China and the currency war.
China and the currency war.
China and the currency war.
In the last years, with increased intensity since 2008 economic crisis started, USA and Europe are complaining about unfair practices of Chinese Economic policy makers. The main complaint is about manipulation with the Chinese currency, which causes an unbalanced world economy. There can be heard voices declaring, that the Chinese currency is undervalued by 30-50%.
The unbalanced exchange rate is created by Government regulation and intervention, which doesn’t let the RMB fluctuate freely on the market. The undervalued currency creates unbalance in relative prices and gives advantage to Chinese exporters of manufacturing products against their US-European competitors. It mainly is translated into reduced production costs, boosts the Chinese exports, but on the other hand it reduces also the domestic demand and standard of living in China.
The unbalanced trade between China causes continues deficit in the US current account and causes accumulation of debts of US against Chine.
This reality on the one hand supports enormous economic growth of Chinese economy and the other hand it supplies to ever hungry US consuming market cheap products. It seems that both economies benefit from the situation.
If so why to bother about it?
There are several problems this situation creates;
-
The US manufacturing capacity has decreased dramatically in the last years as you can see in the next graph representing the decline of manufacturing jobs in US in the last 15 years;
This Chart just verifies the situation known to all of us. Try to ask yourself, how many times you lately used US manufactured products? Personally if I exclude the computer software products and the Boeing plane i fly with my answer would be almost certainly none. Even the Apple’s i-phone and tablets, definitely US originated technology are produced in China, as we discovered lately in the news about some workers in China, who committed suicide, due to the harsh conditions in the Apple production plants.
The second problem is the large trade deficit of US with China, which grow from close to zero in 1985 into annual deficit of 273 milliard US$ at 2010.
In the last decade the US trade balance generated annual trade deficit of 400-700 milliard US$.
The main causes of this debt is government spending with deficit in the public sector, and low rate of private savings, which is insufficient to cover the investments. It seems the US deficit was caused by both causes.
Next chart shows the correlation between US public and the trade deficit
In the next chart we can see the decline of the personal savings in US from 10% of the GDP in 1985 down to negative values in 2008.
You can see that the current savings which are supposed to allocate sourced from immediate consumption to investment are practically non-existent in US and the investments are financed by loans from abroad. Still the main source of the deficit is the public spending which is again covered by loans from foreign countries.
The main negative consequence of the deficit in the mutual trade between China and US is accumulation of debt. The US national debt reached in this days about 14 billion US$, (close to 100% of the GDP), out of which about 9 billion is public debt. The public debt has increased dramatically since 2008, when the economic crisis actually exposed the realities behind the “junk bonds”, nicely wrapped and allocated to the net exporting countries. The financial system that created this allocation of wealth from exporting countries to USA, has developed with the support of both China and USA because it supported their short term interests of fast export oriented development in China and over consumption in USA. But after a more than a decade this unsustainable situation has became the main tool to balance the world economy. The economic crisis was just the trigger to start a long term process, where this unbalance in world trade will have at the end to return to more balanced form.
This debt was financed by government bonds which are partly owned by foreign holders, as it can be seen in the next data.
Foreign holders of US government bonds;
Country |
2011 |
2010 |
|
China, Mainland |
1154.7 |
|
889 |
Japan |
885.9 |
|
765.2 |
United Kingdom 2/ |
278.4 |
|
208.3 |
Oil Exporters 3/ |
215.5 |
|
211.9 |
Brazil |
197.6 |
|
169 |
Carib Bnkng Ctrs 4/ |
166.5 |
|
143.6 |
Taiwan |
157.2 |
|
119.6 |
Russia |
139.3 |
|
124.2 |
Hong Kong |
128.1 |
|
146.6 |
Switzerland |
107.6 |
|
84.4 |
Canada |
86.6 |
|
54.7 |
Luxembourg |
83 |
|
79.1 |
Germany |
61.1 |
|
49 |
Singapore |
57.8 |
|
41.3 |
Thailand |
56.4 |
|
33.3 |
Ireland |
44.4 |
|
39.2 |
India |
40.6 |
|
32.7 |
Mexico |
34.4 |
|
34.4 |
Turkey |
32.9 |
|
27.5 |
Belgium |
32.1 |
|
17.4 |
Korea, South |
31.9 |
|
39.7 |
France |
30.2 |
|
36.3 |
Poland |
26.3 |
|
22.3 |
Netherlands |
25.4 |
|
20.7 |
Italy |
24.6 |
|
21.3 |
Philippines |
22.8 |
|
11.3 |
Egypt |
20.7 |
|
19.4 |
Israel |
19.9 |
|
16.8 |
Colombia |
19.8 |
|
16 |
Norway |
19.4 |
|
12.3 |
All Other |
262.4 |
|
161.1 |
Grand Total |
4453.4 |
3702.1 |
The described problems of US trade deficit rise a legitimate question about Europe, if it is in similar situation. The next chart we can see that compared to US, Europe’s trade is relatively balanced. While in the first half of the last decade Europe generated rather positive balance, in the second half of the decade it was more or less balanced.
