Unpegging the Yuan Might Not Put
Big Dent in China's Trade Surplus
By MARY KISSEL
Staff Reporter of THE WALL STREET JOURNAL
April 25, 2005; Page A2
HONG KONG -- As China faces mounting pressure to loosen or replace its exchange-rate regime, it may find critical lessons in the turbulent economic history of last century's Asian superpower, Japan.
In recent weeks, Congress, the European Union and the Group of Seven industrialized nations have revved up their calls for China to move the yuan's effective dollar peg to a more flexible regime. Their arguments are familiar: China's undervalued currency unfairly boosts its exports, widening the already big trade deficit between China and its Western trading partners. The peg is bad for China itself because an inexpensive currency can stoke domestic inflation. Last week, Federal Reserve Chairman Alan Greenspan told the Senate Budget Committee that China's peg "is beginning to significantly work to the detriment of the Chinese economy."
If the yuan was allowed to strengthen against the dollar, they argue, China's exports would slow, inflationary pressures would ease and the U.S. trade deficit would narrow.
A group of economists led by Stanford University's Ronald McKinnon are taking a contrarian view. Mr. McKinnon argues that if China lets go of its fixed exchange rate of 8.28 yuan to the dollar "that won't reduce its trade surplus," with the U.S. and other countries. "It's an illusion that it would," he says.
Mr. McKinnon reached that conclusion after tracking the experience of Japan's currency in the years following World War II as the yen moved from a fixed-rate to a floating-rate currency. Like China, Japan set its currency-exchange rate to the dollar during its early period of rapid expansion. Like China, Japan was heavily export-oriented. Like China, Japan's economy expanded an average of about 9% a year while it kept its currency's peg in place.
Mr. McKinnon attributes much of Japan's success during the first two postwar decades to its exchange-rate peg, which kept prices for tradable goods from fluctuating wildly, allowing Japanese companies and consumers to plan spending and take manageable risks.
In 1971, however, U.S. inflation spiraled out of control and Japan was forced to move to a floating-exchange rate. The yen strengthened to 80 to the dollar from 360 to the dollar during the next 25 years. The yen's appreciation was at least supposed to fix Japan's trade imbalance, by making imports less expensive. But the imbalance stubbornly remained -- partly because of Japanese savings habits and partly because as Japan's trading partners put political pressure on Japan to push the yen higher, asset bubbles formed, then burst, and the economy slumped. In other words, a stronger currency may give Asians more buying power, Mr. McKinnon says, but it doesn't mean they will spend more.
This conclusion, that a change in currency-exchange policy may not predictably influence spending habits, challenges core modern economic models. "It's a widely held theory by respectable economists, but it's a widely held false theory," Mr. McKinnon says. "And that can lead to very poor policy making."
Another reason the yen's appreciation didn't correct Japan's trade imbalance is that the nation's trade was mostly denominated in U.S. dollars, Mr. McKinnon adds -- as is the case in most of Southeast Asia today. In the 1980s and 1990s, the yen-to-dollar exchange rate fluctuated as much as 20% annually. To persuade Japanese consumers and corporations to hold what they perceived as risky U.S. dollars, Tokyo cut interest rates until they hit zero, and Japan lost its ability to stimulate its economy through its interest-rate policies.
Pushing China to revalue its currency could have equally unpredictable effects, the McKinnon camp holds. Chinese government officials repeatedly have declined to reveal specific plans for their exchange-rate regime. In a speech last month, Premier Wen Jiabao acknowledged that "work related to exchange-rate reform is in progress" and that a change could come "unexpectedly." He also noted that those calling for a move "haven't given much thought" to the impact on domestic corporations, regional neighbors and the global economy. Currency markets expect an appreciation soon, but analysts generally don't think Beijing will make radical changes.
During the weekend, China's central-bank governor and a top financial regulator reiterated that Beijing is examining its options, but declined to disclose details or a timetable. Wei Benhua, deputy director of the State Administration of Foreign Exchange, said it is "probably" time for China to "consider" changing the arrangement, but he added there isn't yet consensus within the government to do so.
HSBC chief economist Stephen King, in a report published in January, estimates that "even a major [yuan] revaluation -- 25% against the dollar -- would make scarcely any difference to the U.S. economy." Since China accounts for less than 10% of total U.S. trade, a 25% revaluation would imply a 2.5% devaluation of the dollar, which Mr. King characterizes as "a drop in the ocean" in terms of bringing trade flows into balance.
Still, many economists disagree with the McKinnon camp, pointing to differences between the modern economic climate and the 1950s and 1960s, when Japan was expanding so rapidly. Today, capital flows much more freely between countries, and central banks have generally intensified their focus on controlling inflation. The Chinese economy also is much less developed than was Japan's postwar economy.
Mr. McKinnon doesn't suggest that China stand still. His advice: Take change slow: Reduce trade barriers, let more foreign ventures raise money within China, and encourage China as a whole -- including the government -- to spend more to balance the trade gap. |
