Tuesday, October 5, 2010

A Bit More on China

Mike Konczal points me to this interesting piece by Walker Frost in The American Scene, on the Chinese currency peg. I asked earlier how much Chinese appreciation would boost US demand (more on that below). But there's a prior question, which is whether an end to Chinese currency intervention would lead to appreciation at all. As Frost points out, the dollar purchases by the central bank coexist with restrictions on private investment abroad and strong incentives for FDI by foreign firms. These policies increase net capital inflows and therefore tend to raise the value of the Chinese currency; the Chinese central bank then pushes it back down with its dollar purchases. It's far from clear which of these effects is stronger, and therefore, whether an across-the-board liberalization would lead the Chinese currency to rise against the dollar, or to fall. In short, we should see Chinese currency interventions not as part of an export-led growth strategy that requires a current-account surplus, but as part of an investment-led growth strategy that would otherwise tend to produce a current-account deficit. [1]

This is a point Anwar Shaikh has also made, when I've discussed this stuff with him. Don't talk about undervaluation, he says, that implies some known free-market equilibrium exchange rate, and there isn't one; talk about stabilization instead.

Another interesting discussion of the Chinese currency peg is in this Deutsche Bank report, which tends to confirm my skepticism about the effect of currency adjustment on US-China trade flows. They note that "RMB appreciation tends to ... reduce nominal wages in the export sector," confirming my sense that exchange rate changes don't reliably move relative costs. And they use an estimate of -0.6 for exchange rate elasticity of Chinese exports. I don't want to put too much weight on this number -- I'm not sure how it's derived -- and they don't give any estiamtes for US-China flows specifically; but given the well-established empirical fact that exchange-rate elasticity is unsually low for US imports, we have to conclude that the number for Chinese exports to the US is substantially lower. So if you believe the Deutsche Bank number for Chinese exports as a whole, my estimate of -0.17 for Chinese exports to the US is probably in the right ballpark. Which, again, means that even a very large Chinese appreciation would have only a trivial impact on US aggregate demand.

[1] The same goes for tariffs and other trade restrictions imposed by Latin American countries as part of import-substitution industrialization.

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