Whither the Yuan?

Political pressure seems to be mounting for yuan appreciation. [0] 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.


21 thoughts on “Whither the Yuan?

  1. Brian

    The Chinese should have revalued already, and this may ultimately cost them; that is, the RMB will revalue and the Chinese economy will rebalance, just exactly how and when, I don’t think anyone really knows, but it will–or be forced to, if not by governments then by market forces.

    The question is, do the Chinese revalue with their current peg strategy or do they allow it to float? I suspect the PBoC will continue to buy dollars at a set rate, albeit 5-10% higher, maybe–certainly only as long as the trade imbalance continues.

    If the RMB floats, you’ll certainly get an initial bump upward in the RMB as Chinese commercial banks sell off the dollar and buy RMB; but whether this RMB appreciation would be sustainable in the long run, I have my doubts–the Chinese have really boosted their credit markets and their money supply and hence inflation are exploding.

    As for the speculators, they’re still there, just waiting–so I think it would be a mistake to assume that they have left: if China wants to shake them then that’s a tough call. They’ve tried to shake them by talking up how they’re going to leave their RMB policy in place, but they don’t seem to by it. The problem that China faces by keeping controls on its currency is that no one really knows how people are playing it and in what quantity–and controls don’t stop investors from getting the RMB, it only prevents the policy makers from knowing (this was the case with the Rubble in the 90′s, and during the Soviet regime, currency trading still took place on the black markets).

    China may have been better off maybe just decreeing the exchange rate of the RMB/USD instead of buying unlimited amounts of it outright at the stated price–yes, a blackmarket would have formed, but that would have at least given you some indication of what the RMB is really worth in dollar terms

    I’m certainly playing for a RMB appreciation, but as always I am very suspect about such vast government intervention and manipulation into the economy that eventually there will be a slip up and the house of cards that is the Chinese economy will come crashing down. I am optimistic about China in the long run, but only if the current governmental regime is done away with and a freer society is implemented along with free markets. This might also relieve China of it employment stability problem, as a major cause of their huge unemployment isn’t just because of their huge population, but that the government herded in many people into the urban centers for cheap labor who once lived perfectly well on self sustaining villages

    Further, I suspect the Chinese government is somewhat fearful of appreciating the RMB too much, too quickly, as their exports would rise in price, and this now might allow countries like Vietnam and Thailand to industrialize and replace the Chinese manufacturing monster. And of course, the Japanese are still a force to contend with.

    What can be taken from this is that I have no idea what’s going to happen and what real effects will follow from any other action; but there is something that I am reminded of that does make me worry; there have been two other times in history that a country has held such store of foreign currency reserves as a percentage of World GDP as China does today: the US in the 1920′s and Japan in the 1980′s.

  2. Get Rid of the Fed

    “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.”

    Can that be applied to the USA so that bernanke’s and greenspan’s access to credit/debt philosophy can be done away with? If so, can both the jobs of bernanke and greenspan be done away with?

  3. don

    The correct policy, it seems to me, is simple cessation of intervention in currency markets. Perhaps it could be phased out. Rather than authorities guessing the appropriate rate for the yuan, let markets decide. Meanwhile, Treaury should make clear that the best metric for currency manipulation is currency intervention.

  4. Brian

    Mr. Chinn,

    First I would like to open by saying that I can imagine the frustration you might feel at times by responders (perhaps I being one of them). Certainly your accumulative experience and learning in economic matters has been a long time in the making, and it probably is not treated with the respect it should be, that is, many disagreements or criticisms towards you on this blog may originate from a reader’s mere difference of opinion, but sometimes gets expressed more as an insult than anything of substance–so, let me apologize for any disrespectful stances or comments I may have made in the past or here.

    For me, I think my life has been guided more by luck than wisdom, and so when I raise doubts–it wouldn’t surprise me to discover or have it revealed to me that they are derived from ignorance on my part, then compounded by the fact they are ill expressed–, I raise doubts not because I posses any greater knowledge (which I don’t) than someone such as you, but it’s because I simply don’t know.

