Transcript Exchange Rates, Wages, and International Adjustment: Japan

The Global Credit Crisis and
China’s Exchange Rate
Ronald McKinnon
Brian Lee
Yi David Wang
Stanford University
Singapore Economic Review Conference
August 6-8, 2009
Advantages of Stabilizing Yuan/Dollar Rate
A Potted History
•
1995 to 2004 fixed rate nominal anchor: 8.28 Y/$
[McKinnon & Schnabl, Jan 2009]
•
•
•
July 2005 to July 2008, one-way bet on RMB
appreciation: hot money inflows, buildup of official
exchange reserves, loss of monetary control,
disrupt forward exchange market [Wang 2009]
July 2008 to Nov. 2008, unwinding of dollar carry
trade with sharp apprec.of $ effective ex rate, (Lee
2009), Y/$ rate reset at 6.83 through to present
2009, monetary control regained with a massive
expansion of bank credit to support fiscal stimulus
for offsetting sharp fall in exports
Figure 1: China’s monetary policy and the
yuan/dollar rate
(1995-2009)
Yuan/Dollar
9.00
8.28
8.50
8.00
7.50
Fixed exchange rate anchor:
monetary stability
6.83
7.00
One-way bet on yuan appreciation:
loss of monetary control, inflation
6.50
"Accidental" stabilization:
regain monetary control
6.00
5.50
5.00
95/Jun 96/Jun
Source: FRB
04/Jun 05/Jun 06/Jun 07/Jun 08/Jun 09/Jun
Figure 2: Foreign Reserves of China, Japan, Germany, and U.S.
(2002-2009)
10,000
billion dollars (log scale)
China
Japan
Germany
United States
1.95 Tr
1,000
100
10
2002
2003
2004
2005
2006
2007
2008
2009
/Q1
Source: IMF and The People’s Bank of China
Figure 6: Bilateral Trade Balances of Japan and
China versus the United States
(percent of U.S. GDP, 1955 – 2008/1)
3.0
Japan
Bashing
Japan
China
Japan+China
2.5
China
Bashing
2.0
1.5
1.0
0.5
0.0
1955
1960
1965
1970
-0.5
Source: Kenichi Ohno, BEA
1975
1980
1985
1990
1995
2000
2005
2008/Q1
U.S Mercantile Pressure, I.
•
Acute Japan Bashing, 1978 to 1995
- Episodic trade disputes steel, autos, color
televisions, machine tools, semi conductors
- Resolution: Japan imposes “voluntary” export
restraints and allows yen appreciation
-Yen/dollar rate appreciates episodically from 360
in August 1971 to peak at 80 in April 1995, when
U.S. announced a strong dollar policy
•
Japan financial system destabilized: bubble economy
1987-90 followed by a deflationary slump and low
interest liquidity trap in 1990s (McKinnon-Ohno,1997)
U.S. Mercantile Pressure, II.
• China Bashing: 2000 to ?
-China surpasses Japan in 2000 as having the biggest
bilateral trade surplus with the U.S
-Unlike Japan, export surge is “across the board” in low
value added manufactures.
