Tuesday, August 23, 2011

This Is What Adjustment Looks Like (an ongoing series)

. Tuesday, August 23, 2011

Martin Feldstein:

China’s government may be about to let the renminbi-dollar exchange rate rise more rapidly in the coming months than it did during the past year. The exchange rate was actually frozen during the financial crisis, but has been allowed to increase since the summer of 2010. In the past 12 months, the renminbi strengthened by 6% against the dollar, its reference currency. ...

There are two fundamental reasons why the Chinese government might choose such a policy: reducing its portfolio risk and containing domestic inflation.

Consider, first, the authorities’ concern about the risks implied by its portfolio of foreign securities. China’s existing portfolio of some $3 trillion worth of dollar bonds and other foreign securities exposes it to two distinct risks: inflation in the United States and Europe, and a rapid devaluation of the dollar relative to the euro and other currencies. ...

Looking back on the past year, the 6% rise in the renminbi-dollar exchange rate might understate the increase in the relative cost of Chinese goods to American buyers because of differences in domestic inflation rates. Chinese consumer prices rose about 6.5% over the past year, while US consumer prices rose only about 3.5%. The three-percentage-point difference implies that the “real” inflation-adjusted renminbi-dollar exchange rate rose 9% over the past year (i.e., 6% nominal appreciation plus the 3% inflation difference.)


There are obviously political interests in China for keeping the RMB's value low, but the most recent Five-Year Plan calls for increasing households' purchasing power above the rate of economic growth. We may start to see (more) political cleavages in China pitting consumers and against producers. Remember: politics exists even in authoritarian regimes.

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This Is What Adjustment Looks Like (an ongoing series)
 
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