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CCTV-9: Renminbi Appreciation

March 25, 2010

I was back on CCTV-9’s “Dialogue” Tuesday night, talking this time about the hot topic of the moment: rising US threats to punish China if it does not take action to strengthen its currency, the Renminbi, against the dollar.  A new bill has been introduced in the US Senate to do just that, and the Treasury Department has until April 15 to decide whether to label China a “currency manipulator” — a designation that could result in heavy tariffs being imposed across the board on Chinese goods entering the US.  You can view the entire show here, or by clicking on the image below.

As you can probably tell from my comments, I’m somewhat torn on this issue.  On the one hand, I think the US is putting way too much emphasis on the exchange rate as a “silver bullet” to solve its trade imbalance with China.  I fear that without more substantive reforms, we’ll see a repeat of efforts to strengthen the Japanese yen in the 1980s — a policy that proved a lose-lose proposition for both sides.  I’ve made this argument many times before, and those who want the full (or at least fuller) version can read it here.

On the other hand, there’s a tendency in China to cling to the Japan example as proof that the Renminbi is fine, and China doesn’t need to do anything.  In fact, Japan’s troubles — its stock and real estate bubbles, followed by a “lost decade” of minimal growth — were due only in part to the appreciation of the Yen.  More importantly, these were the result of how Japan chose to cope with a stronger Yen by refusing to make necessary adjustments in its economy.  In fact, my point is that while China needs to move towards a more flexible exchange rate, it needs to a lot more than that.  If it does — and the US helps — a sensible currency adjustment could be part of a comprehensive strategy that sets both countries on a new, more sustainable growth path.

Even though, from China’s point of view, US pressure is unwelcome, and even though it may in many ways be misguided, it may have benefits.  In one recent conversation, a Chinese economist remarked to me that the US is arrogant to think that it knows China’s interests better than China does.  But China’s interests are not that simple.  China has a long-term interest in switching from an export-driven growth model to one driven by domestic demand, and a more flexible exchange rate (and a stronger Renminbi) is part of that.  But it has a short-term interest in shielding its exporters (and their employees) from the consequences of a stronger currency.  For any country, that would pose a challenge (US politics is repleat with such conflicts).  To the extent that US threats provide a counter to China’s short-term interest in standing pat, and shift the political balance towards China embracing its longer-term interests, it’s not necessarily a bad thing.

The problem is, it needs part of a broader strategy that leads to a win-win, and not the kind of lose-lose outcome that happened when the US and Japan focused exclusively on currency and ignored the nature of the markets in which those currencies operated.

10 Comments leave one →
  1. jay permalink
    March 25, 2010 9:17 pm

    “More importantly, these were the result of how Japan chose to cope with a stronger Yen by refusing to make necessary adjustments in its economy.”

    What adjustments are you talking about?

    Also, how do you explain that goods (branded) are much more expensive in China than in US if RMB is undervalued. Is PPP valid in any sense?

    If the Chinese exporters are having a 2% margin, why is it an interest of China to revalue RMB? If there is no short term, will there be a long term?

    I see a lose(China)-win(US) game if China choose to revalue, yes, there will be a short term pain for US too, but it basically gets rid of a lot of debt and also will shift the jobs back home. I can’t see it as a lose game for US. On the other hand, the structural problem for China is much much more difficult to address, revaluation will only hurt China in the short term and also in long term because no easy reform available to address the structural problem.

    • prchovanec permalink*
      March 25, 2010 10:34 pm

      The rise in the Yen meant (of course) that Japanese goods became more expensive in dollar terms, and US goods became less expensive in Yen terms. That could have resulted in a reduction of Japan’s trade surplus with the US. What happened instead was that Japan was deeply entrenched into an export-driven growth model, and certain structural aspects (besides a cheap Yen) that supported this orientation, combined with certain Japanese policy choices in response to a stronger Yen, mitigated or counter-acted the impact of the shift in prices. People argue about which factors were more important, but they generally include:

      * non-tariff barriers preventing imports from effectively competing in Japan, regardless of price, such as a notoriously impenetrable distribution system
      * the system of corporate crossholdings of shares, which tended to push companies to value retaining market share, even at a loss, over profitability
      * soft budget constraints on companies due to cozy long-term alliances with suppliers, customers, and banks
      * a flood of cheap credit to keep Japanese exporters in business and expanding (to lower per unit costs), in direct response to a stronger Yen, which helped fuel a massive bubble in stocks and real estate

      Essentially, these factors short-circuited the effect that the new exchange rate might be expected to have on the balance of trade.

      To answer your second question, the proof that the RMB is undervalued is the virtually limitless accumulation of foreign currency reserves by the Chinese government. It suggests that, at least under current conditions, there is a glut of dollars (and other currencies) entering China, for which there is insufficient demand (to use in buying imports or investing abroad). Normally when there is a glut of something, when supply exceeds demand, the price of that good drops until it reaches a market-clearing price. The same should be true of currencies. The dollar should drop in value (relative to the RMB) until it becomes attractive enough to generate sufficient demand. But the government is stepping in and buying dollars at the peg, preventing the price from dropping. I say “under current conditions” because if China were to open the capital account, for instance, and allow Chinese companies and citizens to invest abroad without restriction, the demand for dollars might rise somewhat, reducing the gap between supply and demand. Whether that would eliminate the gap entirely, or whether the RMB would remain somewhat undervalued based on the current account imbalance, is anyone’s guess.

