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June 08, 2005
Renminbi Revaluation: How Much Effect?
Not much, suggest at least a couple of important policymakers. From today's Wall Street Journal (page A13 in the print edition):
Chinese central bank chief Zhou Xiaochuan warned that mounting political pressure on Beijing to revalue its currency, and overblown expectations about how such a move may help correct imbalances in the world economy, are making it more difficult for China to take action...
Mr. Greenspan acknowledged that a stronger yuan doesn't mean the overall U.S. deficit will shrink much, because U.S. importers simply would turn to other countries offering inexpensive goods. He said a stronger yuan may help reduce the U.S. trade deficit with China. He also argued that Chinese intervention in currency markets to keep the yuan from rising couldn't continue indefinitely. A more flexible currency "is very much to the advantage of China," he said.
A related opinion appears in this month's edition of the Cleveland Fed's Economic Trends:
A renminbi revaluation seems an eventual certainty, but betting on how it might affect trade is still risky. Trade depends on the real, or inflation-adjusted, exchange rate. A change in the peg will certainly affect the real rate for a while, but few economists expect it to have a lasting effect on the real exchange rate.
The article (which appears on page 9) updates a picture that appeared in an earlier post:
How far is the renminbi likely to fall? The Trends article includes this:
Forward exchange rates often reveal the market’s best guess about a currency’s future path, but no forward renminbi market exists because China restricts such trading. Recently, a market in nondeliverable forwards (NDFs) has arisen to provide cover for companies trading in renminbi. An NDF contract sets an exchange rate for the future purchase or sale of renminbi. But unlike a standard forward contract, delivery on an NDF is made not in renminbi, but in an equivalent amount of a convertible currency, such as U.S. dollars.
Forward rates on renminbi NDFs have been below Rmb 8.28 per dollar since mid-2002, suggesting that the market expects a renminbi appreciation. Recently, NDFs generally have fallen to new lows.
Here's the picture:
By my calculation, that looks like the neighborhood of 6-1/2 percent.
UPDATE: I was reminded by a colleague -- they are all well-practiced in correcting me -- that futures/forward rates are not unbiased predictors of future spot rates: The general direction is more informative than an exact number. You can find a reader-friendly article on the topic of futures-prices-as-predictors here.
UPDATE: Mark Thoma has some additional thoughts.
June 8, 2005 in Asia, Exchange Rates and the Dollar | Permalink
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Comments
Posted by:
pgl |
June 08, 2005 at 01:25 PM
More on this from Stephen Hanke of Cato as well as the Schumer-Graham NYTimes oped. See Angrybear for a post just up. And I'm hoping Mark Thoma adds his wisdom to this debate.
Posted by:
pgl |
June 08, 2005 at 02:41 PM
Not much? Try "None".
For starters, let's review what Greenspan said last month on this issue.
Greenspan's comments during a Q&A following his oil address at the Economic Club of New York:
A rise in the value of China's currency won't cut the overall U.S. trade deficit, but would likely boost domestic prices, Greenspan said.
A move by China to revalue its currency "does not follow that that will lower our overall trade balance," Greenspan said. "Indeed, it's probably quite unlikely."
If the prices of Chinese exports to the U.S. increase, American consumers will likely purchase goods from other foreign countries, not from domestic manufacturers, Greenspan said.
"So essentially what we will find is we are importing from a different area but we'll be importing the same goods," Greenspan said.
"The effect will be a rise in domestic prices in the United States and as a consequence of that, we will have other impacts which I could trace through but I've fortunately run out of time in this question."
Articles: BusinessWeek; Reuters; MarketWatch
http://www.businessweek.com/ap/financialnews/D8A74KKG0.htm?campaign_id=apn_home_down
http://www.reuters.com/financeNewsArticle.jhtml?type=bondsNews&storyID=8561723
For clarity:
A move by China to revalue its currency "does not follow that that will lower our overall trade balance," Greenspan said. "Indeed, it's probably quite unlikely."
Posted by:
Movie Guy |
June 08, 2005 at 04:30 PM
CHINA'S CURRENCY CHANGE WILL NOT HELP SOLVE THE U.S. TRADE DEFICIT
It's my judgment that Greenspan got it right in May 2005. His views echo in clear language what I have addressed regarding the U.S. trade deficit on other blogs and threads.
Import price increases may likely occur, but the overall production of such finished goods (as presently manufactured and assembled in China and elsewhere overseas) will remain offshore. The production cost differentials, barring considerable cost increases abroad, will not result in a shift to manufacturing and/or assembly of such goods in the USA.
As such, there is little likelihood that the U.S. trade deficit will decline in dollar terms due to production price increases in China if we're relying on a supposed reduction in imports for such trade deficit reduction. Yes, Americans may buy fewer finished goods products from Asia due to price increases, but the dollar value of the such overall imports may not decline at all. Or will not decline until such time as the USA suffers another recession or significant economic slowing due to interest rate increases. In point of fact, the import dollar value of the trade balance may increase.
U.S. household savings will not necessarily increase because the currency of China is revalued. As the finished goods prices increase, Americans will hard pressed to add to such household savings without wage and other income increases. As long as the majority of household finished goods in this category of purchase are manufactured overseas, Americans will continue to buy them without regard for "Made in USA" substitutes because such substitutes do not, in general, exist. Americans will simply be paying higher prices for such goods.
Viewed singularly, I fully expect a revaluation of the currency in China to lead to an increase, not decrease, in the U.S. trade deficit in dollar terms.
Why others, including supposed key economists, can't see this possibility strikes me as very odd. This is an elementary exercise in pricing and consumer purchasing behaviors. Consumers will continue to purchase finished goods manufactured in China and elsewhere in Asia. Minor price increases on "single region source" finished goods will not slow consumer purchasing very much.
Posted by:
Movie Guy |
June 08, 2005 at 04:43 PM
David - the premise that the forward rate of an exchange rate is an imperfect measure of the expected future spot rate has a long history in international finance. Risk premia may exist but they are likely quite modest. Given that the best the rest of us have done as far as even measuring real exchange rates (see Brad Setser's comments on my feeble attempt), a rough approximation from Int'l Fisher equivalece is quite good.
Posted by:
pgl |
June 08, 2005 at 05:31 PM
A point of clarification regarding my post above.
It is my expectation that U.S. imports will continue to grow faster than U.S. exports based on existing trade policy.
I am clearly discounting the impact that a slight (5%-8%) China currency revaluation will have on improving U.S. exports. I have every expectation that U.S. imports will not lag U.S. exports due to this single potential change.
That's my viewpoint and I'm sticking to it. We'll find out who is correct later on.
Posted by:
Movie Guy |
June 08, 2005 at 10:10 PM
Excellent discussion. Two points: (1) DeLong has argued many times that a yuan appreciation will have a very modest impact on the US current account deficit and hence a very modest impact on our economy; and (2) I'd like to know more about the real exchange rate metric (circa 1996 to 2004) given my attempt at graphing this from circa 1979 to 2000 using IMF data (which basically stops reporting China's price index after 2000). Brad Setser was kind enough to provide a measure past 2000 but also noted he put little faith in either my measure or any other measure.