Sunday, June 19, 2011

The Yuan Might Not Be As Undervalued as You (or even I) Think

When American politicians (and reality TV stars) start railing against China's "undervalued" currency, they're always talking about the nominal exchange rate - i.e., the rate that governments and banks say the currencies are worth - between the Chinese yuan (or RMB) and the US dollar.  I've repeatedly noted how misguided this approach is for international trade discussions because nominal rates don't actually tell you what goods and services - you know, the things we're trading - are actually worth.  That's what real exchange rates do, and in those terms, China's currency has appreciated dramatically against the dollar over the last few years.

Economist Ed Dolan (h/t Lee Miller) provides some interesting new analysis showing that even I may have been understating the Yuan's real value and, hence, its recent appreciation versus the dollar (insert lawyer-math joke here):
The final item on the scorecard, in many ways the most important, is the real exchange rate as deflated not by consumer prices, but by unit labor costs. Unit labor costs measure the cost of producing goods taking into account both increases in wages, which tend to raise costs, and increases in productivity, which tend to lower them. If a country’s unit labor costs rise relative to those of its trading partners, its exports become less competitive, equivalent to a real appreciation of the currency. In the United States, the unit labor cost series published by the Bureau of Labor Statistics has fallen over the past year by about 4 percent because strong productivity growth has outpaced stagnant nominal wages. China does not publish a comparable series, but there are strong indications that its unit labor costs are rising. Wage settlements with individual employers in export industries and minimum wage increases announced for important manufacturing centers have been rising at rates far in excess of inflation, often 10 to 20 percent. Productivity is presumably rising, too, but surely not that rapidly. A conservative, back-of-the-envelope guess for the rate of increase of Chinese unit labor costs would be about 5 percent per year. It could be more. If so, that would suggest a ULC-deflated rate of real appreciation of about 14 percent per year bilaterally against the dollar. The ULC-deflated Chinese REER is presumably also appreciating significantly faster than the BIS [nominal] figure of 3 percent or so.
In short, China's goods and services are appreciating 14 percent annually versus American goods and services.  Wow.  Dolan's whole piece is definitely worth reading (although I disagree with his final conclusions about the effect of Yuan appreciation on the US economy).  Assuming his calculations are even remotely correct (and considering his background, I have no reason to doubt him), Dolan's analysis provides even further proof that US currency hawks simply have no idea what they're talking about.

(But we already knew that, didn't we?)

Happy Fathers' Day, everyone.

No comments: