Some Random Thoughts on the Chinese Yuan

A few days after I posted “Should China depreciate Its currency?” (July 25), I was told that the Chinese yuan has slowed its rate of appreciation. It is a pure fluke – and I claim no sixth sense in predicting exchange rates.

It is now more than a month after post, I find it quite fascinating when Kenneth Chow showed me the graphs of Renminbi’s spot and non-deliverable forward (NDF) rates. In recent weeks, there is a noticeable change in both the spot and NDF rates. The spot rate is basically flat and the NDF rates are converging towards the spot rate – that is the market does not expect Renminbi to appreciate further in the near future. (The date of the previous post is indicated by the vertical line.)

Nominal Exchange Rate and Renminbi Non-Deliverable Forward Rates (1 Month, 3 Months and 12 Months) (1 Jan 07 – 16 Sept 08)

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Nominal Exchange Rate and Renminbi Non-Deliverable Forward Rate (1 Month, 3 Month and 12 Month) (1 Jan 03 – 16 Sept 08) image004_512_04.gif

Does it reflect a change in the China’s exchange rate policy? Of course, I solemnly say: “I do not know.”

Then, what do I make out of it?

1.     Guonan Ma and Bob McCauley from BIS told me that the bilateral Renminbi/US$ exchange rate can be misleading and, in fact, the nominal effective Renminbi rate has appreciated quite sharply in recent weekly. They are investigating the factors behind these exchange rate movements.

2.     How do these square with claims that Renminbi is still significantly undervalued? Indeed, I just read an article citing a HSBC currency strategy who said say “The yuan is still 25 per cent undervalued.” Unfortunately I do not have the luxury to learn of the way to get the 25% number.

I was also told that, in the last three years, the Chinese productivity has been growing faster than the RMB has been appreciating – that implies a 20% plus in relative productivity! (At least, some of the people I talked to think that such a productivity growth rate is possible but likely to be implausible – see the exchange-rate-trade-balance graphs in the previous post.

With the asserted productivity growth and the increase in the US imports price of Chinese products, the Chinese exporters should have a windfall. Apparently, the anecdotal evidence suggests most Chinese exporters are feeling the pinch, instead.

3.     Currently, China has to deal with the implications of substantial corrections in both its equity and property markets, the continuous jittering of global financial markets, and signs of slowdown in both external and domestic markets. There is a good reason for the Chinese authorities to undertake some policies to improve the sentiment and to avoid its economy to fall into a recession mode.

Indeed, on September 15, China “surprised” the market with a cut in the commercial lending rate and a cut in the required reserve ratio. On September 18, China “supported” the equity market by directly buying shares of a few Chinese banks (via Central Huijin, an affiliate of China’s sovereign wealth fund) and reducing stamp duty on stock transactions.

Since Renminbi appreciation (so far) has delivered no material reduction in its trade surplus, China may put the appreciation policy on hold and attend to other measures that reduce the possibility of a downturn.

4.     At the risk of repeating myself (too often) – I have to say that I am not denying the possible exchange rate effect on trade balance.

The point is: the exchange rate (especially the bilateral exchange rate) is not a panacea for trade imbalances. Over-emphasizing the role of exchange rates could mis-direct the effort to resolve global imbalances. The recent Chinese experience and the Japanese experience in the last thirty plus years should attest the point. Factors including, but not limited to, saving and investment behaviors on both sides of the trade question should be seriously considered.

In the case of China, indeed, the exchange rate effect on trade balance can be quite hard to establish, see, for example, China’s Current Account and Exchange Rate. Further, the Chinese financial is anything but sophisticated. The appreciation policy essentially invites a one-way bet and draws in huge amount of hot money inflows, which creates a whole array of economic problems and limits the Chinese authorities’ ability to manage its economy.

Pushing China to keep appreciating its currency, without other complementary policies in place, can bring more harms than benefits to the global economy

A digression: I told Kenneth to decrease or, at least, not to increase his exposure to Renminbi – hopefully, he would not blame me too much down the road.

One Response to "Some Random Thoughts on the Chinese Yuan"

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