Is China’s undervalued currency set to rise? That depends on how you interpret yesterday’s comments from the governor of China’s central bank.
“The chief of China’s central bank reportedly suggested Saturday that the nation may decide to let its currency rise vs. the dollar, but he gave no clues as to when that might happen,” TheStreet.com reported. Meantime, The New York Times tells us: “China’s Bank Chief Says Currency Is Unlikely to Rise.”
No matter how you interpret Zhou Xiaochuan’s comments yesterday, there was enough innuendo and implication to support almost any forecast. Consider this tantalizing remark via The Telegraph: “If we are to exit from irregular policies and return to ordinary economic policies, we must be extremely prudent about our choice of timing,” Zhou said. “This also includes the [yuan] exchange rate policy.”
Such oblique observations will keep the rumor mills rolling and the forex traders trading. In any case, the stakes could hardly be much bigger for the global economy, and the U.S. in particular. The Middle Kingdom’s GDP (at purchasing power parity) is second only to the U.S., or third if you consider the European Union a single country, according to the CIA World Factbook. And while large economies tend to expand at relatively low rates compared with smaller nations, that doesn’t yet apply to China, which is estimated to have grown at a real rate of 8.4% last year, according to the CIA—exceeded only by four other countries, all of which are tiny by comparison.
“A country’s exchange rate cannot be a concern for it alone, since it must also affect its trading partners,” the FT’s Martin Wolf recently argued. “But this is particularly true for big economies. So, whether China likes it or not, its heavily managed exchange rate regime is a legitimate concern of its trading partners. Its exports are now larger than those of any other country. The liberty of insignificance has vanished.”
That’s a diplomatic interpretation of how America views China and its currency. Robert Lawrence Kuhn, an international investment banker and longtime adviser to the Chinese government, summarizes the American perspective in somewhat harsher tones. “China is seen as a mercantile predator which keeps its currency artificially low to boost exports and steal jobs…”, he writes in his new book How China’s Leaders Think: The Inside Story of China’s Reform and What This Means for the Future. Beijing begs to differ, Kuhn acknowledges. “China’s leaders, of course, do not deny that their policies benefit their own people. But they assert that, in an integrated global economy, China’s stability and development is essential for world peace and prosperity.”
For good or ill, the global ramifications are huge. Keeping the yuan undervalued boosts China’s exports, a major reason for America’s trade deficit, which in turn creates an incentive for China to buy U.S. Treasuries as a tool for keeping its currency cheap relative to prices implied by trade flows. One result of this policy is that U.S. interest rates have been lower, perhaps a lot lower than they otherwise would have been. Economist Robert Barbera, writing in The Cost of Capitalism, explains the linkage in recent years:
Low mortgage rates, booming housing refinance, and strong consumer spending defined 2002-2005. Much of the spending was on products made in China. Incredibly, over the first five years of the new decade, China’s exports to the United States rose from 4 to 11 percent of nonauto U.S. retail spending. China’s excitement about this export boom led directly to its strategy for conducting monetary policy. Central bank authorities were willing buyers of the U.S. dollar in order to make sure that there was very little change in the dollar/Chinese yuan exchange rate.
Accordingly, they bought the U.S. dollars that Chinese manufacturers collected for their exports. They bought the dollars that U.S. multinational corporations spent as they built factories in China. They bought the dollars U.S. investors funneled into Chinese real estate. In total, these purchases led to China’s accumulating trillions of dollars’ worth of U.S. Treasuries in a remarkably short period. If we accept the assertion that China’s bond buying kept mortgage rates low in the United States, we come to an interesting conclusion. China kept U.S. long rates low by lending trillions to the United States. Low mortgage rates allowed Americas to borrow against their homes and use the proceeds to spend. And, increasingly, they bought products that were made in China—vendor financial on a trillion-dollar scale.
The benefits, and repercussions, from the low rates are, of course, well known at this point. But while most of the world we knew under the regime of the Great Moderation is gone, one of its basic building blocks remains intact. But is China’s undervalued currency finally living on borrowed time?
The yuan is essentially unchanged in dollar terms since mid-2008. Almost everything else in the global economy has changed, been repriced or reassessed. Will the status quo as it relates to China’s currency roll on?
“It is encouraging that Gov. Zhou’s statement suggests that the move to a managed float of the renminbi will be resumed once the global recovery firms up,” Eswar Prasad, a professor of trade policy at Cornell University, told The Wall Street Journal yesterday. “Maintaining an undervalued exchange rate certainly benefits China, but at the expense of other countries that lose their relative competitiveness in foreign trade.”
As complicated as all this is, the reality is even more Byzantine. Trade policy is but one slice of the U.S.-China relationship. The challenge is deciding how one corner influences another. Washington’s stance on Taiwan, for instance, and China’s reaction (including the latest announcement from Beijing), is one of many reminders that the game’s is three-dimensional chess.
“Just as the nineteenth century belonged to England the twentieth century to America, so the twenty-first century will be China’s turn to set the agenda and rule the roost,” Jim Rogers advised in A Bull in China. Figuring out what that means in geopolitical and macroeconomic terms has only just begun.