The pressure for one of the world's currencies to move upwards is growing, especially since the fashionable direction is down. Absent any other leading contenders for the rising boat scenario, attention is now gradually shifting to China as the magnitude of what is happening there slowly sinks in. The always on-the-ball Andy Xie argues that the answer to this should be 'not yet', in the interest of Chinese and hence global stability.
RMB revaluation would worsen China's deflation and depress its domestic demand, in my view. With a large amount of surplus labor, China's competitiveness would be restored through a nominal wage decline. RMB appreciation wouldn't ease deflationary pressure elsewhere in East Asia at all. Instead, currency appreciation and wage declines in China would merely destabilize East Asia. A stable RMB is in the best interest of East Asia and the world., in my opinion.
Of course, China must allow the market to determine the value of its currency at some point. We believe this is possible only when China's capital account is mostly open. This wouldn't be possible, I believe, if China's financial sector remains state-controlled. China is adopting a gradualist approach toward financial reforms. It could be five years away before China's capital account becomes fully open, in my view.
China is outperforming other Asian economies in export. This isn't new. Between 1987-97 China's exports grew eight percentage points faster than Taiwan's and by 5.4 percentage points faster than Korea's (see Exhibit 1). This gap widened to 9.6 and 7.2 percentage points, respectively, between 1997-2001. What is taking place is perfectly consistent with comparative advantage. China is a latecomer to globalization and is growing faster to catch up.
Because trade has become so large in China's economy, global demand determines China's wages. If RMB appreciates, it would depress global demand for Chinese goods and, thus, labor. That would translate quickly into downward pressure on wages. Chinese wages measured in US dollars would decline to reflect global demand for Chinese labor. The exchange rate is simply not powerful enough to artificially prop up wages in China.
Source: Morgan Stanley Global Economic Forum