    Imagine we are a group of hikers trying to find our way through a dense jungle, and someone such as yourself has spent a lot of their life studying the art of navigation, and so of course we look to someone like you for guidance through this labyrinth of foliage. And someone like me, that’s a mere member of the hiking party that is probably good for nothing more than carrying gear and such, simply wants to ask: maybe we’re lost? I have nothing to really go by or to show any real demonstration for this feeling I have other than some simple observations that have made an impression on me. And so when I bring up a question or counterpoint, it’s not a question of your skills and knowledge, but more of how it’s being applied, that is, made it’s being applied in the wrong direction. Again, I don’t know; but this is why I take the time to write responses on your blog, not because I have anything important to say, but that I do have many important things to listen to.

    I realize the above was long winded, but I hope, at least in an indirect way, it is pertinent to the topic, or my response in general. And, so, to get to my point: Chinese exports have be looking fairly dismal for the past couple of months (5.5% in Jan and 2.2% in Feb, I believe; as well as German exports being down massively) and perhaps the upward trend is a bit misleading because of the depressed level the year prior and massive government intervention world wide that might not be sustainable over the long and intermediate terms. I suppose that “feeling” I said I had before, well, it seems like the consensus viewpoint is a bit too optimistic and maybe were using the term “recovery” in misleading ways that is affecting the way we’re interpreting things. Also, I realize that trade data can be volatile month over month, but my question: if China’s exports continue down this ever decreasing path would you still believe that the Chinese government will revalue the RMB upward, at least substantially?

    Looking at the actions of the Chinese government’s actions, they don’t seem to be so convinced about a recovery; but of course their caution is well deserved: if they’re wrong, that may lead to social unrest and destabilization. Also, I have no doubt that they’re much more aware about how many businesses that are sustainable without government subsidies.

    I suppose my feelings derive from my impressionable observation, possibly a false observation, that we’re not really experiencing a recovery at all–certainly the newly released Fed’s Z1 report doesn’t give me much room for optimism of a recovery.

    And now that I have expressed some of my thoughts, it has allowed me to realize a more fundamental question that I want to ask, or been wanting to ask but didn’t know how to express it. Perhaps it is not a jungle after all we are traveling through, but a desert, and off in the distance we are being guided towards a watering hole. Again, it is not your ability to guide us to the watering hole that I question (that would be foolishness on my part), I merely question the reality of the distant watering hole, and our teleological quest to get there.

    Sorry for the length; if I had more time I would have written with more brevity, so please excuse me.

  5. RicardoZ

    It is interesting to read Arthur Kroeber’s reasoning for why China should appreciate:
    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.
    Apparently the most important thing is to blunt criticism from the US rather than do what is best for China. It is amusing. Certainly if the US wants to use monetary policy to gain a trade advantage with the rest of the world by making them eat dollar depreciation, they would never criticize China for maintaining parity to the dollar. US monetary authorities are totally altruistic, don’t you know.

  6. RicardoZ

    Don wrote:
    The correct policy, it seems to me, is simple cessation of intervention in currency markets. Perhaps it could be phased out. Rather than authorities guessing the appropriate rate for the yuan, let markets decide. Meanwhile, Treaury should make clear that the best metric for currency manipulation is currency intervention.
    This has to be a joke. The market should decide the rate for the yuan while the US Treasury and FED are the biggest manipulators in the world?! Do you not understand that the reason the Chinese are pegging to the dollar is to blunt the monetary problems caused by US intervention concerning the dollar. Chinese intervention is simply to offset US intervention.
    If we had an honest market based currency in the world it would be gold, not a manipulated dollar.

