What RMB appreciation?
There is a tendency to equate the RMB/ dollar with the RMB. That most often shows up in tendency to equate an appreciation of the RMB against the dollar with an appreciation of the RMB.
That is a mistake. If the dollar is depreciating against other currencies, the RMB can appreciate against the dollar and still depreciate against most of the world.
Back in say 2000, a very large share of China’s trade was with the US — so the RMB/ dollar mattered more, in some sense, than the RMB/ euro. I hesitate slightly to state that because it is fairly clear that the RMB’s move against the euro did matter even then, as the RMB’s depreciation set in motion a huge expansion in European imports from China. One of the reasons why China didn’t export all that much to China back in say 2000 was the RMB’s strength against the euro.
But now China trades as much with Europe as with the US, and its trade with the emerging world is growing as well. One undeniable fact about China is that it is much less dependent on the US market than it used to be. And that means that the evolution of the RMB against a host of other currencies matters. Ask the Koreans (though right now they seem more focused on the yen). Ask the Thais. Ask the Indians. Ask the Brazilians.
The following chart — which was inspired by a suggestion from former Treasury Secretary Summers — shows moves in the RMB against a 40% dollar/ 40% euro (used as a proxy for all European currencies) and a 20% yen basket. That roughly matches the current composition of China’s trade with the G-3 once adjustments are made to account for the large share of China’s trade that goes through Hong Kong.
The chart at the end of 2004 – a point when the dollar (and thus the RMB) was really weak. I made end-June 2005 equal to 100. That makes it easy to see the RMB’s cumulative appreciation against the dollar. It also makes it easy to see that the RMB has been flat against this basket since the end of 2005. No movement in 2006. No movement in 2007.
The financial press has a tendency to report the RMB’s cumulative appreciation since China broke its peg in mid-2005 (a little under 10%). It doesn’t usually report how the RMB’s appreciation over that period compares with moves in other currencies. It turns out that the RMB has appreciated by less than the euro or the Australian dollar (meaning China has depreciated against both those currencies).
It also turns out that China has appreciated by less than most other emerging Asian currencies.
The main exception is the Indian rupee (INR) — and if you look just at 2007, the rupee clearly has appreciated much faster than the RMB. Indian inflation is also a lot higher than Chinese inflation, which adds to the pace of the rupees real appreciation.
I didn’t include a chart showing the yen — as there is no doubt that the RMB has appreciated relative to the yen, and relative to the Taiwanese dollar as well. But I don’t think I am slanting the data. Look at figures 16 (for changes in the nominal RMB v the Asian NIEs) and especially figure 40 on p. 42 (for movements in the real effective exchange rate of a set of emerging Asian economies) in this the ADB’s most recent Asian Economic Monitor. In real terms, the RMB has depreciated since early 2000, while the currencies of all other emerging Asian economies have appreciated.
The RMB looks pretty flat since the end of 2005 on their graph too.
I also decided to take a look at moves in the nominal RMB v. a set of relatively low inflation economies since the end of 2000. The following graph shows the cumulative appreciation (or depreciation) of a range of currencies against the dollar relative to their levels at the end of 2000/ very beginning of 2001. To make them stand out, the euro is the thick blue line, the RMB is the thick red line and the yen is the thick black line. The yuan looks sort of red-blue for a while (i.e kind of purple) because both China (think red) and Malaysia (thin blue) pegged to the dollar for a long time.
The RMB has appreciated by less against the dollar than almost everyone else, with the huge exception of the yen and the GCC countries, which still peg to the dollar.
That implies that the RMB has depreciated v most of the world. And it certainly has depreciated against the euro. The following graph shows the exact same data as the previous graph, but it has been expressed in terms of euros — i.e. if a currency appreciated against the dollar by less than the euro against the dollar since the end of 2000, it shows up as a depreciation on this graph.
Personally, I think it is very hard to build a case why China should be at the bottom of this graph along with Japan. Japan has been mired in a long period of subpar growth. China is booming.
Let’s go back to the first graph — the one that showed the RMB v an index of the G-3 currencies. It turns out the RMB appreciated significantly against that basket in 2005, largely because the dollar rebounded. The next graph shows what would have have happened if China had sustained that same pace of appreciation over the last 18 months: the RMB would be about 15% stronger than it is now.
I suspect my criticism of China’s policy has gotten more strident over time. That reflects my sense that China policy makers missed a major opportunity over the past few years. They opted not to maintain the same pace of appreciation China experienced in 2005. That, in my view, one of the reasons why China’s current account surplus will be truly enormous this year. It is also one reason why China is on track to add almost as much to its reserves in 2007 as the entire world added to its reserves in 2005. Chinese reserve growth is now truly unimaginably large.
UPDATE: Here is an example, from Businessweek’s Brian Bremner, of the tendency to equate moves in the RMB/ $ with moves in the broader RMB.
“The Chinese currency yuan has appreciated about 9% since July, 2005, when Beijing replaced its currency peg to the dollar with a semi-fixed system enabling the yuan to move within narrow trading bands against a basket of currencies. Glenn Maguire, chief Asia economist for Société Générale based in Hong Kong, is forecasting a further one-off 3.5% revaluation by yearend. Paulson and others want more, but it can’t be denied that things are moving in a better direction.”
If you look at broader measures of the RMB’s value, it can indeed be denied. There isn’t much evidence of a real RMB appreciation. Not with the dollar back at 1.38. I don’t mean to pick on Bremner either — the tendency to focus exclusively on the RMB/ dollar is very, very common.
