Whither CNY Revaluation

Earlier we presented one side of the possible consequences of branding China a currency manipulator. In the realm of pundits nowhere is the China debate more pronounced than between Nobel (or is it Oscar) winner Paul Krugman and Morgan Stanley Asia Chairman Stephen Roach, in which the latter has proposed some amusing applied sporting goods suggestions vis-a-vis the former. Last night, the Morgan Stanley strategist made his case even clearer in an Op-Ed in the FT, titled "Blaming China will not solve America's problems." As we are fairly confident that the last thing America needs at this point is to antagonize its primary lender (sorry Ron Insana, the whole "if you owe a bank one trillion, you own the bank" is the most stupid thing one can say in this particular relationship), we would tend to agree that scapegoating at the national level, while easy to do (just ask Bill Lockyer and G-Pap), only shows the market that one is hopeless to actually fix the underlying problems and instead seeks to distract from the matter at hand. Roach's argument, by the way, is spot on: America is deflecting from the savings problem (which incidentally, after yesterday's PCE once again outpacing Consumer Incomes, slipped to 3.1% or the lowest levels since 2008). At this rate we will soon be back to negative savings, and the anger at China will be greater than ever. Why look to ourselves to fix a problem that so easily can be scapegoated onto others. And if it means purchasing a few more MaxiPads, pardon iPads, so much the better (out of curiosity, we wonder just where the components for the iPad are made, and just where it is assembled...).

From the FT:

America’s fixation on the “China problem” is now boiling over. From Google to the renminbi, China is being blamed for all that ails the US. Unfortunately, this reflects a potentially lethal combination of political scapegoating and bad economics.


The political pressures are grounded in the angst of American workers. After more than a decade of stagnant real compensation and, more recently, a sharp upsurge in unemployment, US labour is being squeezed as never before. Understandably, voters want answers. It is all because of the trade deficit, they are told – a visible manifestation of a major loss of production to foreign competition. With China and its so-called manipulated currency having accounted for fully 39 per cent of the US trade deficit in 2008-09, Washington maintains that American workers can only benefit if it gets tough with Beijing.


However appealing this argument may seem, it is premised on bad economics. In 2008-09, the US had trade deficits with more than 90 countries. That means it has a multilateral trade deficit. Yet aided and abetted by some of America’s most renowned economists, Washington now advocates a bilateral fix – either a sharp revaluation of the renminbi or broad-based tariffs on Chinese imports.


A bilateral remedy for a multilateral problem is like rearranging the deckchairs on the Titanic. Unless the problems that have given rise to the multilateral trade deficit are addressed, bilateral intervention would simply shift the Chinese portion of America’s international imbalance to someone else. That “someone” would most likely be a higher-cost producer – in effect, squeezing the purchasing power of hard-pressed US consumers.


The US would be far better served if it faced up to why it is confronted with a massive multilateral trade deficit. America’s core economic problem is saving, not China. In 2009, the broadest measure of domestic US saving – the net national saving rate – fell to a record low of -2.5 per cent of national income. That means America must import surplus saving from abroad to fund its future growth – and run current account and trade deficits to attract the foreign capital. Thus, for a savings-short economy, there is no escaping large multilateral trade imbalances.


Yes, China is the biggest piece of America’s multilateral trade deficit. But that is because high-cost US companies are turning to China as a low-cost offshore efficiency solution. It also reflects the preferences of US consumers for low-cost and increasingly high-quality goods made in China. In other words, savings-short America is actually quite fortunate to have China as a large trading partner.


No, China is hardly perfect. Like the US, it, too, has a large imbalance with the rest of the world – namely, an outsize current account surplus. Just as responsible global citizenship requires America to address its savings deficiency, the world has every reason to expect the same from China in reducing its surplus saving.


But these adjustments must be framed in the multilateral context in which the imbalances exist. Just as China is one of more than 90 countries with which America runs trade deficits, US-China trade now represents only 12 per cent of total Chinese trade. It is wrong to fixate on a bilateral solution between these two nations to address their multilateral imbalances.


Yet some of America’s most prominent economists are claiming that a revaluation of the renminbi vis-à-vis the dollar would not only create more than 1m jobs in the US but that it would inject new vigour into an otherwise anaemic global recovery. Economists should know better. Changes in relative prices are the ultimate zero-sum game – they re-slice the pie rather than expand or shrink it.


