Re: Currency Appreciation
euming yeow
5/3/10
to Alan

RE: THE CHINESE YUAN (ALSO KNOWN AS RENMINBI) - TO APPRECIATE?

Hi Alan,
Sorry for not replying earlier to your March 26, 2010 email on China's position as to the constant US call for its currency yuan (or renminbi) appreciation.

1. Pegging the Yuan to the USD:

1.1. China's rise as an economic powerhouse was helped greatly by its pegging of the Chinese yuan to the US dollar, and making trading arrangements with the U.S. - in 1985 when it began, China's exports to US was around $4 million. By 2008, China's exports to US totalled $337.8 billion!

1.2. From 1985 to 2008, US exports to China was around one-third of China's exports to the US. Thus the Chinese peg to the US$ was beneficial to China's export business as foreign investors were now more confident in China's currency yuan, which then, was virtually unknown outside China.

1.3. The constant bitching from the US is that China's meteoric rise as an economic powerhouse is simply because China pegs its yuan to the US$ at a very low and artificial rate - not based on standard interest rate policy like most other countries' central banks' monetary policies, but on Chinese banks' reserve requirements. Thus the yuan is controlled by China's central bank - called The Peoples' Bank of China - on a fixed exchange rate basis, and here, if the banks' reserve requirements are increased, the money supply in the economy will be reduced and conversely. Traditional interest-rate policies are not used here insofar as exchange rates are concerned.

2. The Yuan/Dollar Relationship:

2.1. The regular US argument is that China is benefitting more each year from such fixed exchange rate regime, to the detriment of US manufacturers and exporters, who cannot compete against the cheaper Chinese goods. But then, cost of production - in every aspect - is definitely cheaper in China than US. Just look at the ridiculous high wages and benefits paid to say, US auto workers in General Motors which has been saved from bankruptcy by the US government pumping in billions $ in 2009.

On the other hand, GM China is No. 1 in China in terms of sales and profits. How did this happen? The Wuling Sunshine van is selling at around $4,500 basic model (about 7% above its Chinese competitors) and is China's best-selling vehicle, with 597,000 units sold last year. GM China built these vans so efficiently with its two Chinese
partners that this Wuling venture is the cornerstone of its growth strategy, and GM is pushing this low-cost business model in Asia, starting with India. It is so confident of its successes (GM already a market leader in China with their Buick and Chevrolet brands) GM is now investing $250 million R&D centre on its Shanghai campus of its new international HQ. See the differences in strategies, thinking etc?

2.2. China's standard argument is that their currency peg is meant to foster economic stability, and abandoning this currency peg would lead to economic chaos in China. An undervalued yuan means lower prices of Chinese goods to US customers, lower inflationary pressure, and lower input prices for US manufacturers that uses Chinese inputs. A lower yuan makes US exports more expensive to Chinese consumers and thus reduces US exports to China. But, as things stand today, nothing from the US to China or anywhere else is cheap because of their high cost of labour, inputs etc!

2.3. As of today, the yuan/dollar peg is 6.8339, that is, US$1.00 = Yuan 6.8339, and this peg has remained since July 2008.

3. Realities about China's Huge Balance of Payments Surpluses:

3.1. This China-bashing is fierce and emotional, so much so master critic Nobel Laureate Paul Krugman even contended that China had since taken millions of jobs globally, especially from the United States!

3.2. China's balance of payments surpluses or trade surpluses came very slowly in the 90s and rose sharply since 2004 (amounting to 3.%% of GDP) to reach a high of 10.8% GDP in 2007. The surplus has now moderated slightly, e.g. March 2010 imports exceeded exports by US$390 million, China's first trade deficit in six years, undermining United States' constant yuan criticism!

3.3. Asymmetric market liberalization in China initiated by the late Premier Teng Siao Peng meant that the factors of production - labour, capital, land, energy and environment in China - became highly distorted in the rush to industrialization and massive export-oriented economy thinking. For example, China's huge labour pool is the key to its worldwide manufacturing exports successes. But in controlling the huge rural labour movements to the cities, labour immobility results and exploitation of millions of these rural migrants led to low pay, and an inefficient, out-of-date welfare system meant that payroll costs should be at least 35-40% higher, according to one internal Chinese study!

3.4. Likewise, land is State-owned mostly, and industrial land use are not based on market price mechanism, but usually sold/given away cheaply to stimulate industrial investment.

3.5. Likewise, energy prices are low and State-subsidized, and environmental control and pollution is serious and not costed in either.

3.6. These capital market distortions it is estimated, contributed to some 40% of overall costs of production, which is not costed in properly, and these structural imbalances will not go away. So the root cause of these factors of production distortions, distorted incentives for investors, producers and exporters must be seriously tackled successfully first by China to arrive at a truer, and higher, cost of production.