55 Responses to “What RMB appreciation?”
Nobody forced china to hold its currency down.i dont think
anybody can force china to revalue its currency. But given
the size of chinese economy having moved into a middle income
country it is in the best interest of china to revalue the
currency. all the productive capacity is moving to china.this
is creating misallocation of capital creating overinvestment
leading to lack of demand in the future( eg. china produces
half of 2 billion phones, most mp3 players etc,sooner car
capacity). this will lead to unemployment of differnt sort
contrary to the objectives of CPC. Hope china revalue now or
enter a severe deflationary depression
As long as the economic growth keeps going nobody cares, but when it slows down watch out. No one wants to talk about how to ever reconcile the global financial system when things go bad which they always do. How do this system end? I’m with gilles.
the yen certainly stands out doesn’t it…
One has to make some careful distinctions between “apprecating the RMB,” “flexible exchange rates,” and “floating exchange rates.” The arguments for and against each are different.
Also, the data (from the IMF report I mentioned in the Prasad discussion) seems to indicate that capital (judging from return on capital) *isn’t* being wildly misallocated and that most of the investment in China is coming in from domestic sources and not foreign ones.
What I find somewhat amusing is that when the RMB depegged from the dollar the PBC said that they were pegging against a currency basket. It looks like that there really *is* a currency basket.
“capital (judging from return on capital) *isn’t* being wildly misallocated”
tell that to the people dying from pollution, lead paint and contaminated food products…
Well Paulson gave China an ultimatum to appreciate NOW, just a few days ago. How soon do you think they will follow his “orders”?
PS Does Paulson have any credibility left?
Cool graphs. I’d like to see 3 more graphs to see if there is any correlation:
1.) Depreciation of RMB vs Euro and US Exports to EU
2.) US Exports to China normalized for dollar depreciation
3. EU Exports to China normalized for dollar depreciation
i have done us and chinese exports to the EU v Euro/$ and rmb/ euro … as the $ fell, us exports (in $ terms) to europe rose significantly. overall us export growth also picked up when $ fell v euro, consistent with the idea that us and european producers compete in many third party markets.
and yes, the yen does stand out. though I would argue the yuan stands out more once you take into account the extent of China’s growth — whether in productive capacity, productivity or real GDP. Japan lags the world in cumulative real GDP growth since 2000, china leads.
“i have done us and chinese exports to the EU v Euro/$ and rmb/ euro … as the $ fell, us exports (in $ terms) to europe rose significantly. overall us export growth also picked up when $ fell v euro, consistent with the idea that us and european producers compete in many third party markets.”
Yes, I am aware of that. I wanted to see if there is anyway to prove the thesis that lack of Yuan appreciation is impeding adjustments. So if the Chinese exports to EU come at expense of (more) US exports due to derpeciating Yuan, then there is a point of investigation. If not, then it shows Chinese and US producers don’t compete directly. The same investigation should also hold in imports side. It’s probably a huge topic requiring many inputs, but if the thesis needs to be proven to make the case, then somebody (US Senate?) ought to fund the study.
i think the data basically shows that the weak $/ rmb is boosting both us and chinese exports, but boosting chinese exports more than us exports. the result is a stable us current account deficit (for now, with a sluggish us leading to a slowdown in import growth) and a rising chinese surplus, so a falling chiamerican overall deficit ..
Brad — Your figures nicely show that the main problem is that the dollar is weak vs. everything except the yen. Once the US economically and financially pulls itself together, and as a result the USD gets stronger, your figures will show a nice yuan appreciation. So, the problem is not China, but the US.
Re: Paulson’s ultimatum
The Chinese understood it a bit differently:
Visiting U.S. Treasury Secretary Henry Paulson on Monday said China would make its own decisions on currency
i still think not everyone has adjusted to the size of china. consider this -
henry ford tried to make a car, the model T, that was cheap enough for the workers who built it to afford one. that is a very good principle. you can only enlarge profits for investors at the expense of the wage earners up to a certain point. after that sales of the motor car start to dry up.
the chinese could become the world’s largest economy but still be only less than a quarter of the way to being the world’s richest people per capita.
china is on course, using the hypothetical example above, for a never never land where collectively the chinese can buy out henry ford, (if allowed), but individually cannot afford the model T. meanwhile the ford workers in america would be unemployed and unable to afford to trade in the car this year, either.
intuitively, i don’t think it makes sense. dave chiang, henry liu, and bernanke can print and helicopter all the greenbacks they like – but the real world will assert itself at some point. a weakening minority of western consumers cannot support a strengthening majority of asian producers, even low cost producers. i think the whole game tends towards a crisis of overproduction, and a decline of consumption, leading to deflation.
the sino-american dance is a little like the struggle of the west german economy to digest the east german economy after reunification. the brilliant investment opportunities for the stronger party, the west germans, came with side effects. it took years to get back to normal. severe indigestion . . .
compare the sizes and economic disparities of e and w germany. now compare the size and the disparity of china. you think that the global economy can admit china without massive distortion ? i do not pretend to know. but intuitively i feel that the deal – ‘we print the dollars, you make stuff to earn them and we keep the profits’ has a downside. the downside is not the danger of china suddenly collapsing the dollar, but bit by bit coming to own chunks of the very economies and companies that make the profits. the fiat boomerang catch 22.
i may sound critical of united states policy, but if the euro were to succeed as a globally preferred reserve currency – while remaining a fiat currency – i don’t think the position would be any different. the power to issue fiat reserve currency is some kind of ‘moral hazard.’
meanwhile iran tries to upset the applecart by selling oil for yen. that would put the skids under the carry trade. o k forget ‘applecart’ let’s say ‘currencybaskets.’
AC –i would put it differently. china’s strategy for yuan apppreciation is $ appreciation. and given the size of the us trade/ current account deficit and the absence of sufficient private demand for us assets, that is a very risky bet indeed.
bottom line — with its big current account surplus, china shouldn’t be managing its exchange rate against the currency of a country with a big deficit.