• Focus is primarily on appreciating the Renminbi:
-Schumer-Graham bill of March 2005 for a 27.5% tariff on
U.S. imports from China unless RMB appreciates
(withdrawn October 2006, but new threat in 2007)
-Section 3004 of U.S. Public Law 100-418: U.S. Secretary of
Treasury must report twice a year on whether countries with
trade surpluses are “manipulating” their currencies. Timothy
Geitner’s congressional testimony January 2009
• RMB rises by 2.1% on July 21 2005, and begins slow upward
crawl
One way bet: RMB appreciation
July 2005 to July 2008
•
•
•
•
•
•
Hot money flows into China
No private capital outflows to finance
China’s huge trade surplus (McK & Sch 2009)
Huge buildup of official exchange reserves:
government sole international intermediary
Massive sterilization: sale of central bank bonds,
increases in reserve requirements of com banks
Direct restraints on domestic bank credit
Still loss of monetary control with domestic
inflationary pressure added to foreign
China’s Foreign Exchange Reserves
Source: UBS
Figure 3: China’s Consumer Price Indices
(Growth rate: % yoy)
10
8
6
4
2
0
2002
2003
-2
-4
Source: EIU
2004
2005
2006
2007
2008
2009
Figure 4: Renminbi and Dollar Exchange Rate
Movements
(2000-2008)
120
Unwinding of Carry Trades
115
110
105
100
July2008
95
90
85
2000
2002
2004
2006
Nominal Rate Dollar Yuan
Effective Rate of the Renminbi
Effective Rate of the U.S. dollar
Source: IFS and BIS
2008
Figure 5: Commodity Price Indices
(Jan 2002 =100)
750
700
650
600
550
The Economist Commodity-Price
Index
West Texas Intermediate
500
450
400
350
300
250
200
150
100
50
2002
2003
2004
2005
Source: globalfinancialdata.com
2006
2007
2008
2009/05
Figure 8: Unwinding the yen and dollar carry trades (effective
exchange rates, 2006=100)
130
120
110
July 2008
100
90
2000
2002
2004
United States
Japan
Source: BIS
2006
2008
Table 1: Returns on carry trades
(2000-2007)
Funding
Currency
Interest rates
Funding
Investment
Returns from
Returns of
Appreciation
Carry trades
US Dollar
3.4
10.2
a
1.1
a
Japanese Yen
0.1
5.3
b
5.2
b
Unwinding in 2008:
c
Trough to Peak Appreciations
a
7.9
19%
10.7
b
Source: Brian Lee (2009)
Note: (a) For funding in dollars, the return is the average for Brazil,
Mexico, and Canada.
(b) For funding in yen, the return is the average for Australia,
Korea, and New Zealand.
(c) Trough to peak for the yen’s effective multilateral exchange
rate.
Caution: The unwinding of the carry trades in 2008 may not fully
explain these exchange rate appreciations.
44%
Dollar carry trade unwinds and “accidental”
stabilization of the RMB since July 2008
• Credit crunch summer and fall of 2008 dries up short-term
•
•
•
•
•
finance for dollar, yen, and commodity carry trades
Surprise dollar appreciation, July to Nov 2008, of approx
20% against all currencies except the Japanese yen
with a general fall in commodity prices.
PBC stops gradual (and predictable) appreciation of RMB,
and stabilizes at 6.83 yuan/dollar.
Hot money inflows stop, some private outflows, minimal
increases in official exchange reserves. PBC regains
monetary control
Massive domestic credit expansion: cuts in reserves required
of commercial banks while lifting credit ceilings,
reductions in deposit and loan interest rates
Domestic spending largely offsets collapse in exports
Figure 9: China’s Nominal Trade
(in billions of U.S. dollar, monthly)
160
Exports
140
Imports
120
100
80
60
40
20
2005
2006
2007
2008
Source: China Customs Statistics Information
2009 /04
Figure 10: China’s interest rates
(%)
Source: UBS
Figure 11: China’s New loans to non-financial
institutions
(RMB bn)
Source: UBS
Figure 12: China’s M2 and Bank Lending
(Growth rate: % yoy)
Source: UBS
Loans for 15 large U.S. banks
