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Saturday, 20 March 2010
History shows that yuan appreciation won’t help
If you don’t believe that, just look at the example of Japan in the 1980s, when a rapidly appreciating currency simply fuelled the excesses of the bubble economy and led ultimately to the crash of the early 1990s and Japan’s subsequent lost decade.
The debate over China’s exchange rate policy just won’t simmer down.
In the past few days, the war of words between Washington and Beijing has flared up with fresh intensity.
On one side, members of the US Congress accuse Beijing of keeping the value of the yuan artificially low in order to steal an unfair trade advantage for Chinese companies in world markets.
They say cheap imports from China are undercutting homemade products in the US market and costing Americans their jobs, while the undervaluation of the yuan is pricing US exporters out of China’s lucrative domestic market.
If Beijing does not let the yuan rise, they say they will retaliate by slapping punitive tariffs on Chinese-made goods.
On the other side of the Pacific, mainland officials protest that China is not to blame for America’s economic problems and that Beijing’s exchange rate policy should not be made into a scapegoat for the US trade deficit.
Behind all the political posturing, however, a growing number of observers believe that Beijing is indeed getting ready to abandon the US dollar peg it put place in mid-2008 and to let the yuan start strengthening again.
Advocates of yuan appreciation, which include both the International Monetary Fund and the World Bank, believe a stronger currency would be good both for the health of China’s economy and for international financial stability.
According to economic theory, a stronger yuan would hold down domestic inflation by reducing the price of imported goods. At the same time, it would give the central bank greater control over monetary policy, allowing capital to be allocated more efficiently. And a stronger currency would raise the purchasing power of Chinese consumers, helping to rebalance the domestic economy.
In international markets, yuan appreciation should trim China’s trade surplus while allowing increased US exports to reduce America’s trade deficit, helping to rebalance the distorted global economy.
That’s the theory. The trouble is that the theory doesn’t work.
Let’s start with the idea that a stronger yuan would help correct global trade imbalances. If it is really true that currency appreciation reduces a country’s trade surplus, and that depreciation cuts a trade deficit, then there should be plenty of historical evidence.
Take China for example. Between mid-2005 and late 2008, the yuan strengthened by 18 per cent against a basket of currencies from China’s trading partners. So if the theory were right, we should have seen a contraction in China’s trade surplus
In fact, as the first chart shows, over the same period China’s monthly surplus actually quadrupled.
Similarly, if the theory were correct, we should have seen the US trade deficit fall between early 2002 and mid-2008 while the US dollar was weakening. In fact, as the second chart illustrates, although the dollar fell by a massive 40 per cent on a trade-weighted basis, the US deficit doubled from about US$30 billion to more than US$60 billion a month.
So although in theory global trade imbalances should have moderated as a result of the prevailing trends in exchange rates, in fact they got considerably worse.
Nor does it follow that a stronger yuan will help Beijing’s policymakers manage China’s growth at home. In fact, history indicates that far from cooling down the domestic economy, currency appreciation could actually exacerbate overheating.
If you don’t believe that, just look at the example of Japan in the 1980s, when a rapidly appreciating currency simply fuelled the excesses of the bubble economy and led ultimately to the crash of the early 1990s and Japan’s subsequent lost decade.
If Beijing succumbs to international pressure and allows the yuan to appreciate in line with market forces, something similar could happen in China, with dire consequences for the domestic and international economy.
“Expecting that China will leave its exchange rate to the mercy of totally unreliable markets and risk a Japan-like appreciation shock ignores the importance of its domestic and external stability for the region and for the globe,” the United Nations Conference on Trade and Development warned in a policy brief published earlier this week.
It’s a warning that Beijing - and Washington - would do well to heed.
2 comments:
History shows that yuan appreciation won’t help
Tom Holland
19 March 2010
The debate over China’s exchange rate policy just won’t simmer down.
In the past few days, the war of words between Washington and Beijing has flared up with fresh intensity.
On one side, members of the US Congress accuse Beijing of keeping the value of the yuan artificially low in order to steal an unfair trade advantage for Chinese companies in world markets.
They say cheap imports from China are undercutting homemade products in the US market and costing Americans their jobs, while the undervaluation of the yuan is pricing US exporters out of China’s lucrative domestic market.
If Beijing does not let the yuan rise, they say they will retaliate by slapping punitive tariffs on Chinese-made goods.
On the other side of the Pacific, mainland officials protest that China is not to blame for America’s economic problems and that Beijing’s exchange rate policy should not be made into a scapegoat for the US trade deficit.
Behind all the political posturing, however, a growing number of observers believe that Beijing is indeed getting ready to abandon the US dollar peg it put place in mid-2008 and to let the yuan start strengthening again.
Advocates of yuan appreciation, which include both the International Monetary Fund and the World Bank, believe a stronger currency would be good both for the health of China’s economy and for international financial stability.
According to economic theory, a stronger yuan would hold down domestic inflation by reducing the price of imported goods. At the same time, it would give the central bank greater control over monetary policy, allowing capital to be allocated more efficiently. And a stronger currency would raise the purchasing power of Chinese consumers, helping to rebalance the domestic economy.
In international markets, yuan appreciation should trim China’s trade surplus while allowing increased US exports to reduce America’s trade deficit, helping to rebalance the distorted global economy.
That’s the theory. The trouble is that the theory doesn’t work.
Let’s start with the idea that a stronger yuan would help correct global trade imbalances. If it is really true that currency appreciation reduces a country’s trade surplus, and that depreciation cuts a trade deficit, then there should be plenty of historical evidence.
Take China for example. Between mid-2005 and late 2008, the yuan strengthened by 18 per cent against a basket of currencies from China’s trading partners. So if the theory were right, we should have seen a contraction in China’s trade surplus
In fact, as the first chart shows, over the same period China’s monthly surplus actually quadrupled.
Similarly, if the theory were correct, we should have seen the US trade deficit fall between early 2002 and mid-2008 while the US dollar was weakening. In fact, as the second chart illustrates, although the dollar fell by a massive 40 per cent on a trade-weighted basis, the US deficit doubled from about US$30 billion to more than US$60 billion a month.
So although in theory global trade imbalances should have moderated as a result of the prevailing trends in exchange rates, in fact they got considerably worse.
Nor does it follow that a stronger yuan will help Beijing’s policymakers manage China’s growth at home. In fact, history indicates that far from cooling down the domestic economy, currency appreciation could actually exacerbate overheating.
If you don’t believe that, just look at the example of Japan in the 1980s, when a rapidly appreciating currency simply fuelled the excesses of the bubble economy and led ultimately to the crash of the early 1990s and Japan’s subsequent lost decade.
If Beijing succumbs to international pressure and allows the yuan to appreciate in line with market forces, something similar could happen in China, with dire consequences for the domestic and international economy.
“Expecting that China will leave its exchange rate to the mercy of totally unreliable markets and risk a Japan-like appreciation shock ignores the importance of its domestic and external stability for the region and for the globe,” the United Nations Conference on Trade and Development warned in a policy brief published earlier this week.
It’s a warning that Beijing - and Washington - would do well to heed.
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