Political pressure seems to be mounting for yuan appreciation.  Figure 1 depicts the stability in the USD/CNY nominal exchange rate over the past year.
Figure 1: USD/CNY nominal exchange rate, period average (blue, left scale); log trade weighted nominal value of the CNY (teal, right scale); log trade weighted real value of the CNY (red, right scale). “Revaluation” denotes the CNY revaluation in July 2005; “Lehman” denotes the Lehman bankruptcy in September 2008. Sources: St. Louis Fed FREDII, IMF, International Financial Statistics.
Note that even as the CNY has been effectively fixed against the USD, it has depreciated against a broad basket of currencies. This is true in both nominal and real terms.
At the same time, it is interesting to look at recent developments in trade flows, in particular the trade balance.
Figure 2: Chinese trade balance, in billions of USD, annualized (blue), and 12-month moving average (red). “Revaluation” denotes the CNY revaluation in July 2005; “Lehman” denotes the Lehman bankruptcy in September 2008. Sources: IMF, International Financial Statistics, and ADB.
Keeping in mind distortions in the trade flows due to the lunar new year, it does appear that there’s been a stabilization in the Chinese trade balance, as predicted by the IMF. Nonetheless, it’s of interest to see what is doing the bulk of the adjustment — exports or imports (keeping in mind a lot of the imports are incorporated into exports).
Figure 3: Chinese exports (blue) and (imports), in billions of USD, annualized. “Revaluation” denotes the CNY revaluation in July 2005; “Lehman” denotes the Lehman bankruptcy in September 2008. Sources: IMF, International Financial Statistics, and ADB.
It strikes me with exports recovering on a year-to-year basis, now is the time for an RMB appreciation. I have little insight into the thinking of the policy authorities in China, so let me turn it over to someone who does. Arthur Kroeber of Dragonomics, a business consulting firm based in China, agrees that the time has come for a change in the currency stance, and further argues for a discrete revaluation, as opposed to a resumption of gradual appreciation:
…the gradual appreciation of 2005-08 was problematic: because the renminbi moved only one way, lots of international capital flowed into China to play the apparent one-way bet. Inciting huge capital inflows at a time when Beijing is already battling the strongest inflationary pressure in years is unappealing.
Logically, the way around this is to start with a very quick appreciation of at least 10 per cent to take the one-way-bet calculation out of the market.
There is a strong case for making a move soon. The longer China waits, the more criticism it will attract for its undervalued exchange rate.
The criticism is likely to come to a head in March— when the US Treasury will need to make its determination about whether China is a currency manipulator—and April, when the G-20 next meets.
Mr. Kroeber has an interesting article in the most recent issue of China Economic Quarterly [not online] where he argues that the labor market tightening is a plus for labor income and hence consumption. That means the policy authorities in China have the space to allow for an yuan appreciation (which is in any case more desireable than constraining growth solely by money and credit restraint, as I argued here three years ago).
How much of an impact would a given appreciation have? Recalling that GDP (in China and Rest-of-world) matter, as do supply capacity, recent partial derivatives/elasticities are discussed in this post.
I would be remiss if I did not mention Eswar Prasad‘s recent testimony before the US-China Commission on the inter-relationships between China, the US and the world economy: see here. As per his usual work, it’s an excellent and finely nuanced assessment of the current situation.
Additional Econbrowser posts on China here.