Two Opposing Opinions On The Yuan Depegging
Yesterday's mega news on the CNY depegging, which went so far as to make headlines out of something as mundane as the PBoC yuan fixing, has now been fully priced in. And before we put the matter to rest, we would like to present two diametrically opposing opinions on this issue: one from Goldman's Sven Jari Stehn, which is full of contained optimism about the future of the world, and one from Gary Shilling, who in a Bberg TV interview, says that the Chinese decision could not have come at a worse time, and that it risks destabilizing the precarious global balance achieved at the cost of so many trillions in stimuli.
First, here is Goldman's traditional bullishness:
China recently announced that the CNY will soon resume its appreciation against the USD. While China is an increasingly important export market for the US, its share in US GDP is still small at ½% of GDP. We therefore estimate that the direct effects of the CNY appreciation on US GDP growth are likely negligible at around 0.01 percentage point during the next two years.
- Obtaining more noticeable near-term effects on US growth would require: (1) other major US trading partners to follow China in allowing their currencies to appreciate, and (2) faster domestic demand growth in China (relative to the baseline, which is now slowing from its prior buoyant pace).
- Independent of these near-term effects we see two important long-run benefits of CNY appreciation: (1) diminished possibility of Senate passage of protectionist measures; (2) reduction of “global imbalances” in the world economy.
China announced on June 19 that it will allow more currency flexibility against the US dollar. We expect the CNY to return to a crawling peg against the USD, resembling the exchange rate regime during 2005-2008, at least initially (see “The resumption of CNY appreciation and further reform of the exchange rate regime: In line with our expectation”, Asia Policy Watch, June 20, 2010). The move is consistent with our long-held expectation that the Chinese government will allow more flexibility in the CNY exchange rate through gradual moves. Our FX team has therefore kept its USD/CNY exchange rate forecasts unchanged, expecting 2.5% appreciation against the USD during the next 6 months and 5% over the next 12 months.
In this comment we discuss the potential implications of the expected CNY appreciation for US exports and GDP growth. Our methodology follows closely our previous work in which we showed that the direct export effects of a deepening Euro area crisis on US growth would be very small; specifically, we found that US growth would slow by just 0.05 percentage points in response to a hypothetical one percentage point slowdown in Euro area growth and a ten percentage point depreciation of the Euro. (See “Euro Area Turmoil: Small Direct Effects on US Exports”, US Daily, May 11, 2010.)
While China is an increasingly important export market for the US, its share in US GDP is still small. During the last two decades real exports to China grew by a factor of 10, making it the United States’ fourth largest export market (after Canada, Mexico and the Euro area). However, because the United States is a relatively closed economy, exports to China accounted for only ½% of GDP in 2009.
Using annual data we estimate simple models which explain real US export growth to China by the nominal rate of CNY/USD appreciation and real domestic demand growth in China. Our results can be summarized as follows:
- Our regressions suggest that a one percent CNY/USD appreciation raises growth of real US exports to China by around ½ percentage point, while a one percentage point boost to Chinese real domestic demand increases US export growth by 1¾ percentage points.
- A 2½% appreciation of the CNY for the balance of 2010 would therefore raise US real export growth to China by around 1 percentage point in 2010. Assuming that the CNY appreciates a further 5% in 2011 would provide a boost of 2 percentage points to US export growth in 2011. Given the still-small share of exports to China in US GDP, however, the contribution to US growth of this boost to exports is negligible at no more than 0.01 percentage point in 2010 and 2011.
This analysis may understate the trade effects on US growth as we focused only on the export effect of the CNY appreciation. Our regressions showed no significant role for the exchange rate in addition to US domestic demand in determining US imports from China. This could be explained by limited pass-through of CNY appreciation into US import prices, as foreign companies have often absorbed a significant part of the shift in exchange rates into their profit margins in an attempt to defend/expand US market shares. However, even if the incorporation of the import effect more than doubled the CNY appreciation effect, the implications for US GDP growth would remain small.
So, what would need to happen for the CNY appreciation to have a noticeable effect on US GDP growth?
First, other major US trading partners would need to follow China in letting their currencies appreciate. If the United States’ other important trading partners in non-Japan Asia—including South Korea, India, Singapore, Thailand and Malaysia—followed China in letting their currencies appreciate by 2½% and 5% in 2010 and 2011, respectively, we estimate that the total effect on US growth would still remain small at 1½ and 3 basis points in 2010 and 2011, respectively. A meaningful boost to US growth would therefore only emerge if the CNY appreciation prompted the Yen, Euro and Canadian dollar to move. Our results suggest that a 5% depreciation of the trade-weighted dollar would boost total nominal US exports by around 3%, providing a 25 basis point boost to GDP growth. Of course, at least against the euro the dollar has appreciated over the past six months.
Second, a sizable boost to Chinese domestic demand would be needed. Our regressions show that Chinese domestic demand is the key driver of US exports, raising US export growth by 1.8 percentage points for every percentage point increase. For every additional percentage point of growth in domestic demand that can be unlocked as a result of the CNY appreciation, we would expect an additional one basis point effect on US GDP growth. That said, Chinese domestic demand has already been growing very strongly in recent months due to policy stimulus and is only now slowing back to trend. While CNY appreciation would create some room for slower domestic demand tightening, this would unlikely be sizable enough to provide a substantial boost to US exports and GDP growth.
Although our results suggest that the near-term US growth implications of the CNY appreciation are likely to be small, we believe it promises two important longer-run benefits to the US economy. First, CNY appreciation is likely to cool the heated rhetoric out of Washington regarding US-China trade relations. In particular, the CNY move has diminished the possibility of Senate passage of Senator Schumer’s proposal to apply trade remedies as a response to undervalued currencies among trading partners. (See also “Trade Rhetoric Likely to Heat Up”, US Daily, June 14, 2010.) Second, sustained CNY appreciation could contribute significantly to reducing “global imbalances” in the world economy—which lowers the probability of another financial crisis.
Next, a far more dire narrative, courtesy of economist Hary Shilling:
On whether China's central bank made a timing mistake in allowing the yuan to strengthen:
“[China's central bank] probably is [making the wrong move]. They run a stop-go economic policy. The last time they tried to slow things down was 2007. The timing couldn't have been worse as it came right on the eve of the '08 global recession. "
"Now they’re trying to slow things down and letting the yuan go up against the dollar is part of that tightening move. They’re worrying about inflation, but they’re really trying to tighten down after all their massive stimulus last year. The timing is probably going to be terrible because we’re getting the eurozone crisis spreading globally and that may give us the sequel to what sub-prime mortgages did in 08.”
On conditions in the Eurozone:
“I don’t think it’s the end of the world but it’s mainly financial. It isn’t so much in trade although obviously if Europe is in weak conditions, they’re not going to be able to buy much of anything including our exports, but the point is that US banks have 48% of their global exposure -1 ½ trillion dollars in the Euro zone plus the UK - so there’s a lot of involvement there. I think we’re probably going to end up restructuring, meaning lower value on the debts, sovereign and private debts, in Greece and probably Spain and a few other of the picks.”
"There's a difference between technical default and actual default…but I think it's coming."
On the European Central Bank owning Greek and Spanish debt:
“The suggestion is that the ECB should sell that that, in effect, to this big fund, this back up fund that they’ve set up. The Greeks have actually proposed that. That's what going on globally: it’s the socialization of debt. It’s taking it over by some, by a government or by a super government agency."