There was plenty of excitement last week, when the People’s Bank of China announced that the country would be restoring some flexibility to its exchange rate system, unpegging the renminbi from the dollar.
The renminbi was supposed to start rising immediately. Many Shanghai stocks jumped on the prospect of lower import costs.
Of course, it didn’t work out that way. The renminbi finished the week at 6.79 RMB/USD, from 6.83 RMB/USD before. I suspected this might prove less dramatic than people thought, so I held off from joining in the flood of speculation last week to see how things turned out.
But with the benefit of a few days’ distance, is there anything worth saying about China’s new policy?
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First, does a rising renminbi spell doom for cheap Chinese exports and exporters? Almost certainly not. I used the chart below a couple of weeks ago when talking about the impact of rising wages. But it’s even more relevant here. As it shows, margins for low-end exporters were extremely thin when the renminbi was unpegged in 2005. And they remained around the same level three years later.
Obviously a rapid surge in the renminbi might be another matter, giving firms little time to adjust. But China’s not going to allow that. China is well aware of what happened when the US pushed Japan to allow the yen to rise strongly in the 1980s. Manufacturers took a hit. In response, the Bank of Japan ran an excessively loose monetary policy. That helped to worsen the already-building bubble. China does not want the same thing to happen to them.
Even so, a gradual rise will drive some marginal firms out of business. But most can probably cope with a gradually rising renminbi, partly by raising prices and partly by cutting costs through greater efficiency.
But we’ll still see plenty of comment from Chinese officials about the risks involved. It’s a mistake to view government in China as monolithic simply because it’s not a democracy. In fact, there are factions at all levels of government lobbying for their favoured policies.
For example, the Ministry of Commerce tends to side with manufacturers. It has been one of the camps arguing against unpegging the renminbi. So unsurprisingly, on Saturday we had a director general for the ministry telling reporters at the G20 conference that this was set to be a hard year for exporters.
Even though the renminbi has been unpegged again, many will be lobbying for very slow appreciation – and that’s what seems likely to happen.
The US needs to solve its own problems
What about the trade balance? Will a higher renminbi cut import costs and encourage China to import more and export less? Will this bring down the US trade deficit?
Probably not. First, the appreciation is going to be very gradual. So it won’t do much for import prices in the short term, although it will have more of an impact over several years.
More important, when it comes to the US deficit, is the matter of what China produces and buys. It exports a wide range of goods, from clothes and toys to electronic goods to steel, metals and industrial goods. In fact, it’s been the increase in heavy industry exports such as steel that’s driven its rising trade surplus in recent years.
On the other hand, it imports raw materials from countries such as Australia, components for assembly and re-export from most of Asia, and investment goods such as industrial equipment from advanced countries such as Japan and Korea.
Obviously, there are significant amounts of imports from the US as well, but you can see the snag. China doesn’t need nearly as much of what the US produces as the US buys of what China produces. And what has happened to China’s trade surplus over the last year or so shows this.
In the face of the global recession, China embarked on a huge stimulus policy. Imports soared far faster than exports. Its trade surplus shrank. Yet if you break that surplus down into the surplus with the rest of the world and the surplus with America, you get the following chart.
You can see that the overall surplus with the rest of the world dwindled to almost nothing. (This doesn’t mean that China had balanced trade with every country in the rest of the world, just that the various deficits and surpluses netted out.) Yet the surplus with the US barely fell. In other words, US exports got virtually no boost from China’s stimulus – because the US doesn’t make what China wants.
This is the problem with US arguments against China’s trade policy and accusations of mercantilism. The reality is that while China certainly needs to boost domestic demand, that won’t fix the US’s problem through higher exports. America needs to rebalance its own excess demand. While the goods that it over-consumes may be made in China, the deficit itself is made in America.
This is not a popular political position. Hence all the talk is about China being a currency manipulator and indulging in unfair trade practices. The carefully-timed unpegging will take the political heat off for a while. But because it’s unlikely to have a real impact on the deficit, that won’t last for ever.
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Expect grumblings about China to grow again in due course. Increased protectionism such as tariffs on Chinese imports remain a real risk. They’re both damaging and futile: if Chinese goods were to become uncompetitive through a huge rise in the renminbi or through tariffs, other low-cost exporters such as India, Indonesia, Vietnam or Bangladesh would simply take its place in many industries.
But that doesn’t mean protectionist measures won’t be put in place. So China and emerging Asia in general need to push ahead with measures to become more domestically dependent and strengthen regional trade. The world has changed and export-orientated growth will no longer work as well as it has in the past for them.
Hot money is not only an issue for China
The most obvious impact we’re likely to see from the unpegged renminbi is in financial flows. The People’s Bank of China has done its best to talk down expectations for a rapid rise in the renminbi. It’s talked more about flexibility, suggesting that the currency could be allowed to rise and fall, and tried to imply that it isn’t a one-way bet.
This is to try to dissuade ‘hot money’ flowing into China to benefit from the rise in the renminbi. So far, markets seem to be taking the central bank at its word, pricing in a rise of just a couple of percent in the exchange rate over the next year or so. That’s unlikely to lure much speculation.
But if the renminbi gets moving again, that could change. The central bank has experience dealing with inflows, both from hot money and from the trade surplus. And indeed, with the overall surplus falling in the last couple of years, even strong speculative inflows would probably leave it needing to mop up less liquidity than it did in the middle of the decade (see chart below). Still, this is something that will be closely watched.
Of course, the bets on rising currencies aren’t just on the renminbi. Most other Asian countries fix their exchange rates to some extent. China’s unpegging will allow them to let their currencies rise more without risking their manufacturers losing too much competitiveness.
That means that these countries might well see hot inflows as well. Given the fact that they mostly have far less in the way of capital controls and much less of a policy of removing excess liquidity, it could have a bigger effect on them.
One of the key problems for Asian central banks over the next few years is likely to be dealing with speculation. A strong growth and development story in a region where many currencies are undervalued is going to attract a lot of foreign money. The prospect that some kind of bubble develops eventually is extremely high.
In the meantime, steadily rising currencies are a major bonus for those of us investing from abroad. The renminbi unpegging will help move that trend along. It won’t be quick, but in the long run Asia’s currencies are only going one way.
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