Transcript Document

The Renminbi
The Case for revaluation
The Context
• 2004: China’s economy is on the overheating side of internal balance
appreciation would
help easy inflationary
pressure
• To achieve both internal balance and external balance China needs to adjust its real exchange
rate
• China’s current FOREX is adequate to shield it against currencies crises and U.S treasury
securities do not pay a high return.
• It is increasingly difficult to sterilize the inflow over time.
• A large economy like China can achieve adjustment in the real exchange rate via flexibility in
the nominal exchange rate more easily than via price flexibility.
• From a longer-run perspective, prices of goods and services in China are low by the
standards of a Balassa-Samuelson relationship estimated across countries.
• The yuan is undervalued by approximately 35%.
• The hybrid basket-band-crawl regime seems to argue for a dollar peg with only a 2.1%
revaluation.
• July 2005: China announces a new policy,
Immediate 2.1 % revaluation,
Followed by “managed float”: controlled appreciation,
supposedly against an unspecified basket of currencies.
But, as often, de jure exchange rate regime ≠ de facto.
Context , continued
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Econometric estimation of true regime reveals:
$ link did not even begin to loosen until 2006.
By 2007, implicit basket had shifted some weight
onto other currencies, especially the €.
RMB appreciates against the $ from 2006 to 2008,
But only because € does.
May 2008: Chinese leaders hear exporter complaints of competitiveness difficulties.
Mid-2008-April 2010:
yuan repegs ≈ $ 6.84 RMB/$
≈ 20% stronger, vs. $, than 2005.
Oct. 2006 -- IMF Article IV consultation
finds RMB “undervalued.”
2007: US Treasury temporarily passes
hot potato of exchange rate complaints to IMF,
which gets mandate for exchange rate “surveillance.”
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2008: Though financial crisis originates in US,
“flight to quality” temporarily raises demand for $.
2009: Chinese leaders, for the first time,
express concerns that their vast holdings
of US treasury bills may not be well-invested.
Pres. Obama & Secy. Geithner seek to reassure.
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-1
0
/RMB
THE RMB ROSE AGAINST THE $ FOR 2 YEARS,
BUT RETURNED TO PEG IN MID-2008
Exchange rates, Jan. 2005 - March 2010
0.18
2
0.16
$/RMB
0.1
0.06
$/RMB
($/2+euro/2)/RMB
euro/RMB
1.8
0.14
1.6
0.12
1.4
1.2
€/RMB
0.08
1
0.8
€/$
0.04
0.02
0
Euro/$ (RHS)
0.6
0.4
0.2
0
Date
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Two hypotheses regarding determinants of US Treasury decisions
whether partners are manipulating currencies:
• (1) Legitimate economic variables
– the partner’s overall current account/GDP,
– its reserve changes,
– the real overvaluation of its currency; vs.
• (2) Variables suggestive of domestic American
political expediency
– the bilateral trade balance,
– US unemployment,
– an election year dummy .
EXPLAINING FINDINGS OF TREASURY DEPARTMENT BIANNUAL
REPORT TO CONGRESS ON INT.EC. & EXCHANGE RATE POLICY
All countries
Excluding oil exporters
US bilateral TB
-0.92***
15 Asian economies
-0.99***
0.0655
Partner’s
CA/GDP
Partner’s Real
Exchange Rate
Change in
reserves/GDP
US unemployment
0.1548
0.014***
0.002
0.028**
0.007
-0.18***
0.0291
-0.23**
0.1115
0.003
0.003
-0.012
0.009
0.022**
0.010
0.08**
0.037
*** statistically significant at 99% level7
THE MAGNITUDE OF DAILY MOVEMENTS
VS. $ INCREASED IN THE SPRING2006
-.002
0
.002
.004
Changes in CNY per USD over Time: 07/22/05-1/8/2007
01 Jul 05
01 Jan 06
01 Jul 06
01 Jan 07
date
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COMPLAINTS: TREASURY & OTHER US
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5
10
15
20
Time plots of cumulative US Treasury and Non-Treasury Complaints
01 Jul 05
01 Jan 06
01 Jul 06
01 Jan 07
date
cumulative non-treasury report
cumulative treasury report
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CHINA’S VIEW
• Countries should have the right to fix
their exchange rate if they want to.
• True, the IMF Articles of Agreement
and the US Omnibus Trade Act of 1988
call for action in the event that a country
is “unfairly manipulating its currency”.
• But
• Almost no countries have been forced to appreciate.
• Pressure on surplus countries to appreciate will inevitably
be less than pressure on deficit countries to depreciate.
• It is time to retire the language of “manipulation.”
• Usually, it is hard to say when a currency is undervalued.
• Don’t cheapen the language that is appropriate to WTO rules.
• China should do what is in its own long-term interest.
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China’s Interest: Sino, US duo
 mutually-beneficial bargain, between equals
 China agrees that:
 its exchange rate is part of the problem,
 it will cooperate to lower the RMB/$ rate in a gradual manner,
 and of course it won’t dump US treasury bills.
 In exchange, US agrees that:
 its low national saving rate is part of the problem,
 it will cooperate to reduce the budget deficit,
 and of course it won’t close off the US market to Chinese goods.
 But perhaps a bargain isn’t even necessary;
It is in China’s own interest to begin appreciating the RMB.
