Speculation about an imminent move in the value of the Renminbi has intensified amid rising trade tensions between the US and China.
The US Treasury has delayed its semi-annual foreign exchange report indefinitely. The Treasury has been under increasing pressure to label China a “currency manipulator”.
Whether that satisfies a group of US politicians threatening increases in tariffs on Chinese imports, remains to be seen.
Meanwhile, Chinese Premier Wen Jiabao has rejected claims the Renminbi is severely undervalued and the AMP’s chief economist, Dr Shane Oliver says there is a sense that new found confidence may be forcing Chinese leaders to stand up more to US demands.
There is nothing new in terms of tensions over the value of the Renminbi (RMB).
The US first started to push for Renminbi revaluation around 2002.
By 2005 US politicians launched a bill threatening an across the board 27.5% tariff on Chinese imports. The tensions then dissipated after China revalued the currency by 2% in July 2005 and then allowed it to appreciate.
By mid July 2008 the Renminbi had appreciated by a cumulative 21% against the $US.
However, with the global financial crisis taking a toll on Chinese exports, China ceased the appreciation in mid 2008 and the Renminbi has been stuck at around 6.83 to the $US ever since.
With Chinese exports now recovering, RMB appreciation being seen as a way to help deal with inflation and US political pressure intensifying again, expectations for renewed appreciation have returned.
Basic economics – why appreciate?
According to the US, the Chinese Renminbi is severely undervalued and causing immense damage to the US economy.
However, this is subject to much debate.
First, it is not clear the Renminbi is actually undervalued.
Most measures which compare the purchasing power or currencies show the Renminbi to be undervalued against the $US.
A popular example of this is The Economist Magazine’s Big Mac index which indicates that if the price of Big Macs were to be equated in the US and China the Renminbi would need to rise in value by around 50%.
However against this, China’s trade surplus has been declining as its imports have been growing faster than its exports.
This is hardly a sign of a significantly undervalued currency.
More sophisticated estimates of fair value from Goldman Sachs, which allow for productivity swings, the terms of trade and relative inflation, indicate the Chinese Renminbi is actually fair value against the US dollar.
Second, it is doubtful the RMB appreciation alone will help reduce the US trade deficit with China, as the US is generally not competing in the same areas.
Liberalising restrictions on high-tech exports to China would probably do more to redress the imbalance than a currency shift.
Third, China has been a big funder of the US budget deficit via bond purchases which is only possible as China is buying US dollars to stop the RMB from rising.
If this hadn’t occurred, US living standards would be a lot lower.
Given all this it’s little wonder China is not convinced its currency is dramatically undervalued and that its currency management is causing big damage to the US economy.
There are a number of other reasons why China has resisted pressure to adjust its currency or let it float: its capital market is relatively undeveloped; having seen the damage caused by wild exchange rate swings during the Asian crisis it has been reluctant to expose itself to the same; and it is aware of the damage the rise in the value of the Yen (under US pressure) caused Japan in the 1990s.
And it still sees significant uncertainty around the global recovery and hence in the outlook for its exports.
Against all this however, there are good reasons for China to resume a modest appreciation in its currency.
First, allowing the Renminbi to rise will make it easier for China to control inflation as opposed to relying on monetary tightening alone, as it will reduce import prices.
Second, by making imports cheaper it will help facilitate a rebalancing in the economy towards consumption, effectively better enabling China to take advantage of the slack that currently exists in major advanced countries.
Third, the US dollar peg arguably works against China’s national interest. It has effectively meant China’s trade weighted exchange rate has gone up with the $US during times of crisis, which is exactly the opposite of what’s required.
It is also working against Chinese efforts to promote the RMB as a reserve currency – what’s the point if it’s just pegged to the $US?
Likely outcome
At the end of the day China does seem to recognise that a trade war with the US would be far worse than allowing a modest appreciation and there are good economic reasons to adjust the Renminbi.
So the most likely scenario is that the Renminbi will resume a path of gradual appreciation against the $US some time in the next few months.
Whether this is kicked off by a one off revaluation as in July 2005 is hard to tell and doesn’t really matter.
Overall we see the RMB rising by around 7% over the next 12 m
