The Yuan’s Course

The debate over the yuan’s value is heating up again. [Free Exchange/RA] [WSJ RTE/Talley] [WSJ RTE] Here is a plot of two relevant time series.


Figure 1: Real trade-weighted value of CNY from BIS (blue, left axis), and nominal CNY/USD exchange rate (monthly average of daily rates). + denotes 9/15/2010 observation. Both series defined as “up” denotes appreciation. Dashed line at de-pegging in July 2005. Source: BIS, and St. Louis Fed FREDII.

Two quick observations. First, the Chinese trade weighted real exchange rate is the relevant one for the world economy; the USD/CNY nominal exchange rate has some importance for the US-China trade balance, but less so for the US overall trade balance — which is the relevant aggregate.

Second, the trade weighted CNY was appreciating before the crisis, and the CNY has largely reverted to that trend over the past few months, after a detour associated with the dollar appreciation during the financial crisis and flight to safety. This observation, however, does not speak to whether the level of the rate is appropriate for moving the Chinese current account to a sustainable level.

Additional (relevant) graphs in this post.

29 thoughts on “The Yuan’s Course

  1. JBH

    The absence of the Economics profession speaking out about the impact of China’s Mercantilist manipulation of the yuan/dollar terms of trade and the deleterious effect of this peg on the US economy’s growth rate at a time where the unemployment rate is virtually double-digit is as deafening the sound of one hand clapping. Where is the robust and open discussion of this preeminent topic on this blog? It is the exact same silence that preceded the systemic financial crisis.

  2. Nemesis

    Why did the PBoC accumulate so many US$ reserves?
    Because there has been a torrent of US$ investments in China over the past 10-15 years by US supranational tech firms, banks, etc., which ends up as deposits in Chinese banks. But the US firms cannot directly convert the Yuan deposits to US$’s or any other currency; therefore, the PBoC and US firms need those US$-denominated assets held in custody at the Fed for the PBoC so that US firms can indirectly repatriate US$’s when needed via book entry transactions via Chinese banks, the PBoC, and the Fed by way of US banks in the US and abroad.
    At some point hereafter, the global economy will again begin to contract, and US firms will begin repatriating US$’s by the tens of billions, resulting in another surge in Fed liquidity swaps (Fed buying the PBoC’s reserves with digital book-entry credit-money) and a rise in the US$.
    The primary reason the Chinese will not float the Yuan is that they don’t want [email protected]@mn Sachs, JP More-Gain, and More-Gain Stainedly taking over their banking system and plundering the country with highly levered hot money flows and then leaving the gov’t to print trillions of dollars equivalent to bail them out and impose “austerity” and impoverish the nation in the process.
    No, the Chinese Communist PLA generals in Beijing and the central planners at the PBoC are doing the job in country before GS does it first.

  3. don

    As I’ve said before, I think looking at the exchange rate to measure imbalances or to gauge whether currency mercantilism is at work is a nonstarter. Official Chinese currency purchases amount to a strategy of forcing loans on the ROW. This is particularly damaging at a time of deficient global AD.
    Back when Brad Setser was posting on this issue, he continually characterized the problem of the building imbalances as “what will happen when China becomes unwilling to fund further U.S. deficits.” I insisted that Chinese reluctance to lend would not be what caused the loans to stop, but rather U.S. pressure to stop the leakage of domestic AD. Two years ago my chances of winning the debate were smaller, I think, than they are today.
    “This observation, however, does not speak to whether the level of the rate is appropriate for moving the Chinese current account to a sustainable level.”
    I think the quesion is better stated as whether the deficit countries will find the rate acceptable.

