This sharp bit of analysis by Ed Dolan on renminbi appreciation has been getting passed around the blogosphere lately (our emphasis):
Heated rhetoric aside, the real question is, how successful has the manipulation been in maintaining the competitiveness of Chinese exports?
To answer that question, we need to look not just at nominal exchange rates, but at real rates. In nominal terms, the yuan has strengthened about 2.5% since China’s June 19 decision to ease its currency policy. That works out to an annualized rate of nominal appreciation of almost 8%. The simplest way to calculate real appreciation is to add on the difference between China’s inflation rate (3.5%, according to August data) and US inflation (about 1%, or even less if the dip in the September figures holds up). Doing so gives us an annual rate of real appreciation of more than 10%. Two or three years of that would pretty well eliminate the 20 to 40% undervaluation that critics are talking about. True, three years is longer than the time horizon of your average politician, but it’s not exactly a glacial pace of change, either.
The natural response is that these changes are only temporary, and that the People’s Bank of China will be all too happy to change course once people realize that substantial appreciation has already taken place.
Not to worry, Dolan says — inflation to the rescue:
In order to slow the rate of nominal appreciation, the PBoC would have to step up its currency intervention. Chinese inflation is already accelerating month after month. Slowing nominal appreciation from its recent 8% pace would increase inflationary pressure even more, both by keeping import prices from falling, and via the newly minted yuan that intervention pumps into China’s domestic money supply. With inflation accelerating further, the rate of real appreciation might not slow by much, if at all.
And as if on queue, today the FT reports:
But besides foreign pressure, one of the most compelling reasons for China to allow the appreciation of the renminbi is to help fight domestic inflation.
Concern over rising price levels and asset bubbles prompted China to raise interest rates last week for the first time in nearly three years.
The move, which follows a strong rebound in growth, is a small step towards scaling back the huge stimulus that China injected into its economy during the financial crisis.
This has a recent precedent:
Win Thin, of Brown Brothers Harriman, believes that China is likely to use currency gains to limit inflation if studies of recent monetary policy tightening from the People’s Bank of China are a guide.
As the PBoC tightened monetary policy in 2006 and 2007, renminbi appreciation was significant.
It rose 1.5 per cent against the dollar in the second quarter of 2007, 1.3 per cent in the third quarter of 2007, 2.8 per cent in the fourth quarter of 2008 and to a peak of 4.2 per cent in the first quarter of 2008.
We’ll quickly note that the Fed’s expected QE2 measures will, if successful in bringing about inflationary pressures, further add to the pressure on China to appreciate.
But if we can trespass for a moment into the realm of political science, there seem to be couple of not-entirely-compatible ways to think about how US politicians should be reacting to this in light of next week’s Congressional elections.
One is that US politicians should calm down. The process is working, if slowly, and will require some patience (admittedly not a virtue anybody associates with politicians). The heated anti-China rhetoric, not to mention the protectionist legislation that’s already been proposed, risks a destructive trade war that would makes things worse for everyone. And so forth.
A second point of view is that the rhetoric and the threats of legislation, however hysterical, have actually helped. They keep pressure on China not to reverse course. Not that the Obama administration or Congress should make good on these threats, but it can point to them and make it clear that there are worse alternative scenarios. Under this view, it’s useful to have a protectionist bill in Congress at the ready — so long as you don’t intend to actually pass the damn thing.
Instinctively we gravitate to the first perspective, though we don’t pretend to really know which is right or where this is headed. Just thought it was something to keep in mind as American voters head to the polls next week.
Related links:
Chart of the day, RMB appreciation edition – FT Alphaville
G20 has to show compromise FX pact has meaning – Reuters
China’s sizzlingly (disappointing) growth record – FT Alphaville
China and the missing treasuries – FT Alphaville