China’s Currency and Trade

Currency traders around the globe lazily staring into their screens must have found themselves transfixed last Friday when the flatline indicating the value of the Chinese yuan (or renminbi if you prefer) suddenly jumped to life. And so it was that during a brief 20 minute interval the yuan surged to a level of 8.270 to the dollar from the hypnotic and seemingly eternal value of 8.276. Now 6 thousandths of a dollar isn’t really a very big deal, but it is the sheer fact that it happened that is causing all the fuss.

The official explanation offered was that there had been ‘technical problems’ (which were interpreted that some state minion somewhere or other accidentally pushed the wrong button: not altogether impossible), but the fact that this ‘blip’ occured on the same day that a state-run newspaper – The China Securities Journal – ran an front page article that seemed to depart from previous government statements has been widely interpred as meaning that the ‘blip’ was more than a blip.

The article asserted that China had completed all the technical preparations necessary to remove the US dollar peg and allow greater flexibility in currency movements (presumeably these are not the same technical preparations that allowed the wrong button to be pushed 🙂 ). This article if taken in conjunction with recent statements from Zhou Xiaochuan, China’s central bank governor, who suggested last week that China might accelerate its timetable for a more flexible rate in response to growing international pressure, *might* indicate that some move was in the offing. Certainly Asian currency markets have interpreted things this way: the ‘glitch’ has been viewed as a dry run for a forthcoming ‘float’. Again it is interesting to note that – according to the Financial Times – currency traders could not say whether the State Administration for Foreign Exchange, the government agency that handles currency trades, conducted any business at the higher rate. This is important since one of the things the ‘experiment’ might have been intended to test – if experiment it was – would be the sensitivity of the market price to currency intervention from the above named body.

At this point it is impossible to say when China will move to make its currency more flexible, but it does seem probable that the day will not be too long in coming. The really important and interesting question is what consequences this change will have.

This question needs examining since in my view too many people are placing an exaggerated emphasis on this change as a solution to some of the major ‘ills’ which the global economy is currency facing. In particular this issue has often been raised in the context of the US current account deficit, and more recently in the context of what is being increasingly perceived as the EU ‘textiles crisis’.

In order to get things in perspective it is important to keep in mind three basic and obvious facts: China is huge, China is poor, and China is currently undergoing a process of rapid economic development.

The first of these facts is fundamental. It is this that makes all the difference between what is happening in China (and of course also India) today, and what happened in the so-called ‘Asian Tigers’ (S. Korea, Singapore, Taiwan, Hong Kong) twenty years ago. China is so big that any change in China is inevitably going to cause a major backwash in the global economy. This is all too evident in the case of the current surge in oil and other raw material prices. Even a small change in China can have a significant global impact.

So I think it is important first to situate what is happening in the context of a more general phenomenon of what are called ‘global imbalances’. Since these imbalances have been accumulating over decades now, it is clear that any rapid unwinding is not going to be an easy matter.

Now for the currency question. It is hard to foresee how far the Chinese currency will float up when the change happens. As I indicated in the introduction, any float is likely to be a controlled float. What does this mean? Well it is highly likely that the above-mentioned State Administration for Foreign Exchange will intervene in the currency markets to control the rate of increase. Not only is this likely, it is also desireable. As is often repeated China is still not a market economy. It is making important steps in the direction of becoming one, but there is still a long, long way to go.

In terms of the non-market characteristics of the Chinese financial system Bloomberg’s Andy Mukherjee had an interesting recent article: Greenspan Misses the Point About the Yuan which is well worth reading as background.

In particular I think it is important to stress the evolutionary approach to China’s financial arrangements since the consequence of introducing change too rapidly would be to destabilse China and (given the point about China being huge) through China destabilise other parts of the global economy. I repeat the global imbalances are important and they cannot be resolved at the stroke of a pen. One of the consequences of these global imbalances at the present time is that growth in the global economy is unduly dependent on growth in China, so we need to remember this.

