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  • Dec 23, 2014
  • Updated: 9:48am
CommentInsight & Opinion

Yuan bashing a missed opportunity for US

Stephen Roach says by fixating on the weakening yuan, the US is missing an opportunity to restructure its own economy and benefit from China's rebalancing towards domestic demand

PUBLISHED : Friday, 02 May, 2014, 4:53pm
UPDATED : Saturday, 03 May, 2014, 5:05am

The yuan has been weakening in recent months, resurrecting familiar charges of manipulation, competitive devaluation and beggar-thy-neighbour mercantilism.

In mid-April, the US Treasury expressed "particularly serious concerns" over this development, underscoring what has long been one of the most contentious economic policy issues between the United States and China. This is a timeworn debate - politically inspired and grounded in bad economics - that does a serious disservice to both sides by diverting attention from far more important issues affecting the US-China economic relationship. Taken to their extreme, America's accusations risk pushing the world's two largest economies down the slippery slope of trade frictions, protectionism or something even worse.

First, the facts: since hitting its high-water mark on January 14, the yuan has depreciated by 3.4 per cent relative to the US dollar up to April 25. This follows a cumulative appreciation of 37 per cent since July 21, 2005, when China dropped its dollar peg and shifted its currency regime to a so-called "managed float". Relative to where it started nearly nine years ago, the yuan is still up 32.5 per cent.

Over the same period, there has been a dramatic adjustment of China's international balance-of-payments position. The current-account surplus - the most telling symptom of an undervalued currency - has narrowed from a record 10.1 per cent of GDP in 2007 to just 2.1 per cent last year. The International Monetary Fund's latest forecast suggests that the surplus will hold at around 2 per cent of GDP this year.

Seen against this background, US officials' handwringing over the recent modest reversal in the yuan's exchange rate appears absurd. With China's external position much closer to balance, there is good reason to argue that the renminbi, having appreciated by nearly one-third since mid-2005, is now within a reasonable proximity of "fair value". The IMF conceded as much in its latest in-depth review of the Chinese economy, which calls the yuan "moderately undervalued" by 5 to 10 per cent. This stands in contrast to its earlier assessments of "substantial" undervaluation.

America's fixation on the yuan is a classic case of political denial. With US workers remaining under intense pressure in terms of both job security and real wages, politicians have understandably been put on the spot. In response, they have fixated on the Chinese component of a gaping trade deficit, claiming currency manipulation is the culprit behind the long-festering woes of the American middle class.

This argument is politically expedient, but wrong. The US trade deficit is a multilateral imbalance with many countries (102 in all), not a bilateral problem with China. It arises not from the alleged manipulation of the yuan, but from the simple fact that America does not save.

Lacking in domestic savings and wanting to grow, the US must import surplus savings from abroad and run massive current account deficits to attract the foreign capital. And that leads to America's multilateral trade imbalance.

Yes, trade with China is the largest component of this imbalance, but that largely reflects the complexity of multinational supply chains and the benefits of offshore efficiency solutions.

That brings us to the uncomfortable truth about America's politically inspired China bashing: it will backfire. If America fails to solve its saving problem - a reasonable scenario in light of fiscal gridlock and persistently subpar personal saving - the current account deficit will persist.

That means any reductions in China's share of America's external imbalance would simply be shifted to other foreign producers. Significantly, this alternative sourcing will most likely have a higher cost base than Chinese production, thereby imposing the functional equivalent of a tax hike on already beleaguered middle-class Americans.

As China rebalances towards a growth model that draws greater support from domestic demand, Washington should stop ranting about the renminbi and start focusing on the opportunities this bonanza will create. That means emphasising US companies' access to China's domestic goods and services markets. Pushing for a bilateral investment treaty that relaxes caps on foreign ownership in both countries would be an important step.

Similarly, the US needs to give China credit for having taken meaningful steps on the road to further currency reform. The mid-March widening of the daily yuan-dollar trading bands to plus or minus 2 per cent (from the earlier 1 per cent band) is an important step in relaxing control over the so-called managed float. That, coupled with the 3 per cent depreciation in the past few months, should send a strong signal to speculators that one-way renminbi bets are hazardous - a signal that could help dampen inflows of hot money, which have complicated liquidity management and fuelled asset-market volatility in China.

There are two different views of the future of the US-China economic relationship: one that sees only risk, and another that sees opportunity. Fixating on the yuan falls into the former category: it misses the rebalancing and reforms already under way in China and deflects America's focus from addressing its most serious long-term macroeconomic problem - a lack of saving.

By contrast, viewing China as an opportunity underscores the need for America to undertake its own rebalancing - rebuilding US competitiveness and pushing for a meaningful share of China's coming boom in domestic demand. Unfortunately, the revival in US saving that this will require is being drowned out by the renminbi rant.