  4. Qc

    We should be entirely delighted from the fact that China does not want to lower the number of goods it sends us for every US dollar we send them. Why do economists want to destroy our term of trade? While China is busy sending us plasma TV, toys and furnitures, it would be a great idea to employ our own ressources to improve and develop better infrastructure. Of course, for this to happen, we would need significantly more deficit spending. I am not holding my breath…
    From Milton and Rose Friedman:
    “Another fallacy seldom contradicted is that exports are good, imports bad. The truth is very different. We cannot eat, wear, or enjoy the goods we send abroad. We eat bananas from Central America, wear Italian shoes, drive German automobiles, and enjoy programs we see on our Japanese TV sets. Our gain from foreign trade is what we import. Exports are the price we pay to get imports. As Adam Smith saw so clearly, the citizens of a nation benefit from getting as large a volume of imports as possible in return for its exports or, equivalently, from exporting as little as possible to pay for its imports.”

  5. Cedric Regula

    I think you are going to win the argument. Brad’s old boss, Timothy, finally started saber rattling about exchange rates. Europe and Japan joined in too. So they are more worried about leaking AD/leaking companies than finding enough buyers of sovereign bonds. At least for the moment.
    So maybe the loop gets unwound by the US, Japan and Europe instead of China taking it’s money and going home.
    China’s overcapacity made them blink first.

  6. tj

    Menzie, I’d be interested on your thoughts on the op/ed piece in todays WSJ. One of the points is that the debate over $/CNY level is misguided if China continues to sterilize and break the link between trade imbalance and inflation.
    I thought the piece made several good points and placed today’s China in historical context.
    Focus on yuan sterilization, not the yuan-dollar rate.
    “China’s real sin is sterilization, which insulates its domestic economy from the money-creating effect of a currency board. When a company like GE invests in a Chinese factory, or a retailer like Wal-Mart buys Chinese-made goods, they exchange dollars for yuan. The Chinese government then buys those dollars with yuan. But instead of adding to the money supply, it removes those yuan from circulation by selling bonds and raising reserve requirements. Without a rise in the general price level, China’s trade surplus with the world persists and grows as productivity rises.”
    subscription required –

  7. purple

    Yeah it’s fine to get cheap stuff from China, but that employment, tax revenue and money has enabled them to move up the supply chain very quickly.
    Unless you consider high speed trains as ‘cheap stuff’, that is.
    Americans are pretty deluded about the state of China’s economy; China is increasingly swamping the world in leading edge technologies – trains, solar, battery research, turbines of all sorts. They will get into cars very shortly, too.
    Realistically, I can’t see this being resolved diplomatically. Because the U.S. and the G7 elite is going to lose if it only sticks with diplomacy.

  8. Qc

    This just goes to show you how journalists are totally confused. When the US Government deficit spends it also sterilises (ie. withdraw) the money it injects through an emission of bonds. The goal of this operation is to make sure no money is left sloshing around the economy as this would push down the overnight rate below the Fed’s target if the Fed does not intervene. Would the WSJ makes a big story of this sterilisation move by the US treasury everytime it deficit spends? Of course not.
    China’s sterilisation move is exactly the same. It is a monetary operation to ensure that the overnight rate set by the People’s Bank of China (PBC) is achieved. If Yuans would be left sloshing around the economy, it would be impossible for the PBC to maintain the interest rate close to the target it has set. A country with a flexible currency regime, although it does have to sterilise its fiscal deficit spending, does not have to sterilise Foreign Direct Investment as the movements in exchange rate ensures that the market clears -ie. the flutuacting exchange rate makes sure that supply of US dollars equal demand.

  9. Cedric Regula

    I think wsj has it upside down, inside out and backwards, but I’ll wait for Menzie to show us the math.
    First error is part of the currency peg regime is that china accepts payment in dollars from companies like Wal-Mart. The exchange is done internally by the the banking system/PBOC at whatever rate the PBoC states.
    When foreign corporations invest, they may exchange currency, but it is at the level the PBoC states.
    Lack of sterilization should be inflationary in the domestic market, by means of devaluation of the currency. Hard to imagine that makes international purchasing power go up.
    More business leads to more investment and more learning curve which increases productivity and that leads to more profitability and the option to maintain or lower prices. That is what current mercantilism has allowed china to accomplish.

