Renminbi Blues

Dave at Macroblog has a link to an FT article which reports that the US are effectively trying to give the Chinese authorities six months to make a renminbi float. As the FT notes, and Dave concurs, this is a rather foolish thing to do. One thing must be clear in all this argument, the Chinese authorities will not publicly let themselves be seen to be pushed around.

But then, even if the pressure were to work, would it have the desired impact?

Brad Setser has a post on this very subject, outlining five (at least) myths about the renminbi float. Four of the 'myths' are just that: myths, as Brad shows. But the fifth one - namely that: Chinese wages are so far below US wages (and for that matter wages in other industrial countries, and many emerging economies) that a change in the renminbi won't have any impact - seems to me to be probably valid. And of course this is the key point on which the whole debate turns.

Now there is a semantic detail here - the won't have *any* impact bit - clearly everything has some impact or other. So lets rephrase the point: won't have the impact that the renminbi float advocates suggest - this I think isn't a myth, but rather an extreme liklehood.

I quote myself from the comments:

I don't think Brad, many of us would disagree that China should revalue (or rather 'flexibilise'). The issue is when, in what way, and above all what the consequences would be.

Whatever the rest of the world wants I wouldn't be too optimistic that the Chinese administration are going to be pushed anywhere very quickly.

There are lots of points, but this seems to be the key one:

"Myth. Goldman Sachs estimates that a 1% rise in the renminbi's real value (which can come either if Chinese inflation is 1% higher than inflation in the rest of the world, or is China's currency rises by 1% and inflation is unchanged) leads to a 1% reduction in China's export growth rate."

I think one would need to see the methodology applied by Goldman Sachs (you wouldn't have the link would you?). I mean intuitively I find this hard to accept.

You youself yesterday were citing Greenspan about how German exporters have swallowed a 40% plus rise in the currency and still go from strength to strength.

If Goldman Sachs say one thing, Morgan Stanley - in the shape of Andy Xie - say another. I tend to trust Andy's intuitions on China, and they fit with mine. But it shouldn't come down to this: we should have some way of trying to validate our intuitions.

My reasoning would be, following Xie, that the differentials between prices of origin in China and end prices in Europe and the US are so huge that there is bags and bags of room for absorption along the line. So I don't think that Chinese exports are likely to reveal the kind of currency sensitivities which you suggest.

Of course there are more arguments. Firstly one could look at the excess fixed capital formation that is taking place in China. A chunk of this is going to end up in products which arrive at end users. This xcess capacity will exert deflationary pressures on prices ex works in China, and these could easily compensate for any upward movement in currency.

Then there is outsourcing. If China is as so sensitive to currency movements then China will outsource: either into the vast interior of China itself, or, as has already been happening as wages have been slowly ticking up in China, to Cambodia, Vietnam and elsewhere. Of course, the ability to do this depends on the product profile. It depends on the level of skill input required, but my guess is that in many of the cases where China is having export success, part of the supply chain is in fact mobile.

OK, that more or less is why I think this myth isn't such a myth.

Brad's response: The Goldman paper looks at overall chinese exports/ imports, not us-chinese trade. And the basic reasons for the econometrics are pretty easy to see -- China's export growth rate picked up dramatically after the real exchange rate started to fall in 02 (along with the dollar).

And my riposte: Just two points here Brad: Firstly these things are not necessarily symmetrical - you may react differently to an opportunity than you do to a threat, it is easier to hire workers and buy equipment than it is to fire and 'decomission' them. ie once you're in for the fixed costs, the economics of decision taking are different.

Secondly, there is the cause/effect problem. ie was the important point here a cheap renminbi, or a high euro. My feeling is that you need to start from the latter, and its impact on re-structuring in Europe.

Prior to 2002 China outsourcing was very much a US thing, probably driven by the high dollar and the need to sell to Europeans and Japanese (we need some trade theory as well as econometrics here). So post 1995 the US corpration increasingly reaches out globally to extend supply lines, and discovers China. The EU response - as with IT - comes later, and post 2002 there is a major push into Central Europe and China.

So the methodological question is what is driving what here. As I say, given the capacity expansion in China, any obstacles to trade are just going to drive prices down there.

The point maybe is this:

"leads to a 1% reduction in China's export growth rate".

Now is the export growth rate being driven primarily by the value of the currency, or by the increase in fixed investment, which may be rather responding to other factors? All I am really saying is that this problem is a fairly complex one, with a lot of inter-connections, and I still am not convinced that the Goldman Sachs argument gets us very far.

Also, of course, if the myth is that a revaluation 'won't have any impact' then clearly it is a stupid one: some impact there will be (so it's a trick question :) ). The question is: will a renminbi revaluation have the consequences that its most vociferous advocates assume it will? I think this is much more open to doubt.

Anyway, the whole thread is worth a look, so go read :).