Stephen S. Roach, a faculty member at Yale University and former chairman of Morgan Stanley Asia, is the author of a new book Unbalanced: The Codependency of America and China. Copyright: Project Syndicate


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The yuan may continue its persistent devaluation in the foreseeable future, for at least four reasons:
Firstly, it reduces the country’s pressure of internal devaluation resulting from the present probably-quite-overvalued yuan.
Secondly, it discourages continuous inflow of hot money into the country and the one-way bet on yuan revaluation.
This inflowing hot capital tends to fund the country’s precarious Ponzi-scheme-like shadow banking and property markets.
The country’s savings is more than enough to fund its needed investments.
Thirdly, it helps reinvigorate the country’s export competitiveness, reducing her wasteful capacities and the extent of bad loan accumulation, maintaining its aggregate demand and thereby sustaining her future GDP and employment growth.
Fourthly, the resulting possible imported inflation can sustain or increase China’s current still-positive inflation rate, and so reduce the real value of the rising debts accumulated by the local and central government in the coming years.

The seriousness of China's so-called property bubble and banking crisis has been greatly exaggerated by the foreigners.
To know more, you are highly recommended to read Stephen Roach's recent book ('Unbalanced: The Codependency of America and China', chapter 8, The China Gripe, Collapse, The property bubble and The banking crisis).
Urbanization requires shelter, commercial and office buildings, and infrastructure --- all of which must be in place before new citizens arrive.
China's stock of capital remains woefully deficient, especially when measured against the steady growth of its urban workforce.
China will need to run a high-investment economy for years to come.
The criticism of China's high-investment economy is not well justified --- investment is the means toward an end.
The end is the stock of productive capital that the economy needs to drive longer-term productivity and growth.
A larger stock of productive capital is needed not only in China, but in America (and the South-East Asian countries) as well.
I don't think you've seen China up close. Much of the "investment" in China is clearly speculative. Places like Chongqing do in fact need lots of housing, but much of the new housing has been big flats, far from the city center and places of employment. What the market would like would be smaller places, less opulently appointed and closer in to the city center. Go to look at Xining and see the huge amount of building in the airport area. There is nothing much out there, certainly no jobs. You might think that urbanization will eventually fill those places, but think again. Xining is the capital of Qinghai province. There simply aren't that many people in Qinghai that can move to Xining to fill up those places. You see this kind of thing all over China.
Investment volume is one consideration, but the efficiency of these investments is something financial types can't see but engineers can. From what I have seen in the power industry in China there is absolutely zero improvement being made in this industry. Not better designs, not better application and not better operation. What you see is the risk-free option of doing the same thing over and over. I've seen power plants in the U.S. during the same 10 year period and U.S. plants are always making improvements both large and small, while keeping their staffing levels reasonable. You don't see this in China.
Don't be so sure that China's economic growth is going to continue without major upheavals.
Many people are worrying about China’s potential drop in her coming quarterly GDP growth rates and the accompanying problem of rising unemployment, and are suggesting that the central bank lower the banks’ reserve ratio later in the year to cope with the problem.
But the country’s M2/GDP ratio is about 2 right now, quite high when compared with her past record and with other countries.
From MV=PQ, to stimulate the nominal GDP on the right hand side, we can keep M's present growth rate constant and instead raise V, by utilising the amount of money more often than now.
One way is to securitise some of the bank loans related to property purchase, by imitating the US and setting up the China-equivalent Freddie Mac and Fannie Mae.
The money raised by the MBSs can be allowed to make further property loans through the banks, but nothing else.
This helps sustain China’s present too-big-to-fail property market.
After the recent Great Crisis we should have learnt enough to prevent any potential Chinese-style sub-prime crisis from developing in China in the future.
(Chinese readers: ****www.hkcd.com/content/2014-04/30/content_840546.html)
M's growth rate should only be increased (say, through lowering the banks' reserve ratio) if, due to the yuan's continued devaluation, serious capital flight out of the country occurs which bids up the country's market interest rates.
Over time, the country's continued growth will reduce the M2/GDP ratio to a lower and more healthy level.
The Feb's QEs can only take the US economic recovery so far.
There is no miraculous shortcut to economic growth.
Expansionary and accommodative monetary policy, a kind of manipulation of short-run aggregate demand, can't increase the productivity of the whole economy, it only leads to bubbles and recessions.
It's time for the country to pay more attention to the supply side, like Reaganomics in the early 1980s.
For the US Phoenix to really rise out of the fire of the recent Great Crisis, the country, like China, has to rebalance her own economy as well, from a predominantly consumption-led economy to a more investment- and export-led one --- exactly opposite what should be done in China.
Both countries need to rebalance their economies, not China alone.
As before, it takes two to tango.
In particular, more infrastructure spendings are needed in the US to overhaul the overall competitiveness of the whole economy.
This will further increase the already very large government's debt burden in the coming years, thereby increasing the total amount of debt incurred by the next generation.
But without proper amount of infrastructure investment now, the present generation will reduce the relative competitiveness of the country in the future, and burden the next generation even more than the rising accumulated debt that otherwise would have been incurred.
Unfortunately, the political structure of the country encourages the politicians to think short term, not long term.


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