  10. rayllove

    China already produces more cars than the US does.
    And resolving the currency issue is only possible diplomatically. The US is guilty of more dubious trade tricks than what China is by far. For example, Colombia has the fastest growing stock market in the world right now. But this is not because Colombia is an unusually productive nation, it is instead because the US allows Columbia almost free access to US markets while also allowing Colombia to widely protect Colombian markets. Call this the ‘who should care if we allow ourselves to be taken advantage of wrap-around scheme’, or whatever, but this violates the very essential purpose of the WTO and all of the international efforts to eliminate this very type of unilateral trade practice (jingoistic).
    There are countless such examples, we do not have all of those military bases around the world just because we are ‘popular’. Throw in ag subsidies and trade escalation schemes and it unnecessary to even mention the 17 intelligence agencies to make a case for how revealing it could be to incite a shouting match about unfair trade practices with China.
    Plus, the WTO has allowed so many unfair advantages to the developed nations there is an established term for what holds the poor nations back, that is of course ‘democratic deficit’.
    There is always the risk, or the inevitability perhaps, that at some point the global population gets tired of the MNC exploitation and simply stops buying US goods etc. The only thing that keeps that from happening is ignorance of the exploitation itself. China though could very well cut the slender thread that supports what is left of America’s reputation or ‘brand’. The MSM only has so much reach and that is diminishing.
    This will be called the ‘information age’ for reasons that most people don’t fully understand yet. But as global market share becomes increasingly precious, international boycotts will have immense influence on nations which are dependent on equity shares. That is in part what is happening now.

  11. Menzie Chinn

    tj: I gave up my subscription to WSJ a while ago — but I’ll guess at what the WSJ op-ed page writers wrote.

    Really, there are two lens through which one can address this issue. Using the Mundell-Fleming (fix price) approach – discussed in this post, one can see that the sustainability of the peg and current account surplus depends critically on sterilization. But it’s a matter of degree — even without sterilization, pegging in the given configuration could still lead to a larger current account surplus than would occur with a stronger currency.

    An alternative approach is the monetary approach to the balance of payments, as discussed in the 2007 Economic Report of the President (under the Bush Administration), which I discussed in this post. That’s a flex-price model, and in that case sterilization does mean that the current account can be maintained at a higher level than otherwise.

    In either case, I’m not sure whether one can say it’s the sterilization which is the true culprit, or pegging at a given rate that’s the culprit.

    I think it’s more useful to skip the moralizing, and just say that a stronger RMB is in China’s overall interest, and is in the world’s interest.

  12. tj

    I thought that the point was that without steriliztion, then a growing inflow of dollars would become a growing Chinese money supply. The result would be rising prices for Chinese goods, given a defacto fixed fx rate. In turn, rising prices for Chinese goods would effectively serve the same purpose as an appreciation of the RMB, in that Chinese goods would become more expensive and automatically stabilize the trade imbalance.
    From a Chinese policy perspective, and assuming the mechanics are correct, (a growing inflow of $ creates a growing Chinese money supply), then allowing the currency to appreciate at 0% to 2% per year with sterilization, is better than allowing prices of Chinese traded goods to increase by something greater than 2% without sterilization.
    If either of the fx market(yuan appreciates) or money market(Chinese inflation) were allowed to function, then Chinese exports would be more expensive than they are. As a result,
    *the U.S. trade deficit would not be as large, *interest rates would not be distorted to the low side,
    *the savings rate would have been higher in the U.S.
    *mortgage rates would have been higher.
    Chinese growth is slower, but higher U.S. savings leaves us with more investment for long run growth.
    I dunno, just trying to think outloud.