Brad — I understand you. But as I understood, your main point in this post was that the yuan is not appreciating against currencies other than the USD. If the USD appreciated against the other currencies, then so did the yuan. And we will have something like 5%/year yuan appreciation against the USD for years to come, I think. So, an USD appreciation would lead to a yuan, which is appreciating against everything. This could happen if the US could put its economy and financials in order. Do you think that the only way to achieve that is a yuan appreciation? If that is so, then the US is in a really big trouble, since its fate is in someone else’s hands.
if china won’t allow the rmb to move by more than 5% against the $, then china is the one that is putting its faith in someone else’s hands …
i don’t think china should rely on the us to generate an appreciation of the rmb that is in china’s long-term interest.
and i actually think $ depreciation (and a shift towards tradables production) is part of the process that helps the us put its house in order — it tho isn’t the only thing that the us needs to do.
“bottom line — with its big current account surplus, china shouldn’t be managing its exchange rate against the currency of a country with a big deficit.”
Based on your post, is 40%EUR/40%USD/20%JPY a good basket to peg to? If not, what would you change?
bsetser: if china won’t allow the rmb to move by more than 5% against the $, then china is the one that is putting its faith in someone else’s hands …
If it is the case that China is pegging to a basket, then it means that there isn’t a set limit for how much it is willing to let the RMB/$ move. If the US sharply drops with respect to the Euro or Yen, then it will drop sharply wrt the RMB.
Guest: tell that to the people dying from pollution, lead paint and contaminated food products…
Can you explain to me what you meant by that? How does pollution, lead paint, and contamination have to do with return on capital investment?
Gilles: the real world will assert itself at some point. a weakening minority of western consumers cannot support a strengthening majority of asian producers, even low cost producers
But if you run the numbers, I think the system is sustainable for about two to three decades if China starts loosening capital export rules so that it can run a trade surplus without massive reserve growth.
Gilles: you think that the global economy can admit china without massive distortion ?
You ask the question as if there were some sort of choice in the matter……
“ The downside is not the danger of china suddenly collapsing the dollar, but bit by bit coming to own chunks of the very economies and companies that make the profits “
That’s exactly what’s happening – methodical diversification into other currencies, methodical diversification of US assets from debt to equity, and steady flow of wealth (assets) from US ownership to China ownership.
emerging asia would need to have some weight in any basket, and china would need a policy course that lets the rmb appreciate against the basket — which is different than a basket peg.
twofish — i don’t the the rmb should be stable v the basket (which is the goal of a basket peg). I think — based on a bunch of analysis that i won’t repeat here — that the rmb needs to appreciate v. the basket.
“Can you explain to me what you meant by that? How does pollution, lead paint, and contamination have to do with return on capital investment?”
if the concept of ‘negative externality’ needs to be explained to the chinese gov’t, we’re all doomed…
btw, the mortgage origination window has officially been ‘closed’, unless it’s conventional prime, nothing’s getting thru…
and who owns it _all_?
the PBoC has US by the balls
Guest on 2007-08-03 17:32:44:
“if the concept of ‘negative externality’ needs to be explained to the chinese gov’t, we’re all doomed…”
How would you suggest Chinese government deal with the negative externalities of pollution, lead paint and contaminated products?
What do you think of Menzie Chinn’s new paper, referenced at Econ Browser?
i generally like the chinn et al paper, and much prefer how they framed their findings on the rmb (substantially undervalued, but doesn’t quite meet the test for statistical significance) this time around compared to the way they framed the issue the last time around (when their title suggested that the rmb was not undervalued, even tho the data points showed it well below where one would expect). their finding that exports respond to real moves in the rmb makes sense to me — and seems consistent with my read of the recent data (i.e. RMB real depreciation from 02 on leads to an acceleration in chinese export growth)
What’s your take on the paper’s finding regarding imports?
Again, thanks for responding to comments and working late into night on a Friday.
Bottom line, any revaluation of the yuan will never be enough to satisfy the demands of the Washington Consensus. The almost 10% revaluation of the Chinese yuan versus the US dollar over the past two years is significant by almost any objective measure. It’s not China’s fault that the US massively misallocates capital on McMansions and stupid wars in the Middle East; public infrastructure and investment in human capital is seriously neglected. The Chinese leadership should pander less to Washington and foremost concentrate on the rural development of China’s economy where the bulk of the population lives today. When the inevitable collapse of the US dollar reserve currency occurs, then China will have a large enough domestic consumer market to support economic growth of the Asian regional economy without the requirement for significant exports to the United States. For the trillions of dollars of consumer products representing “real economic wealth” exported to the United States, what has the Chinese government received but several trillion dollars of fiat paper money printed in unlimited quantities by the Federal Reserve.
Guest: “Can you explain to me what you meant by that? How does pollution, lead paint, and contamination have to do with return on capital investment?”
Guest: if the concept of ‘negative externality’ needs to be explained to the chinese gov’t, we’re all doomed…
I’m trying to understand what you are arguing here, but you aren’t providing enough information here. You might try to be arguing that things like pollution indicate overinvestment, but that’s not obvious since it may also mean massive *under*investment in things like pollution controls.
Alternatively, you may be trying to argue that once the cost of environment damage is factored in that Chinese capital investment has negative return. If you can give the reasons why you think that it would be easier to evaluate that argument.
The thing about return on capital investment numbers is that they are marginal, I spend an extra $1, how much is the return? If spending $X produces Y environment damage and spending $(X+1) produces Y environment damage, then the effect of environment damage is zero. That extra $1 could even reduce pollution if it goes into anti-pollution devices or health and safety inspectors, or increases the general standard of living so that people care more about pollution. In any case, it doesn’t seem obvious to me how reducing savings and boosting consumption is going to help pollution.
If you spell out your argument, we can disect it, and see where we disagree and then look at some data. However, “argument by one liner” doesn’t allow one to do that.
