That was the title of a seminar at the annual IMF-World Bank meetings I participated in last Thursday (agenda here).
Also on the panel were People’s Bank of China Deputy Governor YI Gang, and Asia-Pacific Department Senior Adviser Nigel Chalk. Anoop Singh, the director of the Asia-Pacific Department introduced the panel and summed up, while Jeremy Marks from the External Relations Department moderated.
The proceedings highlighted the larger aspects of China’s development strategy (which is much more extensive and complicated than just the exchange rate regime), as well as the familiar concerns with the value of the Chinese yuan.
My presentation is here. I emphasized the fact that, while there were many facets to a successful strategy to adjusting to a world of slower growth, exchange rate adjustment was one important measure that could be implemented more rapidly than other — perhaps more important — policies. One key graph is here:
Figure 1: Chinese yuan (black), and other East Asian currencies against the USD, all normalized to 2005M06=1. “Down” is defined as appreciation. Source: IMF, International Financial Statistics, St. Louis Fed FRED II, and author’s calculations.
Among many other items, Deputy Governor Yi noted a commitment to stabilizing and shrinking the current account balance as a share of GDP over time.
Other coverage of this discussion surrounding this issue at the Bank-Fund meetings here: [WSJ1] [Bloomberg1] [Bloomberg2] [FT] [WSJ2]. Other China-related Econbrowser posts here.
China may have a hard time adjusting its currency. There is rather substantial misallocation of resources based on a seriously undervalued currency. A sudden realization of market prices would make much of this redundant and could bring substantial disruption to their ecnomy. And meaningful appreciation may increase “hot money” inflows to such an extent that it would involve increased foreign reserve purchases – that is, yuan appreciation would actually be accompnaied by greater official currency purchases, at least for a time.
On the other hand, such a large trade surplus being held by an economy growing far beyond the rate of the ROW seems clearly inappropriate. Of the $200 billion annual surplus (which in today’s world translates into $200 billion in net de-stimulus for ROW), my guess is 150% is caused by the currency manipulation. This is based on annual currency purchases of $450 billion, of which $150 billion just offsets “hot money” flows into China, leaving a net capital outflow (and corresponding improvement in the trade balance) of $300 billion. This means that without the official currency purchases, China would have a “natural” trade deficit of $100 billion annually. (These are just my “best guesses.”)
Of course, all this supposes that China’s economy would not collapse from the loss in AD if it ceased the currency interventions. And if global growth turns down in the near future (going negative again in many of China’s best customers), the surplus could shrink rather dramatically again.
I note Taiwan’s currency appears to not to have appreciated relative to the dollar over this period. For its size, Taiwan has one of the most egregiously high stocks of foreign reserves obtained from currency interventions of any nation.
Why does the graph end in 2007? Data for exchange rates are available, literally, “up to the minute.”
don
Ask and you shall receive.
Zero Hedge just posted yesterday’s heat map of GLOBAL FX.
3 multi color maps generated using the dollar, euro and yen as base comparison currency. In all cases, the color of china matched the color of the US.
Of course the difference in look for the three heatmaps is the current state of global monetary policy.
1) US: We are about to start.
2) ECB: We are all done.
3) Japan: We haven’t started yet.
So that should update everyone that hasn’t been watching the game.
If we operate under the assumption that China is providing material liquidity in financing the US budget deficit, would a re-valuation of the yuan imply higher interest rates in the US?
“If we operate under the assumption that China is providing material liquidity in financing the US budget deficit, would a re-valuation of the yuan imply higher interest rates in the US?”
I would say ‘yes’ before we hit the liquidity trap (causing Greenspan’s “conundrum”), but ‘no’ afterwards. As Krugman points out, we have excess desired savings right now and have no need of external ‘help’ to fund the federal deficit. In fact, such ‘help’ merely reduces the stimulus we get from the fiscal deficits.
I suspect the appreciation of the Yuan will start an extended increase in long-term interest rates. A number of other currencies will probably follow the Chinese lead, or be in roughly the same place of needing to fight domestic inflation [India, Indonesia, etc]. I am not however suggesting this is imminent; it may be a while yet.
“Excess desired savings” will prove to be another part of the illusion the central banks create.
In support of the propsition of ending the pegs by Asian central banks boosting interest rates:
While the US Fed was directly buying $23.1 billion in US Treasury paper over the last four weeks, Foreign Official Accounts [central banks] have purchased $85.69 billion.
Emerging market currency manipulations–aguably responding to some extent to Fed manipulations–have lowered interest rates globally for years. Is there no price to be paid for this ‘free lunch’?