  13. don

    “I think it’s more useful to skip the moralizing, and just say that a stronger RMB is in China’s overall interest,”
    I seriously doubt this, especially at this time of deficient global AD. I think a stronger Chinese currency now would lead to reduced output in China and wasted (unemployed) Chinese resources, to the extent that the loss in production would exceed the gains from improved terms of trade.
    There may be a divergence of interests within China that causes them to keep the rate low despite a deleterious effect on their own overall economic welfare, but I think it more likely that their policy officials are simply right that their current strategy of taking AD from ROW is in their own best interests.
    Actions of Japanese officials appear to reveal that they are in firm agreement on the benefits of an undervalued currency.
    If you were to wait for action on the renminbi to come, because China recognizes that such is in its own interests, I think you would wait a very long time.

  14. Bryce

    Setser stated a year or 2 back that PBoC only sterilized about half of the pegging, using freshly created Yuan to buy the other half of Treasury bonds. Can anyone comment on whether that is still the case?
    PBoC contributed to the boom leading to the so-called Great Recession. Primarily they contributed to artificially low long-term interest rates that misled buyers of homes & other things for which people borrow long-term to buy. The people who make those things were also mislead. Both in the US & Europe, the primary Chinese markets. (Europeans used the cheap loans for lots of things other than housing.)
    PBoC–and the other Asian central banks of countries with whom they compete–are still contributing to below market long-term rates, whether by their forced saving procedure that harms the Chinese people, or by printing Yuan. A market price for the Yuan would be cataclysmic for the Chinese economy, but in the fullness of time, will it not prevail?

  15. Cedric Regula

    “I think you would wait a very long time.”
    That’s what I think, especially since they said they have about 400 million under or unemployed and they need to grow a bit more. Export led of course.
    Imbalances are supposed to blow up one way or another, probably many ways. China has too much money overseas from pegging, they never develop a workforce with adequete purchasing power, or the global biz cycle hits and they have overcapacity which results in massive bankrupty and stress on the banking system or the government becomes the provider of AD of last resort.

  16. Cedric Regula

    I think what Setzer meant was chinese companies accept payment in dollars, then by law must exchange them at the bank for yen at the PBoC mandated rate. The PBoC prints up that amount of yuan for the bank and takes the dollars. Almost all these dollars were used to buy treasuries and GSEs. More recently China has been stockpiling oil and commodities, so some they used that way. Oil they can buy in dollars, but maybe iron ore from the Aussies or copper from somewhere else makes them go thru Fx.

  17. rayllove

    I don’t know which nations are importing autos from China but I did find this:
    “Shanghai September 10 ( China’s auto exports in January to August reached 336,100 vehicles, up 80.01% from a year earlier. In August alone, 47,200 vehicles were exported, up 1.47% month on month and up 115% year on year, according to data released by the China Association of Automobile Manufacturers (CAAM).”

  18. Bruce Hall

    The absence of the Economics profession speaking out about the impact of China’s Mercantilist manipulation of the yuan/dollar terms of trade and the deleterious effect of this peg on the US economy’s growth rate at a time where the unemployment rate is virtually double-digit is as deafening the sound of one hand clapping. Where is the robust and open discussion of this preeminent topic on this blog? It is the exact same silence that preceded the systemic financial crisis.
    Posted by: JBH at September 16, 2010 02:14 PM

    I’ve often wondered that about economists in general.
    While I don’t subscribe to most conspiracy theories, I believe that China’s government has more than mere economic expansion in mind and that the trade policies are a major underpinning of its overall strategic plans.

  19. brandon

    wow… china acting within its own interests, i mean, america would never be guilty of that… how dare china.
    (here’s the fundamental arguement, my dear wonks)

