Thursday, November 13, 2008


Sometimes a development signifies more than meets the eye and sometimes, less. China took an important step in July 2005 to free up its currency, variously called the yuan or the renminbi (RMB), from its longtime peg to the US dollar. Since then, the RMB has strengthened by a nominal 17 percent. That is, Chinese buyers need to pay fewer RMB for each dollar of imports, and Chinese exporters receive fewer RMB for each dollar of exports.

One would think that such a change would produce substantial effects in the real world. In theory, at least, currency appreciation is expected to reduce trade and current account surpluses and to slow growth in the domestic economy. That’s why overheated economies often seek to strengthen their currencies.

In the case of China, these results have been extraordinarily slow in materializing. In fact, as summarized in the table below, China’s appreciating currency has actually led over the past 39 months to substantially larger imbalances in its bilateral trade with the United States, its overall trade with all trading partners, its current account surplus, and – most shockingly – in the build up of official reserves, which have grown by 168 percent as the RMB was strengthening.

Now by far the largest in the world, China’s reserve position is a matter of concern for the rest of the world. China’s hard currency glut is a destabilizing factor in the shaky world economy. As we discussed in the previous post (“The Mercantilist Menace vs. The Protectionist Peril,” November 11), China’s recently announced stimulus package will not reduce these imbalances unless and until there is a much greater appreciation of the RMB.

Unfortunately, appreciation of the RMB stalled out around the end of July, freezing its value at around 6.85 to the dollar. Since then, foreign money has continued to pour into China by means of its trade surplus (more than $35 billion in October), foreign investment and speculative “hot money.” While the growth in official reserves has tapered off, China is stashing dollars in places not captured by that statistic: the China Investment Corporation (China’s sovereign wealth fund), the Social Security Investment Fund, and commercial banks that are still largely under government control.

When China tries to take credit for its ”stable” currency policy at this weekend’s G-20 meeting, it would be on point if someone would remind China of its obligations under the IMF Articles of Agreement. Article 4 binds China and every other IMF member to “avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members.” To maintain an exchange rate that does not reflect market values is to be part of the problem, not the solution.

China may object, but the reality behind these numbers seems to be precisely what meets the eye: Its “stable” currency policy has destabilizing effects for the rest of the world and needs to be abandoned if we are to work our way out of the global financial mess.

Charles Blum

Effects of Appreciation of Chinese RMB:
Selected Indicators

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