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Why China isn’t revaluing their currency

February 16th, 2010 · No Comments

Actually, it makes sense..
The trade surplus will only shrink when the Chinese save less (or invest more, but the latter really isn’t an option). How will they be induced to save less? If China had public healthcare and pension systems, the need for extraordinary amounts of savings would be a lot less.

Risks Fuel China’s Resolve On Yuan
by Andrew Batson
Tuesday, February 16, 2010

Economists and politicians from Brussels to Washington say that the Chinese yuan is undervalued. For China’s own good and that of the global economy, they say, the currency needs to move up in a big way, and soon.

So why hasn’t China revalued? Part of the answer is Japan.

The last time the U.S. was faced with a rising Asian export power, the currency also became a big political issue. And in September 1985 the major economies of the time met at the Plaza Hotel in New York to ease those tensions. The accord they reached caused the dollar to fall from roughly 240 Japanese yen to about 160 over two years.

Today, China’s critics are demanding a similarly sweeping move. But Japan soon regretted agreeing to a big surge in the yen: Growth slowed abruptly, which pushed the government to boost spending and lower interest rates. A real-estate bubble and a years-long slump followed. And the issue the Plaza Accord was intended to fix — Japan’s sizable trade surplus — remains to this day.

From Japan’s example, Chinese thinkers learned that a big exchange-rate move could damage their economy, and won’t necessarily help the trade balance.

Most Chinese economists say they think their nation’s large trade surplus is best addressed with domestic policies to lower high savings rates. “To only focus on the exchange rate is the wrong approach. You have to look at fundamentals,” said Yao Yang, an economist at the China Center for Economic Research in Beijing. “It will kill China’s economy if you appreciate the renminbi by 20% in one month.”

The costs to China of a big exchange-rate move would be immediate and concrete: export factories whose goods suddenly got too expensive would close, idling workers. Yet the benefits that proponents say come from yuan appreciation are diffuse and abstract: chiefly, a more “balanced” global economy.

So what could persuade China to revalue? The most likely factor is inflation.

China’s leaders have bristled at rising foreign pressure on the yuan, also known as the renminbi, with Japan’s unhappy example giving them few reasons to heed Western advice.

“Accusations and pressure clearly do not help solve the problem,” foreign-ministry spokesman Ma Zhaoxu said recently. But the leadership’s fears of an inflationary cycle that could spark social unrest may prove a stronger motivator.

Thanks to its government stimulus, China’s economy has recovered well ahead of the rest of the world. The problems of rapid growth also have arrived early: Consumer prices were up 1.5% from a year earlier in January, and are expected to accelerate in coming months. The central bank has already raised banks’ reserve requirements twice this year, most recently on Friday, aiming to contain a boom in credit as housing prices soar.

China’s government tried to counter the last surge in inflation, which began in 2007, with currency appreciation. The yuan gained about 15% against the dollar until authorities returned to a de facto peg in mid-2008. A similar response now is plausible.

So how might China go about revaluing its currency? There is no perfect solution. The textbook answer is to revalue in one fell swoop. But a fast move would be harder on the real economy, because exporters wouldn’t have time to adjust.

Gradual appreciation creates its own problems, as China found out during the yuan’s rise in 2007 and 2008. Investors could easily anticipate gains in the currency, and the money that flowed into China as a result probably fed a surge in inflation and asset prices that was only interrupted by the onset of the global financial crisis.

Today’s dilemma is familiar to China. That means Beijing may opt for a familiar solution: a variation of the compromise approach it took in July 2005 when it moved off a de facto peg to the dollar. That involved making a small appreciation, then setting the currency on a path of gradual gains. Authorities also widened the yuan’s daily trading band, in a mostly unsuccessful attempt to convince markets that the yuan could go down as well as up.

Tags: China · currencies