Appreciating the People's Currency
Krugman is still beating the war drums about China’s export-dependence. I believe this is his sixth such condemnation of the year, though in the fourth he recognized that not everyone agrees with his analysis:
“There have been all sorts of calculations purporting to show that the renminbi isn’t really undervalued, or at least not by much. But if the renminbi isn’t deeply undervalued, why has China had to buy around $1 billion a day of foreign currency to keep it from rising?”
Federal Reserve Chairman Ben Bernanke seems to have the answer: “In a closed economy investment would equal national saving in each period; but, in fact, virtually all economies today are open economies, and well-developed international capital markets allow savers to lend to those who wish to make capital investments in any country, not just their own.” Unfortunately this is not the case in China, which restricts capital outflows while encouraging foreign direct investment. Your average Wang can’t use RMB savings to purchase USD assets or to invest in a Wisconsin cheese company. China makes it relatively easy to bring money in but tough to get money out.
As Jiawen Yang and Isabelle Bajeux-Besnainou explain in the International Research Journal of Finance and Economics: “If Chinese investors were allowed to adjust their investment portfolio and diversify into international asset holdings, it would certainly create a significant downward pressure on China’s currency… China’s rapid accumulation of international reserves has mainly been built through increases in capital inflows, which are a result of a few key non-market driven factors (such as controls on capital outflows and the preferential treatment of foreign investment).”
Or in the words of Linda Yeuh, Director of the China Growth Centre at Oxford, writing for the IMF, “This growth of credit in an economy with capital outflow controls means investments will be largely domestic, increasing the likelihood of asset bubbles in the stock and housing markets and generating concerns about a banking crisis… With enough capital outflows, appreciation pressures on the currency may even ease.”
Does this mean the RMB is overvalued? Well it’s hard to say exactly, and probably not, but we must start by recognizing that China’s capital controls (before FOREX purchases) actually encourage RMB appreciation. Then, the People’s Bank offsets the relative absence of capital outflows with centralized FOREX purchases, which could be seen as a sort of pressure valve to keep the RMB from appreciating faster than it already is against a wide basket of currencies. That does help exporters by preventing artificial appreciation and stabilizing prices, but the RMB would be overvalued if they didn’t. By how much is hard to say. I’m just not as confident as Krugman because I don’t know how much money would flow if the capital restrictions were lifted (and hopefully, but gradually, they will be).
Capital outflow controls are a form of currency manipulation, but I don’t see how or why this is all one grand scheme to protect exports. There just isn’t enough evidence that China’s economic growth is export-dependent. In 2009, despite a precipitous drop in exports, domestic demand grew by 12.3% and production output grew by 9%. Think of it this way: it would be weird if China was risking a trade war and geopolitical conflict just to defend 10% of value added to the country’s gross domestic product. If you don’t believe me or Jonathan Anderson , maybe believe DeutscheBank: “The impact of 3-4% annual RMB appreciation on the economy is modest. If the RMB appreciates 3% vs. the USD per year, it reduces GDP growth by 0.2%.” That would bring China’s GDP growth down from like 11.4% to 11.2%… scary stuff. This is an important point, because it undercuts the alleged motive behind China’s ‘mercantilist’ currency practices. If China is not an export-dependent economy, what incentive would they have for aggressively devaluing the RMB? You can’t have it both ways.
Would an appreciating RMB be overwhelmingly positive for the US? Probably not, as more than half of China’s exports are produced by foreign companies. So basically you would tax those globally-focused companies who are striving to compete in the global economy, and you would raise prices for US consumers (and make saving even harder). You would also encourage a trade war with one of the fastest-growing consumer of US products, like our world-class, savory chicken feet. Some of China’s production would probably shift to Indonesia or Vietnam, or more impoverished regions of China, and maybe a few manufacturing jobs would remain in the US for a few more months — but the reality of globalization won’t disappear. And neither will the need to train future generations to compete and/or be self-sustaining in the future global economy. Krugman helps me to make this case:
“The undervalued renminbi is good for politically influential export companies. But these companies hoard cash rather than passing on the benefits to their workers, hence the recent wave of strikes.”
