Sunday, November 23, 2014

America's Renminbi Fixation

NEW YORK – For seven years, the United States has allowed its fixation on the renminbi’s exchange rate to deflect attention from far more important issues in its economic relationship with China. The upcoming Strategic and Economic Dialogue between the US and China is an excellent opportunity to examine – and rethink – America’s priorities.

Since 2005, the US Congress has repeatedly flirted with legislation aimed at defending hard-pressed American workers from the presumed threat of a cheap Chinese currency. Bipartisan support for such a measure surfaced when Senators Charles Schumer (a liberal Democrat from New York) and Lindsey Graham (a conservative Republican from South Carolina) introduced the first Chinese currency bill.

The argument for legislative action is tantalizingly simple: the US merchandise trade deficit has averaged a record 4.4% of GDP since 2005, with China accounting for fully 35% of the shortfall, supposedly owing to its currency manipulation. The Chinese, insists a broad coalition of politicians, business leaders, and academic economists, must revalue or face sanctions.

This reasoning resonates with the US public. Opinion polls conducted in 2011 found that fully 61% of Americans believes that China represents a serious economic threat. As such, the currency debate looms as a major issue in the upcoming US presidential campaign. “Enough is enough,” President Barack Obama replied, when queried on the renminbi in the aftermath of his last meeting with Chinese President Hu Jintao. Obama’s presumptive Republican challenger, Mitt Romney, has promised to declare China guilty of currency manipulation the day he takes office.

But, however appealing this logic may be, it is wrong. First, America’s trade deficit is multilateral: the US ran deficits with 88 nations in 2010. A multilateral imbalance – especially one that it is traceable to a saving shortfall – cannot be fixed by putting pressure on a bilateral exchange rate. Indeed, America’s major threat is from within. Blaming China merely impedes the heavy lifting that must be done at home – namely, boosting saving by cutting budget deficits and encouraging households to save income rather than rely on asset bubbles.

Second, the renminbi has now appreciated 31.4% against the dollar since mid-2005, well in excess of the 27.5% increase called for by the original Schumer-Graham bill. Mindful of the lessons of Japan – especially its disastrous concession on sharp yen appreciation in the Plaza Accord of 1985 – the Chinese have opted, instead, for a gradual revaluation. Recent moves toward renminbi internationalization, a more open capital account, and wider currency trading bands leave little doubt that the endgame is a market-based, fully convertible renminbi.

Third, there has been significant improvement in China’s external imbalance. The International Monetary Fund estimates that China’s current-account surplus will narrow to just 2.3% of GDP in 2012, after peaking at 10.1% in 2007. American officials have long bemoaned China’s saving glut as a major source of global instability. But they should look in the mirror: America’s current-account deficit this year, at an estimated $510 billion, is likely to be 2.8 times higher than China’s surplus.

Finally, China has evolved from the world’s factory to its assembly line. Research shows that no more than 20% to 30% of Chinese exports to the US reflect value added inside China. Roughly 60% of Chinese exports represent shipments of “foreign invested enterprises” – in effect, Chinese subsidiaries of global multinationals. Think Apple. Globalized production platforms distort bilateral trade data between the US and China, and have little to do with the exchange rate.

Rather than vilifying China as the principal economic threat to America, the relationship should be recast as an opportunity. The largest component of US aggregate demand – the consumer – is on ice. With households focused on repairing severely damaged balance sheets, inflation-adjusted private consumption has expanded at an anemic 0.5% average annual rate over the past four years. Consumer deleveraging is likely to persist for years to come, leaving the US increasingly desperate for new sources of growth.

Exports top the list of possibilities. China is now America’s third largest and most rapidly growing export market. There can be no mistaking its potential to fill some of the void left by US consumers.

The key to realizing that opportunity lies in access to Chinese markets – all the more significant in light of China’s upcoming pro-consumption rebalancing. Historically, China has had an open development model, with imports running at 28% of GDP since 2002 – nearly three times Japan’s 10% import ratio during its high-growth era (1960-1989). As a result, for a given increment of domestic demand, China is far more predisposed toward foreign sourcing.

As the Chinese consumer emerges, demand for a wide variety of US-made goods – ranging from new-generation information technology and biotech to automotive components and aircraft – could surge. The same is true of services. At just 43% of GDP, China’s services sector is relatively tiny. There is enormous scope for America’s global services companies to expand in China, especially in transactions-intensive distribution sectors – wholesale and retail trade, domestic transportation, and supply-chain logistics – as well as in the processing segments of finance, health care, and data warehousing.

The US needs to refocus the US-China trade agenda toward expanded market access in these and other areas – pushing back against Chinese policies and government procurement practices that favor domestic production and indigenous innovation. Some progress has been made, but more is needed – for example, getting China to join the World Trade Organization’s Government Procurement Agreement. At the same time, the US should reconsider antiquated Cold War restrictions on Chinese purchases of technology-intensive items.

For a growth-starved US, the opportunities of market access far outweigh the currency threat. The long-dormant Chinese consumer is about to be unleashed. This plays to one of America’s greatest strengths – its zeal to compete in new markets. Shame on the US if it squanders this extraordinary chance by digging in its heels at the upcoming Strategic and Economic dialogue.

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    1. CommentedProcyon Mukherjee

      Paul Jefferson has actually given the answer, but at the very end. Renminbi appreciation does not help the American business partners who source cheap goods into U.S. which is equivalent of importing labor and exporting capital goods, which the Chinese buy. It would actually benefit the Chinese a little bit if the Renminbi appreciates.

      The CCER study showed that 44 percent of the Chinese trade surplus was contributed by U.S. companies operating in China, and 20 percent by other foreign companies there.

