Louder Complaints About an Undervalued Chinese Yuan and Some History

October 26, 2009

The U.S. Treasury semi-annual report on International Economic and Exchange Rate Policies, released earlier this month, bluntly called the Chinese yuan “still undervalued” and said it had depreciated 7% in trade-weighted terms since February despite brisker Chinese productivity and GDP growth, a $186 billion increase in Chinese reserves in the first half of 2009, and outstanding reserves of equal to roughly 50% of GDP, an excessive ratio.  New York Times columnist and economics Nobel prize winner Paul Krugman on Friday described Chinese currency policy as “outrageous” and concluded that “with the world economy still in a precarious state, beggar-thy-neighbor policies by major players can’t be tolerated.”  This week’s issue of The Economist features a special report on China and America and claims that Beijing’s management of the yuan, which hasn’t moved against the dollar since July 2008, is “stymieing the adjustment of China’s economy, fueling dangerous domestic asset bubbles and placing an unnecessary burden on other, more flexible currencies.”  The lead story in today’s Money and Investing section of the Wall Street Journal is entitled “Yuan’s Fall Annoys the Neighbors.”  Everyone’s hopping on the bandwagon.

Under communist leadership, China’s currency has been always controlled carefully through capital controls and intervention.  It averaged 2.46 per dollar through the decades of the 1950’s and 1960’s and appreciated 64% to 1.50 per dollar in the awakening decade of the 1970’s.   As capitalist mechanisms were gradually reintroduced, the 1980’s and 1990’s saw the currency depreciate very extensively, hitting a record low of 8.62 per dollar in 1994.  In mid-1997, sovereignty over Hong Kong passed from Britain to China, and on the very same day, July 1, a devaluation of the Thai bhat triggered what would become known as the Asian financial crisis.  To protect their economy, Chinese officials fixed their currency to the dollar at 8.277, a parity that would hold until July 21, 2005.  The mid-1997 values of the mark and yen were 1.746 and 114.7 per dollar, and their values on July 21, 2005 were 1.609 (1.216 per euro) and 112.7.

Beijing officials claim that from July 2005, the yuan has been managed against a basket of ten currencies.  The weights are not know publicly, but the dollar, euro, yen and won supposedly have the larger weights with the pound, bhat, rouble, Singapore dollar, Aussie dollar, and Canadian dollar in the mix, too.  Officials stressed gradualism and flexibility when the new scheme was introduced, and for the ensuing year, the dollar depreciated irregularly relative to China’s currency.  In sequential half-year increments the annualized pace of yuan gains against the dollar amounted to 5.2% in the six months to January 2006, 1.8% in the six months to July 2006, 6.0% in the six months to January 2007, 5.6% in the six months to July 2007, 9.3% in the six months to January 2008 and 12.1% in the six months to July 2008.  The pace was accelerating, and officials in other countries were applauding.

When the yuan initially stopped climbing against the dollar, few complaints were made.  The dollar was depreciating, so a fixed USD/CNY translated into further yuan appreciation on a trade-weighted basis.  Over the year to February 2009, China’s currency climbed 13.3% in such terms according to the U.S. Treasury.  China’s trade and current account surpluses were imploding due to the global recession, and substantial fiscal stimulus in China was making a contribution to the cooperative effort to promote a way out of recession.  However, since the dollar peaked in March, other Asia economies have suffered a competitive loss in particular from a frozen China.  While the dollar is just 3.6% lower now against the euro than in July 2008, it has weakened 14% against the yen and even more against the South Korean won.  Since mid-1997, the dollar has fallen somewhat less against the yuan (17.5%) than against the mark (25.5%) or yen (19.7%).  And whereas the U.S. currency is 355% stronger against the yuan than it was in 1980,  net losses have been accrued of about 59% against the yen and 29% against the mark.

Independent estimates of the yuan’s under-valuation do not generally run as high as these contrasting changes imply.  The Big Mac index has suggested an under-valuation of marginally less than 50%, but a World Bank study four years ago put the discrepancy at only roughly 10% based on purchasing power parity theory.  Other similar estimates made in 2005 when yuan policy was changed put the under-valuation at 20-25% at that time.

Beijing officials are unlikely to be affected by the complaints.  They have consistently managed their exchange rate according to the dictate of  domestic economic and political factors.  China tends to have greater leverage than its competitive adversaries in negotiations on this matter.

Copyright Larry Greenberg 2009.  All rights reserved.  No secondary distribution without express permission.



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