AHEAD of a looming Sino-American summit, it’s once again time for newspapers to allocate ink to coverage of the spat over the value of China’s currency. Happily, we seem to be seeing an improved understanding that movement in the nominal dollar-yuan exchange rate is not the most important factor shaping imbalances. Tim Geithner (who, bless him, once got in trouble for saying that the dollar needed to decline) declared today that the yuan is “substantially undervalued” and needs to strengthen. But he later elaborated:
“This is a pace of about 6 percent a year in nominal terms, but significantly faster in real terms because inflation in China is much higher than in the United States,” Geithner said. Taking inflation into account, the yuan is rising at a rate of about 10 percent a year, “so if that appreciation was sustained over time, it would make a very substantial difference,” he said in response to a question after the speech.
Yes, China continues to manipulate its currency. This much is clear from the latest data on Chinese reserve accumulation. Here’s the Washington Post:
At issue is the imbalance in their financial relationship. China’s central bank said Tuesday that Beijing’s holdings of foreign cash and securities amount to $2.85 trillion – a jump of 20 percent over the year before – despite Chinese promises to try to balance its trade and investment relations with the United States and other countries.
China added $200 billion to that stockpile in the last three months of the year alone, as the country socked away capital from the rest of the world at a torrid pace.
That reserve accumulation is directly connected to China’s interventions in currency markets to keep the yuan cheap against the dollar. But the Post makes a mistake in saying that:
The reserves are so large and the recent run-up so rapid that it’s casting new doubts over whether Beijing is reforming the handling of its currency and curbing its heavy reliance on exports as a source of jobs and growth.
And the reason has everything to do with China’s limited ability to control its real exchange rate. A cheap yuan makes for dear Chinese imports and excess demand for Chinese goods, leading to rising Chinese inflation. That’s makes Chinese goods more expensive to foreign buyers—just what a nominal appreciation would accomplish.
When garment buyers from New York show up next month at China’s annual trade shows to bargain over next autumn’s fashions, many will face sticker shock.
“They’re going to go home with 35 percent less product than for the same dollars as last year,” particularly for fur coats and cotton sportswear, said Bennett Model, chief executive of Cassin, a Manhattan-based line of designer clothing. “The consumer will definitely see the price rise.”
Chinese inflation is running consistently higher than American inflation, which is scarcely above 1%. That translates into rapid real appreciation despite the slow movement in the nominal exchange rate. And that should produce a decline in Sino-American imbalances, which seems to be emerging. In December, China’s trade surplus fell sharply its November level, from $22.9 billion to $13.1 billion.
It appears that markets are pushing the real exchange rate in the appropriate direction, despite Chinese intervention. That will help bring trade between the countries closer to balance. But it’s up to the governments in China and America to facilitate this process and reduce its cost to citizens by removing structural obstacles to adjustment.