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Evaluating the renminbi manipulation
By Martin Wolf
Published: April 6 2010 22:21 | Last updated: April 6 2010 22:21
The incumbent superpower has blinked in its confrontation with the rising one: the US Treasury has decided to postpone a report due by April 15 on whether China is an exchange-rate manipulator. Since a programme of multilateral and bilateral consultations is under way, it was right to give these discussions a chance before taking any action.
Is China a currency manipulator? Yes. China has intervened on a gigantic scale to keep its exchange rate down. Between January 2000 and the end of last year, China’s foreign currency reserves rose by $2,240bn; after July 2008, when the renminbi’s gradual appreciation against the dollar – begun three years earlier – halted, reserves rose by $600bn (see chart); and reserves are now close to 50 per cent of gross domestic product. Finally, a massive effort has been aimed at curbing the inflationary effects of intervention.
Thus, China has controlled the appreciation of both nominal and real exchange rates. This surely is currency manipulation. It is also protectionist, being equivalent to a uniform tariff and export subsidy. Premier Wen Jiabao has protested against “depreciating one’s own currency, and attempting to pressure others to appreciate, for the purpose of increasing exports. In my view, that is protectionism”. The Chinese pot is calling the US kettle black.
Yet some economists deny this, offering four counter-arguments: first, while the intervention is huge, the distortion is small; second, the impact on the global balance of payments is modest; third, global “imbalances” do not matter; and, finally, the problem, albeit real, is being resolved. Let us consider each of these points in turn.
On the first, estimates of the extent of undervaluation vary hugely: some even argue the renminbi is overvalued. This is partly the result of contrasting methodologies – fundamental equilibrium exchange rates against purchasing power parity – and partly of different assumptions about the right starting point. If, for example, Chinese people were free to export their savings, the capital outflow might be even bigger than today’s intervention. But if the world were free to buy Chinese assets, the capital inflow would explode, too. Who would not want a bit of the world’s most dynamic economy?
Plausibly, the undervaluation is considerable, possibly as much as the “25 per cent on a trade-weighted basis and ... 40 per cent against the dollar” suggested by Fred Bergsten of the Peterson Institute for International Economics. The JPMorgan estimate of a trade- weighted real exchange rate is only 10 per cent above its average level since the beginning of 1994, even though China has been the world’s fastest-growing economy over this period. It has also depreciated by 8 per cent since October 2008. This is surely peculiar.
On the second point, Stephen Roach of Morgan Stanley has argued that differences in savings behaviour determine current account balances and the Chinese surplus cannot determine the US overall deficit.
I find neither argument persuasive. If the Chinese currency influences the dollar exchange rates of China’s competitors, as it surely does, it will definitely affect multilateral balances. Furthermore, one of the points I made in my (recently updated) book, Fixing Global Finance, is that real exchange rates also determine savings rates, not just the other way round. This is because governments care about GDP. The undervalued Chinese real exchange rate generated a contribution of net exports of 5.6 per cent of GDP between 2006 and 2008. The Chinese authorities had no reason to try to lower the surplus of savings at that time: it went into net exports. But when net exports plunged in 2009, knocking 3.9 points off GDP, the Chinese authorities acted to lower the savings surplus, by expanding domestic credit and promoting investment (see charts).
Mr Roach also points to today’s negligible net US savings. But this, too, is the result of a fiscal offset to a surge in private sector savings surpluses. Why was this needed? The answer is that, with a huge structural current account deficit, a rise in private savings in the US would otherwise have created a depression. In sum, savings surpluses are a policy variable, not a given.
On the third point, yes, imbalances do matter. This was partly because of the form they took. As Anton Brender and Florence Pisani argue in a brilliant study for the Centre for European Policy Studies, the salient characteristic of the capital outflow from emerging economies was that it came in the form of reserves – an overall increase of close to $6,000bn in the noughties.* This led to huge increases in demand for liquid and safe assets. Our cunning financial sector fabricated such assets wholesale, from those “subprime” ingredients, with results we now see.
Imbalances also matter because they will have a big impact on the recovery. As Mark Carney, governor of the Bank of Canada, pointed out in a recent speech, should imbalances persist, two outcomes are conceivable: either countries with big external deficits continue with their huge fiscal deficits, until “global interest rates begin to rise, crowding out private investment and ultimately lowering potential growth”; or the deficit countries start to reduce the fiscal deficits sharply, without any offsetting changes in surplus countries, in which case there is “deficient demand globally”.
On the fourth point, Jim O’Neill, chief economist of Goldman Sachs, argues that the Chinese surplus is ceasing to be a significant factor. It is true that it has halved, as a share of GDP, since 2007. The question is whether this shift is structural or the result of exceptional and temporary measures. The World Bank still expects China’s current account to stabilise at high levels, with net exports about to make a positive contribution to growth. The world’s fastest-growing economy would be exporting unemployment. Mr O’Neill is ahead of himself.
I conclude that the renminbi is undervalued, that this is dangerous for the durability of global recovery and that China’s actions have not, so far, provided a durable solution. I conclude, too, that rebalancing is a necessary condition for sustainable recovery, changes in competitiveness are a necessary condition for rebalancing, real renminbi appreciation is necessary for changes in competitiveness, and a rise in the currency is necessary for real appreciation, given the Chinese desire to curb inflation.
The US was right to give talking a chance. But talk must lead to action.