DC: It’s not China’s fault that the US massively misallocates capital on McMansions and stupid wars in the Middle East;
The real estate bubble in the US is nowhere as bad as the bubble in some urban areas in China. And regardless of what one may think of US intervention in Iraq, the fact remains that it is the US military that keeps the oil from Saudi Arabia going to China.
Also we are all in the same boat. I don’t think one needs to spend too much time arguing whose “fault” things are, since that just produces finger-pointing that makes it harder to *fix the damn problem*. Developing the rural Chinese market is going to take *decades*. In the meantime, there is no reason to be overly confrontational against the United States since the US could make China’s rise either easier or more difficult.
About Chinn’s paper. One thing that seems to be missing is looking at the relative value of capital assets. The other thing is that it is far from clear what is the proper metric to use to determine the correct value of the RMB. If you look at asset prices, the RMB can be argued to be overvalued not undervalued, and appreciating the RMB is going to make that overvaluations worse.
My own thinking right now is that current reserve acculumation by China is unsustainable for more than three to five years, and the key limit is the ability of the PBC to invest currency reserves But a system in which China runs a persistent trade deficit and in which this money is recycled into foreign capital investment by non-state actors can last a lot longer.
DC: For the trillions of dollars of consumer products representing “real economic wealth” exported to the United States, what has the Chinese government received but several trillion dollars of fiat paper money printed in unlimited quantities by the Federal Reserve.
Well, it’s getting the US State Department telling the President of Taiwan that a referendum on joining the UN is a really bad idea, and that he is welcome to visit the nice city of Anchorage, Alaksa rather than Washington DC. It’s making it extremely unlikely that the US is going to spend more money on its navy than its army. It’s got a whole bunch of farmers and bankers strongly opposed to any effort to destabilize Beijing or press the Chinese government too hard to change politically.
(If anyone has seen Monty Python, I’m reminded of the “What have the Romans done for us?” scene)
If you want to be rich and powerful, your life is a lot easier if you make yourself useful to people and countries which are already rich and powerful rather than to try to work against them.
To Twofish re:
“the fact remains that it is the US military that keeps the oil from Saudi Arabia going to China. ”
Maybe I misunderstood your statement but China rakes 4th after the US, Japan, and South Korea in oil imports from Saudi Arabia. (Russia and Kazakhstan are important oil exporters for China due to physical location.. similar to Canada and Mexico for the US..) Saudi Arabia has increased trade with China and oil exports since the US went into Iraq in 2003:
China is developing it’s own oil industry for employment and knowledge (Saudi Arabia controls all of the industry within it’s borders..) so China has been making ventures into Africa in a similar fashion as the Western oil interests. In fact Western oil majors have completely abandoned the potentially lucrative oil assets in The Sudan to China and India (Due to political pressure over Sudan’s actions in Darfur..)
Brad — I wonder what kind of a yuan appreciation you prefer. An ordered (a few percents/year) appreciation against a basket of currencies, or a sharp and substantial (40-50-?%) appreciation immediately? If you think that the latter would be desirable (from your writings, I think you do), then don’t you think that such a move could ignite an immediate stock market crash and bond market turmoil in the US? This could hurt the US more than China.
A follow up on the concepts in bsetsers comment from the previous thread below would be appreciated. A credible analysis with stats and charts of the USD value added vs foreign value added components of both US exports and domestic consumption would be very helpful to discussions of the impact of changes in USD/RMB exchange rates. Without this analysis discussions appear to be based on theoretical and ideological suppositions and/or micro level short term private advantage without macro level empirical basis.
bsetser from the previous thread:
suppose a US firm produces goods in China for both the US and Chinese market using components sourced in China, including chinese managers. Quilan’s measure would have a huge number of “US export” — really sales by US owned companies. but it wouldn’t generate any US jobs/ result in any economic activity in the geographic location of the US. The balance of payments would accurately record a debit from the import of goods for the portion of the firms Chinese production that is exported to the US, and a credit from the profits the firm earns on its sales in both China and the US(which should register in gross national income as well). basically, US owners of capital (the firm) do well, and get an inflow from abroad — but there are no jobs for us workers in that example/ no economic activity in the US other than collecting the profits sent back by the chinese factory.
I agree with AC that RMB will appreciate more (against other currencies) if USD strengthens. EUR is very overvalued vs USD on a PPP basis. Why should China link to EUR? Among major currencies USD seems to be the cheapest on a PPP basis.
I must admit I don’t understand your point or how it relates to Brad’s comment. Perhaps he will.
But my interpretation of his comment is that the output of a foreign affiliate only adds value to the corresponding domestic economy to the extent that it generates factor income (labor and/or capital) for that economy. Foreign affiliates of US companies generate income for the US economy directly to the extent of the income earned on the domestic parent’s capital position in that affiliate. Indirectly, to the extent that the foreign affiliate buys imports from the US, they are included in the calculation of US value added by recognizing them as US exports in the normal way.
T N says what I was trying to say but better –
I have no idea what the US share of the value-added of US exports is — i would assume it is high, but it clearly is not 100%. the most valuable bit of a Boeing is typically american (the engine), but a lot of other parts are not — especially for the 787.
as for the import share of US consumption – consumption is roughly 70% of GDP. Imports are around 17% of GDP, but some of those imports are capital goods (tied to investment) or imported components (for the 11% of GDP the US exports). Let’s say around 12% are consumption goods (counting imported oil as a consumption good) — the real number is calculatable if you go to the BEA web page and spend some time doing the work. that implies imports account for about 1/5 of US consumption. they obviously account for a larger share of US goods consumption than US service consumption — my guess is that the import share of goods consumption in the US could be as high as 50%, but that is a pure guess. if anyone knows, do tell. it almost certainly is higher than a third.