  20. The Rage

    People still do not and may not EVERY understand the real problems with the current regime is the gutting out process it does: demand for US debt.
    The demand isn’t by the governments of developing countries, but by operators inside the economy of these countries. They constantly push for some form of US debt. Lets say, we would have destroyed the banking system completely in the fall of 2008. The private sector deleveraging would be vast, but government debt would have ballooned to 2-3 times MORE as demand there would have increased thanks to the operators.
    Lets say the US government then slashes spending to deal with the depression and will not comply with the debt demands of the operators? Sorta like slashing your own throat economically. No problem, the developing countries then come in and basically “buy up” America. Most of our destroyed private sector all but controlled and rebuilt by foreign capital. This IMO, starts getting to the real side of the “bailout” and one that impacts Main Street to the point of government officials like Bernanke and Bush doing gross things to appease the “middle men” aka the bankers who can stop the deleveraging of the private sector.
    FWIW, if the Republican party and Bush had enacted bigger fiscal deficits say, with a huge multi-trillion dollar infrastructure program for the “naughties”, it probably would have tamed the housing boom alot. Capital would have flown around the infrastructure boom and not around “innovative” mortgages leading toward a more financially stable condition. Why? Because the Republicans would have satisfied the need for debt and thus the massive private borrowing is tamed.
    We still would have run into the problem when the infrastructure program ended…..oh about now, but we would have been in a MUCH better position to poison the operators off US debt AND a more eficient country to boot. Talk about mistakes. Yet, you never hear about that.
    It is what the Austrians can never GET. You try to run public surpluses to much, you get massive borrowing in the public sector, which leads to bubbles and which bust into ugly depressions and anti-capitalism no matter if you have a central bank, fixed currency or any other type of monetary system.

  21. don

    Somehow I have the feeling that Timmy’s present posture is merely an attempt to forestall more effective measures by Congress.
    I’ve had my doubts about the Administration’s true aims as regards China’s currency policies, going back to Hilarious’s entreaty to China to keep buying Treasuries to fund our stimulus. Summers would never say such a thing, of course, but one wonders if she was spouting this drivel entirely on her own. Maybe she was, at the urging of multinationals operating in China, and perhaps also the U.S. financial services industry.

  22. rayllove

    Evidently you don’t understand. The Chinese failed to inform US policy-makers that: “(Europeans used the cheap loans for lots of things other than housing.)”. After-all, the Chinese should have known that social engineers in the US are unable to foresee bubbles. This would be much like making a car loan to a blind-man who has a history of reckless and foolish behavior. There are few transgressions more egregious than lending money to someone without taking responsibility for how that money is spent.
    Plus, you seem unaware of the fact that the Chinese tricked the US into taking responsibility for the having the world’s reserve currency in the first place. John Maynard was of course a master at the use of reverse psychology and… naturally, he was Chinese, but, surely brandon, you must have at least known THAT!.
    Then, later on, ninjas made several attempts to silence Robert Triffin. The ninjas failed (this is how Triffin got the nickname: ‘Fidelito’), but Triffin’s credibility was severely damaged by unfounded accusations of ‘dyslexia’ by a Monsanto employee who mysteriously disappeared shortly thereafter. Concerns that Triffin had it all backwards do, conversely, linger to this day.
    It is also widely known that the Chinese secretly manipulate the WTO, IMF, USPS, IRS, the World Bank, FDA (‘they’ own Monsanto which substantiates and helps to explain the ‘Triffin Dyslexia Dilemma’).
    ‘They’ are manipulating nearly EVERYTHING! Simply put, ‘they’… are… ‘THEY’.

  23. Cedric Regula

    We’d have to be brain dead not to worry about what our leaders true intentions are behind their statements meant for public consumption. And there is the election coming up, so the “party of change” has lots of lip service to catch up on. So far healthcare reform and financial reform won’t make great talking points for the dems in my opinion.
    I have a little more hope this time because all developed countries are having the same concern.
    And it would take a large currency re-val to make a difference. I don’t hold out hopes that re-val will bring Nike tennis shoe production back home, even tho the $115 tennis shoe price would seem to support it. But I think it has to be done to stop the ongoing bleeding of offshoring that will certainly continue in the future.
    Also currency re-val isn’t the only way to do it, but economists always say it’s the easiest way.
    Then again, tariffs are the stick we use at our end if China continues with their usual argument that they are just doing what’s good for China, and stop meddling in their internal affairs, ROW.