3.7. Thus, looking at the picture in this respect, the undervalued yuan is just one element in this big jigsaw puzzle!

4. China's Savings Ratio:

4.1. Another favourite Western bashing is that China saves more, and spends very much less, thereby not stimulating their own internal economy. For over 15 years, China's household savings rate has been stable at about 30% - nothing unusual here, as most Asian countries definitely save around these % or more, against the US, where the propensity to spend is adversely affected by their low propensity to save!

4.2. Corporate savings it is estimated, are growing exponentially largely due to China's huge exports, and this is a major factor accounting for its huge balance of payments surpluses, not the savings rate.

5. The Yuan Exchange Rate Options - How Much to Rise?:

5.1. The usual Paul Krugman-type thinking is to let the yuan rise to "a certain margin" to eliminate the undervaluation - but this then begs the question: how much is right/correct/equitable? And definitely China and US and Europe all see this so-called "equalization" factor very differently from each other!

5.2. Goldman Sachs, in an April 2010 report stated that "....... our model suggest that the RMB (renminbi or yuan) is very close to the price that it should be...... The model used to suggest that the currency was undervalued by about 20%, but it has moved by that degree over the past five years."

5.3. A 2009 research paper of Goldstein and Lardy at the US Peterson Institute estimated a 12-16% undervaluation.

5.4. But here's the interesting notes: Between mid-2005 and end-2008, the yuan appreciated by 19%, and this after it appreciated some 30% over past 10 years since January 1994! Yet, China's balance of payments surpluses surged during these periods!

I don't see any comments on these phenomenon by Paul Krugman or any other Western economists, monetarists etc.

5.5. It is generally accepted that any large, sudden, foreign exchange adjustments will cause long-term and permanent damage to any economy, and, in China's case, will not
solve its huge BoP surpluses unless and until its huge internal structural market distortions to its factors of production are resolved satisfactorily.

5.6. Suggestions have always been made that China should adopt a more "flexible exchange rate policy" and here again, this begs the question of what is "flexible" and to China, maintaining economic stability and growth are key issues and factors affecting this flexible exchange rate.

5.7. Moreover, empirical studies have shown that there is no correlation, systematic or reliable relationship between its BoP position and exchange rate flexibility. That is to say, no significant benefits are going to accrue to say, US, from China adopting "a more flexible" exchange rate policy, and its trade surpluses will continue to grow regardless.

5.8. Any significant yuan appreciation will not reduce in any sizable form, the huge and ballooning US BoP deficits: in the US Federal Reserve exchange rates basket for the greenback, the yuan contributes only 15%. So, even a 20% appreciation of the yuan will only mean a 3% appreciation against the dollar!

5.9. Moreover, the US is not going to win any major support from Asean and Asian countries like Singapore, Malaysia, South Korea, Taiwan, Indonesia, in its quest for appreciating the yuan.

According to a recent Bloomberg study, the Korean Won rose five times as fast as China's yuan currency in the 12 months after Beijing last relaxed its foreign-exchange regime in July 2005. Singapore $ climbed three times as much, the Indonesian Rupiah five times, and the Malaysian Ringgit twice as much.

5.10. As President Obama pressed Chinese President Hu Jintao in Washington during the latter's visit to US in April 2010, to let the yuan rise at a faster rate, China, i believe, will now do so(but, of course, at its own pace, not US pace). since an appreciating Yuan will boost China's power to buy Malaysian palm oil, Indonesian coal to Indian copper! Such revaluation or appreciation of the Yuan will also enabled the Asian nations to do the same with their own currencies, without damaging exports, while fuelling US trade, and assist the global economy to emerge from its deepest postwar recession. The rising costs of imports will also spur Taiwan to let its dollar appreciate.

5.11. Some latest Nomura Japan estimates:

***** The Chinese yuan will appreciate 6.8% to 6.36 against the US$;

***** The Korean Won and Indonesian Rupiah may climb 13% against Japanese Yen, and 9.6% to 1,025 per US$ for the Korean Won;

***** Singapore $ to appreciate 9.1% to $1.28 against the US$;

***** The Taiwan $ up 5.3% to NT$30 per dollar by end March 2011.

5.11. Goldman Sachs' latest forecasts:
China's currency won't gain more than 4.9% to 6.49 in the next 12 months against the US$, as the Korean Won will jump 6.7% and the Taiwan $ 5.2% against the greenback.

6. "The Yuan Peg Doesn't Matter" says Johnathan Anderson, chief Asian economist at UBS:

6.1. The Central Bank of China - called the Peoples Bank of China - is the third largest foreign holder of US Treasury debt, and the biggest source of financing for the ever-growing US budget and current accounts deficits. It ploughs more than US$100 billion into dollar markets.