Thanks T N and Brad,
I believe I understood Brad’s parsing of values to appropriately reconcile both sides of the CA ledger. Brad, your response does begin answer the question I’m raising. As people balance the impact of rising import prices against potential increases in the competitiveness of US exports these figures are important. I understand that US deficit spending is unsustainable and that some correction is inevitable. I’m concerned that advocates of an rapidly appreciating Yuan may be overestimating the impact of any increase in competitiveness it may offer to US value added and underestimating the inflationary impact of a declining dollar on US prices and the dislocation it will cause in the US economy. Given the current strength in global economic growth it’s difficult to assume that a reduction in US demand will lower prices for goods priced in a global market.
I posted a longer response earlier, but unfortunately it didn’t appear in the comments, even with the confirmation keyword typed in. I’ll see what I can find at the BEA site.
Re: Saudi. The point I was making is that the US army helps to keep the Saudi regime in power and the US navy helps keep oil flowing from Saudi Arabia to China. Financing said army and navy seems to be a good way of keeping those things from being used against you.
Also, one reason that Western oil companies have left the Sudan and other political disasters is that you just don’t make that much money in those areas. Chinese oil companies are discovering this too. If you really want to drill in those areas without having human rights groups screaming at you, there are all sorts of ways that you can do that, and the reason Western companies have avoided those areas has as much to do with $$$$ than with bad PR.
Guest: Saudi Arabia controls all of the industry within it’s borders..
Saudi Arabia owns all of the oil facilities and reserves in its borders. That’s a different statement than what I think you meant by “controlling all industry.” In fact, Saudi-ARAMCO is a huge customer of Western oil service companies. The other thing about the Saudi government is that it got full control of Saudi-ARAMCO by buying out Western companies, so there isn’t “bad blood.”
‘ecoshift’: as the unvalued member of this community who posted the Sesit excerpt and link, and as some ‘guessing’ seems to be allowed on this topic, for what it’s worth, my first response was that you may have been inferring Brad’s interpretation ended a bit too soon. If it may read something like: “…no economic activity in the US other than collecting, [and recycling by: 'spending' - at least in part through the portion of the firm's profits which presumably are allocated to healthcare benefits and wages paid to 'local workers' - both NR's and citizens - employed in the HQ, along with locally outsourced entrepreneurs and professional services providers, who in turn, spend and invest the money on a huge range of products and services which also create and develop markets for tradables and 'non-tradables' - and remittance flows) and reinvesting; in the firm's expansion through research, design, education, technology upgrades, advertising and marketing... and in the expansion of US financial products and services facilitated by the firm's growth and profitability, presumably part of which also filters into the multi-trillion dollar U.S. pension fund industry, tax-deductible contributions to the philanthropy and endowment industry, and at least some taxes paid to a government which presumably shares an interest in the firm's capacity to grow from] the profits sent back by the chinese factory…”
Whether some part of these flows may also facilitate job creation in the private and semi-private sector US economist industry, given its obsession with this topic. That being said, a bit frustrating, perhaps to them too, that they can’t come up with something “I have no idea what the US share of the value-added of US exports” when that seems to be such an important part of the equation.
‘Twofish’: I can’t speak for the other guests, but on the negative externalities question, and looking at today’s headlines, that the worry may be the extent to which (hidden) negative externalities extend beyond China’s borders, and what appears to be China’s lack of concern about its own responsibility in dealing with those issues.
in the short-run, RMB appreciation would have three impacts:
1) it would increase the price of chinese imports (around 2.5% of US GDP), tho that would be offset to a degree by firms eating higher costs (whether in the us or china) out of their profit margins (as has happened with the euro, the so called pass through of changes in exchange rates to changes in import prices is less than 1) and by the savings Chinese firms would get from the lower cost (in rmb terms) of their imported components.
2) it would increase chinese purchasing power, leading to more US/ world exports to china (tho this impact is ambiguous given that some share of exports to china are then rexported as finished goods to china — so 1 offsets 2). in the short-run, i wouldn’t expect this to have a huge impact, tho i think the us may do well selling to those who sell more to china. RMB appreciation would also allow more currency appreciation throughout asia magnifying the impacts of 1 and 2.
3) US (and global) firms would have a stronger incentive to invest in us production rather than shift production of things now made in the us – think auto parts, furniture and the like — to china. that would over time slow the increase in Chinese exports. Of all the effects, i suspect 3) is the most important, but it also plays out over a relatively long time frame.
finally, depending on how all this ends up impact China’s current account (it isn’t obvious – in the short-run, china might sell the same quantity but for a higher dollar price, so its dollar surplus might initially rise before the effects of (3) kick in) and capital inflows (again, not obvious, as a faster pace of rmb appreciation might attract more capital inflows, but if the rmb rose too far, folks might start betting on a fall or take profits), it also would have an impact on Chinese foreign asset growth, and thus the availabity of chinese financing of the US.
I don’t worry too much about the inflationary impact of higher import prices — the usual arguments for why china hasn’t led to the loss of all that many jobs (trade is small v gdp and trade with china is even smaller) also applies here. I suspect there will be offsets in profit margins. and china already has contributed to inflation by pushing up the price of a lot of commodities (and by pushing down int rates, the price of housing), so i don’t see china’s impact as unambiguously disinflationary. it is only disinflationary if you take food and energy (where China clearly exerts upward pressure) out of the picture …
Plus, since i think adjustment off an equilibrium that relies on subsidized access to cheap chinese goods and credit is good, i am willing to accept the dislocations associated with the transition. remember, shifting to the current equilibrium also led to dislocations — dislocations American’s relatively flexible economy (i am not convinced it is as perfectly flexible as some claim, but that is another story) managed. W/o minimizing the scale of the needed transition, i think it should be manageable — plus the size of the needed transition only increases over time, so my calvinist side says get on with it.
2a) It would make US financial assets even cheaper than they currently are, leading to pressure for massive Chinese purchases of US assets.