  7. Cedric Regula

    The Chinese really can’t let their currency “float”, without opening up their capital markets completely. I’m sure they view relinquishing the control they have now as dangerous and counterproductive, and rightfully so from a domestic economic standpoint. I think they probably did a better job of studying the Rise and Fall of Japan than our myopic policy makers. I would conclude that the Plaza Accord of 1985 (which essentially doubled the value of the yen vs other major currencies) had a major cause and effect relationship on the 1990 meltdown in manufacturing, real estate, and bad banking that supported what was finally shown to be a bubble economy in manufacturing capacity and real estate.
    So the path they will take is slow eventual appreciation of the peg, the only question is will it be fast enough for the rest of the world. In the mean time we will have to listen to them complain about dollar weakness, massive Treasury issuance, and if our floating dollar does go up now and then, that we are making their low tech industry uncompetitive with Vietnam, Sri Lanka, etc…But it is difficult to tweak this system so it works just right.

  8. Cedric Regula

    Another thing that strikes me odd about this whole discussion of exchange rate policy is the apparent assumption that this is the only way towards re-balancing.
    Lately everyone seems to agree, including even the Chinese in some official statements, is that the US consumption torch needs to be passed to the Chinese domestic consumer.
    One thing that industrialized nations learned a hundred years ago is that a minimum wage law is necessary to do the heavy lifting of smoothing out a populations’ income gap and insure the growth of a middle class with the means to consume. The price of goods goes up in any currency you choose.
    How this means to an end has escaped a “communist” government causes me giggles to no end.

  9. Jeff

    The rebalancing is already underway. China’s real exchange rate is appreciating due to higher Chinese inflation. It would be less disruptive to the Chinese economy had the currency been appreciated or allowed to float, but it seems people have to keep learning the same painful lessons over and over again.

  10. pat

    Can someone please enlighten me why they are so convinced that RMB is undervalued? Trade surplus is not a reliable indicator, as a country with a higher savings rate will run a persistent trade surplus, just look at Germany. Government intervention is not a reliable indicator either, as most governments intervene, for example, Swiss National Bank this week. PPP would suggest RMB is about right measured against USD. For many traded goods, prices in China are almost comparable to prices in US; and if they appear to be a bit cheaper in China, the difference in labor cost in the distribution channel should be able to explain it. Some already go the other way, such as coffees sold in Starbucks.
    One might be able to argue both USD and RMB are undervalued against, say euro, based on PPP, but many also seem to believe USD is over-valued …

  11. Cedric Regula

    I think the strongest evidence that the RMB is undervalued is the way they intervene.
    It’s not the traditional style of FX intervention in which CBs try to fight 100% of trade and financial flows. This method fails over the long run if they are attempting an unrealistic peg.
    The Chinese make it law that corporations turn over trade dollars to Chinese banks, who in turn must turn them over to the PBoC and receive whatever RMB rate the PBoC cares to print. This is sustainable from a CB currency peg standpoint.
    In the case of USD, financial flows (in and out) now seem to overwhelm trade flows, and this makes determination of the true trade value of the dollar more problematic.

  12. Mari

    Dr. Chen: Dr. Prasad is arguing by reducing fiscal deficit, US would be able to reduce its CA deficit. If I remember, Dr. Setser used to argue, it doesn’t matter whether US budget is balanced or not, China has to hold US bills or other US assets as long as there is a CA deficit and China decides to peg to US$….what’s your take?

  13. don

    So, Krugman is on Bloomberg telling people that China’s currency policy s slowing global growth. Earlier, he called China’s policies “currency mercantilism.” I think it is counterproductive to guess about the level of the yuan (renminbi). The problem is that the currency interventions constitute forced savings, and in the current global situation of deficient global AD, they have to be strongly discouraged. So no, I am completely serious in calling for a halt to such interventions.

  14. Cedric Regula

    Menzi must be in lecture, or maybe working up a model to answer your question.
    In the mean time, I think the answer is that Brad was stating an accounting truism from Balance of Payments. That is that CA deficits must be “financed” by foreign capital. It so happens that China had the capital, and they re-invest the dollar flow back into the US to avoid RMB appreciation, (selling dollars for something in FX, and they don’t put many RMB there to buy) and the investment of choice was Treasuries and GSE MBS.
    The rest of us sort of argued that if the USG balanced the Federal deficit, presumably by raising taxes since they always tell us there is no way to cut a $3.5 Trillion budget, then there would be less disposable income to buy Chinese stuff.
    There probably is some way of showing how reduced investment resulting from increased taxation would reduce US exports, making CA worse. But economists would probably use a closed economy in the model, then once again I would be a “Doubting Thomas”.

