China’s Exchange-Rate Trap

Feb 9, 2016 Barry Eichengreen

For months now, China’s exchange-rate policy has roiled global financial markets, because officials have done a poor job communicating their intentions. But criticizing Chinese policymakers is easier than offering constructive advice: In fact the authorities no longer have any good options.

NEW YORK – For months now, China’s exchange-rate policy has been roiling global financial markets. More precisely, confusion about that policy has been roiling the markets. Chinese officials have done a poor job communicating their intentions, encouraging the belief that they don’t know what they’re doing.

But criticizing Chinese policy is easier than offering constructive advice. The fact is that China’s government no longer has any good options. No question, the country would be better off with a more flexible exchange rate that eliminated one-way bets for speculators and acted as an economic shock absorber. But the literature on “exit strategies” – on how to replace a currency peg with a more flexible exchange rate – makes clear that the moment when China could have navigated this transition smoothly has now passed.

Countries can exit a pegged rate smoothly only when there is confidence in the economy, encouraging the belief that the more flexible exchange rate can appreciate as well as weaken. This may have been true of China once; it is no longer true today.

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Nathan W Feb 15, 2016

Capital outflows are a function of stock. Presumably the share of total capital which is eligible for outflow is the short or medium term is very small.

A priori, wouldn't you expect that if a bunch of money exits this month, the pool of capital which is eligible for outflow in the following month should be smaller?

The precise opposite of what people are concerned about?

I mean, if sustained for several months in a row this would be clear cause for concern.

But even bandying about such statistic figures as the number of months until foreign currency is depleted? Beyond early. Almost like you're just looking for something to say. Which is fine, I guess. it's not like we're talking about a peripheral or irrelevant statistic, just something that seems very unlikely to worry about given a single month of high outflows.
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Jeongho Kim Feb 11, 2016

Thank you for your insightful comments
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Charles Estes Feb 11, 2016

China needs a good dose of helicopter money. What better way to spur demand and stimulate creation of a consumer economy? The Peoples Bank needs to create some money for the people!
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Luke Lea Feb 10, 2016

Restructuring and rebalancing the economy easier said than done. Tis said the division of labor is limited by the extent of the market. But in China's case, though there are more than a billion potential consumers, there is no real market, least of all a capital market. How could there be when all the major banks are owned by the state and the state is "owned" by the Party? And efficient allocation of capital is impossible under such circumstances. Which raises the question: have the life savings of the Chinese people been squandered?
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Valerio Gand Feb 10, 2016

Another way would simply be to invest in the huge parts of China to create new jobs, services and manufacturing.
Also addressing the present global warming issue would help the transition to this new phase.
So, in my opinion, China should use this huge surplus to make the whole Country more "3rd millennium oriented", rather than playing with it as a mere financial puppeteer.
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Yoshimichi Moriyama Feb 10, 2016

The ways economy is managed, politics is played and society is integrated or disintegrated are all interwoven in any country. The huge economic imbalance in China is closely knitted together with huge political and social imbalances. It comes inevitably from other imbalances and vice versa. Only the gigantic authoritarian political power in the hands of dynasties, and the CCP is one of the dynasties, have kept the imbalances under control in Chinese history.
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Yoshimichi Moriyama Feb 10, 2016

China has always had big troubles since the CCP came to power in 1949, and of course all the time before 1949. It had the purges, executions, the One Hundred Flowers Bloom, the Great Leap Forward, the Great Cultural Revolution, the Tiananmen Square Protest. All these things happened when China was dreaming the great China Day-Dream and were internal affairs, and the world was saved from being caught up in the China-made maelstroms.
But China has participated in globalization and I am not sure if the world can save itself from the great economic imbalance of globalized China.

I (Michi) posted a comment, It Is Not China's Fault, Nov. 16, 20015, on Michael Pillsbury/The Hundred-Year Marathon, amazon usa. I would appreciate if anyone reads it and is interested.
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Henry Rech Feb 10, 2016

If the considerations were purely economic/financial, then one might think that the Chinese authorities would be brave enough to let the currency float freely, given the economy's very strong trade and current account surpluses and foreign exchange reserves. It would seem there might be considerations of another nature at play. Given the strong currency fundamentals, it would be difficult to argue that the outflows are due largely to speculation about the currency rate - on this score there would be little argument for a devaluation. This all suggests that the currency outflows are of a longer term nature and would therefore be of more concern for Chinese authorities. If the outflows are of a long term nature and not driven by speculation about a devaluation, then it would seem the Chinese authorities might have less reason to free the exchanges. It would be interesting to know how much of the $100 billion/month outflow is by residents and how much by foreigners.
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Paul Daley Feb 9, 2016

We should have China's troubles. A six hundred billion trade surplus, a 33 percent increase in its current account surplus to $300 billion, and 3 trillion in reserves hardly suggests imminent trouble. And capital outflows can't be assessed as a sign of weakness or a sign of strength until we see the back flows in the investment account. So far, to judge from last year's hundred billion jump in China's current account surplus, things look pretty good. If that keeps up, China will soon have a strong international investment position to go along with its already strong trade position.
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