I don’t think 3) will turn out to be that important, since:
1) the cost difference between US and China won’t disappear for most manufactured goods if we are talking about a revaluation within tens of percents, and
2) the main effect of the RMB appreciation will be to move production from China to other countries (Mexico), I don’t see the jobs going back to the US
brad: Plus, since i think adjustment off an equilibrium that relies on subsidized access to cheap chinese goods and credit is good, i am willing to accept the dislocations associated with the transition.
My worry in any sudden appreciation is that there will be some unforsee consequence that will cause a massive crisis. Unforseen crises tend to happen when there is 1) a sudden change and 2) strong and unclear linkages in a complex system. The global economy is an extremely complex and poorly understood system, and any suddenly change is likely to cause someone unexpected to happen, and if that this is unexpected bad, there may be no time to step back, and deal with the problem. If you make gradual incremental changes, when the unexpected thing *does* happen, you can step back and deal with it.
What will be interesting is to see the July inflation numbers. There is a lot of talk among Chinese economists that the PBC has reached the limits of sterilization and that China has to something to cool the economy. If the July inflation numbers show that the June CPI numbers aren’t a fluke, then I think you’ll see a much more rapid appreciation. The other debate that seems to be popular among the Chinese economic press is to what extent the Japanese appreciation in the late 1980′s led to the collapse of the Japanese stock and real estate markets in the early 1990′s.
‘Twofish’: I can’t speak for the other guests, but on the negative externalities question, and looking at today’s headlines, that the worry may be the extent to which (hidden) negative externalities extend beyond China’s borders, and what appears to be China’s lack of concern about its own responsibility in dealing with those issues.
There is a lot of ambulance chasing in headlines. Newspapers look for extremely dramatic and new events and quiet changes aren’t often reported. Also what satisifies the press is some sort of “blood sacrifice” whereas quiet efforts to actually fix the underlying problems rather than to appease the press aren’t reported because newspapers don’t have the attention span for that sort of thing. Newspapers do have a useful function at pointing out problems, but you need to keep in mind that newspapers have a bias toward the dramatic, and when the Chinese government actually fixes a problem, it doesn’t get reported. (Remember the bad banks that were going to kill the regime? )
I’m actually trying to figure out what the next big issue that will attract the attention of the Western press once people start getting bored of talking about bad food.
The virtuous cycle for adjustments start with the rise of food prices which leads to higher farm income. Farm income not only directly affects a major part of the Chinese population that are most likely to covert income into current consumption, it also sets the wage of unskilled labor at the margin (due to the unique land distribution pattern in China). I hope the Chinese government doesn’t lose sight of this endogenous demand — a large appreciation that suppresses food price will kill it off and most benefits will accrue to those who don’t need a further boost in purchasing power.
It is silly to fear the mild inflation in China. China needs it to readjust from exports to internal demands.
I am very open to some less than conventional ideas to ease the pain of RMB appreciation for the rural sector — i am not really worried about tariffs or quotas on imported rice, for example, to change the rural/ urban terms of trade inside China. But i would rather not use the exchange rate to achieve agricultural policy objectives.
Twofish — i disagree on the “what doesn’t go to china will go elsewhere argument”. at some point, the US will become competitive, and equilibrium will be achieved through the exchange of goods and services for goods and services not the exchange of goods and services for debt. germany retains a competitive tradables goods sector even with high wages; the us has some very competitive tradable service sectors (and one civil aircraft exporter that is on a roll). agree tho that the Chinese inflation data will have a big impact on policy.
i am quite aware of the China cannot let the rmb appreciate b/c yen appreciation in the 80s killed japan argument/ debate. i don’t buy the analogy tho. the yen appreciated substantially in real terms from say 1960 to 1980 — without destroying japan. and there are plenty of other examples of appreciation that haven’t been negative — the us dollar appreciated in the late 90s and the us boomed, the euro has appreciated substantially over the past several years and europe is booming, etc. moreover, if you think japan’s mistake was loose monetary policy to offset yen strength — loose monetary policy which in turn fueled the land/ stock bubble, then, well china is well on its way to repeating japan’s mistakes. it just is running a loose monetary policy not to offset yuan strength but as a consequence of yuan weakness. but it still may end up with a bubble economy …
i thought the BIS quarterly report was good on this topic; have been meaning to blog about it at some point.
HZ: The virtuous cycle for adjustments start with the rise of food prices which leads to higher farm income.
I don’t see an easy way of boosting food prices enough to make that much of a difference to the farmer. Also most of the recent rise in food prices hasn’t gone to the farmer. The cause of it was that supply of pigs was hard hit, which means that farmers net income didn’t increase.
HZ: Farm income not only directly affects a major part of the Chinese population that are most likely to covert income into current consumption.
I don’t think so. Since most farmers have few grandkids to support them in their old age and they also don’t have any pension benefits, I think that most income will go into retirement savings.
HZ: It is silly to fear the mild inflation in China. China needs it to readjust from exports to internal demands.
The worry is that a slight budge in food prices has traditionally been the first sign of bigger problems. The trouble with the Chinese economy is that since macroeconomic controls are crude, by the time there is definitely a big problem, it’s too late to do anything except slam on the brakes really hard.
bsetser: Twofish — i disagree on the “what doesn’t go to china will go elsewhere argument”. at some point, the US will become competitive, and equilibrium will be achieved through the exchange of goods and services for goods and services not the exchange of goods and services for debt.
I think it was Keyes who said that at some point we are all dead.
The problem with this argument is that it’s not clear to me that equilibrium in trade balances is going to be result in maximum economic productivity. The reason that people exchange good and services with debt may be that the US has the economic infrastructure to invest that debt and insure higher longer term returns than would be available in the absence of that debt.
To take this argument further. If you look at economic trade balances between different states, some states are running trade surpluses and some are running trade deficits, but there is no particular reason to think that a zero trade balance between individual states is a good thing.
