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[Excerpt] This report provides an overview of the economic issues surrounding the current debate over China's currency policy. It identifies the economic costs.
Table of contents

Controlling the move is the hard part, especially at a time when Chinese interest rates are close to U. If the yuan is expected to depreciate tomorrow, or next month, or next year, it basically makes sense to hold dollars rather than yuan until the move is over. That is why managed depreciations tend to burn through reserves.

Historical USD to RMB Exchange Rate

China has firsthand experience here—as it lost about a trillion dollars of reserves managing its depreciation in and Even though some of the channels for outflows have subsequently been closed off and the level of domestic foreign currency debt has fallen, China faces a similar risk if expectations that the yuan is now a one way bet down are allowed to build. The controls of course play a role. The entire monetary base cannot pick up and leave. And China still has a lot more external assets than anyone else, and far more external assets than external debt. The following graph sums of the reserves and the core assets of the state banks, compared to the banks' core debt and foreign holdings of Chinese bonds.

Exports to the U. So if the short-run elasticity of trade to the tariffs is 1 and the exchange rate elasticity is also 1, a 2 to 2.

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Nonetheless trying to pull off a controlled depreciation is a risk. A weaker currency could be the first step toward some mix of a bigger Chinese surplus and an even larger retreat from the existing trade rules, as other parties around the world try to protect themselves from the combination of U. It would also put additional pressure on those emerging economies that are struggling to cope with higher U.

Nonetheless I increasingly expect that China will test just how far it can let the currency move without triggering a broad market and political reaction.

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Creative Commons. Endnotes 2 See all Endnotes. Fiscal policy is the fiscal stance of the central government and the local governments. In fact they moved in the wrong direction after — making Chinese products more, not less, competitive. As with Japan after the Plaza Accord, policies aimed at unwinding the employment effect of currency appreciation more than compensated for the appreciation. In other words, the exchange rate appreciation after may very well have caused a relative improvement in the trade balance between the two countries, but the widening differential between wages and productivity and, more importantly, the reduction in real interest rates and the forced expansion of credit would have had the opposite effect.

There is a big difference between saying that the RMB exchange rate is not the only thing that matters to the U. The former statement is almost certainly true, while the latter statement violates common sense and nearly all historic precedent. He says that because there is little overlap between what China produces and exports and what the U.

It can only matter if when China sells one fewer widget to the U. This is only partly true. In fact trade almost never settles bilaterally. It settles multilaterally. So even if Wu is right in saying that a revaluation of the renminbi would directly reduce Chinese exports to the U. But aside from the fact that this is not such a terrible outcome for Mexico, it will still affect U.

After all if Mexico suddenly increases its exports to the U. It is hard to imagine that a massive surge in Mexican exports would be perfectly matched, dollar for dollar, by a surge in Mexican savings, and no increase in Mexican investment. Both of these would cause imports to rise.

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This means that Mexican imports would rise, perhaps by the same amount as Mexican exports. I would argue that in fact there is a very different reason why the U. What would happen if the U.


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The good news for China is that raising the RMB shifts income from the tradable goods sector to households, and so lowers the trade surplus. The bad news is that if this happens too quickly, and results in an increase in domestic unemployment, as export companies experience financial distress or move abroad, gross household income might actually decline.

The rebalancing would still take place, but it would take place very painfully. So how would China respond? Almost certainly by stepping up investment and lowering real rates. This effectively shifts wealth from households to borrowers, and allows the capital-intensive sector to take up the slack created by the contracting tradable goods sector and of course there is a lot of overlap between the two. So would the world be better off?

Not only will there have been no Chinese trade rebalancing, but there would have been a shift in the composition of Chinese trade that would more directly harm the U. This is because all Chinese exporters would suffer, but at the same time, all Chinese capital-intensive industries would benefit. The net result would be a shift in Chinese exports away from labor-intensive exports shoes, lighters, toys, etc.

In other words Chinese exports will become more directly competitive with U. So of course the level of the RMB matters, and of course the U. China has no need to revalue the yuan for trade reasons, as export growth will slow to a 10 percent this year and its surplus is set to contract by , its trade chief said. Chen dismissed calls for China to strengthen the yuan to tackle the trade surplus, and called instead on countries with reserve currencies — a reference to the United States — to prevent their currencies from weakening. Chen Deming, as Minister of Commerce, has always opposed RMB revaluation, so there is no need to read too much into these statements.

It may have far more to do with very anemic demand growth in the rich countries. I am not sure I agree with the first part of his statement. In the first one, it says:.

However, tensions have surfaced after China last year also emerged as one of the biggest sources of cheap imports into Brazil, helped by a surge in the value of the real, which is undermining the competitiveness of domestic industry. My friends in Brazil tell me that the anger arises from the perception that with all the difficulty Brazil has had in preventing its currency from revaluing excessively, the surge in Chinese investment has made the process all the more difficult.

More Chinese investment requires more central bank intervention, and so more monetary expansion. This hurts partly because of inflationary pressure and partly because a rising real reduces the value to Brazil of its commodity exports and makes it more difficult for Brazilian manufacturers to survive. And that difficulty is the topic of the second Financial Times article:.

But a growing flood of cheap Chinese manufactured goods into Brazil is testing the relationship. I am often asked about the shifting balance of global power relations, away from the traditional West and towards the BRICs.

China’s Currency Is Back in Play

I am skeptical. BRICs are a great marketing concept with which to sell emerging market paper, but the idea that they have the same global interests requires that you squint ferociously when you look at them. Four countries with more diverse and even opposed global interests, economic as well as political and geopolitical, it would be hard to find than Brazil, Russia, India and China.

Former Economic Council director Larry Summers on China's currency and trade

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Chinese Currency Manipulation: Are There Any Solutions? |

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