I find the title of this presentation, “Transforming China’s Economic Development Model,” to be wholly misleading, and a not so subtle attempt to convince China to resort to policies – specifically a Yuan appreciation – that first and foremost “benefit” the US.
Firstly, I’m struggling to find the link between how an appreciation of the Chinese currency will aid Chinese development. While Chinese growth has been “wildly successful” (as quoted in your presentation), per capita income is still extremely low – less than a fifth of US GDP/Capita at PPP – and domestic consumption weak. If we expect an appreciation of the Yuan to substantially reduce US exports (see previous post here), how can this benefit China’s working class? Surely not through increases in import purchasing power – those at the bottom of the pyramid are not the ones importing – and unlikely through a sudden rise in domestic consumption (it will take more than the currency to overturn the savings culture China’s history has bestowed). An appreciation is more likely in the short term to increase unemployment and reduce per capita income – all factors that will hinder a re-orientation towards your warranted point on domestic consumption.
Secondly, I think it pertinent to point out that China has been less of an “open door” to FDI than you imply. FDI has been substantially limited to Special Economic Zones, and only averages around 5% of Chinese domestic investment. In fact, if we are really focused on the development of the Chinese economy (and not the US) further liberalization of FDI might be a sound alternative to a Yuan appreciation, as it would facilitate investment in profitable projects (perhaps those oriented toward domestic consumption), and would encourage an eventual appreciation of the Yuan in a manner both less brash and more oriented towards assisting true Chinese development.
Finally, what is interesting about this whole push for Yuan appreciation is that it is seemingly unfounded. In the short term US consumers will likely suffer via higher import prices (the standard J-Curve argument), and longer-term benefits are questionable. Other Asian countries with “cheap” currencies will likely fill any Chinese export gap, and rises in US interest rates would be a standard reaction to drying up Chinese capital. So instead of making enemies by forcing currency policies, let the US focus on its own domestic problems and let China do what it does best: determine its own Economic Development Model.
Remembering the days when economics professors were teaching
Receipts from foreigners- payment to foreigners = BOP
Now they are talking of foreign currencies wars when it is still “Love in the time of cholera”
Good points, Samantha. The difference in real wages (real living standards) as opposed to nominal wages can’t be corrected through FX rate. The condition that Chinese migrant and other poor Asian workers are willing to work with is not something that US or European workers are willing to put up with. This gap will only narrow with further urbanization of the Asian countries.
“Emerging market currency manipulations–aguably responding to some extent to Fed manipulations–have lowered interest rates globally for years. Is there no price to be paid for this ‘free lunch’?”
We are paying a hefty price in the form of higher unemployment. As Samuelason pointed out, during a liquidity trap, all the old arguments to support trade mercantilism are true.
“Finally, what is interesting about this whole push for Yuan appreciation is that it is seemingly unfounded.”
Krugman and I disagree. The only question is whether stopping the theft of foreign AD through China’s official reserve accumulation would do such damage to China’s economy that the gains in ROW AD would not compensate. The notion that the entire reduction in China’s trade surplus would be taken up by other countries (that the U.S. trade deficit is exogenous with respect to the yuan) is unlikely. If you are arguing that China’s currency interventions do not create deficits in ROW, you are implicitly arguing that its capital controls are entirely subverted. I would say this claim is seemingly unfounded. If it does create net trade deficits in ROW, why would the U.S. not share in the improvement if this deficit creation were to stop?
“Firstly, I’m struggling to find the link between how an appreciation of the Chinese currency will aid Chinese development.’
Here we agree. Yuan appreciation would not be in China’s interests right now. Nor do I think U.S. business (as opposed to U.S. labor) would favor a reduction in China’s currency interventions. Apple and Nike would not like to pay higher wages in China.
H.Z.,
Every developed nation and some others are subsidizing a wide range of ag goods and this is causing the illusion of prosperity in urban areas. But this ‘prosperity’ is coming at the expense of rural areas.
As part of the ‘Grand Bargain’, the developed nations agreed to phase out these subsidies way back at the beginning of the never ending Doha Round. It is fairly obvious that if food and cotton prices were where they belong that ruralites would be able to improve their lot but of course that would provide alternatives for the global working poor. Those alternatives have historically lead to collective bargaining and of course higher wages, and in the US, when the working poor have choices they choose not to volunteer for military service. This was the lesson of Viet Nam. The key to controlling labor costs and military recruitment rates is to keep labor markets in a state of oversupply. Ag subsidies do just that and on a global basis.