What I really haven’t found is a good argument *why* a balance of trade between the US and China is the state that maximizes standard of living. It seems to me frankly to be an exercise in making the world fit a theoretical model.
twofish — all the money invested in subprime debt looks so good right now, doesn’t it? I am not totally convinced the US is the best at generating debt that the rest of the world wants to buy. private investors seem less impressed by us debt than central banks. and i think the biggest problem isn’t subprime – it is something different. in an economic sense, external debt is a claim on future exports. china may be buying an MBS, but it hopes to trade the $ it gets from a US household for goods and services that can be used in china. and the us hasn’t exactly taken out debt recently to invest in future tradables produciton. that implies, at least to me, that us dollar denominated debt isn’t all that great an investment for those who ultimately don’t want dollars, but rather goods and services. And i put china in that category –
i don’t see much evidence the us will deliver a better real return on the debt china has bought than it delivered on the debt some europeans bought in 2000 and 2001 …
on your other point, there is no reason why trade between the us and china should balance. but it also is qualitatively different than trade between two us states. the state of kansas doesn’t have a central bank that finances the much richer state of new york. trade deficits between us states are financed entirely by private capital flows. that isn’t the case for the us and china.
“The cost of shipping dry bulk commodities, such as coal, iron ore and cereals, has surged to a new high boosted by strong demand, port congestion and a significant lengthening of trade routes. The Baltic Dry Index… last week rose above 7,000 points for the first time – an increase of 103 per cent in the past year. The index, which closed at 7,007 on Friday, has jumped almost fivefold since 2000. The sharp increase threatens to add to already rising prices for agriculture, base metals and ore commodities…” http://www.ft.com/cms/s/d5448e54-4378-11dc-a065-0000779fd2ac.html
re: “there is no reason why trade between the us and china should balance”
but hasn’t one of your central arguments been that it should?
Q: essentially china is making bad investments given US assurances that it is AAA, when it is manifestly not… so what is wrong with this picture?
A: it prolongs the illusion that the US is AAA… so when the eventual realisation comes about, dislocations will be that much more severe as the US is ‘marked to market’ by the RotW.
re: “US assurances that it is AAA”
the big lie? the hegemon never lies.
“ In an economic sense, external debt is a claim on future exports. China may be buying an MBS, but it hopes to trade the $ it gets from a US household for goods and services that can be used in China. “
I wonder about this. The outstanding claims of surplus nations on deficit nations represent a distribution of claims on global investment. Global investment is a growing and renewing entity in its entirely and to that extent permanent in characteristic. Global financial claims on investment (domestic and international) in aggregate therefore are similarly permanent.
You wrote a paper several years ago on the sustainability of international deficits where an equilibrium position can be attained if the current account deficit ultimately grows less quickly than GDP (probably implying a near 0 trade deficit or trade surplus). This allows for a permanent and growing debt position, while achieving stabilization of the debt to GDP ratio at some future point (this is my recall – maybe not exactly correct).
Given this scenario possibility, it implies that a particular nation’s debt or surplus position can persist for a long time (i.e. forever) without debt being converted to exports.
While the broad classification for such international imbalances is debt, it might just as well be described as international equity. When viewing an international balance sheet in isolation, the logical balancing item to a surplus nation’s net asset position is positive (international) equity, and the balance to a deficit nation’s net liability position is negative (international) equity. These equity positions can be added to the respective domestic positions to arrive at the consolidated equity positions of individual nations (e.g. US household wealth equals domestic wealth minus the net international liability position.)
(I’m assuming by ‘external debt’ you mean broadest generic category of net international liabilities including both debt and equity claims on the US. I would define ‘external equity’ in the same way).
Whatever the future outcome, I see some other constraints apart from this math. The desire for foreign diversification of US dollar surpluses is already evident. But given the requirement for global surpluses and deficits to balance, this really means that surplus nations with ‘excess surpluses’ must exchange their unwanted dollars for something else from more balanced nations in order to diversify. Second, if the US sustains a current account deficit path toward some future equilibrium, it will become increasingly constrained in providing non-bank financial assets sufficient to absorb those flows. This is why I’ve said before that the eventual result could be some sort of dollar glut in the international banking system, resulting from a shortage of viable alternative assets in aggregate. The banking system is ‘surplus absorber’ of last resort, given that that’s where the money starts.
That said, I suppose the model whereby China (or the rest of the world) would target a permanent growing investment in the US without necessarily receiving any future payback in term of net imports would seem to be an insane objective. But it seems achievable apart from the constraints I mention. Also, it would not preclude continuing diversification by a country like China in swapping US asset positions for the asset positions of other countries, which then could be switched for imports from those countries. China thus could become a global distributor or ‘dealer’ for the capital account offset to a permanent US current account deficit.
jkh — you are right; it is a claim on the external sector of the economy (including investment income) but a debt position does not necessarily need to be paid back per se, and indeed, you can borrow to cover some interest payments — tho generally not to finance an ongoing trade and transfers deficit — without an exploding external debt to GDP ratio. so technically, the us simply needs to move toward a position where it pays for its import bill with exports —
that said, i was making a broader point that taking on external debt to finance homebuilding, consumption, fiscal deficit and LBOs (financial engineering) is different than taking on external debt to finance an expansion of tradables production — and the current expansion of the us net debt position (offset by gains on the equity side) doesn’t seem to be financing investment in tradables, which likely implies larger losses for the united states creditors than otherwise would be the case.
guest — i have argued that but for chinese intervention in the fx market, china’s trade would move back towards balance, and that the combination of china’s huge external surplus amid an investment boom is strange. and i have argued that the US global trade deficit needs to move back towards balance to stabilize the us external debt position/ reduce US dependence on central bank financing. but i don’t think i have argued that either should necessarily always have a zero trade deficit/ surplus, or that the bilateral us-chinese trade should balance.
bsetser: all the money invested in subprime debt looks so good right now, doesn’t it?