Krugman was presumably referring to the well-publicized strikes at Honda Motor Company — the Japan-based automotive giant that manufactures components in China. How a Japanese industry leader becomes politically influential in Chinese government circles is beyond me. Regardless, this is just one small example of how major multinational companies benefit from global supply chains that drive down prices for consumers everywhere. Lower input costs allow for greater sales and better margins, meaning that companies can grow, research, invest, and hire. As economies grow, so do wages and so do living standards. That’s exactly what we’re seeing. Believe it or not, China is now loosing jobs to lower-cost manufacturing hubs throughout Southeast Asia. We should be celebrating this — free markets are bring people around the world out of poverty in mass.
If Krugman really wants to address the US trade deficit, he should set his sights on the single greatest contributor: petroleum. And the long-term market opportunities for US-based companies in Saudi Arabia, Iran, Venezuela, Russia and Qatar are almost insignificant compared to those in East Asia, places like India and China. With the overwhelming majority of US-based companies operating in China for market access (and not cheap labor), now is not the time for burning bridges. Instead, we should focus on promoting greater market access and legal protections for US companies in China. More importantly, we should drop the victim complex and go to work. Part of that will require figuring out how to get Americans, who are still some of the world’s most productive and capable workers, more involved in global (in particular, Asian) economic development. China will eventually consume more than the US, and be a bigger economy, and we want to be involved when it does. China is already on the cusp of running an account deficit with the world, although per capita income in China is only fraction of that in the US. As domestic consumption continues to increase in China, so will the opportunities for US companies.
In all of Krugman’s rants about China’s predatory currency policies, he refuses to even tip his hat to the opportunities of globalization. That’s not constructive judgment — it’s just complaining.
this is just one small example of how major multinational companies benefit from global supply chains that drive down prices for consumers everywhere.
And lower standards of living for workers everywhere. Whoops! I’m not being a Very Serious person.
— Freddie · Oct 4, 03:35 PM · #
“And lower standards of living for workers everywhere”.
You are right Freddie, no one will take you seriously when you make stupid comments that aren’t supported by facts. All those Chinese peasants streaming into the coasts for factory jobs (and all the other East Asian peasants who have done the same, especially in the Tigers) must be stupid to leave behind those good paying subsistence farming jobs. I mean, how could they know what’s good for them and their families? It’s crazy and the rising standards of living across Asia, which is the most amazing anti-poverty program the world has ever know in terms of numbers, is all a big lie.
Thanks Freddie for another insightful comment.
— Jeff Singer · Oct 4, 03:40 PM · #
Yes, it’s true. There are only two options: subsistence farming or working in horrific sweatshop conditions. It’s just A or B.
— Freddie · Oct 4, 04:20 PM · #
Walker Frost,
I normally try not to think about global economics because there is so little I—or maybe even anyone—can do about it. It’s like making policy statments about the weather. But I do have a question: If the chinese aren’t trying to keep their currency artificially low, what is the reason for the currency restrictions?
— cw · Oct 4, 04:59 PM · #
The reason you are not a Very Serious Person, Freddie, is that in comment 1 you said that global trade “lower[ed] standards of living for workers everywhere” and in comment 3, you say something closer to “improve standards of living for workers, but not as much as I believe they could otherwise.”
If you’d started with your second position, we could have had a discussion about why you are wrong, but your first position is sufficiently absurd that I’m confident that no amount of facts or expert opinion will change your mind. (If not, please read Krugman’s articles in defense of globalization — he published several in Slate back in the 90s.)
— J Mann · Oct 4, 05:42 PM · #
Thank you J Mann for that eloquent defense.
Also I should have also thanked Mr. Frost for an excellent and thoughtful post. Much to consider and think over.
— Jeff Singer · Oct 4, 06:47 PM · #
Everyone write this post down. You’ll see here that J Mann has made no argument. S/He has merely deemed it absurd. This is the way of globalization. It is an impervious circle-jerk precisely because people like J Mann feel that they need make no recourse to argument. Saying something is absurd, and then being congratulated by a racist like Jeff Singer, is not an argument. And yet J here thinks that an argument is accomplished.