trade between China and Europe, if compared to US is relatively balanced, as you can see in the next chart;
Of course it doesn’t mean that Europe is without problems of trade deficit. But this problem is rather internal matter. We can see in the following chart, that the PIGS (Portugal, Ireland, Greece, Spain) countries have deep trade deficit, which is balanced on the other hand by the German surplus.
Eurozone Current Account Balance as % GDP
But what about the future? If China will continue its current exchange rate policy of linking the Chinese RMB to US$ how will it influence European economy?
We Assume that US will have to cope sooner or later with its deficit. First process that already started is that US$ will lose its value against the Euro. During this process Euro will strengthen its position as a reserve and international trade currency.
This process started as you can see in 2002, when 0.8 US$ was equivalent to one Euro. Today it is more than 1.4 US$ to one Euro.
If we compare the exchange rate change of the Chinese RMB to Euro or to US$, we can see immediately that in the last 10 years the Euro strengthened from 7.5 RMB to one Euro to 9 RMB to one Euro, the US$ lost its value in the same period from 8.2 RMB to 6.8 RMB per one US$. (The last updated figure is 9.4 RMB/1 Euro and 6.5 RMB/1 US$). It seems these trends are
This trend is supported not only by the fact that European trade is balanced as mentioned above, but to the fact, that behind Euro currency is economy of similar size as the US economy, as you can see in the next chart.
Our understanding is, that the US$ will have to have long term trend of depreciation either by increasing inflation or by devaluation against all freely floating currencies. US central bank already started inflationary policy by purchasing back US government bonds, in other words printing money. This will necessarily have impact on the real value of the US$.
If China will continue its currency exchange rate policy of linking the RMB to US$, European Union economy and the Japanese economy as well and probably also other countries like Brazil will necessarily pay the price with increasingly strong currency with all the consequences that will follow. This trend could cause to European economy all the deficiencies it caused to the US economy. To mention some of them; reduction of international competitiveness, damage of the industrial production and employment, probably also growing trade deficit etc. To my opinion the Chinese exchange rate policy is more damaging to Europe than to US economy.
To our understanding the current economic policy of Chine is on the long run unsustainable not because it is damaging US economy. The Chinese economic policy has already had its damaging effect on the US economy. (US economy and its population has become addicted to cheap Chinese products and probably in the next decade it will have to go thru painful cure to get rid of this addiction), but because its future impact on the European economy, which will cause Europe to defend its economic environment against such trends. Since it is hard to believe that Europe can manipulate its own currency in the way China is doing it, it will implement some policy of protectionism, as it is used to do. (viz. European policy of subsidies to agricultural production) .
It appears, China is aware of these realities and since the 2008 crisis had adopted policy of increasing investments and domestic consumption by loosing its monetary policy. In the short term this policy can be effective, but in the long term it will bring inflation and will have to be balanced by contra measures, like change of exchange rate policy.
The real choice of China is not if to change the relative prices between its economy and US-European economy, but to do it by increasing the RMB exchange rate, or let it happen by inflation or increased domestic demand regulated by the government. From the US-Euro perspective the result of these three alternative policies is increased Chinese consumption and decreased surplus in its trade, but in the internal perspective the two alternative policies will have different socio-political impact in China. While the inflation will enrich unevenly the Chinese people, the revaluation would have impact on broader level of the population. Of course on the margins of the economy the labor intensive activities will be negatively influenced, and some of them will move to lower income states (Bangladesh, Pakistan etc.). Yet during the 2008 crisis, Chinese economy showed strong resilience to the dramatic drop in world demand to its products by creating robust grow based on the local demand and shifting it production toward it.
Other side of the story is that if China wants to make RMB a world currency, which will participate as currency of international trade and reserve currency, I can’t see any alternative to changing the policy of fixed exchange rate of the RNB.
From → China versus World, ECONOMICS, Economist view, Geopolitics, MENUE