Better than all of the money being invested in the Shanghai stock market/real estate bubble. But note that the an entire sector of the housing market has collapsed and there is not blood in the streets. Part of the reason is that the US market is big enough to withstand these shocks.
bsester: china may be buying an MBS, but it hopes to trade the $ it gets from a US household for goods and services that can be used in china. and the us hasn’t exactly taken out debt recently to invest in future tradables produciton.
jkh has pointed out one problem with this assertion. I’ll add to this by mentioning that a persist current accounts deficit and permanent investment in the US makes a lot more sense once you move out of pure economics and into political/military realms.
One impact of Chinese purposes of US debt is to keep oil sea lanes from Saudi open. The political/military aspects of the US-China relationship are very relevant and tend to be ignored. Thirteen aircraft carrier battle groups are as much an economic capital investment as a factory.
As far as the analogy with US states, I don’t see what difference it makes if private flows are financing the deficit or if a central bank is, unless one wishes to argue that private flows result in more effective capital allocation (which may be the case).
Beijing Smog Forces Olympic Teams to Prepare for Asthma Attacks
2007-08-08 07:51 (New York)
By Wing-Gar Cheng and Grant Clark
Aug. 8 (Bloomberg) — Gunn-Rita Dahle got a taste of
Beijing’s smog at a race last year that left her fretting over
the defense of her Olympic mountain-biking title.
“It’s probably the most polluted place I’ve ever
competed,” says the 34-year-old Norwegian. “Your mouth and
throat dry up because of the dust. It’s not good for the
While the Chinese government is spending $13 billion to
clear the air in time for the 2008 Olympics, national teams are
preparing for the worst. The U.S. plans to base its athletes in
Korea, and the Australian team will be accompanied by an asthma
doctor for the first time. The games begin one year from today.
“There is nothing we can do to stop the pollution or
improve the air quality, but we can be prepared for the effects
of it,” says Juan Manuel Alonso, medical director of Spain’s
Olympic track and field team. “We have to make sure the first
aid box is well-stocked.”
Air pollution is choking Beijing as economic growth of 10
percent a year drives a building boom and increases demand for
cars. Construction spending increased 13 percent last year, and
new car sales jumped sixfold in the past five years, according to
The U.S., which won the most medals in each of the past
three Olympics, will base athletes in South Korea, 75 minutes
away by plane, so they spend as little time as possible in
Beijing, says Randy Wilber, senior sports physiologist for the
U.S. Olympic Committee.
Most U.K. athletes will stay in Macau, 2,200 kilometers
(1,365 miles) to the south, says Marco Cardinale, a doctor for
the British Olympic Association.
“You don’t want to acclimatize to air pollution, you want
to avoid it as much as possible before you compete,” Wilber
says. “Some of our strategies and equipment are, quite frankly,
Beijing’s air contains the second-highest level of tiny
particles that can trigger asthma attacks, according to a ranking
of 20 Asian cities in the United Nations Environment Program’s
2006 Year Book. Only New Delhi had worse air quality.
In 2005, Beijing’s air contained an average of 145
micrograms of particles per cubic meter, almost three times the
World Health Organization’s recommended maximum, according to the
State Environmental Protection Agency.
Concerns about air pollution also clouded the buildup to the
2004 Athens games, only for the event to go ahead without mishap.
Particulate levels in Maroussi, where many events were held,
breached the WHO standard on 47 days in the Olympic year.
Beijing officials say pollution is manageable. In a trial
run to cut vehicular emissions, the city may take 1 million cars
off the road for two weeks this month. Beijing’s biggest steel
plant will move out of the city before the games, and builders
will be asked to stop work during the event.
“We’ve invested vast sums of money over the past few years
to tackle the issue,” says Deputy Mayor Ji Lin. “Although some
problems still exist, the conditions are improving.”
The city targets 245 “clean-air days” in 2008, compared
with 241 in 2006 and 100 in 1998. Still, the Chinese threshold
for particulate matter is three times higher than WHO guidelines.
Endurance events such as cycling may be postponed if
pollution levels are too high during the games, said
International Olympic Committee President Jacques Rogge, speaking
on Cable News Network on Aug. 7.
“We are going to put the athletes first, we’ll have
contingency plans,” Rogge said.
Endurance athletes such as runners and cyclists are pre-
disposed to asthma because heavy training damages their airways,
says Karen Holzer, an asthma specialist who will travel with the
Seconds From Glory
About 27 percent of U.S. athletes at previous Olympics
suffered from respiratory problems, and the incidence will be
higher in Beijing, Wilber says. In response, all American
competitors will get facemasks and have lung tests to see if they
need asthma drugs.
“It’s all about identifying athletes who are at risk with
asthma and making sure they have strategies in place to minimize
the impact of pollution on their airways,” Holzer says. “Mild
asthma results in a drop in lung function of about 10 percent.”
Such margins may be the difference between winning gold and
sporting oblivion. Just 11 seconds separated the first two places
in the 2004 women’s marathon.
Pollution also threatens athletes’ performance in other
ways. Sinus, throat and nose problems suffered by water polo
players and track and field athletes at last year’s World Junior
Games in Beijing were probably the result of bad air, says Peter
Baquie, Australia’s chief team doctor.
Dahle, the Olympic mountain-biking champion, says she plans
to stay in Beijing for the shortest time possible. She rues the
decision to award the games to Beijing.
“I’ll minimize the amount of time spent in the city and
will stay as much as possible inside the hotel,” Dahle says.
“There would have been many far better alternatives than
Beijing. It goes against all common sense when it comes to doing
–With reporting by Dan Baynes in Sydney, Bob Bensch in New York,
Alex Duff in Madrid, Robin Wigglesworth in Oslo and Sam
Sheringham and James Cone in London. Editor: Pritchard (wsm)