Why? Because of the unique status of arguing about globalization. I tell you true: the knee-jerk, lock step defense of globalization and neoliberal economics is an orthodoxy far more powerful and ruthlessly enforced than, say, the interdictions against racism, sexism, rape, or similar.
What’s particularly interesting about this case is that what J and I are saying are exactly the same. As neoliberalism’s zealots feel that they don’t have to defend themselves with argument, they instead substitute a cult of the informed, which they designate by referring to themselves as Very Serious people. They then cast anyone who deviates from their preferred line as inherently unserious and not deserving of counter-argument. J has exactly stated the conditions on the ground, and eloquently, too. Neoliberals don’t defend their positions. They just practice verbal eliminationism.
Which is fine as it goes. I’ll tell you— this was once a remarkable space, where dissenting opinion was cultivated and respected. It has instead turned into a mutual admiration society where the people who post and a few commenters who march in lockstep congratulate each other for how great they all are. (“Great post!” “You nailed this one.” “You’re the best!” “No, you— YOU are the best.”) Well, enjoy. I will continue to seek out some space on the Internet where the only voices are not people like J Mann, who has never known material need, and where the only interest is not in perpetuating the advantage of those who have everything.
(PS “But Paul Krugman!” isn’t an argument, either.)
— Freddie · Oct 4, 08:21 PM · #
Thanks, Jeff and J Mann, for the defense and the kind remarks.
cw, good question. I think about it often and would love to hear other ideas out there on this.
I believe the main reason for the outflow restrictions was to encourage FDI and then domestic re-investment, particularly in the 80s and 90s. China wanted the money to stay in China to finance development, and not be used to make hedonistic foreign asset purchases (read Hummer).
Here is the catch: China should have had to pay for this policy with an artificially high currency value (which would have stymied then-important export industries), but instead they made strategic FOREX purchases to offset what otherwise would have been artificial appreciation. And where safer to invest than USD.
Now that the majority of companies are operating in China for the China market, those outflow restrictions are less important and you are beginning to see more diversified foreign asset purchases like Rio Tinto and Ford. That trend will continue and as it does China will have less of a need for massive FOREX purchases. This is partly why China has allowed the RMB to appreciate by 20% against just about everything over the last five years.
So yes, part of the puzzle was (and to a smaller extent, still is) about protecting export industries. But that was necessary because the first goal was to facilitate investment for infrastructure and to build an industrial base. That need is no longer so pressing (actually, there is too much domestic investment), so I’m fairly confident you will see the continued loosening of outflow restrictions and more imports (Krugman and I agree that this is the best path for China). Really everybody wants this, it’s just a question of how to best manage the process. I think we are better off spending our energy focused on the new market opportunities instead of the marginal costs associated with a somewhat delayed (largely because of GFC) transition.
Freddie, it’s hard to find anyone in China who believes that life has been made worse by economic liberalization. As far as I can tell, living and working standards in East Asia have improved dramatically over the last 30 years (though far from perfect), and that probably never would of happened without FDI and capitalism. Do you disagree? If so I would love to hear your argument (seriously).
— Walker Frost · Oct 4, 08:44 PM · #
Freddie, your post seems unnecessarily long, particularly since it’s clear by the end that you did not intend to address the criticism addressed at you — namely, that your initial post did not make any sense because it does not appear to be the case that the “globalism” at issue is lowering the living standards of workers (whether or not it has actually improved living standards was not addressed in your post). Are you conceding that this is in fact the case?
There are certainly potential empirical issues here, but having not raised them, it seems that you have merely taken a long time to do same thing that you accuse J Mann of doing; I don’t see an argument anywhere amongst your snark. But of course, I’m sure it was psychologically satisfying to self-righteously denounce both the commenters on the post and the posters on this blog as a bunch of circle-jerkers.
(PS, “neoliberals!” is not an argument either)
— Jay Daniel · Oct 4, 08:57 PM · #
Freddie,
You started off the thread with a fatuous, off-handed bit of self-congratulation, and your interlocutors have been as generous as anyone could expect (I say this as someone who thinks very little of the discussion in this space these days). Please don’t stalk off (for the 2,741st time) thinking you have defended some patch of rhetorical high ground.