6.2. Anderson stated that fixed or floating, up or down, renminbi exchangep rate policy simply does not have any major impact on the global economy.
This is because Chinese exports may have penetrated European, Japanese and US markets at some 35% growth rate per year, but overall Asian market share grew very slowly, which means that for each additional dollar industrialized countries spend on Chinese imports, imports from the rest of Asia actually fell! Again, this is because Asian countries have moved their low-end assembly functions to China, as a final stop on the production chain before shipping the finished goods to Wal-Mart or Tesco!

6.3. Roughly half of China's foreign reserve inflows come from portfolio capital, including so-called hot money flows. Chinese banks and firms then draw down their asset positions abroad, or borrowing money in foreign markets, and bringing these funds back to China - in part to speculate on a possible renminbi devaluation move. So as these speculators and agents move out of dollar into yuan, the Peoples Bank of China PBC) is forced - as part of its overall monetary policy - to buy up the dollars - and then later pump them right back into the US by way of their dollar investments! The net effect on US markets from these transactions is ....... virtually zero!

6.4. The PBC hold a huge US$ reserve, now estimated at some $450 billion. It also has a diversified asset portfolio, including a sizeable amount of euro instruments. If China sells off a large chunk of its US$ assets, the US will suffer cardiac arrest. But would China do it and why would it do it? The PBC, like any other Central Bank, is a conservative policy institution, not a speculative hedge fund body, and it would not serve China's interests to rock the G3 currency markets!

7. So wither the US then? An exercise in futility and much ado over nothing, given their still very weak economy?

7.1. In the past two years, the US has trade deficits with 90 countries! Yet the US is pushing for a bilateral solution (namely, "forcing" China to revalue by its constant threats to tax Chinese exports) to essentially a multilateral problem. Any credible solution must
lie in multilateral approach. After all, remember that China-US trade accounts for only 12% of total annual Chinese trade.

7.2. It is now fairly well established that a stronger yuan will not reduce the huge US trade deficits, e.g. a sharp appreciation of the Yuan between June 2005 and June 2008 widened the US deficit! US imports from China rose by 39%, offseting China's US imports which (even without revaluation) had been increasing since 2002!

7.3. Moreover, higher import prices to US means a fall in the purchasing power of US income, whereas the stronger yuan will raise the purchasing power of China's producers who rely on imported raw materials! Because imports are now cheaper, Chinese exporters can now reduce their export prices to maintain their market shares!

For instance, it is estimated that the iPod cost US$150 to produce, of which only US$4 is Chinese value-added. Most of the components are made in the United States. It is then all shipped and put together in China, and exported back to the US for the full US$150 as imports from China - thereby adding to the US deficit and exaggerating the US job loss!

8. China Will Move At Its Own Pace - But A Package Deal Is Needed:

8.1. Beijing knows, Alan, as you have also pointed out in some of the Chinese studies you quoted above, that a greater exchange rate flexibility and a gradual but steady yuan appreciation is needed to streamline its own internal markets and this means it must seriouos liberalize its factors of production so as to reduce costs distortions. If done correctly, and they have the political clout and will, China will then move to a truer market economy with less distortions.

8.2. China knows it has to be equally pragmatic in restructuring its macroeconomic policies so as not to keep over-emphasizing the mantra of successive annual economic growth at the expense of anything else. It has, for example, to liberalize faster and further its financial services sectors, move out/consolidate/scrap inefficient State enterprises to the extent of privatising them, promoting more aggressively the services sector, especially encouraging more medium and small-scale industries and enterprises to flourish and not just concentrate on State behemoths which, like anywhere else, becomes lumpy and clumsy and unprofitable.

8.3. For instance, even though Chinese banks lent a record 9.6 trillion yuan (US$1.4 trillion) last year, and introduced a 4-trillion yuan stimulus package to bolster growth through the global financial crisis, it did not stop the authorities to tighten property financing in April 2010 by curbs on loans for third-home purchases, increased down-payment requirements and higher mortgage rates, to dampen the surge in domestic property prices.
Property prices in 70 cities rose by 11.7% in March 2010, and China's economy expanded by 11.9% from a year earlier in the first quarter 2010, suggesting that tighter policies are needed to cool the economy.

9. CONCLUSION:

9.1. China, as the rising global economic and political power, knows its own position and responsibilities, and will chart its own course in reforming the yuan, as President Hu Jintao told President Obama during his April 2010 US visit. He also made it clear that, whilst China would not bow to external pressures, it has always based its yuan exchange rates in accordance to its own national and economic needs. But, at the same time, he stressed, China is committed to reform, reform, reform - but at its own pace and direction to protect its economy.

