China’s Renminbi Announcement: A Big Headfake
Naked Capitalism;
There are some real internal inconsistencies. While this does represent an announcement of an intent to liberalize, it lacks any particulars as to timing and mechanisms. Moreover, it specifically rejects the idea of widening the bands in which the RMB trades, which is the litmus test of a move to a market-based exchange rate (you’d expect gradual widening of the permitted band as a precursor to abandoning currency intervention).
Instead, what this appears to signal is a shift of the basis for managing the currency to:
1. Use of a basket of reference currencies, rather than just the dollar. China is contending that that is what it has been doing since 2005, but the language allows for the possibility for a change in the mix. Thus this signals China’s intent to move away from a dollar reserve currency regime (it has taken other measures along these lines, for instance, encouraging invoicing in currencies other than the dollar). The problem is that a permitted trading band vs. a basket of currencies is what China supposedly implemented in 2007, and the results have looked an awful lot like a dirty float against the dollar.
2. Arguing for the balance of payments as the metric of the appropriateness of the exchange rates. China contends that because its balance of payments is improving (as in its trade surplus is weakening) it really does not need to do much (as in it has ruled out a meaningful revaluation). This is essentially an argument that the large trade deficit for March means critics need to lay off, a posture it took in April. The problem, however, was the March deficit appears to have been the result of one-off factors. China’s exports in May were larger than expected, due to more robust export growth. And note Chinese officials had expected exports to rise 50% over 2009.
The fact is, as Michael Pettis pointed out in his latest post, no country in modern times has ever run a trade surplus as a percent of GDP as large as China does. That means even if it does decide to extricate itself from this position, it will want to do so gradually. As Pettis noted:
As a share of global GDP China’s recent trade surpluses (roughly 0.6-0.7% of global GDP) are easily the highest recorded in the last 100 years.
This is all the more striking when you consider that the two previous record holders, the US in the late 1920s (with a trade surplus equal roughly to 0.4% of global GDP) and Japan in the late 1980s (0.5% of global GDP), were relatively much larger economies. The US represented more than 30% of global GDP in the late 1920s, and Japan represented 15% of global GDP in the late 1980s. By contrast China represents only 8% of global GDP today.
In the same post, he also rejected the idea that China’s trade balance is moderating:
In other words the cost of capital for China’s already too-capital-intensive and overinvesting economy is declining, and so worsening the domestic imbalances, and all but assuring that China’s trade surplus excluding Europe will surge (and maybe even including Europe it will still rise). In fact one of the least surprising of the “surprises” of recent months was China’s May trade figures. Here is what an article on Thursday in the South China Morning Post says:
Mainland’s exports rose 48.5 per cent in May from a year earlier and imports were up 48.3 per cent, the General Administration of Customs said on Thursday, giving the country a trade surplus of US$19.53 billion, up from just US$1.7 billion in April. The median forecast of 32 economists polled by Reuters was for exports to rise 32 per cent and imports to climb 45 per cent, with a projected trade surplus of US$8.8 billion.
Sources said on Wednesday that export growth was up about 50 per cent from a year ago, giving a boost to global financial markets as investors expressed relief that the country’s fast growing economy did not appear to be juddering to a sharp halt.
Some surprise, although I should add that I have a worrying feeling that the subsequent applause by the global stock markets may have got it exactly backwards. Net exports had to surge after the temporary contraction earlier this year, and in fact if you exclude the impact of commodity stockpiling, which overstates outflows due to consumption imports and understates outflows due to investment, China’s trade surplus would have probably been much higher. It is being artificially reduced by commodity stockpiling, which of course must be reversed at some point in the future. I expect that Chinese net exports will continue very strong this year, perhaps even taking into account the effect of the European crisis, which should be excluded from the number. And of course I expect US net imports, and with it US unemployment, will surge to politically unacceptable levels throughout this year and next, thanks in large part the European crisis and the unwillingness of anyone else to absorb it.
http://www.nakedcapitalism.com/2010/06/is-chinas-renminbi-announcement-mainly-optics.html