Recent arguments by many Western economic commentators have focused on the benefits of renminbi revaluation for the other sputtering economies of the world. Most vociferous among these has been that of the United States, making the case based primarily on the role of China as a responsible “global citizen” (Becker & Andrews 2003; Goldstein & Lardy 2003; The Economist 2003a, 2003b). In retaliation, Chinese economists have struck back, shrugging off global concerns and state unequivocally that China was not responsible for the world economy’s continued growth, that Chinese monetary and exchange rate policy should be calibrated to accord with Chinese interests, and that China had already fulfilled its international responsibilities by not devaluing during the Asian financial crisis of 1997/98, anyhow (Angell 2003, Chen 2003; see also the summary in Fong 2003).
These arguments clearly have merits on either side. However, there has been little consideration of how China might actually benefit from renminbi revaluation. Such a strategy might seem counterintuitive – how can China possibly gain from a revaluation? Yet, a closer examination of the facts might prove otherwise.
Consider, first, the point that China’s main concern at the moment is deflation, not inflation; as such, government and central bank policy should be oriented toward kick-starting growth, rather than securing an inflation-fighting stance. There are some parallels to pre-1990s Japan that support such a view. China has the makings of a massive real estate bubble, leading to uneasy possibilities of an end to China’s recent rise in world markets. However, such an approach seems unnecessarily (and excessively) cautious. FDI inflows into China seem nowhere near the saturation levels of pre-bubble Japan. Moreover, with continued foreign money rushing to pour into Chinese assets, the danger of not allowing the exchange rate to adjust to maintain external balance means that the money supply has to bear the brunt of mopping up any excess liquidity. An inflationary environment could rapidly develop, and if expectations of inflations are validated and become entrenched, the situation would rapidly deteriorate into an inflationary spiral, not uncommon in developing economies. Given the relative youthfulness of the People’s Bank, this is the last thing that a central bank of an emerging economy needs.
Second, the case for a weak renminbi also revolves around the belief that China growth is largely driven by exports. While Chinese exports do account for a significant part of the Chinese economy, one should not underestimate the potential impact of domestic demand. Biasing the exchange rate toward exporters and import-competing industries – to the detriment of the labor force as well as domestic firms, many of which continue to obtain raw materials from abroad – is a plan that can easily backfire. After all, one of China’s primary comparative advantages lies in the strength of its one-billion strong domestic market, and this forced redistribution could end up stifling growth, rather than keeping it chugging along.
A final point regards the external economy. Even if China holds no interest in the welfare of the world at large, it might still be to its advantage that the major G7 economies recover as quickly as possible. Continued sluggish or stagnant growth in countries such as Germany, Japan, and the United States would trickle back down to China in the form of lower demand fore imports from China, and, in the medium to longer term, a drying up of the previous FDI that China has come to rely so heavily upon as a key driver of development. Furthermore, the recover of export-oriented economies such as Hong Kong and Singapore – both of which have provided China with much of the higher value-added services (such as education and finance) that the Chinese economy is currently unable to fully provide for itself – hinges on the recovery of the big economies. Although the linkages and feedback effects are indirect and far from obvious, they are definitely not tenuous. In an era of globalization, China would be shooting itself in the foot if it fails to recognize, or chooses to ignore, this essential symbiosis.
Should China then revalue its currency? My view is to let the markets decide. A flotation of the renminbi is long overdue, and it is only a matter of time before the Chinese economy becomes sufficiently complex and diversified such that a floating regime would be the best instrument to maintain internal and external balance. What better time than now to do so, in a move that would not only serve China’s purely economic interests, but also placate Western voices and possibly even buy some valuable political capital from the rest of the world.
Angell, Wayne (2003), "The Siren Song of Yuan Devaluation", Asian Wall Street Journal, August 14
Becker, Elizabeth & Edmund L. Andrews (2003), "U.S. Job Losses Blamed on China's Currency", The New York Times, August 26
Chen, Zhao (2003), "China Should Say No to a Stronger Currency", Asian Wall Street Journal, August 14
Fong, Leslie (2003), "China Will Resist Pressure to Revalue the Yuan – For Now", The Straits Times, August 23
Goldstein, Morris & Nicholas Lardy (2003), "A Modest Proposal for China's Renminbi", Financial Times, August 26
The Economist (2003a), "Asia’s Artificially Cheap Currencies", The Economist, July 10
The Economist (2003b), "Fear of Floating", The Economist, July 10