      As to long-term vs. short-term benefits, let me just raise this point. When China exports to the US, what does it get in return? Well, the exporters themselves get RMB at the fixed rate, so they’re reasonably happy, but China’s economy as a whole gets a pile of IOUs (in the form of dollars) far in excess of what it wants or needs — and which adds nothing to China’s standard of living. Essentially, the Chinese work for free, and sell stuff to Americans in return for a promise, all for the sake of keeping their jobs. Now, of course, China is getting nervous about the value of all those IOUs they are left holding, which are valued in a currency the debtor actually controls. But if China doubts the true value of the dollars it’s earning, it has a easy solution: demand more dollars for what it produces. But that implies an appreciation of the RMB! It’s a catch-22. Chinese exporters look like they’re winning, but only because the cost of selling for dollars nobody wants is being assumed by the Chinese people as a whole. So really, it’s in China’s long-term interest to shift away from this situation towards a more sustainable growth model.

      For 30 years, China has had a mindset that says “exports good, imports bad; capital inflows good, capital outflows bad.” That made sense 30 years ago, when foreign exchange was incredibly scarce. But today, China is drowning in foreign exchange. Today, exports aren’t so great, and more imports would mean the Chinese get more of the benefits of what they produce. Capital inflows are okay, if they go into productive investments, but China is awash in capital that is bottled up and ends up channeled into inflated stocks and real estate, instead of going abroad to seek better returns. Much like Japan, China has succeeded in using exports to develop its economy, but has reached a stage where it has outgrown that strategy. When Japan reached this critical point, it refused to adapt. China cannot afford NOT to adapt.

    • March 28, 2010 1:35 pm


      > Also, how do you explain that goods (branded) are much more expensive in China than in US if RMB is undervalued. Is PPP valid in any sense?

      Branded goods are very expensive in China due to the inefficient distribution system and import costs.

      Factories get tax rebates for exports, so everything the factory produces needs to be exported. Once it lands at a given brand’s distribution center (such as the Apple, Inc Asia distribution center in Singapore) a portion of the products are forwarded back to China for distribution.

      Once it lands in China, VAT is added (17%) and depending on the class of product, there are frequently import tariffs attached too. Additionally, in China everyone’s a reseller, so there are inevitably a few more points in the middle added for commissions.

      Compare this to buying something Made in China from a Wall Mart in Oregon (no VAT, no import tariff, no sales tax, no middle men)…

  2. jay permalink
    March 26, 2010 12:22 am

    Thanks for your response, Professor.
    Actually, I was not arguing against that China needs to increase domestic demand and cut its trade imbalance. What I was arguing is exchange rate is not the right tool to do the job because it is not beneficial to the Chinese people at all (short pain and then long pain). As a matter of fact, I agree with Steven Roach that China’s currency is not undervalued. So, what is a better tool for China? I’d say implementing policy to better distribute wealth. China as a whole accumulated a lot of wealth over the years, but unfortunately those wealth belongs to a relatively small portion of the Chinese people. One of the reasons why China’s domestic consumption is so small is because rich people don’t have the appetite to consume and majority of people simply don’t have money to consume. China needs to direct its government resources to help the majority poor people to the point where they have some resources to consume. In that process, of course, wages will need to go up. Once wages go up and domestic consumption is up, trade surplus will come down, it’s a natural process.
    On the other hand, if you do it through exchange rate, what is good for China? Exporters will suffer, jobs will be lost, poor migrants will become less capable of consuming, small enterpreneurs will suffer, the whole country is likely to collapse with the help of the bursting of the real estate bubble. In that scenario, I see a quick devaluation of RMB after a revaluation.
    I just don’t see the logic to revaluate RMB if I’m a Chinese (and I’m a Chinese living in US). Increasing domestic consumption and RMB revaluation are 2 completely different things, revaluation of RMB will not lead to increased domestic consumption, on the contrary, it will decrease as far as I can see. If Paul Krugman is a Chinese, he will oppose a RMB revaluation I’m sure, he is a politician.

  3. Greg Ludvigsen permalink
    March 26, 2010 4:11 am

    Won’t appreciating the RMB simply encourage US importers like WalMart to move to another low cost country to manufacture these products like India, Mexico, etc rather than buy expensive US products.

    The problem in the western economies is that their cost of labour and production is way too high in relation to all third world countries, not simply a problem with China.

    All we will do is exchange one creditor for another.

    The US, and my country Australia, will not engage the real problem that we will lose all production (including agriculture) unless we lower costs of production. Removal of penalty rates would be a good start.

  4. jay permalink
    March 26, 2010 9:54 pm

    By the way, the Chinese government is just trying to make efforts to re-distribute wealth more fairly, I believe that is the right direction and major step toward a better Chinese society, and a better world.
    US doesn’t have a Chinese currency problem, US has a savings problem (live on other people’s money for ever, seems like). China doesn’t have a currency problem either, China has a wealth distribution problem, a social justice problem. When these two problems are solved, we won’t hear rantings from folks like Paul Krugman anymore. Krugman has been proven wrong on Japan (see Richard Koo’s book) and he will be proven wrong again on China. So much for the economics profession, I’ll stick with my science and technology field which at least does some real good things. And I also disdain those trained economists, once they stick to one school of thoughts, they will never be able to think outside of the box, that’s why serious good economists are so rare. Untrained eyes like me predicted the US housing collapse just by using common sense, how many economists did that?

  5. February 17, 2012 9:51 pm

    Hi professor,
    I’m just curious, if the Renminbi eventually becomes a reserve currency, how will all that money get out when the country is still running large current and capital account surpluses? Does that mean they will eventually have to reach a deficit at some point?


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