“You’re imbalanced!” “No, you’re imbalanced!”

Key News

Quotable

“By nature all men are equal in liberty, but not in other endowments.”

                           Thomas Aquinas

FX Trading – “You’re imbalanced!” “No, you’re imbalanced!”

There’s been a specific, yet passive, global contingent led by the US and somewhat supported by Europe, that believes the Chinese yuan is undervalued, that China possesses an unfair trade advantage by keeping their currency tied down.

Then, of course, there’s China who’s relied on the growth boost that’s come with running a huge trade surplus which seems to have been amplified by the low relative costs that come with a “stable” currency; they do not believe the yuan is undervalued.

And neither does a certain state-run Chinese newspaper. Here’s a fresh piece of news for you, as taken from Rueters:

"Currently, the renminbi exchange rate does not have a problem of being undervalued; on the contrary, it may be overvalued," said the commentary by Xie Taifeng, an economist at the Capital University of Economics and Business in Beijing.

China’s consumer prices have risen by 68.8 percent since 1994, when the government brought in a single yuan currency, wrote Xie. Until then, China operated a separate system of yuan specifically for foreign exchange and use by foreigners.

Over the same time, Xie wrote, China’s inexpensive exports helped to hold down inflationary pressures in the United States.

"Therefore, according to purchasing power parity theory, the exchange rate of the renminbi against the dollar should not appreciate, and instead it should depreciate."

Thank you Mr. Xie, but it seems the argument is about imbalances, regardless of whether or not China was exporting low inflation to the West’s benefit.

US Dollar – Chinese Yuan Weekly

And so the bickering over currency manipulation begins anew.

If you want to learn about China’s economy and China’s policy, go visit www.mpettis.com. I just went back to visit a post Mr. Pettis wrote back in March, and the following excerpt is one he drew from a People’s Daily article:

The saying that "undervalued yuan leads to global trade imbalance" cannot stand up to close scrutiny. Zhao Qingming, a researcher with China Construction Bank stressed that imbalance of an economy’s deposit and investment was the fundamental reason for trade surplus or deficit. Exchange rate has only minor influence.

In fact, yuan appreciation brings more adverse effects to western countries than positive ones. In the past tens of years, because of the yuan devaluation and export rebate policies, western countries, to a large extent, were able to enjoy low inflation, low living cost, and current standard of living, and western governments were able to reduce financial deficit and allow their people to consume excessively.

Ok, so people in the West consumed excessively – exactly. And they were able to do so because of yuan devaluation – exactly.

As a result of excessive consumption in the West and devalued-currency-driven export policies in China, we’re left with a large deficit in the West that’s balanced by a large surplus in China. The benefits of importing low inflation are irrelevant to the argument of whether or not imbalances exist because of a manipulated currency.

Am I missing something here?

I ask: if the exchange rate “has only minor influence” on trade imbalances, then why not let the yuan float freely as other major currencies do? It’s a simple question, I think. And the answer may be simple – propaganda and power.

China knows just how much the undervalued currency held up their export model; they know how much their export model contributed to growth and a corresponding turn towards becoming a major developed economy; and they certainly don’t want to see the government’s fortunes reversed.

But the fact is that China boasts a still measly GDP-per-capita. The United States GDP-per-capita, based on 2009 estimates, is roughly 7.5 times greater than China’s. My point with this: despite the growth engine that the West believes China has become, there are quite a few Chinese that aren’t as quick to assume prosperity has arrived just because China can hit double-digit GDP growth.

China can less afford a set-back to growth than most other developed nations, even if just for social reasons. Rebalancing frightens them; they need to attack it with whatever they can or risk losing manufacturing steam and an unraveling of the public financial positions (excessively short the yuan) … even though Chinese households and importers would benefit from stronger purchasing power.

China is fully aware that the West won’t be consuming excessively again anytime soon; and Europe is now playing with a much weaker currency. A stronger yuan could very well prove disastrous for the Peoples Republic’s “economy management” if there’s no source of growth yet in place to accommodate the export model that would surely become stagnant if the West’s attitude change combines with relatively more expensive Chinese goods.

Sure, China can fight the revaluing pressure as much all they want, but they can’t make the West buy all their stuff. If the other key players accept that rebalancing is a necessity, what choice does China have?

This is no extraneous risk to Chinese growth; it is very real.