What is China doing wrong with its currency?

[Throatwarbler_Mangrove]

@Hellestal

Let’s take a look at what I actually wrote:Underlined emphasis added. China is deliberately undervaluing its currency with its managed exchange rate. This is inflationary. As a response to the inflation, China has increased interest rates. This is contractionary, decreasing demand.*

That’s not what you actually wrote. I quoted what you actually wrote. If you read the part that you’ve left out, your complaint is that Chinese policy was suppressing global demand. You can’t have both excessive inflation and a lack of demand, if there was a lack of demand, where is the inflation coming from? Lack of demand is why the US experiences no inflation presently. In any case, now you admit that Chinese monetary tightening has not curtailed inflation, i.e. Chinese demand is still quite robust, so we’re probably on the same page.

What should the exchange rate be? You assume that the “market” exchange rate must be the correct exchange rate, but all countries that suffered through the Asian financial crisis of 1997-8 would probably disagree with you, as would Paul Krugman who advocated tight currency management as a solution to hot money flows at the time. While the price of an American house in 2006 accurately reflects the price payed by a willing buyer to a willing seller, Americans would probably question whether that was what the price “should” have been. That’s also an example of how seeing a larger trend is easier than trying to time the market. The RMB has been appreciating, the Chinese government has stated that it will appreciate for the foreseeable future, so broadly speaking, the Chinese and American governments are on the same page anyway, the complaint is that it isn’t appreciating fast enough.

If it were properly valued, they wouldn’t be suffering this recent spike in inflation.

Many people, e.g. Jim Chanos, have pointed out that government directed capital investment and not export has been the primary driver of growth since probably before 2008, and the (government directed capital investment)stimulus of 2008 has significantly exacerbated that problem. The current Chinese inflation has little to do with the exchange rate more to do with the lack of fine control the government has over economic policy. The stimulus of 2008 has simply overshot its intentions somewhat.

The American government likes to rail against the Chinese currency because it’s a safe and useful scapegoat.

[Baboonanza]

@even_sven

I’ve never really understood the moral outrage behind this issue. China seems to have found an economic policy that works well for them. Don’t all countries basically do what is in their best interests? Why should China tailor it’s economic policy to our needs?

I think some of it comes from the feeling that they are playing different rules than everyone else. The Chinese get away with currency manipulation because they are the only major player doing it, but would the whole international trading system break down if everyone started controlling their currency exchange rate?

I don’t know. But people see China doing things that we in the West are told is bad economic policy and that we would never do while they get richer and we get poorer (relatively speaking).

[Damuri_Ajashi]

@John_Mace

It’s on the side of Chinese imports that people get upset about the exchange rate. If the yuan is undervalued, it makes foreign products more expensive, and more difficult to sell. It is, effectively, a tariff on imported goods. The people who really get screwed are the Chinese, who can’t buy what they “should” be able to buy if the currency was allowed to float.

On the flip side, they can sell what they “should not” be able to sell if the currency were allowed to float.

[Damuri_Ajashi]

@DragonAsh

I’m hardly a Sinologist or apologist for China, but this whole ‘yuan undervalued’ debate is much ado about nothing to me. To anyone that things the yuan is undervalued, I ask you: So what rate should it be at vs the dollar, the euro, the yen, the pound, etc?

I’m no expert either but my understanding is that China is limiting the ability of Chinese to invest their dollars in anything other than US treasuries. Somehow this suppresses the value of the RMB in some way that is unfair.

[DragonAsh]

Hmm - Chinese companies have been investing overseas like crazy these past few years, buying up companies in the US, Asia, and Latin America. Note this news item reported just today:

Industrial & Commercial Bank of China Ltd. agreed to the first Chinese takeover of a U.S. retail bank, boosting financial ties between the two largest economies as President Hu Jintao concluded a four-day visit.

But I suspect it’s really beside the point -once China has converted the yuan to dollars, or euro, or yen, or whatever, it doesn’t matter what they buy, does it?

It partially reminds me of when Japan went on a massive buying binge in the late 1980s, and we know how that ended for Japan (rather badly). In the end the US is quite happy to have Toyota and Nissan building cars here.

[Hellestal]

@Throatwarbler_Mangrove

In any case, now you admit that Chinese monetary tightening has not curtailed inflation, i.e. Chinese demand is still quite robust, so we’re probably on the same page.

Maybe so.

To the extent that China is attempting to solve its inflation problems with internal demand suppression (higher bank reserves, higher interest rates, etc.), rather than exchange rate appreciation, that is roughly the extent to which they are being internationally unfriendly. But this is, I have readily admitted, not an easy balancing act for them. As you say, they haven’t succeeded with their price problems yet. And even if they did enact harsher internal measures, I don’t think it’d be anything to freak out about.

@Throatwarbler_Mangrove

What should the exchange rate be? You assume that the “market” exchange rate must be the correct exchange rate, but all countries that suffered through the Asian financial crisis of 1997-8 would probably disagree with you, as would Paul Krugman who advocated tight currency management as a solution to hot money flows at the time.

I don’t know what you mean by “correct exchange rate”. You say I’m assuming things, but I have no idea what you think I’m assuming.

I’m calling the Chinese currency “undervalued”, and yeah, I’m using the presumed market rate – which would be higher than it is now – to make that determination. But nowhere have I suggested that China let its currency float tomorrow for some vaunted “correct” value. It depends on the situation. Krugman would tell you the same thing. What’s good policy during one sort of crisis is not necessarily good in different times. Now, even though he should take a chill pill before he opines on this particular topic (or hell, the whole damn bottle), he is still a man who must be listened to on trade.

It’s a bit of unfriendliness to try to squash inflation problems with internal monetary policies when they could let their exchange rate rise more quickly. You have to admit that the undervalued currency is contributing to their inflation, even if it’s not the primary driver. I suppose I was sloppy in leaving out those other factors of inflation earlier, but I was trying to focus on this one point because it’s the focus of the OP.

@Throatwarbler_Mangrove

The American government likes to rail against the Chinese currency because it’s a safe and useful scapegoat.

True, but that doesn’t mean their criticisms are entirely without factual basis.

@DragonAsh

Hmmm…cite? In case you haven’t noticed, other countries are also seeing stronger inflationary pressures regardless of currency: food inflation (expect ‘agflation’ to be a big buzzword this year) is usually pointed to as the main culprit. For example, the Food and Agriculture Organiztion (a UN body) announced just a couple of weeks ago that its food price index for December hit a record high, beating the previous highs in 2008.

Okay, you’re right about this and I was being lazy there, failing to hit my point.

Your question was about how we know that China’s currency is undervalued. The most basic answer to that is that if they actually had a freely floating exchange rate, their currency would appreciate much more sharply than the government is currently allowing. It is “undervalued” because unfettered supply and demand would result in a stronger RMB. This undervalued currency is one factor (yes, among others) that is driving the inflation in China.

I will repeat here for clarity that I agree with you that complaints about Chinese currency manipulations are overblown. It’s not so friendly what they’re doing – I think it could be appropriate for them to speed up their currency appreciation, rather than attempting to contract demand within the country – but it’s not the end of the world, and given their interesting internal dynamics, they don’t have any perfect options available. Anyway, there are much more important things for us to concentrate on.