If, after of all the turd-quality comments this place has been blighted by over the past few years, this is the thread that convinces you to slam the door and never come back, the rest of us will have lost far less than we might have thought.
— Matt Frost · Oct 5, 02:08 AM · #
Interesting, but I’m really curious how this structure relates to the strange trade relationship between the U.S. and China, i.e. we sell them piles of debt that we can’t possibly service in the future.
Are the current RMB policies a hedge against our future probability of high inflation or default? I’m guessing China, if its leaders have good heads on their shoulders, actually would like their economy to become as non-export-dependent as possible ASAP, so they’re insulated against the next major international asset bubble.
Maybe the offsetting currency inflation is either a) an irrational legacy of the time when buying U.S. debt made sense, or b) a method of trying to gradually wean the country off of the Fed’s teat without undergoing a severe market correction.
Maybe China figures that its present rate of growing domestic economic strength is just peachy, and it’s just a matter of time until the currency controls are no longer needed. Or maybe they’re just as bad at macroeconomic decision-making as our own economic geniuses are, and their policies simply make no sense. I guess we’ll see when the T-Bills finally hit the fan.
Also, can you tell that I’ve been reading Peter Schiff recently? :)
— Ethan C. · Oct 5, 05:31 AM · #
Ethan, I think they are diversifying FOREX holdings in part because of concerns over the strength and investment returns of the dollar, but also recognizing that the EU is now China’s largest trading partner. So the RMB-USD exchange rate has lost its priority position in some ways, and we should look at RMB movements against a basket of currency. (Note: the RMB has appreciated against the MXP, INR, EUR, GBP, and many other currencies over the last two years while pegged to the USD.)
Your absolutely right that China should continue to move away from export-led growth, they have and they are. Most economic growth in China over the last decade has been driven by domestic investment, such as infrastructure projects and apartment complexes. Domestic consumption continues to grow as a share of GDP, represented by a recent government program that subsidized the purchases of specific household appliance (both domestic and foreign brands) in developing regions. I would argue (with Stephen Roach) that China’s leadership get it and the rebalancing is well underway.
So I agree (as do many within China) that FOREX (particularly USD) purchases are no longer as necessary, and they will probably pull back simultaneously with loosened capital export restrictions. We have already seen this in purchases of Blackstone, Morgan Stanley, IBM PC, AIG, Volvo, and commodity assets around the world. The process won’t happen overnight, and different factions in China’s leadership have different economic babies and nobody wants breakneck restructuring.
What will be interesting to see is how Americans respond to increased natural capital inflows from China, particularly if Chinese SOEs start buying good-ole American brands. I suspect Americans will complain just as much then too, even though that’s partly what’s needed to correct the imbalance that everyone is currently complaining about.
— Walker Frost · Oct 5, 12:11 PM · #
Freddie,
Two points:
1) I take it as a point of pride to be called a racist by you;
2) Believe it or not, some of us on the Right, who believe in globalization, free trade and capitalism actually think that these forces will help those in real need. It is certainly true that I have “never known material need”. But that doesn’t mean I can’t cultivate moral emphathy with those who have and think hard about ways to improve their lot. I know it must seem crazy, but I actually think that it is in the poor’s interest for their countries to adopt capitalism and market economy norms. While I was certainly influenced by all the usual suspects in neo-classical economic thinking, one of my favorite authors on the subject of international development and third-world poverty is Hernando de Soto, who has spent a lot of time in Third World countries living with and talking to the poor. I think he is someone who you would characterize as his “only interest is not in perpetuating the advantage of those who have everything.” As Walker Frost asks, what is your argument against the evidence of his own lying eyes (and the millions of Chinese who have been lifted from poverty — not to mention the millions of South Koreans, Taiwanese, whatever you call people in Hong Kong and Singapore, now Malaysia, now Vietnam, etc.) Google for the stats on living standards (which is not to say everything is perfect — in Sweden not everything is perfect — or that sweatshop abuses don’t exist).
