stimulus and surging capital expenditure.

  3. RMB == Ruble!

    Everyone "forgets" that China is as much a command-economy as the USSR was and whatever figures are reported will have the values required by the central planning commitee.

    Un-pegging the RMB would undermine central control by necessitating that RMB-denominated assets can be changed into other currencies and leave the country; i.e. the RMB would likely crash instantly.

  4. We are in a resource & economic war & China cheats – thru Pegs, PBOC sterilization of RMB, subsidizing exports, capital controls, tax exemptions, tariffs, manufacturing inputs, patent infringements, WTO violations, slave labor, declining exchange dollar, etc. It's a mess.

  5. Hi rahuldeodhar,

    It will print as much dollars as it can forcing China to buy them because China committed to the peg in the first place.

    I never quite understand statements like that. The US can't force China to do anything. And right now, the “printed” money isn't really money at all – it's just base that's sitting in accounts at the Fed. Consumer spending remains historically low, and import growth – although positive – is coming off of such a low base. So until Europe and the US bounce back (not likely if you believe the IMF), China's will maintain their domestically-led growth strategy. My point is: China is doing okay on its own – eventually, it will lose the export growth model, and allow the yuan to fluctuate more freely. It has to in order to maintain its desired trajectory (do what Korea and Taiwan did last century).

    I'm pretty sure that Chinese policy makers get the full extent of the game – nice choice of words because it does imply a certain strategy. Changes are already underway in China – patent applications are off the charts, domestic programs (like education and health) are improving markedly, and production is moving up the value-added chain. It's not going to happen tomorrow, but I suspect that China will continue to make the right economic decisions.

    Hi Flow5

    You are right – it is a mess. Sometimes I just wonder how they keep all of their ducks in a row. So many controls requires a lot of added resources just to maintain economic order. $2.4 trillion of reserves (plus who knows how much in the banking system) could really make a difference domestically.

    But like I said to rahuldeodhar above, changes are already underway.