we can see on page 1 that China’s GDP growth has been pretty consistently at 8-9% pa for the last 20 years and is projected to average 7.5% for the next few. On page 2, we see that inflation has gone from 6.4% in 1992 and even higher than that in 1996 (see the accompanying CPI graph) to deflation in 98, 99 and 02.
Now back on page 1, I can see that Gross National Savings has gone up as a proportion of GDP (so savings growth has exceeded income growth) but what exactly did China do that brought inflation from rampant levels in and before 1996 to such low levels within 2 years and hold them there without affecting growth?
Is this an answer to my question or just a comment?
I don’t see how intervention of the renminbi-dollar rate is directly applicable to holding down domestic inflation, especially since China has what I believe to be the world’s largest trade surplus. ie. Exports far exceed imports.
If there is something I’ve missed, please enlighten me.
Inflation can not happen naturally when the actual value of the currency is in question.
If the value of the currency is itself inflated, then that offsets the traditional inflation.
A manufacturer doesn’t need 4.5% more if the currency value is artificially inflated 4.5%. If the currenct deflated down to it’s true worth, inflation would rear it’s ugly head. The Chinese government know this and has been playing games with their currency to avoid it.
I have a degree in Economics and Finance but I am a bit rusty so let’s walk through this like I don’t know what I am talking about (because I probably don’t).
Prices (and therefore inflation) is driven by the interaction between supply and demand in the economy. Aggregate demand has been increasing in China. This brings inflationary pressures. In order for deflation to set in, aggregate supply has to shift out even more than the demand.
Now, holding the domestic currency (renminbi) lower than it would normally be does two things, I guess. It makes imports to China more expensive than they would otherwise be. This is this is inflationary for consumer goods and for inputs to manufacturing. It also makes Chinese exports cheaper and more competitive. All this intervention must be funded, of course, and that is paid by the Chinese government, taking it from the domestic economy (which is growing so fast, it doesn’t matter).
All of which points to the inflation decreasing (or deflation increasing) without Chinese intervention on the exchange rate. Not the other way around, as you are arguing.
In the course of composing my response, I found this quoted from the Asian Wall Street Journal 27 June, 2003:
Finally, your cite, I believe is from a Falungong website. That doesn’t immediately discredit its content but you do have to consider that there is an agenda present in all such publications.
China’s currency policy may change because of something much more mundane and apolitical: inflation.
.
Chinese consumer prices rose 3.2 percent in December, matching a high in more than six and a half years. If that points to inflation accelerating in 2004 - and that’s still a big “if” - the authorities may counter rising prices by allowing the yuan to appreciate, http://www.iht.com/articles/128209.html
Imagine letting an overinlfated currency to increase in value.
In other words, inflation is going to get so bad anyway (when you can find out what it really is) that the Yuan is going to be exposed for the overhyped value it carries. It gets to a point that overhyping it’s value means that when it’s over run and then set to it’s true value all along, it’s damn near worthless. They are risking the long term value for the short term hype.
Kind of like borrowing foolishly against your future.
It’s artificial value will be over run, and it’s real value will be pathetic.
Intervention in the Yuan has caused the Yuan to be undervalued right now. The US wants China to revalue the Yuan (or even better, let it float) to a higher peg against the US. Doing this would, as far as I can see, cause domestic prices to decrease, causing further deflation or less inflation. In other words, as I said before, China’s intervention in the exchange rate has been inflationary to prices in their economy. That means that it is not the reason inflation is so low there.
Your cite is reinforcing that: if inflation goes up, stop intervention, yuan rises, inflation falls.
These, it would appear, are not the droids you are looking for…
qoute Johnny B: The US wants China to revalue the Yuan (or even better, let it float) to a higher peg against the US. Doing this would, as far as I can see, cause domestic prices to decrease, causing further deflation or less inflation.
Okay, aren’t we back to what I originally pointed out? How does China keep inflation under control? < the issue…the OP!
I said a jacked up currency from jump street!
Yes, the U.S wants it even higher because that benefits the U.S $, but if anything, after all the games are sorted, most think it’s actually too high since…well, yesterday!!! It’s all goofed up now.
The trouble is that after China is done playing games, you don’t know what the hell the standard is, or what is relative to what.
Philster, I don’t know your background but I think you may be confusing a few issues here.
Firstly, China’s intervention in the foreign exchange rate market is to fairly simple in concept. They have a “peg” or target rate of 8.28 yuan to the USD. They have maintained this rate for about 10 years now. In order to maintain this rate, they sell yuan for USD when the price of yuan per dollar starts to rise beyond the peg and buy yuan with USD when the price of yuan per dollar starts to fall beyond the peg. China has been selling yuan furiously because the demand for it is so high since everyone around the world needs it to buy China’s exports. This cite states that since 2001, China’s foreign reserves (from selling yuan) has increased from $153 billion to $360 billion.
Now the reason many economists reckon that China’s currency is undervaued is because without this intervention, the Yuan would appreciate markedly against a range of currencies. So instead of being worth 8.26 yuan, if China was to let the market decide the value, the dollar would be worth maybe 5 yuan. This is what people mean by the “true value” of China’s currency. I have absolutely no idea where you have gotten the notion that the Yuan is “jacked up” or “too high” because there is only an argument for the opposite being true.