Mr. Frost,
Americans might complain about those SOEs, but if at the same time the Chinese consumers start spending their money on the same good-ole American brands and companies like Caterpillar here in my home state of Illinois keep exporting big machinery to Asia, I think we’ll calm down and realize that China as a market is more of an opportunity than a threat.
— Jeff Singer · Oct 5, 04:21 PM · #
Jeff, on your last point, I sure hope so. Maybe we can manage to devalue our currency in a sufficiently non-catastrophic manner to allow U.S. high-tech manufacturing exports to pick up. I’m not holding my breath, though. The bigger the debt numbers get, the more laughable it seems to me that we’ll be able to back out of this thing in an organized fashion.
Mr. Frost, I guess my question is, then, can China hit a level of domestic development and/or export diversification that’s sufficient for sustaniable growth before the dollar bubble pops? Or do you think they’ve already reached this point? My theory is that as soon as the Chinese government figures they’re in good enough shape that they don’t need dollars anymore, they’ll stop buying Treasury products and that will be the end of our unlimited national credit binge. They’re delaying the inevitable because it’s in their best interests to get out from under the boulder before it falls.
My feeling is that at least one party needs to get ready to get a lot poorer: either the U.S., or the folks we owe money to. Probably both, but China is trying to make damn sure it isn’t them.
— Ethan C. · Oct 5, 07:13 PM · #
Jeff, I hope so too.
Ethan, I do think they have generally reached that point, but any transition away from USD purchases will be gradual to ensure stability. In my view exports to the US are no longer essential for China, but they still matter. China’s relative economic success during the GFC, when exports declined like 30%, provides confidence. China has already begun to move away from USD with diversification to other currencies, and I suspect once the global economy recovers China’s total central FOREX purchases will decline as a percentage of GDP (and natural capital outflows will grow and the RMB will continue to gradually appreciate against the USD). I agree that the US should be prepared to lose relative purchasing power over the next decade, and inflation coupled with unemployment could be tough.
— Walker Frost · Oct 5, 08:06 PM · #
Walker:
1. This is a fabulous post. Exactly what I look to TASers to produce.
2. How much of China’s export sector was ever SOEs? My impression was that the export sector was dominated by a gazillion tiny firms making specific electronic components. Very much in contrast to the Japanese experience to which China is often compared. Do I have that right?
3. Controls on the export of capital should artificially inflate the currency if they don’t have any effect on how much foreign investors are willing to put in to the country. But there’s no reason to believe that to be true. Capital controls should result in less foreign investment than would otherwise have come in; arguably, given that China was such a huge investment opportunity, without capital controls foreign investment would have been even bigger, and the RMB would have appreciated more.
4. On the other hand, those same investors might have (foolishly) panicked when the global financial crisis hit, and pulled their money out. Because of capital controls, that’s not an option. That’s probably unlikely in the case of China because of its sheer size, but that’s a genuinely good reason for smaller developing economies to impose such controls: even if they do cost something in terms of reduced investment, the cost is worth it in terms of reduced volatility. Malaysia had tougher capital controls than many of their neighbors, and, if I recall correctly, they also weathered the currency crises of the late 1990s better.
5. The Chinese saved a huge amount of money during the boom times and have spent a nice chunk of that change on domestic investment since the start of the global slump. This has paid off immediately in terms of keeping aggregate demand up, but will pay off even more down the road because this new infrastructure will improve the lives of hundreds of millions of people. During the same boom period, the United States had access to extraordinarily cheap money. We didn’t feel like we needed to save, in part because the vast pool of Chinese savings kept American long-term rates low. We spent that cheap money building houses in our deserts (Arizona, Nevada, California) and destroying houses in other people’s deserts (Iraq). I’ve been very pleasantly surprised that we haven’t faced a dollar crisis yet – and that has nothing to do with the Obama Administration’s spending plans.
— Noah Millman · Oct 5, 09:12 PM · #
Noah,
1. Thanks and I appreciate the thoughtful feedback/observations.
2. Yes, you do. China’s major SOEs are focused on domestic infrastructure, like Bank of China, China Telecom, or the Shanghai Railway Corporation (rumored to be the world’s largest employer). The majority of China’s exporters are contracted or branches of foreign-based enterprises.
