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September 11, 2006

More Fuel For The Yuan-Debate Fire...

... which, thanks to Tyler Cowen (here and here), Brad Setser (here and here), and others, was burning pretty hot last week, comes today in the form of the latest report on the Chinese trade surplus.  From The Financial Times:

China’s trade surplus reached $95.7bn through the first eight months of the year, soaring to a monthly record of $18.8bn in August, according to customs statistics released on Monday.

The figures for August were the fourth consecutive monthly record this year, well exceeding the $14.6bn reported in July. China’s trade surplus this year is expected to exceed last year’s total of $102bn within weeks.

Says Brad today:

The soaring Chinese trade surplus though does imply that the scale of capital outflows needed to keep the RMB from rising, should Chine ever liberalize its capital account (which, as Drezner notes, isn’t about to happen), has grown.

I reckon that's right, but I couldn't help notice this story, also from the Financial Times

Xinhua, Beijing’s official news agency, on Sunday issued rules demanding international counterparts censor news and information distributed in China and barring them from dealing directly with local clients.

The rules, which take effect immediately, mark a dramatic resumption of Xinhua’s efforts to regulate the Chinese operations of rival foreign news agencies tightly...

Sunday’s ban on the distribution of any agency content that “harms China’s national security or honour” or “disturbs the Chinese economy or social order” matches other recent moves by Beijing to tighten media censorship.

Where this will lead is still anyone's guess...

However, it is unclear how forcefully Xinhua will be able to implement its new regime, which is likely to be opposed by domestic banks and other financial institutions as well as by the foreign news agencies themselves.

... but I'm moved to emphasize this passage, from Tyler's original New York Times article:

The yuan should not, as matters stand, float freely with free capital movements. Large quantities of Chinese savings, currently restricted to the domestic currency, would probably flee the country, worsening the serious solvency problems at Chinese banks. The Chinese must first clean up their banking system before they can have free capital markets. Contrary to the conventional wisdom, a market-determined value for the yuan might well be lower than today’s exchange rate, not higher.

Here's a question: What would normally happen to a free-floating currency, unrestrained by pervasive capital controls, in the wake of, to borrow the characterization in the FT headline, moves to "tighten the leash on foreign media"?

September 11, 2006 in Asia , Exchange Rates and the Dollar | Permalink


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It would fall, in the abscence of other factors.

But what would normally happen to the official foreign-currency reserves in a country that "tightens the leash on foreign media"?

Posted by: ErikR | September 12, 2006 at 07:13 AM

A few disjointed observations. The experience in Korea over the past several years leads me to increasingly question my long held standard econ view that a large yuan appreciation would lead to meaningfully slower Chinese export growth and a smaller trade surplus. This has just not happened in Korea despite won appreciation from 1400/$ to 950/$. Korea's exports grew about 14%yoy in H1 06 and its non-oil surplus hit a record high.

HOWEVER, this is not to say Korea has not experienced any adjustment to this appreciation in the real exchange rate. The current account surplus has plunged from $30bn several years ago to about $4bn this year, in large part because of a sharp deterioration in the net services balances. The lesson being that where the economy is very productivie - manufacturing - the excahange rate adjustment has been compensated for via productivity growth, but where the economy is less competitive and productive - in a variety of services - the real appreciation has swung flows powerfully.

I am not saying China should not appreciate. I am merely making the perhaps pedantic point that appreciation may not yield the 'standard' outcome in exports and the trade balance most commentators expect. And from a political economy perspective, that's the point. The Chinese fear yuan appreciation will lead to severe dislocations in the rural agrarian sector in which China is uncompetitive. This is politically important because this is where the bulk of the population resides. This labor is generally less educated and less able to transition into domestic services. So the fear is an even faster pace of rural to urban migration that is socially destablizing (and perhaps provides more fodder for ultra cheap Chinese basic manufactures/exports). Again, I'm not saying this definitively justifies the Chinese position, but it does help one to understand where it comes from.

Finally, i feel the bit about a free capital account is a red herring in the whole yuan debate. First, even the IMF now agrees that free and open capital accounts should be approached very, very cautiously by developing countries. Second, a free capital account is neither a necessary nor sufficient condition for a freely floating currency. Currency regime is a totally separate decision. Hong Kong has a completely free capital account and a very tightly pegged currency. Third, read the emperical findings, hold your breath, have an extra cup of coffee, and look at Japan. Japan had de facto bankrupt banks and ZERO interset rates, but never had a massive, destabilizing flight of deposits from its banking system. The combination of home bias and a government guarantee do wonders to keep a deposit base stable, despite low real interest rates. And remember, something like 80% of China's deposit base is in government owned banks (read, already guaranteed).

Posted by: rfarris | September 12, 2006 at 08:45 PM

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