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September 7, 2006
More yuan debate
For part I, see here.
My focus was, as usual, on the merits of gradual rather than sudden yuan revaluation, and I come to that conclusion mainly from considering how fragile the Chinese banking system is and how a gradual revaluation really will help them in the long run. Yes, the yuan is undervalued. No, it should not remain that way forever. But I think that as Tyler Cowen suggests, it's a waste of political capital for American politicians to keep harping on it. When the yuan appreciates, it will not be because we told them to. I know we have big egos, but come on. Don't get me wrong. I understand why a hard line stance on the yuan makes sense politically. Therein lies the problem.
But Cowen also made some comments that I don't find as convincing when he downplayed the effect of a revaluation.
The belief is that if the dollar has less value in China, Americans will spend less on Chinese products to offset the prices they pay per item. But even if the numbers work out so that the flow of dollars to China diminishes, American consumers will pay higher prices and see fewer goods from China. Yuan revaluation is unlikely to benefit the United States, even if it does lower its trade deficit.
The trade effects of a revaluation of the yuan are unlikely to be large, in part because many Chinese exporters specialize in assembly. China sends out money buying components like semiconductors and turns them into finished goods, thereby running a trade deficit with East Asia. A new and higher value for the yuan would largely be a wash for these activities. With a stronger currency, China would have a harder time selling its electronic goods, but this would be offset by its greater purchasing power over the semiconductors. It would not do much damage to the Chinese competitive position.
See the discussions at numerous blogs: Brad DeLong, Brad Setser, Greg Mankiw. (Mankiw does not take Cowen's assertion about the small effect of a revaluation head on in his post. His post is more about the benefits to the U.S. of an undervalued yuan.) Cowen responds that he is still "skeptical" about yuan revaluation, and throws in another line that is more to the point I have been making:
My view is not that China should stay put on all matters of economic policy (see today's FT for an excellent article on the internal Chinese debate); rather my argument is that the U.S. won't do a good job micro-managing Chinese reforms.
Precisely. But I'm less skeptical about the effect that revaluation might have for the U.S. On that score, I fall somewhere between Setser and Cowen, probably leaning towards Setser. I just don't think that outweighs the substantial case for encouraging the Chinese to take a gradual approach--as long as they reach the goal in the end. And I think Cowen gets one more thing right:
The fundamental problem in the U.S., to the extent we have one, is our propensity to spend, especially given our long-run demographic position and our government's fiscal irresponsibility.
So when Brad DeLong says:
We should be moving toward Andrew Samwick's policy of a cyclically-appropriate on-budget government surplus in order to put downward pressure on domestic absorption, and we should be strongly advising the Chinese and others to shift from export-led growth and allowing their real exchange rates to adjust, in order to reduce the risks of a really unpleasant episode.
I can at least sign on to the first part.
Posted by William Polley at September 7, 2006 5:56 PM
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