  24. rayllove

    One of the many advantages to a higher valued yuan, but an advantage which has received too little attention, is that of the affect on the prevalence rates of obesity in the US. It is highly probable though that the working-poor in the US will have less disposable income as a result of higher-cost imports; consequently, the working poor will have less to spend on food and beverages.
    This price inflation, arguably, could only have a temporary influence on obesity rates because wage inflation could eventually restore the previous purchasing-power levels among the working poor. However, the main objective here is to increase US exports which would suggest that wage inflation will come under increasing downward pressure from foreign competition. It is therefore almost a certainty that wage trends will continue to remain at least as stagnant as they have for the past few decades.
    Naturally, obese consumers have in the past found ways to increase their caloric intakes without an increase in their disposable income levels. As disposable income levels have decreased over these past few decades producers have discovered innovative methods to provide high calorie food and beverage products at comparatively lower costs in relation to other food products. So it is conceivable that further food devaluing innovations are possible although the price inflation on all other goods and services will most definitely have a deleterious effect on the stockholders of food and beverage manufacturing firms. This effect will therefore cause this food and beverage type to inflate even though most of these goods are of domestic origin. This is safe to assume because the value of equity shares must continue to rise and increasingly so as economies become more dependent on asset values.
    In conclusion… it is more than just probable that currency manipulations by the Chinese are causing obesity in the U.S.A.. Furthermore, a higher valued yuan will diminish the related health-care costs in the US with the added benefit of lessening the odds of having to sit next to a fat person whether on a plane, or wherever (even if they do remain fat ‘they’ will have less disposable income! {most of the citizens who matter most do not use public transportation. [the Chinese could even eventually also be responsible for unnecessary stresses on our public transportation system.[})!!!
    Of course, obesity is far less important than the underlying issue here. Inflation will shift a great deal of our debt burden off the shoulders of US citizens and onto the shoulders of foreigners who are holding dollar related assets. Our detractors will presumably argue that this ‘debt shift’ is at mankind’s expense but this is ludicrous because a large portion of mankind has nothing left to lose. Detractors will most certainly also claim that the US is responsible for the recent global economic crises and the US should take responsibility for the harm it has caused as opposed to contriving ways to cause further harm via inflating its debt away and on to other innocent parties. But of course as time passes it is becoming increasingly clear that the Chinese are at least as responsible for the recent economic crises as what the US is. And… with so many writers, economists, pundits, religious leaders, and court jesters, all clamoring for attention, and/or whatever, in a marketplace of ideas where the supply of misleading and distorted information far exceeds the demand for even the most clever demagoguery… any and all needed justification is just a matter of time.
    Ray L. Love

  25. Cedric Regula

    You are right that the chinese are making us fat, but I think that is one of those “unintended consequences” of chinese policy rather than design.
    But there is the problem with a strengthening yuan that has concerned me for some time. Since US Ag is one of our stronger export industries, a much stronger yuan will result in much more US exports of Ag products, and all our pigs, chickens and cows may leave the country for China.
    Of course if US Ag starts pricing their products in yuan in US grocery stores, the scope of the problem will become apparant to all.

  26. don

    tj: “I thought that the point was that without steriliztion, then a growing inflow of dollars would become a growing Chinese money supply. The result would be rising prices for Chinese goods,”
    This result of unsterilized currency intervention is based on the notion that the economy is more or less on its production possibilities frontier. And some of that may have happened (I think China now has greater inflation than the U.S., for example.) But China has a large unemployed or underemployed sector, from which resources can be transferred for some time before inflation offsets the effects of the currency purchases. Similarly, Japan is experiencing deflation and unemployment, so its currency purchases are unlikely to be offset by domestic price increases.
    Cedric: “Since US Ag is one of our stronger export industries, a much stronger yuan will result in much more US exports of Ag products, and all our pigs, chickens and cows may leave the country for China.”
    Whether U.S. agriculture might give us a case of ‘Dutch Disease’ is something that I have wondered about.

  27. ProfNeumann'sClass

    Has anyone noticed that the CNY/USD is wrong? Otherwise this graph shows the wrong thing appreciating.

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