9.2. As pointed out above, the US war-cry to China to appreciate the yuan is based more on political sentiments and to please the home crowd, and, as shown above time and again, any such appreciation - and it will come - will be to the US's disadvantage not advantage - and more importantly, it will in no way, help to reduce the massive US trade deficits and or give back US job losses which are all of their own making!

9.3. But, unfortunately, like in any other country, partisan politics and the control of the US media means "China-bashing" will continue, since the general public is rather ignorant of the real reasons for the huge US deficits and its perenially trade deficits for example, and blaming someone is the best game to play in these circumstances! And, coupled with the US' insatiable consumption and thereby huge imports and their propensity to spend, spend, spend, and giving little thoughts to save for a rainy day - these are the hallmarks of a failed nation!

9.4. Notwithstanding, China appears ready to loosen somewhat this US$ currency peg in the coming days, according to most internal and foreign reports. The PBC favours a prompt move, but the Commerce Ministry, aligned with China's exporters, have opposed currency appreciation.

9.5. Holding down the value of the renminbi through huge market intervention has been very very costly to China. The central bank spent 9.2% of the country's economic ouptput last year on the purchase of foreign currencies, mainly US Treasuries, that are now paying very lower interest and not that profitable to PCB.

9.6. As stated earlier, a stronger renminbi could prove to be a mixed blessing to the US: if China cuts back sharply on the purchase of Treasuries, then the Obama administraiton could find it even harder to finance US budget deficits!

9.7. With the continued booming Chinese economy, a small appreciation of the renminbi would still leave the PCB struggling with trade surpluses, and an expected tide of speculative investment into China, That could force the PCB to continue buying Treasuries - even those it is a loss-making proposition - with the extra dollars!

9.8. Inflation in China is accelerating faster than what most Western economists expected, e.g. the recent move to curb property financing, and a stronger renminbi with larger devaluation would help hold down prices and make imports cheaper. This would then give the PCB as China's central bank more room to raise interest rates and put a brake on economic growth, and help lessen the drawing of more speculative investments into the country.
Of course, the stronger renminbi would hurt the low-margin, labour-intensive industries in China, like shoes and textiles. Much of this production have already started to move to cheaper-cost countries like Vietnam and Bangladesh, since these Chinese factories now faced internal labour shortages arising from continued high-speed economic growth, including huge spendings on high-speed electric rail lines and other infrastructure investments.

9.9. The US economy grew at annual rate of 3.2% in Q1 2010, but economists cautioned that the pace of growth is still not fast enough to recover ground lost during the recession. Consumer spending was a major contributor to this expansion, growing at an annual rate of 3.6% this quarter, against 1.6% annual rate in the previous quarter.

The national debt is approaching $13 trillion, and even President Obama predicts total outstanding debt will exceed 100% of GDP by 2015! Annual deficits are running at a rate of 10% of US total output despite the near-0%-interest regime prevailing for some time, and which, by definition, should be providing the economy with abundant stimulus.

So the US is still in the shits and long way from out of the woods, and it would be in their own interests to put their own messy house in order fast. In the final analysis, as has been pointed out above repeatedly, do not expect China to devalue their yuan/renminbi sharply, say 10% -15% in 1 go, and whatever rate of devaluation that it will do soon, it will have little or no effect/benefit to the US!

Best Regards,
Eu Ming.

On Fri, Mar 26, 2010 at 7:37 AM, Alan McPhate wrote:

Hi Ming, Please tell me again why it is not in every one's best interest that China allow the value of its currency to slowly appreciate. Regards Alan

Yesterday I wrote about Chinese CEOs calling for China to bring its currency up to market rates.

Today Chinese economists are joining the call. Chinese economist Gong Shengli, in his book, China is Very Happy, calls for a strong yuan, "In order for China to survive and to continue developing, it is imperative that the renminbi goes global," says Mr Gong. "That means it is absolutely necessary and inevitable that the currency should appreciate." From the Financial Times story, A small but prominent group of economists at the Chinese Academy of Social Sciences has been pushing in recent months for a sizeable appreciation of the currency.

In an article published this year, Zhang Bin called for a 10 per cent rise and greater flexibility in daily trading limits in order to give the authorities more control over monetary policy and to restrain inflation. "There is a very urgent need" for reform of the currency system, he wrote. Zhang Shuguang, another Cass researcher, said a stronger currency was needed to boost China's services sector and reduce the emphasis on exports. The fact is that this currency imbalance distorts everything in the world economy. Chinese consumers face a barrier of up to 40% keeping them from being able to buy goods produced outside of China. Chinese businesses face the same problem. Meanwhile the rest of the world continues to lose jobs, factories and purchasing power. On April 15 the President must declare China a currency manipulator and take the necessary steps to being to remedy the p..