3/4. I think much of this comes down to the policy specifics: how much capital are you allowed to use for a JV or WOFE; are you allowed to repatriate profits; will profit outflows be taxed; etc. As you allude to, China does have capital import restrictions as well, but they arn’t nearly as rigid as capital export controls and generally China has gone out of its way to encourage FDI. Regardless, I agree with your point: these types of policies make a lot of sense for developing economies, not because they are predatory but because they facilitate stability. Especially when the policies are stable, transparent, and consistent (which has been and still can be a problem in China).
5. Absolutely. We could have theoretically financed a massive energy technology revolution, built a world-class national infrastructure, and eradicated TB and Malaria. I’m probably exaggerating, but not by all that much. It seems clear that our bureaucracy is incapable of similarly strategic investments, and our consumers will continue to follow prices. We’re stuck until the market forces change.
— Walker Frost · Oct 5, 10:47 PM · #
Matt, you confuse the crap out of me. This is the standard Freddie post. He says something dumb — arguably even, from the standpoint of Indians and Chinese, a tad racist. Someone points it out. He doubles down, acts like he alone is Morally Serious, and you all haven’t done the reading, and besides poor little rich kid Freddie is the only guy who Knows Need. Give me a break; I’ve never heard anything else from him. If that’s what you’re appealing to, then you’re as much deluded as is he.
— Confused by Frost · Oct 5, 11:35 PM · #
Confused:
I like Freddie. I suppose I might like him less if I still were a regular reader here, and I might like him a lot more if I knew him in meatspace, but I’ll split the difference and say that Freddie is a standup guy nonetheless.
— Matt Frost · Oct 6, 03:59 AM · #
“It seems clear that our bureaucracy is incapable of similarly strategic investments…”
There is an enormous amount to unpack in this sentence, a whole Decline and Fall (maybe).
Just for my education, what exactly was the process that lead from the chinese buying treasury bills to low interest rates? Was that mediated through the fed? And if so, wasn’t the Fed’s actions a response to the tech crash?
— cw · Oct 6, 03:16 PM · #
Could the Bush presidency have been more disasterous?
— cw · Oct 6, 03:20 PM · #
1) I didn’t mean to make this the “jump on Freddie” thread. I’ve always liked Freddie, and think he deserves props for hanging out on a board where the comments aren’t congenial to him.
2) That said, I take breaks from time to time from this board too, also because it’s maddening. I hope Freddie’s break does him good, and that he comes back refreshed. (I’d love to see a few more of the old-school posters come back too).
3) With that said, Freddie’s argument of “you are a bad person, so your argument is wrong” is not all that convincing to me. I think we would all like to see the world’s poor freed from want, but even granting that Freddie is a much more moral and caring person than me, his gigantic caring heart does not necessarily make him right about the Ricardian gains from trade.
4) Lastly, my argument wasn’t “Paul Krugman,” it was “I recommend that you read Paul Krugman’s articles on international trade published in Slate in the 90s.” They really are good articles – accessible, well reasoned, and by an economist I think Freddie trusts.
— J Mann · Oct 6, 05:04 PM · #
“in comment 3, you say something closer to “improve standards of living for workers, but not as much as I believe they could otherwise.”
Not to defend Freddie, but that’s not at all what he actually said. He’s making the point that far too often criticism of global economic theory and practice is dismissed with nothing more than a total denial that any other options are possible.
Mike
— MBunge · Oct 7, 05:54 PM · #
“There just isn’t enough evidence that China’s economic growth is export-dependent”
This is like saying that there was no evidence of home prices in the US increasing to bubble-proportions by 2006 because US savings were very high, and could manage a decline in home prices (when, in fact, these very savings included home price appreciation as savings!). The point has been made, quite extensively, that high capital investment in China, which skews the investments-to-GDP ratio unbalancedly against consumption, exists to service exports and hence is part of the mechanism to keep the currency low to keep the export machine chugging. Not many emerging countries allow their citizens to invest their savings in foreign countries freely, but yet have seen their currencies appreciate because of the natural dynamics of supply-and-demand and differential growth and real interest factors, operating in their relatively non-interventionist forex markets (India is a case in point).
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