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Monday, February 14, 2011

CHINA'S CURRENCY MANIPULATION AND ITS IMPACT ON USA JOB-GROWTH

TODAY'S BUGGY COMMENTARY

It deals with Chinese and USA trade relations, and more specifically with whether or not the huge unsustainable trade imbalance between the two countries will be corrected by a Chinese government decision to reorient its developmental path away from export-led growth toward domestic growth --- and hence to stimulating the extraordinarily low percentage of household consumption in its GDP from 36% (nothing ever like that staggering low percentage anywhere in developmental history, not even remotely in Japan much earlier, or in Taiwan and South Korea half of the 20th century).    In 2010, the national savings rate was an astonishing 51% of GDP --- a figure that has no parallel in modern history, or maybe even since Noah floated his ark.

As a result of low national consumption and very high national investment --- not to mention an undervalued Chinese Yuan compared to the $US and a variety of trade-barriers ---China's current account surplus with the USA last year was a record $274 billion.   All this, mind you, at a time of unusually high unemployment here that still hovers above 9.0% a good year-and-half after the recent Great Recession ended officially in mid-summer 2009.  Globally, China's all current account surplus with all its trade-partners was also high: a total of $181 billion.

Some Sidebar Clarifying Comments

1)  Keep in mind that a surplus in a country's current account as in China--- international trade in goods and services, plus income flows in and out of the country, and unilateral transfers like foreign aid (click here for a good brief explanation) --- will automatically occur in national income statistics if national savings exceed national investment.  That country's current account surplus will automatically be balanced in its overall balance of payments by investing the excess national savings in foreign financial assets, whether long-term or short-term . . . such as (in the Chinese case) buying US Treasury bills or private firm equities or bonds or for that matter American firms or real estate.   And, among other things, buying American financial assets keeps the Chinese Yuan (Renimbi) from revaluing upward against the $US and hence keeping the prices of Chinese imports into the USA from rising over time.

As the example suggests, China's strikingly large national savings rate--- which results from its low national private and public  consumption and is a long way from being exhausted its large rate of private and public investment --- is the prime example of such export-led growth.  The country's extraordinarily high savings do not reflect cultural habits and so on --- not much anyway.  They result from deliberate government policies: no public health-coverage, no retirement pensions, and government-imposed limits on real wages and on the availability of credit-finance for household consumption.  By contrast, there are very low and privileged interest-rates and land-subsidies that the Chinese government extends to export-oriented businesses and their supplier business-firms in the country. 

2) Oppositely, a country whose national savings don't suffice to cover private and public investment --- which can result from either excessive household and government consumption or excessive and likely misallocated investment --- will automatically find that it will suffer a current account deficit and offset it in selling its financial assets to foreigners.  That results in an inflow of foreign capital into, say, the USA, the prime example of a country with a long-standing current account deficit.  Put in different terms, a current account deficit for the US occurs because American household consumers, private businesses, and government at all levels absorb more goods and services --- due to consumption and investment --- than the US economy produces each year.  The gap between national output and absorption materializes precisely because of the current account deficit. 

Click on the "continue" button just below.

For a clear, easy-to-follow illustration of the role of a country's  national savings and investment rates in determining the current account surplus or deficit --- more than enough to cover national investment, and hence cause a surplus; or oppositely not enough to cover it, and hence result in a current account deficit --- click here on this 2003 buggy post and scroll down to the explanation of all this using national income statistics to measure final GDP for the year.

3)  The alternative way to explain a current account surplus or deficit --- which is balanced in the balance of payments by either an inflow of foreign capital from abroad for a deficit, and an export of capital for a surplus ---is to look at the exchange rates for the persistent surplus and deficit countries . . . at any rate, over several years.  The deficit countries' exchange rates are overvalued --- say, to be more specific, the $US, is overvalued compared to its major trade partners' currencies like the Chinese Yuan (Renimbi or RBM for foreign commerce).  That's the same thing as saying the Yuan is undervalued vis-à-vis the $US, and probably anywhere from 15% to 30%, though some non-economists have called for 40% or more. 