Currency, or relative price, adjustments between any two nations are not a panacea for structural imbalances in the global economy. What is needed, instead, is a shift in the mix of global saving. Specifically, America needs deficit reduction and an increase in personal saving, while China needs to stimulate internal private consumption.


Washington’s scapegoating of China could take the world to the brink of a very slippery slope. It would not be the first time that political denial was premised on bad economics. But the consequences of such a blunder – trade frictions and protectionism – would make the crisis of 2008-09 look like child’s play.

Alternatively, Zero Hedge has long been contending that the Renminbi is, gasp, not really undervalued. We provide some additional color on the whole CNY fair value situation, as well as some commentary on Wen Jiabao's last week press conference from Bank of America. Pay particular attention to the last part.

Highlights of Premier Wen’s press conference

Much more interesting than the government report

As always, there are no major surprises from these kinds of press conferences. But compared with the presentation of government report a week ago, it’s a nice summary of Premier Wen’s views in a slightly more personal and casual way. We can highlight two points which might have policy implications:

  • China’s policymakers do have their own currency reform plans even they believe renminbi is not undervalued. But coercions from other countries will only do disservice to this cause. We take this as signs that there will be no one-off revolutions in coming months. We reiterate our view that this year China will likely copy the Singapore model by letting renminbi move within a band determined by a basket of currencies instead of the dollar alone.
  • Chinese policymakers are quite concerned about those uncertainties in the global economy (such as sovereign debt risks). They believe the risk of a double-dip is still there, so we believe it’s unlikely for China to reverse all those stimulus policies rapidly. We are more convinced that there will be no rate hike in the first half this year.

The citation of “Lisao” ()


Premier Wen started the Q&A with a phrase “” from Lisao, a poem by Qu Yuan, one of the greatest poets in China living in more than 2000 years ago. To understand this phrase, we must know the context. In China, Qu Yuan is a symbol of patriotism and caring for people. One phrase preceding the cited one is , which means “I sigh deeply because I am sad about how poor people’s living conditions are”. So the citied phrase literally means that “I am determined to serve the people; I won’t regret even if I need to die nine times”.


Macro: Inflation, income inequality and corruption


Unsurprisingly, China is to maintain stability of macro economic policies by continuing current “proactive fiscal policy and relatively loose monetary policy” to solidify the economic recovery. However, China will increase policy flexibility to stay in tune with changing conditions.


He reiterated three policy goals: economic growth, restructuring and managing inflation expectations. He agreed it’s very hard to do meet all these goals, but they will do it. Monetary policies will be the key to these goals. He is very concerned about inflation, asset bubble and overheating. Inflation, income inequality and corruption could result in social instability and CCP’s ruling status.


Global economy: double dip is possible


The global economy has posted some signs of recovery, but those major economic and financial problems are not fully corrected. A double dip of the global economy is possible. There are still a lot of uncertainties around the globe. Wen mentioned the following problems: (1) Sovereign debts in some countries lead to fiscal and financial risks; (2) Big volatilities in commodity prices and exchanges rates; (3) Rising inflation expectations make policy choices difficult; (4) Unemployment rates in some major economies are still high.


Currency: renminbi not undervalued


China opposes finger-pointing or even coercions on currency issues, which will only do disservice to China’s currency reforms. China will push forward its exchange rate regime reforms anyway. China will maintain broad stability of renminbi’s exchange rates at a reasonable and equilibrium level. Here are evidences on why renminbi is not undervalued:

  • Renminbi’s real effective exchange rate (REER) appreciated 14.5% from July 2008 to Feb 2009 when the global economy was in its most difficult.
  • In 2009, China exports contracted 16% while imports only fell by 11%. China’s trade surplus declined by US$102bn. The stable renminbi during the global financial crisis made significant contributions to the global recovery.
  • Germany’s exports to China in 2009 reached a record high at EUR76bn. US exports to China dropped only 0.22%, though US exports on the whole slumped by 17% in 2009. EU’s exports to China dropped 15.3%, compared with 20.3% decline in its total exports.
  • Of the 37 countries which China already has statistics for 2009, 17 countries posted gains in exports to China.

Lastly, in order to grasp as comprehensive picture of China as possible, here is a recently declassified CIA report from September 1989, titled "The Chinese Economy in 1988 and 1989; Reforms on Hold, Economic Problems Mount" focusing on the event surrounding the Tiananmen Square events and shortly prior. It is amusing what 20 years of a rampant credit bubble, and the need to export inflation will do to the countries' relations. The report comes courtesy of Operations Officer (no illegal downloads from Wikileaks were performed in the creation of this post).