Now going back to any revaluation, in the short term China’s currency might rise say 5%. What would be the consequence of this? Well I think in the end price of Chinese products here in Europe or in the US the effect would be negligable. You only need to look at the origin costs of manufactured products in China, and the end price in our shops to see that there are huge mark-ups along the line. A small rise in the currency could be easily absorbed imho. If you look at the fact that the euro has risen something like 45% in the last two to three years, while export prices (in dollars) for German manufactures have risen to nothing like this extent then you can begin to get some idea of what will in all probability happen.

We could also remember that the arguments used by the ‘anti-China’ lobby have gone through three phases so far. In the first place it was suggested that China’s growth figures were not real. Then the argument moved on, and China was suggested to be riddled with financial black holes. Now the problem is perceived to be an undervalued currency. The interesting thing is that all of these points are in some measure true: we cannot place the same confidence on official figures in China as we do on, say, the US government figures, the Chinese banking sector *does* have a significant problem with non-performing loans, and yes, China’s currency is undoubtedly undervalued. The key question is to encourage China to put in place measures to resolve these issues over time, and also to bear in mind that progress on none of these issues is going to have an immediate and dramatic impact on our trading relations with China in the here and now.

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About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".

3 thoughts on “China’s Currency and Trade

  1. Great to see you back here Edward!
    Last months my visits of Afoe declined, so only now I spot your fine contributions.
    As to China’s currency and trade: during your absence 😉 I turned to other blogs for help from time to time: Brad Setsers blog, Brad deLong, Golden Age (of Paul Anderson), Angry Bear, Different Opinion (of Mats Lind), and recently Economists’ view.
    From their observations and some other observations on the USA more and more I get the idea that the threat of imbalance is to be found there.
    What I mean is that China-bashing is mostly wrong when it comes to protectionism etc but on the other hadn the question of how the US will be doing economically, -and so the world-, next few years depends on China’s policies to an extend that is a little frightening.
    As Angry Bear puts it “Month by month, the non-service portion of the US economy has slowly been evolving from a goods-producing economy into a house-producing ecoomy…”
    This combined with the skyrocketing of mortgages in the US, the giant (account)deficit and the 600 billion USD China’s central bank bought…
    Looks like I am implying that hope the Chinese *dictatorship* shows more responsibility (for growth and stability of the world economy; I am less sure about the sustainability) than the *democratic* US administration.
    Hm, maybe I should.

  2. “Great to see………”

    Great to be back Frans, thanks.

    “Month by month, the non-service portion of the US economy has slowly been evolving from a goods-producing economy into a house-producing ecoomy…”

    The same is true of Spain. Something like a staggering 40% of all new homes in euroland were built in Spain last year. But maybe the goods producing to construction analogy isn’t the best one. The real issue is that with ‘non-normalised’ (and often negative) interest rates money has moved after the stock market demise into property. This is a complex question, and I’ll have a better bash at it next week.

    “I am implying that hope the Chinese *dictatorship* shows more responsibility”

    This could prove a vain hope. What they will attempt to do is avoid their own economy crashing, and since they have bags of growth potential they should be able to underwrite a lot of things. Sure global growth is going to depend a lot on China (and India) there is just no getting away from this since they are – as I said – huge. Three years ago I subtitled my China blog page: the third industrial revolution. I stick by that. I think it’s going to be that big.

    “the threat of imbalance is to be found there.”

    Imbalances are a complex question, and, as you say on your blog, there is never *one* answer to complex questions. Looks like a post is called for on this :).

    On China in general I would follow Andy Mukherjee at Bloomberg (as linked) and above all Andy Xie at Morgan Stanley GEF. The latest instalment can be found here.

    http://www.morganstanley.com/GEFdata/digests/20050502-mon.html

    BTW I am slowly cranking up BonoboLand again (http://bonoboathome.blogspot.com/), and will obviously spend more time on these technical issues over there. Afoe is European in focus, and I will try to keep my posting in that vein.

    BTW II: the FT are reporting that “Speculators have been active buyers of non-deliverable forward (NDF) contracts in the renminbi in recent weeks as speculation of a widening of the currency?s trading band has mounted.”

    The interesting thing is that the discount on one-year NDFs has been steady at 4,750 points, which suggests a coming revaluation of 5.7 per cent. All of which makes my best guess 5% not looking bad at all :).

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