FIVE REASONS CHINA SHOULD LET RMB APPRECIATE,
IN ITS OWN INTEREST
1. Overheating of economy
2. Reserves are excessive.
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It gets harder to sterilize the inflow over time.
3. Attaining internal and external balance.
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To attain both, need 2 policy instruments.
In a large country like China,
expenditure-switching policy should be the exchange rate.
4. Avoiding future crashes.
5. RMB undervalued, judged by
Balassa-Samuelson relationship.
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1. OVERHEATING OF ECONOMY
• Bottlenecks.
Pace of economic growth is outrunning:
• raw material supplies, and
• labor supply in coastal provinces
• Also:
• physical infrastructure
• environmental capacity
• level of sophistication of financial system.
• Asset bubbles.
• Shanghai stock market bubble in 2007.
• Inflation 6-7% in 2007
=> price controls
 shortages & social unrest.
• All of the above was suspended in late 2008,
• due to global recession.
• But it is back again now; skyrocketing real estate prices.
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ATTEMPTS AT “STERILIZATION,” TO INSULATE
DOMESTIC ECONOMY FROM THE INFLOWS
• Sterilization is defined as offsetting
of international reserve inflows,
so as to prevent them from showing up
domestically as excessive money growth & inflation.
• For awhile PBoC successfully sterilized…
• until 2007-08.
• The usual limitations finally showed up:
• Prolongation of capital inflows <= self-equilibrating mechanism shut off.
• Quasi-fiscal deficit: gap between domestic interest rates & US T bill rate
• Failure to sterilize: money supply rising faster than income
• Rising inflation (admittedly due not only to rising money supply)
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2. FOREIGN EXCHANGE RESERVES
Excessive:
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Though a useful shield against currency crises,
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China has enough reserves: $2 ½ trillion by April 2010;
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& US treasury securities do not pay high returns.
Harder to sterilize
the inflow over time.
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The Balance of Payments
≡ rate of change of foreign exchange reserves (largely $),
rose rapidly in China over past decade,
due to all 3 components:
trade balance, Foreign Direct Investment, and portfolio inflows
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Successful
sterilization
in China:
2005-06
ATTEMPTS
TO STERILIZE
RESERVE
INFLOW:
High reserve growth
=> steady money
offset by cuts in
domestic credit
While reserves (NFA) rose rapidly, the growth of the monetary base
was kept to the growth of the real economy – even reduced in 2005-06.
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IN 2007-08 CHINA HAD MORE TROUBLE
STERILIZING THE RESERVE INFLOW
• PBoC began to pay higher interest rate
domestically, & receive lower
interest rate on US T bills
=> quasi-fiscal deficit.
• Inflation became a serious problem.
• True, global increases in food & energy prices
were much of the explanation.
• But
• China’s overly rapid growth itself contributed.
• Appreciation is a good way to put immediate downward
pressure on local prices of farm & energy commodities.
• Price controls are inefficient and ultimately ineffective.
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STERILIZATION FALTERED IN 2007 & 2008
Monetary base
accelerated
Growth of China’s
monetary base,
& its components
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Source: HKMA, Half-Yearly Monetary and Financial Stability Report, June 2008
CHINA’S CPI ACCELERATED IN 2007-08
INFLATION 2002 TO 2008 Q1
Source: HKMA, Half-Yearly Monetary and Financial Stability Report, June 2008
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3. NEED A FLEXIBLE EXCHANGE RATE TO
ATTAIN INTERNAL & EXTERNAL BALANCE
• Internal balance ≡
demand neither too low (recession) nor too high (overheating).
• External balance ≡ appropriate balance of payments.
• General principle: to attain both policy targets,
a country needs to use 2 policy instruments.
• For a country as large as China, one of those policy instruments should
be the exchange rate.
• To reduce BoP surplus without causing higher unemployment,
China needs both
• currency appreciation, and
• expansion of domestic demand
• gradually replacing foreign demand,
• developing neglected sectors:
health, education, environment, housing, finance, & services.
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4. AVOIDING FUTURE CRASHES
Experience of other emerging markets suggests it is better to exit from a peg in good times,
when the BoP is strong, than to wait until the currency is under attack.
Introducing some flexibility
now, even though not ready
for free floating.
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5. LONGER-RUN PERSPECTIVE:BALASSASAMUELSON RELATIONSHIP
•
Prices of goods & services in China are low
• compared at the nominal exchange rate.
• Of course they are a fraction of those in the U.S.: < ¼ .
• This is to be expected,
explained by the Balassa-Samuelson effect
• which says that low-income countries have lower price levels.
• As countries’ real income grows, their currencies experience real appreciation:
approx. .3% for every 1 % in income per capita.
• But China is one of those countries that is cheap or undervalued even
taking into account Balassa-Samuelson.
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1
.5
-1
-.5
0
The Balassa-Samuelson Relationship
200 5Balassa-Samuelson relationship 2005
-3
-2
-1
0
1
Log of Real Per capita GDP (PPP)
2
coef = .23367193, (robust) se = .01978263, t = 11.81
Source: Arvind Subramanian, April 2010,
“New PPP-Based Estimates of Renminbi Undervaluation
and Policy Implications,” PB10-08, Peterson Institute for International Economics
Undervaluation of RMB in the regression estimated above = 26%.
Estimated undervaluation averaging across four such estimates = 31%.
Compare to Frankel (2005) estimate for 2000 = 36%.
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