      CCR study showed that if we take iPhone, a personal electronic device designed by the U.S. Apple Inc. as an example. The product, assembled in China, alone accounted for 1.9 billion dollars of China's trade surplus with the United States in 2009.

      CCER study showed that most of China's trade with the U.S. is compensation trade, which may account for 60 percent of the total (bilateral) trade. The yuan's appreciation may somewhat increase China's trade surplus, contrary to the common sense.

      It means China can import raw materials and equipment at relatively low prices.

      Even if China is forced to give up exporting some of its products once the yuan appreciates, the United States will still have to buy those products, which it usually does not manufacture, from other countries -- which neither helps bring down its trade deficit nor create jobs.

      According to a CCER model co-developed with a U.S. institution, if the yuan appreciates by 5 percent against the dollar, the U.S. employment rate will rise by only 0.03 percent; even if the yuan appreciates by 20 percent, it only helps to raise U.S. employment by 0.16 percent.

      The effects of the yuan's appreciation on stimulating consumption are even smaller. According to the model, U.S. consumption will be up a mere 0.02 percent, given a 5-percent appreciation of the Chinese currency against the dollar.

      Meanwhile, the model showed that the increase in the yuan's value is unlikely to affect the U.S. gross domestic product (GDP) much -- if the yuan rises by 5 percent, the U.S. GDP would go up 0.02 percent, while China's GDP would contract 0.56 percent.

      We could do some sensitivities with the modeling, but the truth will not be any far. If renminbi appreciates significantly, the Chinese foreign exchange reserves at $3 Trillion poses a significant challenge to both the nations, it could be either way a situation to make new adjustments.

      Procyon Mukherjee

    2. CommentedPaul Jefferson

      The Chinese yuan has actually appreciated by about 3.6% per year for the past two years, according to this chart:

      But if the yuan had instead been allowed to float freely, how much more would it have appreciated? Would the appreciation have been greater by a factor of 10, or 20?

      Why is the Chinese dictatorship afraid to find out? Are they afraid because they themselves know that the yuan is significantly undervalued? Probably.

    3. CommentedPaul Jefferson

      There must be some advantage for China in keeping its currency low. Otherwise, China's leaders would not be so stubbornly persistent in depressing the value of the yuan.

      Obviously, China's artificially low currency gives them a price advantage in international trade. This allows them to penetrate and dominate foreign markets.

      Conversely, the low yuan is an obstacle for any USA-based manufacturer who wants to sell to China. USA-made goods are typically too expensive, partly because China's currency is held at an artificially low level.

      Similarly, the low yuan has made China's labor costs so cheap that American workers cannot compete. Consequently, many are unemployed or underemployed. Yet the author believes these financially stressed individuals can be persuaded to save more. How?

      The advantage of a low currency is clear: China enjoys an 8% growth rate, versus a quarter of that in the USA. And China's dictators want a low yuan to help them retain their grip on power, by keeping Chinese workers employed, thereby avoiding economic discontent.

      Clearly, China has strong motivation to depress the yuan's value, which is why they still do it. The 31% appreciation the author referred to is not recent. In fact, the yuan has been held in a tight range for the past several years.

      Anyway, why would the author consider 31% to be sufficient? Is this number based on purchasing power parity? Or on an interim target set by a USA politician long ago? Why not just allow the currency to float freely, and let the market decide?

      Other excuses offered by the author for China are equally suspect. He states that "the endgame is a market-based, fully convertible renminbi". However, what we are actually witnessing indicates that China's real endgame is to dominate the world economy. They intend to become the new imperial, dictatorial master of the world.

      The author also states that "China has had an open development model, with imports running at 28% of GDP". But what did those imports consist of? Oil? Raw natural resources? From where? If this is such a significant statistic, then the author should break out the components to reveal the true story.

      Finally, the author advises that "the US should reconsider antiquated Cold War restrictions on Chinese purchases of technology-intensive items." In other words, the USA should concede defeat, and surrender their last major technology advantage. After all, the US cannot defeat North Korea, because China will not allow any meddling with their puppet. And the US cannot prevent China from stealing US technology and selling it to Iran. Resistance is futile, the author seems to say, so let's just surrender now.

      This is not to imply that the USA should base its economy on weapons technology. But sadly, that is one of the few remaining areas of competitive advantage left. This is after years of assault on the USA economy by nations such as China, who have manipulated their currencies for their advantage, at America's expense.

      But the real threat to the USA is not China! Instead, it is wealthy Americans whose loyalty is not to their own country, but to themselves and to trans national corporations. China's unfair cost advantage only makes these individuals and corporations richer. And if America collapses, they can afford to move to Singapore or Shanghai.

      Who can we trust to save America and the world from centuries of domination by the fascist dictatorship that is China? Not the 1% protesters, whose goals are vague, and whose strategies are ineffectual. Not Obama, who has squandered every opportunity to resist currency manipulators such as China. And not Romney, who is beholden to the ultra rich.

      Sadly, without competent leaders, lacking sufficient political will, and mostly blind to the danger, America – and it's industrialized peers – seem destined to succumb.

        CommentedLawrence Fassio

        In response to Paul Jefferson's claim about the increase in the value of the Chinese yuan, my computation of its increase over the past two years, from the chart whose link he supplied, is a 0.3% increase, or slightly more than 0.1% per year

        CommentedPaul Jefferson

        The Chinese yuan has actually appreciated by about 3.6% per year for the past two years, according to this chart:

        But if the yuan had instead been allowed to float freely, how much more would it have appreciated? Would the appreciation have been greater by a factor of 10, or 20?

        Why is the Chinese dictatorship afraid to find out? Are they afraid because they themselves know that the yuan is significantly undervalued? Probably.