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| The great Chinese currency shift that wasn't |
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All the excitement about China's small 2.1 percent revaluation of the yuan against the U.S. dollar was sorely misguided - even before anyone noticed the statement by its central bank that there would be no further change for the "foreseeable future." Taken together, the details outlined in the announcement left the future of China's currency as murky as if the peg had remained fixed for an indefinite period. The plan eventually to tie the yuan to a basket of currencies instead of to the dollar raises troubling new possibilities, including even a reversal of any appreciation of the yuan. Decisions about China's currency are political ones, not necessarily driven by the same economic considerations as in democratically governed nations. The overriding goal is to continue to create a massive number of jobs and keep political unrest under control. An explosive surge in exports is the principal force behind China's economic growth and therefore job creation. So there is no reason to expect the political authorities to make any decisions that might soon cap the sharply rising trade surplus. The first point to keep in mind in assessing the 2.1 percent revaluation of the yuan is that there is no reason to expect much change in the dollar cost of Chinese exports. In recent years, much larger declines in the dollar's value relative to other important currencies has had a very limited impact on prices of U.S. imports or trade flows. For example, even after a partial rebound, the dollar's value is down about 40 percent against the euro since February 2002. Yet the U.S. Labor Department's index of prices of European manufactured goods exported to the United States was up only 15 percent as of last month. Over the same period, the yen is up about 18 percent against the dollar, and up about 12 percent after adjustment for Japan's lower inflation rate. And the Labor Department's index for Japanese exports to the United States? Last month it was a 10th of a point higher than in early 2002. As the Federal Reserve chairman, Alan Greenspan, said in February, "Although the dollar has been declining since early 2002, exporters to the United States apparently have held dollar prices relatively steady to preserve their market share, effectively choosing to absorb the decline in the dollar by accepting a reduction in their profit margins." After the revaluation announcement, one analyst predicted that Wal-Mart customers would see prices of goods made in China rise by 2.1 percent. "Surely no one expects Wal-Mart or its suppliers just to absorb the price rise caused by the revaluation of the yuan, do they?" Well, in a world of intense competition, maybe the Chinese suppliers will do just that. Japanese exporters seem to have done it, and European exporters certainly appear to have absorbed a large share of the shift in currency values rather than passing all of it through to their customers. If the dollar cost of Chinese exports doesn't go up, then there is no immediate impact on trade flows or the amount of dollars being accumulated by the Chinese government. And that suggests that another reason for the excitement that followed the revaluation announcement - the possible impact on the purchase of U.S. Treasury securities and therefore on U.S. interest rates - also was misguided. Or take an alternative. Suppose that the dollar cost of Chinese exports went up in line with the revaluation, and further suppose that the price elasticity of demand for such goods was one. In other words, that a 2 percent increase in price caused a 2 percent decline in demand. In that case, the volume of Chinese exports would fall while that country continued to take in the same amount of dollars. Again, there is no reason to expect much change in the Chinese desire to buy Treasuries. Any adjustment in the real world, where existing contracts may have months to run, may take extended time to play out, and the U.S. trade deficit could actually increase in the short run. That would be an example of the well-known "J-curve" effect, in which prices rise more than volumes fall, at least initially. And that could mean an increase in the demand for Treasuries. Another question, of course, is whether the revaluation will make any difference in Chinese demand for U.S. goods and services. If U.S. exporters left their prices unchanged, the cost of American goods in China would dip. Still, imports from China so outstrip U.S. exports that it would take a very large percentage change in exports to offset even a small change in imports. The Chinese announcement that the value of the yuan, which is a denomination of China's currency, the renminbi, may end up managed against a basket of currencies rather than just against the dollar creates brand-new problems. Simon Hayley, an economist at Capital Economics in London, raised the issue Wednesday by asking "what would happen if the dollar continues to strengthen against other currencies and Beijing wanted to keep the trade-weighted value of the renminbi constant? In these circumstances, the renminbi would have to weaken against the dollar, to offset the rise against the euro and the yen. "This reinforces the point that the dollar-renminbi rate is not the one-way bet that many seem to assume. The new regime still gives the Chinese authorities a great deal of discretion," Hayley said. In an interview, Edwin Truman, an economist at the Institute for International Economics, raised another issue about linking the yuan to a basket of currencies. Truman noted that China had a current account surplus last year equal to about 4 percent of its gross domestic product and that it appeared to be headed for a surplus equal to 6 percent or 7 percent this year. Eventually "China's surplus has to go down," and that will require the value of the yuan to rise substantially, Truman said. "If the yuan is in a basket, it is going to appreciate against no one, and it has to appreciate against everyone. "China now has to play a disproportionate role" in reducing the very large imbalances that are a danger to the international financial system, including the huge and rising U.S. current account deficit, he said. At first glance, revaluation of the yuan looked like a step in that direction. A close look at the details indicates that may or may not be the case. Certainly there's no sign the Chinese are even thinking in terms of the sort of adjustment Truman believes ultimately will be needed. Then again, not many others are thinking in those terms either, certainly not the politicians in the United States or Europe. Source: www.iht.com July 28, 05 |
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