China, Inflation And Revaluation

A Wall Street Journal article webbed by Yahoo! Finance discusses a geopolitically sensitive subject: the value of the renminbi, or the undervaluedness of it. The piece explains the fear that PRC officials have regarding their currency: a substantial upvaluation of the yen after 1985 squeezed Japanese growth. It's likely believed in the PRC that allowing the renminbi to shoot up will kill off growth and make for a "Lost Decade" (or worse) in China.

However, PRC officials may be amenable to a small upvaluation because of rising inflation:

Most Chinese economists say they think their nation's large trade surplus is best addressed with domestic policies to lower high savings rates. "To only focus on the exchange rate is the wrong approach. You have to look at fundamentals," said Yao Yang, an economist at the China Center for Economic Research in Beijing. "It will kill China's economy if you appreciate the renminbi by 20% in one month."

The costs to China of a big exchange-rate move would be immediate and concrete: export factories whose goods suddenly got too expensive would close, idling workers. Yet the benefits that proponents say come from yuan appreciation are diffuse and abstract: chiefly, a more "balanced" global economy.

So what could persuade China to revalue? The most likely factor is inflation....

Thanks to its government stimulus, China's economy has recovered well ahead of the rest of the world. The problems of rapid growth also have arrived early: Consumer prices were up 1.5% from a year earlier in January, and are expected to accelerate in coming months. The central bank has already raised banks' reserve requirements twice this year, most recently on Friday, aiming to contain a boom in credit as housing prices soar.

China's government tried to counter the last surge in inflation, which began in 2007, with currency appreciation. The yuan gained about 15% against the dollar until authorities returned to a de facto peg in mid-2008. A similar response now is plausible....

Later, the article says that any upvaluation on that basis would be more modest - more likely to resemble 2005's guided and slow one.


A rise in Chinese inflation is, of course, one of the factors pushing up Chinese demand for gold. An upvaluation would tend to lower PRC international competitiveness, but it would also lower prices of imported goods.

One possible side consequence: despite Chinese resistance to another Plaza Accord, a gentle lowering of the U.S. dollar is workable in this framework. Although a co-ordinated move would lessen the price drop of imports, it would also lessen the impact on Chinese competitiveness in other currency zones. The U.S. government has incentives of its own for a lowered greenback, revolving around export promotion. And, if the PRC rulers express a wish to upvalue the yen, they can hardly complain if a gentle drop in the U.S. dollar lowers the value of held U.S. Treasury securities. After all, an upvaluation will have that effect anyway.


The potential losses are lessening, anyway: as of December of last year, the PRC is the second-largest holder of U.S. Treasury securities thanks to net sales of $34.2 billion' worth. That move doesn't seem to have affected T-rates all that much.