Ag subsidies also make it less than cost effective for poor nations to develop their ag infrastructures. Development though typically begins with agriculture. This inability to produce staple goods puts poor nations in a position where they must rely on selling their natural resources as opposed to developing their industrial infrastructure. Consider who benefits from cheap natural resources, cheap labor, and diminished competition… and it should come as no surprise why nations refuse to phase out ag subsidies. But it would be foolish to expect these trade violations to be tolerated indefinitely.
The urbanization trends also have some negative externality issues, the number of dead-zones for example that are the result of urban sanitation shortfalls is spiking. And of course there is growing evidence that employment levels are in conflict with advancing technology. So perhaps it is a little early to sign-off on the ‘demographic dividend’ assumptions right now?
Menzie, Is there a link to the People’s Bank of China Deputy Governor YI Gang’s remarks?
Ricardo: If you click on the hyperlink “seminar” in the original post, you will see the entire 1.5 hour video, which includes Deputy Governor Yi’s remarks, about ten minutes in.
Don,
Thanks for your comments. On your point on trade surpluses – I agree, the US would surely participate in some benefits of the decrease in ROW deficits, and I am not implying that China’s currency interventions do not create deficits in ROW. However, I find it hard to believe that the US would benefit to anywhere near the extent that has been implied in coverage of this topic. Rather, I think it more likely that the benefits in Yuan appreciation (and reduction in ROW deficits) accrue to other emerging economies that also have a comparative advantage in value-add manufacturing like that of China (Brazil, SE Asia). At the very least, if we both agree that the exact impact is debatable and definitely not pre-determined, my point then is whether such ambiguous gains in the US warrant the potential for such severe degradation of China-US relations by “forcing” a Yuan appreciation (i.e. via the threat of protectionist trade policies)? The global power dynamics are definitely changing, and burning bridges with China at this stage in the game just does not seem like such a fortuitous option.
“At the very least, if we both agree that the exact impact is debatable and definitely not pre-determined, my point then is whether such ambiguous gains in the US warrant the potential for such severe degradation of China-US relations by “forcing” a Yuan appreciation (i.e. via the threat of protectionist trade policies)?”
The answer to that question depends on whether you view the U.S. trade deficit as the result of U.S. demand-pull, or foreign supply-push. I have commented elsewhere on the share of China’s currency interventions that might be expected to result in improved U.S. trade balance. Here it is, repeated:
(Mark Thoma: “In China’s case, the main impact [of yuan under-valuation] is probably on workers in other developing countries where labor is also relatively cheap. That’s not to say that there’s no impact at all on the U.S. economy, only that we shouldn’t expect too much if China revalues its currency.”
This sounds seductively reasonable (enough to merit frequent repetition by pundits like Roach), but I think it is just wrong. Just as the first-blush tendency might be to believe that China should naturally run a trade surplus, because it has such low-cost labor. In fact, I think its natural trade balance would be one of deficit without its official currency purchases. (This is world-wide trade, not bilateral with the U.S.)
To begin with (as Krugman notes), it is easiest to track the effects of China’s currency policies by focusing on the volume of official currency intervention, not the value of the yuan. It has been estimated that the great bulk of China’s official reserve accumulations (over two thirds) is not offset by private capital flows. This is very reasonable and merely supports the view that China’s capital controls are effective. For example, it has been estimated that of the net official outflow of $450 billion in 2009, only about $150 billion was offset by so-called “hot money” flows back into China. This means the currency interventions improved China’s trade balance by $300 billion on net (from a ‘natural’ deficit of $100 billion to a surplus of $200 billion). This corresponds to a $300 billion deterioration in trade balance in ROW. It seems reasonable to suppose that the U.S. would share in this change in proportion to its share of China’s total trade.
The notion that the reduction in China’s surplus will merely be taken up by other low-wage countries is also unfounded. First, we need to ask what would occasion the increase in net savings from these countries required for this argument to hold. In fact, in the short term, if supply is expanded in these countries, the investment inflows would cause their trade balances to move towards deficit, not towards surplus. And if they don’t have trade balance improvements to replace China’s lost surplus, who will? In fact, it is entirely plausible that the short-run improvement in the U.S. trade balance may exceed its share of the deterioration in China’s.
Another way to look at the question is to ask where the savings end up that China is now forcing on the ROW with its currency interventions. To the extent that they are initially pushed out in the form of dollar asset purchases, it seems the U.S. may get a disporportionate share, since assets denominated in different currencies are imperfect substitutes for each other. Even if the initial outflow from China is into yen, the same result will obtain if Japan merely translates the initial outflow into a dollar asset purchase with its own official interventions (as it has been doing of late.)