China’s Open Economy Exchange Rates, Exports, and Economic Performance

1980s- 1994: Dual Currencies, Overvalued RMB, Non Convertibility, and Black Markets 1994-early 2000s: Single currency, Overvalued RMB, Convertibility on Current Account 2002(?)- Present: Undervalued RMB, Still Non Convertible on Capital Account 2005-June 2008: Gradual, managed appreciation of RMB, still undervalued June 08 to present: Fixed at around 6.8RMB/US$

Starting in June 2008, the RMB appears to again be fixed against the US $ at 6.8 -6.9 RMB per US $

Excess Supply of $ at 8.27 8.27RMB/$

Supply$2

Demand$

$$$$

RMB/$

US Financial Assets

People’s Bank of China Official Foreign Reserves $$$$$$$$$$$$$$$$

Chinese Official Reserves are used to purchase interest bearing assets in the US and elsewhere

US Capital Account

Supply0 RMB $$$$

US$/RMB

Supply1 RMB .121RMB/$

Excess Demand for RMB at .121

US Financial Assets

People’s Bank of China Official Foreign Reserves $$$$$$$$$$$$$$$$

Same Story, but using the market for RMB: Price is US$/per RMB and the Quantity is RMB

Demand RMB US Capital Account

People’s Bank of China Official Foreign Reserves $$$$$$$$$$$$$$$$

Excess Supply of $ at 8.27 8.27RMB/$

Supply$2

$$$$

RMB/$

US Financial Assets

These Things Fit Together • Undervalued RMB (overvalued US$) • Chinese Current Account Surplus and accumulation of Official Reserves • Increase in Chinese Money Supply • Possibility of Rising Chinese Inflation (if China verges on full employment)

US Capital Account Demand$

Accumulation of Foreign Reserves China now has the largest reserves

Accumulation of Foreign Reserves

Increase in current account surplus starting in 2001 Undervalued RMB

Fixed exchange rate Rapid accumulation of foreign exchange reserves after 2001

Continued high rates of export growth (around 20% per year) Real GDP growth rates exceeding 10% per year (2008 expected to drop to 89%) Rates of inflation rising in 2007 (but now lower in 2008)

Inflation – Unemployment Tradeoff? China may face the following choice – Continue with the undervaluation of the RMB • But this requires an increase in the Chinese money supply (buy surplus $ with “newly printed” RMB) • Inflation is a threat, but the recent economic crisis (2008) has postponed this problem.

– Allow the RMB to appreciate toward its market equilibrium value • This will help with domestic inflation and reduce import prices (in terms of RMB) but it will dampen exports and employment in the relatively higher paying export sector

Hard Times Ahead for the Chinese Economy? • The decision to let the RMB appreciate (to avoid domestic inflation) could reduce Chinese exports • Recession in the US and EU will also operate to reduce Chinese exports • Can China depend on expansion of the domestic consumer markets to generate economic growth?

Paulson Visits China (December 08) • Coverage by the New York Times • Coverage by China Daily

Is China an Export Led Economy? Article by Anderson

Usually, you see the graph to the right with the description that Chinese exports have grown, now make up more than one third of the economy, and the economy will have a hard landing if exports decrease

How are Exports Measured? For China Exports/GDP = 40%. Using the same technique, you would find that Singapore exports 244% of their economy. (Table) How is this possible? You can’t export your whole economy (even once).

Old and New Export Regimes • Old: produce shirts, buttons, sew buttons on shirts and export 1 unit of buttoned shirts. • Income(shirts) =$10 • Income(buttons) = $1 • Income(sewing) = $4 • GDP = $15 • Imports = $0 • Exports = $15 • Exports/GDP = 100%

• New: import shirts and buttons, sew buttons on shirts and export the buttoned shirts. Exports increase to 4 units of buttoned shirts. • Income (sewing)$16 • GDP = $16 (4x$4) • Imports = $ 44 • Exports $60 (4x$15) • Exports/GDP = 375%

Exports/GDP • GDP is the sum of value added for the various sectors of the economy. • Exports is a total • The ratio Exports/GDP will be overstated to the extent that exports are products assembled from imported components rather than 100% domestic content

Growth or Change in Chinese Trade? • In the 1990s, Chinese leading exports were footwear and apparel. These products were produced largely from materials (textiles etc) produced within China. • More recently, the leading category of Chinese exports is “computer equipment”. These exports are assembled using imported components. The “domestic content” of exported computers is about 20% (much lower than for exported apparel which is about 80%). • This shift to low domestic content exports results in a more rapid growth in imports and exports than in GDP.

“True” Exports/GDP “Headline” “Value Added”

China

40%

Singapore Over 100%

10% 30-35%

Have (correctly measured) Chinese Exports Increased over Time? The green line shows the time trend for the “headline” Export/GDP ratio. The blue line shows the export share when exports are measured on a “value added” basis, that is, only accounting for the domestic content of the exports.

China; Export Led Growth? Anderson concludes that Chinese economic growth is not led by its export sector. China is a large economy, and, properly measured, exports are less than 10% and not growing rapidly. About 2% (of 10% total growth rate) is traced to the export sector

China; Consumer Led Growth? Economist; From Mao to the Mall concludes that recent Chinese economic growth is led by its growth in domestic consumer demand.

Effects of RMB Appreciation • China is accelerating the pace of RMB appreciation and this will hurt Chinese exports and workers in the export sector, but China is a large economy driven by domestic demand • Imports (food and oil) will be less expensive • Money supply growth can slow down • Domestic inflation can be reduced • “Excess” accumulation of foreign ($) reserved can be reduced (note losses on holding $s)

Summary • China is allowed its currency (RMB) to gradually appreciate from Sept 2005 to June 2008. From June 2008 until May 2009 it appears to be fixed again. • How much will currency appreciation and reduces exports to the US market hurt the Chinese economy? – China’s export sector and growth of its export sector are overstated – China’s economic growth is driven more by domestic demand than exports

• The Chinese economy may rebalance its plan to emphasize growth in domestic markets and exports to ASEAN countries.