Thursday, December 10, 2009

China Currency and Trade Imbalances: Don't Believe the Hype

The blogosphere has been rumbling over two recent op-eds in the Financial Times - a generally free market publication - arguing against China's currency policies and warning of their attendant economic harms.

The first, and more hysterical, op-ed came from University of Chicago(!) economist Robert Aliber who argues that drastic protectionism is needed to force China to appreciate its currency (the RMB) and thus correct the "unsustainable US-China trade imbalance." This is pretty startling coming from an economist from the free market U.Chicago. Fortunately, Cato's Dan Ikenson gives Aliber's op-ed a proper fisking, so all I need to do there is point you to Dan's great blogpost.

Martin Wolf's op-ed is more thoughtful, but no less alarming. He sees four serious problems with China's currency regime:
First, whatever the Chinese may feel, the degree of protectionism directed at their exports has been astonishingly small, given the depth of the recession. Second, the policy of keeping the exchange rate down is equivalent to an export subsidy and tariff, at a uniform rate – in other words, to protectionism. Third, having accumulated $2,273bn in foreign currency reserves by September, China has kept its exchange rate down, to a degree unmatched in world economic history. Finally, China has, as a result, distorted its own economy and that of the rest of the world. Its real exchange rate is, for example, no higher than in early 1998 and has depreciated by 12 per cent over the past seven months, even though China has the world’s fastest-growing economy and largest current account surplus.
Wolf is a smart, reasonable guy and expresses a view held by a lot of smart, reasonable guys: China's currency is very undervalued; it's distorting global trade balances; and something needs to be done to stop it (and thus end these imbalances). I've expressed skepticism about these views, as have other people far smarter than me (linked throughout my aforementioned posts).  But I thought that a direct response to Wolf - printed in today's FT - also warranted notice.  Here's Jim O'Neill, chief economist at Goldman Sachs:
Like many others, I often, all so easily, fall into the camp that the Chinese exchange MUST still be undervalued, and cite the reserves fact and its growth as evidence, but I am not so sure when I really analyse it. We have a model for estimating fair values for many currencies, our so called GSDEER, and it did used to suggest that the CNY was undervalued. However as a result of the approximate 20pct appreciation of the past 4 years, and higher prices than many other countries, our model suggests it is no longer so clear. Now FX models are FX models, and having spent so much of my career on them, I know only too well that it is subject to even more risks for somewhere like China. But when I see our own- objective -model saying things like this, observe surveys showing that Mexico is now back to being the no 1 place to produce heavy industrial goods, and China’s imports rising much more sharply than exports, I stop to question my underlying tendency. On top of this, and Martin, as many others, never seems to address this, China’s current account surplus this year is going to be close to about half what it was a year ago amidst lots of evidence that domestic demand, especially consumption, is roaring away. Yesterday, we got news that in November, Chinese auto sales rose by 92pt year on year. They are so strong, that they are now importing some directly from overseas. You see similar evidence when you look at LCD TV sales and almost anything else. As some Chinese policymakers point out, this is almost definitely more important than the exchange rate issue that so many are still rather perhaps excessively focused on.
O'Neil's response is reprinted here not to trumpet a big, silly "see, I told you so; look how smart I am" (really!).  Instead, I fully admit that I don't know whether China's currency is undervalued or overvalued, or whether a revaluation will affect bilateral trade flows between China and the US or other countries. (Although I do know that history argues against it, and I'd prefer letting the free market decide.)  But I hope that my posts, and O'Neil's very well-reasoned and researched response, will make clear that there's a lot of good debate among honest and smart people about China's currency policies and global trade.  There's also a lot of idiotic demagoguery, and we should be very, very suspicious of economists (*cough*PaulKrugman*cough*) and politicians who loudly proclaim with steadfast confidence that (i) China's currency is harming the US economy, and (ii) RMB appreciation will be a magic cure for "unsustainable" global trade imbalances.

It just ain't that easy.

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