Secondly, I think that you may not fully understand how inflation is measured. Inflation is a measure of change in prices for goods bought or sold in the domestic economy using domestic currency. Fluctuations in the exchange rate have no immediate effect on inflation because goods are valued and traded in domestic currency. I believe you have approached this looking at prices being valued in say SD, and you might be thinking that if goods cost $1 today and $1.10 next year but China has tinkered with the exchange rate in some way since then, we can’t say inflation is 10%. The truth is if goods cost 1 yuan today and 1.1 yuan next year, inflation is 10% pa, no matter what has happened in the foreign exchange market because that is the measure of China’s inflation.
I believe you have approached this looking at prices being valued in say USD, and you might be thinking that if goods cost $1 today and $1.10 next year but China has tinkered with the exchange rate in some way since then, we can’t say inflation is 10%. The truth is if goods cost 1 yuan today and 1.1 yuan next year, inflation is 10% pa, no matter what has happened in the foreign exchange market because that is the measure of China’s inflation
It’s real simple, goods keep getting cheaper and cheaper to produce in China owing to the serious market competition in the Chinese domestic market.
In fact, for the past decade China has been in a deflationary environment.
Also there is and has been massive foreign direct investment in China for the past 20 years.
One thing to keep in mind is that China has been investing heavily in infrastructure, on top of an extremely low base. Putting in roads, freeways, train lines, airports, etc in places that had been completely isolated, and are reaping substantial economic returns on said investments. Look at it this way, putting anothe freeway in LA doesn’t add much incremental value, but putting in a freeway when nothing but a crappy two lane road existed between Shanghai and Beijing and HOng Kong brings about a huge amount of payback.
China has a massive surplus, IIRC around USD200 billion, and they are now one of the biggest buyers of US government debt. Which btw keeps helps to keep interest rates low in the US.
The Yuan or RMB is pegged to the USD. China does not have a convertible currency, although this is being relaxed somewhat.
Concensus of investment banker economists is that the RMB would appreciate vis-a-vis the USD if it were allowed to float and was fully convertible.
Full convertibility is probably still 10 years away. China has no real reason to move to full convertibility and the lessons of 1997 are very fresh in their minds.
Philster, you need to brush up on what is going on in China. By pegging the RMB to the USD for the past 8-10 years, means that China is expressly not tinkering with the value of their currency on the global market. The US government is howling for China to do just that and appreciate their currency. Certainly China is not artifically inflating (eg devaluing) their currency. Any government such as Argentina that is artifically inflating the value of their currency tends to get paid back over time in the form of hyper inflation.
China Guy, the statistics provided by the World Bank cite in my OP show that deflation has only set in 1998-99, coming from a steady average of 8-9%pa in the twenty or so years before that.
Also, the IMF cite states that macroeconomic tightening (assumably both fiscal and monetary), the economic slowdown from the 1997 Asian economic crisis and lower commodity prices and WTO-related tariff cuts were also amongst the causes for the deflation in China over the past few years. So it was not just longer term supply-related issues such as infrastructure, technology and increased competition and efficiency.
I’m not sure I agree with this statement. In order for the peg to be maintained, China has to intervene in the foreign exchange market. I would classify this as tinkering. If China stayed out of the foreign exchange market (ie. not tinkering), the peg could not exist. The Yuan still fluctuates wildly against other currencies but it does so in lock step with the US (ie. if other currencies fluctuate against the US, then accordingly they fluctuate against the Yuan). The US government is not expressly calling for China to appreciate the Yuan, they are asking for looser exchange rate controls, with the view that the Yuan will eventually be allowed to float. Yes, in the short term, that would mean that the Yuan would appreciate against the USD (and probably a whole range of other currencies too) but longer term, there would be no guarantee of what might happen to the Yuan exchange rate.
I can’t come close to answering this question, but one of the recent Economists had an article about reforming China’s banks which are pretty corrupt and have enormous amounts of money out in bad loans. How could this impact the situation?
China does not have a freely convertible currency. That is one huge difference. China is not tinkering in the foreign exchange market to depress the value of the RMB because there is no foreign exchange market in this currency as comparable to say the British pound. The BOC is not intervening in the currency markets such as the Bank of England did back in what was it '93?
China was on the verge of hyper-inflation in 1993-94. Inflation was running 20-30%. This was brought under control and has been in a deflationary or flat environment for goods ever since. [maybe we are quibbling about the definition of inflation, but prices have been falling since 1985. To me that is deflation.] Worldbank stats shows that. At the same time, incomes have been rising. Where you are seeing some pretty serious inflation is in the housing market, especially here in Shanghai. But that is a supply and demand issue that will likely self-correct as supply increases.
The other big factor on inflation is for farm goods. China is importing ever greater quantities of food commodities. If the government increases the official domestic purchase price of staples like soy beans (as they did recently), this will translate into some higher prices (as is happening). However, Chinese farmers are growing more value added cash crops instead of subsitance. In addition, given levels of trade, Chinese domestic prices can not get too far out of whack with global commodity prices, or there is an arbitrage, and such goods would be smuggled into China. Witness what happend a few years back when oil was not aligned with global prices.
Agreed that longer term, there is no telling what will happen with the exchange rates if allowed to float freely on the capital account basis.
Erislover, the banks are the one big iceberg on the horizon. The Chinese government has tried twice with pretty limited success to clean up the banks. The problem is that the banks get injected with fresh capital and then continue their same crappy policy lending without due diligence. That said, I think the consensus opinion of the investment banking community in HK is that given the levels of foreign direct investment and sustained growth rate, the banks can grow out of their bad debt problem (which is in marked contrast to Japan).