It is the market that wants China’s currency to devalue, not China’s government
As China’s recent currency devaluation rekindles the “currency manipulator” argument and rapidly enters the presidential campaign as a political football, it seem clear that those tossing the ball around are determined to ignore one important fact—it is the market that is driving China’s currency (RMB) lower. The Chinese government has actually been supporting the RMB. If China were to withdraw that support, i.e., stop “manipulating” the RMB, it is highly likely the RMB would fall further.
The exchange rate is not the main reason China became an export powerhouse
Being a poor country with low wages is more important
The fact is the “currency manipulator” accusation, while never completely wrong, has always been overstated and one-sided. “Overstated” because the value of the currency has never been a primary driver for China’s exports. Evidence of this comes from the fact that, although China’s currency has appreciated by more than 30% over the last ten years and there has been tremendous wage inflation as well, China’s export competitiveness has remained strong. China has actually gained market share on higher value added products like computers, electronics and appliances. Relative to lower value added products, like apparel, shoes, and toys, China has lost market share, but not precipitously. It is worth noting that, for the most part, China’s lost market share has not gone to US, but to Vietnam and other low cost countries. It is China’s lower wages, which are typical of a poor country, combined with its economic liberalization program, that are primarily responsible for China’s competitiveness.
Some Chinese policies aren’t fair
Currency manipulation isn’t one of them anymore
That’s not to say all Chinese trade and economic policies are fair. For example, when China’s inefficient and highly corrupt state-owned financial sector and local governments combine to build way more steel plants than China needs and then dumps its excess capacity on the world market, that isn’t fair. It also isn’t currency manipulation. Most importantly, it isn’t good for China which has to bear the burden of so much wasted investment.
Capital flows are having more impact now
Less restrictions and weak economy are driving capital out of the RMB
The “currency manipulator” argument is one-sided because it considers only one side of the currency market. For many years China’s extremely tight capital controls not only prevented foreigners from investing in China’s capital markets they prevented the Chinese from investing overseas. That’s one reason why real estate prices (and, more recently, equity prices) in China are so high—people have nowhere else to put their money. Because of the capital restrictions, in the past the exchange rate for the RMB was determined almost solely by trade flows, unlike more free-market-oriented countries like the US for which exchange rates are determined by the combination of trade and capital flows. For many years some made the argument that, if China loosened its capital controls, we might actually see the RMB fall further. That is exactly what is happening now.
China began loosening its capital controls a few years ago, giving capital a greater role in moving the currency. Plus, as China’s economy has grown more international, the ability to move capital offshore via the gray or black market has also increased. Lastly, we have the fact that the Chinese economy is currently passing through the most difficult period it has faced in two decades and we all know that investors are prone to dump the currency of an economy in trouble. That’s why, for at least the last six months, if not longer, China has actually been supporting the RMB, i.e., trying to prevent its depreciation.
China has been supporting the RMB to minimize capital flight
Capital flight will make it harder to get the economy back on track
China hasn’t been doing this simply out of the goodness of its own heart. Capital and exchange rates have a symbiotic relationship. Just as capital flight can put downward pressure on a currency, a depreciating currency can cause capital flight. China has been supporting the RMB in order to prevent more capital flight because the loss of capital will make it even more difficult to get the economy back on track.
Other countries have devalued much more than China recently
We don’t call other countries “manipulators” even though their policies result in depreciation
There’s one other reason why the “currency manipulator” argument is one-sided. It only takes into account the US dollar to RMB exchange rate. Over the last 12 months the RMB has appreciated by 23% against the Euro and roughly 15% against a trade-weighted basket of currencies including the Japanese Yen and South Korea Won. We don’t call any of these other countries “currency manipulators” but the fact is that many of them have pursued monetary policies that have inevitably led to a lower currency. Not only can China justifiably claim that the devaluation of the RMB was not manipulation but rather acquiescence to the market, China can also say that when it comes to recent devaluations, they aren’t even close to the top of the list.
It would be nice if politicians got their facts right on China
Using outdated arguments won’t help the quality of the campaign
Much uncertainly surrounds China’s the future of China’s economy and currency policy. Will the market continue to push the RMB down? How far will China let if fall? How will other countries react? Is this the beginning of a currency war? Will capital flight accelerate? China is in a difficult position and only time will tell how they manage it.
While the economic picture is cloudy, the political one, at least as far as the campaign is concerned, should be clearer. Politicians shouldn’t use arguments that are clearly out of date and weren’t that strong in the first place. They ought to base their comments on facts. The fact is that the market is pushing the value of the RMB down, not manipulation by the Chinese government.