  15. Young Economist

    The most concern is the emerging central banks to control the overheating economy because all emerging economies move back to grow above average and the central banks still fail to tighten. The most concerning country is India because the inflation accelerates at 20% currently and the monetary and fiscal policies both flows and balances (fiscal deficit, trade deficit, and government debts > 80% and external debts higher than international reserve) point to crisis position. I think India will fail to control inflation and if they decide to act to control inflation they will fail except they must bring economy to deep contraction. Surely, it is impossible for India to have large fiscal and external debts during all population age is so young and need more supports. I think India will face the most difficulty and maybe will create crisis in the emerging economies.

  16. Anonymous

    I don’t think Chinese authority controls foreign currencies as tight as you seemed to imply. Chinese citizens are allowed to have foreign currency accounts in banks as long as the deposit is in the same foreign currency — they don’t have to exchange the currency to RMB. And nowadays there are many Chinese students in US universities whose parents in China pay their tuitions/fees by sending USD here (our big service exports). My position is not that RMB is correctly valued, but there is no strong evidence to say one way or the other.
    Of course, one might say that is exactly why China should let its currency float — but in reality, many countries choose not to have a totally free float currency, and just because economists don’t have a convincing model to explain such a behavior does not necessarily mean it is the wrong practice.

  17. Cedric Regula

    Yes, I’ve heard that but there is a very small limit what individuals can hold, and it is not the same as ,say, some company getting paid in dollars on their Wal-Mart contract and being allowed to exchange the revenue for Euros, if they felt that was a better deal than the PBoC is offering in RMB.
    Also, most people think large persistance trade surpluses and massive reserve accumilation is evidence enough!

  18. Tom

    This is a rare case where I agree with Krugman. China’s currency manipulation is bad for the global economy, and for China itself. But it’s good for top Chinese communist party officials and their cronies, so they will not voluntarily give it up. Congress and Obama should act, and should coordinate on this with the EU. But they won’t.
    The main effect of China’s currency manipulation is to suppress China’s imports from the rest of the world. It’s a blatant act of protectionism on China’s part.
    China’s currency manipulation is also a form of subsidy of exports, but that side of the equation tends to get overplayed. If China floated its currency, its imports would grow to match its exports, spurring growth in the rest of the world, and thus increasing the rest of the world’s capacity to buy Chinese goods. That is crucial for China to continue increasing exports.
    There has been much talk of China leading the world out of recession, but the reality is that China’s imports are far too small for that to be happening. Besides, the vast majority of the growth in Chinese imports is in raw materials, the import of which is subsidized in various ways. That has spurred a bit of output recovery in mining and smelting and the like, but has also driven up raw materials prices, impeding growth in the rest of the world.

  19. HZ

    Don’t expect a discrete jump. Since that could cause uncontrollable capital outflow (or they will have to reverse the jump if the outflow becomes too large). The real appreciation through faster inflation is discounted in your nominal rate curve. To see where the real exchange rate is you need to include inflations. Chinese trade surplus will likely revert soon to an even lower level. However even with zero surplus reserve will likely continue to grow because of FDI and investment income of reserve assets.
    Fast wage growth is really positive for Chinese domestic consumption (much more direct impact than currency revaluation could achieve). It is hard to understand why so many prominent economists ignore such obvious things and focus on the nominal exchange rate when they know (or should know) real rate is what counts.

  20. HZ

    There is a simple reason why China would not float now. It does not have the infrastructure and financial market maturity for all the fx tradings and hedgings necessary. The subsidy to the exporters is not really the undervaluation of Yuan but the undervaluation of the volatility of the Yuan (since USD is the dominate trade currency). China simply outsources that aspect to US and it pays a hefty price for it (large holdings of low yield reserve assets).
    A floating Yuan will also likely means that the end is nigh for USD’s status as the dominate trade currency. Be careful about what you wish for. You may just get it.

Comments are closed.