Sunday, June 27, 2010

Is the "Rising Yuan" going to help?

FROM a global perspective, the world has every right to expect large surplus savers, such as China, to reduce outsize current account surpluses. At the same time, the world community needs to be fair in putting equal pressure on large deficit savers, such as the United States, to address its saving problem.

Is it wrong to insist that China’s global rebalancing imperatives be addressed by a realignment in a bi-lateral exchange rate with the dollar. What matters most insofar as global imbalances are concerned is China’s broad multilateral exchange rate. China can hardly be accused of manipulation vis-a-vis the rest of the world. In real terms, the trade-weighted renminbi is up 7.5% over the past six months and fully 20% over the past five years. These is good reason to believe that a pro-consumption structural policy agenda, is likely to be a central feature of the upcoming 12th Five-Year Plan, could achieve far greater traction in promoting a timely and effective rebalancing. There is good reason for China to view a tight RMB/dollar relationship as an important anchor for an embryonic financial system. Washington’s China complaint seems especially off base when it comes to the renminbi. Yes, the United States has a large bilateral trade deficit with China. But it turns out that America ran trade deficits with over 90 countries in 2008-09. Given the unprecedented shortfall of US saving—a net national saving rate of -2.5% of national income in 2009—the US must import surplus saving from abroad in order to grow and run massive current account and multilateral trade deficits in order to attract the foreign capital.

Without a fix to America’s saving problem—highly unlikely in an era of trillion dollar federal budget deficits—forcing the Chinese to appreciate the RMB versus the dollar, or imposing trade sanctions on them if they don’t, is like rearranging the deck chairs on the Titanic. It would shift the Chinese piece of the US trade deficit to someone else—most likely to a higher cost producer.
IT ALL sounds so simple. Let the renminbi appreciate and the world's economic problems will be solved. Yet, when you think about it, this is a distinctly implausible claim. The idea that an adjustment in one relative price in the entire global economy will rid the world of imbalances and lead to a new economic nirvana doesn't really make sense.

There are doubts to these and they need to relook at some of the pending events :
The Japanese yen has risen dramatically over the last forty years—from JPY380 against the dollar at the beginning of the 1970s to around JPY90 more recently. Despite this momentous rise, Japan's current account surplus has steadily gotten bigger as a share of its GDP. When the Japanese tried to do in the late-1980s exactly what is now being asked of China—shift away from export-led to domestic demand-led growth—it all ended in tears.
The Japan's experience shows, countries run current account surpluses for structural reasons that may have nothing to do with the value of the nominal exchange rate. Inadequate social security provision and a poorly-developed consumer credit system undoubtedly play a big role in boosting savings relative to consumption in china's situation. China uses a currency target partly because of a lack of credible alternatives. No one has any idea of what is really going on with Chinese money supply while an inflation targeting regime is highly problematic for any country with low per capita incomes, where the typical consumer basket is heavily weighted towards food and energy, the prices of which are highly volatile from year to year.

Discussion of the nominal exchange rate ignores the obvious point that it's the real exchange rate that ultimately matters. Let's face the fact, China was cut off from the rest of the world for over 500 years. Now that it's opening up, it can flood the world with workers who are prepared to accept wages a tiny fraction of those being paid in the West. Western workers have enjoyed a "monopoly" on access to global capital for most of the 20th Century, rewarding themselves with wages well above the market-clearing price. Nominal exchange rate adjustment won't prevent Chinese workers from undercutting their Western equivalents.

Admittedly, the terms of trade will likely move in China's favour whether or not there is nominal exchange rate adjustment. But the way that's playing out at the moment is through some hefty wage increases in China accompanied by deflationary pressures in the West. Whether through nominal or real exchange rate appreciation, however, this simply means that China's buying power over the world's scarce resources will slowly improve and, by implication, the West's will diminish, most obviously through rising commodity prices in dollar or euro terms. A rising Chinese real exchange rate will lead to a redistribution of income from commodity-consuming to commodity-producing nations.

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