Reevaluating a Renminbi Revaluation
Cynic's Delight
Wednesday, June 08, 2005
cynicsdelight.blogspot.com
Calls for a renminbi revaluation are becoming rather more pronounced these days. Senators Chuck Schumer and Lindsey Graham weighed in today in an op-ed in the NY Times that plugs their proposed legislation imposing trade tariffs unless the Chinese revalue. Notwithstanding the fact that such threats merely reinforce China’s determination not to be seen as bowing to foreign pressure to revalue, this really is a case of being careful what you wish for.
As this paper by Jeff Frankel notes, there are in fact two ways for China to adjust its real exchange rate. First and most obvious is to adjust the peg to the dollar, allowing a nominal appreciation of the renminbi. But the Chinese could achieve the same affect (in terms of making Chinese exports more expensive) by increasing domestic inflation.
There is at least some evidence out there that this is the trend we should be looking at. While many have warned of the deflationary impact of China on the world economy, by some measures domestic Chinese inflation is heating up. For one, rising commodity prices and China’s increasing appetite for imported oil are driving up some basic price inputs. The Chinese economy is much more dependent on oil (as a percentage of total output) than the more developed service oriented economies of the west are. Second, China’s ability to sterilize all those US Treasury purchases may finally be running out of traction. A broad measure of Chinese monetary growth, M2, grew by 14.4% in the first quarter year over year to reach 25.5 trillion Yuan at the end of March. The core CPI numbers rose 3.9% in 2004.
But there is also a more fundamental reason to keep an eye on domestic Chinese inflation. There is growing awareness China needs to adjust its excess savings rate and increase domestic consumption. The Asian Development Bank’s 2005 Development Outlook for China has a wealth of interesting information on this subject. The Statistical Appendix (which can be found here) reports that Chinese domestic investment as a percentage of GDP was an astounding 45.6% in 2004. This is high even by the standards of the East Asian export-led development model. South Korea and Malaysia, by contrast, had savings rates of 29.1% and 22.5% respectively last year.
Much of that domestic investment, of course, was aimed at the export sector. China ran a trade surplus of $58 billion in 2004, powered by a 35.4% surge in merchandise exports. The trade surplus accelerated further in the first quarter of 2005, running up to $16.8 billion. This, of course, is the source of rising protectionist sentiment in the west. But all those job losses in the west look like job creation in China, so the Chinese government is unlikely to want to slow export growth. Instead, they are more likely undertake measures to boost domestic demand, which should lessen the country’s twin current account and trade surpluses.
Evidence supporting this view can be found in recent comments by China's central bank governor Zhou Xiaochuan, suggesting that China is planning on boosting domestic consumption as a means of righting the country’s excess savings rate and trade imbalances. Increased domestic consumption might also be attractive to the Chinese government for domestic political reasons.
If China does adjust in this way, who are the winners and losers? The US will not benefit much from an adjustment in the real renminbi exchange rate. First, Chinese goods will suffer more of a decline in competitiveness compared to other exporting nations than to US products. So the overall US trade deficit will not decline, but merely shift to other countries. Second, if the Chinese really do succeed in boosting domestic demand and decrease their trade and current account surpluses, this means they will stop buying so many US Treasuries, leading to higher interest rates in the US as demand for Treasuries falls.
The real winners are export industries in the rest of the world. Not only will rising Chinese demand increase their business, but they will become more competitive in industries in which they compete with the Chinese. A recent policy brief by the ADB makes this very prediction. Senator Schumer in particular might do well to wonder whether his constituents are more worried about having their jobs outsourced to Asia or their mortgage payments hiked due to higher interest rates. |
