itf-220 - prof.j.frankell example of china’s rmb, continued (2005-2014)
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ITF-220 - Prof.J.Frankell
Example of China’s RMB, continued (2005-2014)
ITF220 - Professor J.Frankel
China has mostly taken the BoP surplus as fx reserves.
But it also allowed RMB appreciation (2005-08 & 2011-12).
ITF-220 - Prof.J.Frankell
Appendix: Five reasons China warranted a more flexible exchange rate regime, in its own interest
• Overheating of economy in 2007-08 & 2010-12: => real appreciation.
• Excessive reserves ($3.7 trillion as of 2014)– Harder to sterilize the inflow over time.
• Attaining internal and external balance.– To attain both, need 2 policy instruments. – In a large country like China, the expenditure-switching policy
should be the exchange rate.– Along with expenditure-increasing policies (2009).
• Avoiding crash: – Experience suggests it is better to exit from a peg in good times,
when the BoP is strong, than to wait until the currency is under attack.
• RMB undervalued, judged by Balassa-Samuelson relationship.
ITF-220 - Prof.J.Frankell
Longer-run perspective:Balassa-Samuelson relationship
• Prices of goods & services in China are low– not just low judged by Absolute PPP (.23 relative to the US),– but also low by standards of Balassa-Samuelson relationship
estimated across countries (which predicts .36).
• The RMB is undervalued in this specific sense.– 2000 estimate was 35%
• before 2007 statistical revisions by IPC project.
– Now undervaluation estimate more like 15%.
ITF-220 - Prof.J.Frankell
Estimation of B-S relationship for 2000
• For every 1% increase in real income/capita (relative to US), prices increase .4% (relative).
• China’s estimated residual is .15– Using revised ICP stats.– Subramanian (2008).
loginc00
Fitted values logRER00 CHN
6.17768 10.6917
-2.15096
.370385
CHN
Frankel (2006)118 countries, PWT
Real appreciation
• The RMB’s real appreciation against the $from 2009 to 2012 amounted to 12%,
• reducing the degree of undervaluation by roughly half,• depending on whether one measures it against the $
or against all currencies.
• More is expected, as China’s relative wages continue to rise.
• In any case, China’s real exchange rate is already closer to this measure of equilibrium than are most countries’ exchange rates (Cheung, Chinn & Fuji, 2010).
China Adjusts, 2009-12
• Various measures suggest that China has achieved a major share of the needed trade adjustment since 2009:
• Its trade surplus peaked at $300 billion in 2008, and declined thereafter.
• Substantial real appreciation of the RMB has brought it closer to equilibrium. – Some nominal appreciation +– Some price inflation and, especially, wage increases.
Adjustment of relative prices
• The famous “China price”:– Ever since China rejoined the world economy
3 decades ago, its trading partners have been snapping up exports of manufacturing goods,
– because low Chinese wages made them super-competitive on world markets.
• But in recent years, relative prices have adjusted– following the laws of market economics.
Adjustment of relative prices, continued
• The change in relative prices is reflected as real exchange rate appreciation. – This comprises, in part, nominal appreciation
– and, in part, Chinese inflation.
– Government officials would have been better advised to let more of the real appreciation take the form of nominal appreciation ($ per RMB).
– But since they didn’t, it showed up as inflation instead.
– See charts below: • appreciation, against the $ and other currencies.
Appreciation versus the US $, 2005-12
0.9
1.0
1.1
1.2
1.3
1.4
1.5
2005 2006 2007 2008 2009 2010 2011
CNY/USD,2005M06=1
nominal
real
The RMB rose against the $ during 2006-08, but temporarily returned to peg in mid-2008.
Appreciation vs. index of currencies, 2005-12
0.95
1.00
1.05
1.10
1.15
1.20
1.25
1.30
1.35
2005 2006 2007 2008 2009 2010 2011
CNY Index,2005M06=1
Real valueof CNY
Valueof CNY
China’s trade balance
The surplus peaked in 2007, and then fell.
Source: Reserve Bank of Australia (June 2013)
China runs a deficit in primary products, offset by a surplus in manufactures.
13
China’s trade balance
The bilateral surplus with the United Statesis as big as ever – which has no economic importance,
but is politically sensitive.
The natural adjustment process was delayed.
• 1st, because the authorities intervened to keep the exchange virtually fixed against the dollar, in the years 1995-2005 and 2008-2010.
• 2nd, workers in China’s increasingly productive coastal factories were not paid their full value. – The economy has not completed its transition
from Mao to market, after all.
• As a result of these two delaying mechanisms, Chinese continued to undersell the world.
But then two things happened.
• 1st, the yuan was finally allowed to appreciate against the $ during 2005-08 & 2010-11, by 25% cumulatively
• =17% + 8%. • Though less against other currencies.
• 2nd, labor shortages began to appear => China’s workers at last won rapid wage hikes. – Major cities raised their minimum wages
sharply over each of the last 3 years: • 22% on average in 2010 & 2011;
• Meanwhile another cost of business, land prices, have risen even more rapidly.
Chinese wages have been rising
16Source: “China’s wage inflation,” Aug. 28, 2013
Real appreciation
• The RMB’s real appreciation against the $from 2009 to 2012 amounted to 12%,
• reducing the degree of undervaluation by roughly half,• depending on whether one measures it against the $
or against all currencies.
• More is expected, as China’s relative wages continue to rise.
• In any case, China’s real exchange rate is already closer to this measure of equilibrium than are most countries’ exchange rates (Cheung, Chinn & Fuji, 2010).
5 types of adjustment are gradually taking place in response to the new high level of costs
in the factories of China’s coastal provinces:
• 1st, some manufacturing is migrating inland, – where wages & land prices are still relatively low.
• 2nd, export operations are shifting to Vietnam or Bangla Desh – where wages are lower still.
• 3rd, Chinese companies are beginning to automate, – substituting capital for labor.
• 4th, they are moving into more sophisticated products, – following the path blazed earlier by Japan, Korea, & other Asian tigers
• in the “flying geese” formation.
• 5th, multinational companies that had in the past moved some stages of their production process to China, out of the US or out of other high-wage countries, are now moving back.
• All five of these ways of reallocating resources represent the economic process operating as it should.
• None of this comes as news to most observers of China.
• Many Western politicians are unable to let go of the syllogism that seemed so unassailable just a decade ago:– (1) The Chinese have joined the world economy; – (2) their wages are $0.50 an hour; – (3) there are a billion of them, and so – (4) their exports will rise without limit:
“Chinese wages will never be bid up in line with the usual textbook laws of economics because the supply labor is infinitely elastic.”
• But it turns out that the laws of economics do eventually apply after all -- even in China.
Expansion of the services sector.
This 6th dimension of adjustment still lags behind,
• despite the consensus in favor of it.
• China has had great success in manufacturing– especially via exports.
• Now it needs to help the other side of the economy catch up: services, via domestic demand– Retail, education, environmental quality,– health care, pensions, social safety net.
• Some of this could be done via government spending– especially with the economy in slowdown in 2014,– as China did in 2009; but that was mostly heavy investment.