Comerica
Marshall & Ilsley
Wells Fargo
Fifth Third
SunTrust
Regions
Citigroup
Bank of America
US Bancorp
PNC
BB&T
KeyCorp
J.P. Morgan Chase
Amercian Express
Capital One
2Q 2009 in billions
46.60
48.60
821.60
81.40
122.80
96.20
641.70
942.20
182.30
165.00
100.30
70.80
680.60
62.90
146.30
Change from 1Q
-4.1%
-1.8%
-2.6%
-1.5%
-0.9%
0.5%
-2.4%
-3.6%
-1.1%
-3.7%
0.1%
-3.9%
-3.9%
-3.2%
-2.7%
4,209.30
-2.80%
Total for 15 banks
Source: Wall Street Journal
M2 growth around the world
Source: SCB
Violation of interest parity conditions and
breakdown of China’s forward market
mid 2007 to mid 2008
• Open Interest Parity (OIP): E(∆S) = it(yuan) –
it(dollars) , where S = yuan/dollar
• Covered Interest Parity (CIP): ft = it(yuan) – it(dollars)
where f = (F – S)/S is forward premium on dollars
OIP breaks down when the interest differential is less
than expected appreciation because of fall in US rates
CIP breaks down when SAFE had to impose controls on
financial capital inflows, i.e., borrowing in dollars
• Result: China’s exporters can’t cover dollar earnings
forward, thus tightening credit constraint
Figure 13: Interest Differentials versus Percentage
Changes in the Yuan/Dollar Exchange Rate
(2002-2009)
6
4
2
0
-2
Exchange rate stabilization
8.28 yuan/dollar
Accidental
stabilization
6.83 yuan/$
-4
-6
Yuan/Dollar Change (yoy)
-8
Interest Differential
Fed Funds Rate
-10
-12
2002
China overnight
2003
2004
Source: Datastream.
Note: OIP is Open Interest Parity.
OIP holds
2005
2006
2007
OIP
OIP fails Restored
2008
July
2009 09/5
Figure 14: Forward Rate vs. Forward Rate from
Covered Interest Parity
(yuan/dollar,6 month)
8.0
7.8
7.6
7.4
7.2
7.0
6.8
6.6
6.4
Outright Forward
6.2
Implied Forward
6.0
Oct-08 Dec-29 Apr-04 Jul-05 Sep-27 Dec-27 Mar-31 Jun-27 Sep-22 Dec-22 Mar-26
06
07
Source: Wang (2009)
08
09
Jun
Figure 15: Percentage Deviation From Covered
Interest Parity
(yuan/dollar, by maturity)
2%
0%
-2%
-4%
-6%
6 Month
3 Month
9 Month
-8%
-10%
Oct-08 Dec-29 Apr-04 Jul-05 Sep-27 Dec-27 Mar-31 Jun-27 Sep-22 Dec-22 Mar-26
06
07
Source: Wang (2009)
08
09
Jun
Reducing China’s Saving-Investment Surplus
Increase share of household disposable income
in GDP in order to increase private consumption
•
•
•
•
reduce personal income and sales taxes
increase government transfer payments
increase dividend payouts from enterprises
Increase government social expenditures.
Stimulate household spending
• increase consumer credit
• abolish one-child policy?
Objectives
(1) Reduce China’s trade surplus
(2) Counter cyclical downturn in China and rest of the
world
• Caveat: Stabilize exchange rate (Mundell-Fleming)
Figure 16: Investment, Savings and Current
Account of China
(as a percent of GDP)
60
Investment
Savings
50
Current Account Surplus
40
30
20
10
0
2000
2001
Source: EIU
2002
2003
2004
2005
2006
2007
2008
Figure 17: China’s Labor Income and
Operating Surplus
(Share in GDP(%))
Source: UBS
Table 2: China’s Economic Positions in 1997
and 2007
Source: UBS
Note: The NPL ratio is 2.8% for four largest commercial banks, Dec 2008.
Conclusion:Countering the Global
Cyclical Downturn in 2008-09
• New U.S. fiscal stimulus is problematic: weak domestic
financial institutions, and trade deficit would increase
• China now a big actor on the world stage with stronger
public finances and much stronger banking system
• To stimulate the U.S. and world economies, the primary
fiscal stimulus should be in China and other surplus Asian
economies—and possibly Germany.
• Nov 2008, China announces a half trillion dollar fiscal
stimulus—now supported by rapid bank credit expansion
• U.S. quid pro quo: No more China bashing on exchange
rate, or through antidumping duties, and other policies