 4)  How do the two explanations match? 

Well, an overvalued currency like the $US encourages an inflow of relatively cheaper consumption products and investment goods for business firms that are imported from abroad.  And so, in American national income statistics, both household consumption and business investment are encouraged and have long --- unless  the dollar could depreciate against the Yuan and other foreign currencies of the countries that it has large and persistent current accounts --- exceeded  both household and business savings to cover such expenditures.  Something else too.  If the US government at all levels also runs federal and state budget deficits, such deficits add to national consumption and reduce national savings.  The opposite is the case if governments run surpluses. 

Who are the beneficiaries in the USA?  Consumers and certain business firms, including American firms operating in China.  Who have been the losers?  American firms shut down or reduced in size and the workers in them laid off. 

Enter the Controversy over the Value of the Chinese Yuan (Renimbi for Foreign Trade and Investment

Right now, recall, there was a $274 billion deficit for goods and services last year on the American side, at a time of over 9.0% unemployment 18 months after the recession officially ended . . . and with a poky revival of job-growth despite a return to long-term trend growth in the US economy that existed before the recession began in the last quarter of 2007.

True enough.  That huge trade imbalance doesn't mean the US-Chinese trade-relationship hasn't had some advantages for the American people, mainly of course in far cheaper consumption goods sold Wal-Mart and elsewhere in clothes, shoes, certain consumer electronics, cosmetics, and so on.  It does mean, though, that with the slow revival of job-growth in the USA, the chief concern of our policymakers will be focused on reducing it --- this for both sound economic reasons and electoral considerations.  In September 2007, to jog your memory, unemployment was only 4.6% or so. 

Then the turbulent recession and its staggering financial causes and ongoing fall-out hit us in late 2007  Unemployment leapt to almost 10% in 2009, and it still persists above 9.0% despite solid GDP growth and a booming stock-market, and no doubt for complex reasons: fast-growth in productivity that lessens the need for business firms to hire as they did after the 1991 and 2001 recessions;  and more caution by indebted households and businesses to spend as much as they had been doing for consumption or investment before 2008;  and some structural unemployment as jobs that are being offered require certain skills that, say, unemployed construction workers lack.   Then, too, if some of the unemployed do have the skills, they're probably reluctant to move to another city or region if they can't sell their houses and use the money to buy a residence elsewhere.  Not to mention another problem: if these skill-qualified people owed more on their mortgage than the house is worth and walked away from it, their credit-rating would be ruined.

Nor is this all.   Owing to slow job-growth, a return to 5.0% or lower unemployment not likely to occur for five years or more into the future. 

And So --- What to Do with the Soaring Chinese Trade Surplus with Us?

 As long as unemployment remains high in the USA, then a large multilateral trade deficit with the rest of the world will add to the slow growth because it reduces aggregate demand for domestic goods and services and hence slows down job growth.  By how much is a source of controversy, but it's clear that a huge trade deficit with China that is almost $300 billion yearly will be regarded most voters as harmful ---a neo-mercantilist policy that harms job-growth here.  The pressure will mount, then, on Beijing to let its Yuan-currency rise far more rapidly in value than it has since 2008. 

Whether or not the US government can convince the Chinese government on this score is another matter.  It would require a far-reaching switch of the Chinese economy to domestic-generated GDP-growth, at the expense of its large multilateral trade surplus with the rest of the world ($181 billion for 2010 ) and, above all, its huge bilateral surplus with the USA.

Sidebar Clarifying Notes:

1) Keep in mind that the Yuan's value in $US dollars --- or in Euros or Japanese Yen or Brazilian  Real (R$) and so on --- is set in nominal terms, which means that it doesn't take into account the rising cost of producing Chinese exports due to rising inflation.  Officially, inflation last year was 4.6%.  Most specialists on the Chinese economy, whether inside the country or abroad, believe its closer to double that percentage.  Not the least indicator here is the rapid rise of wages in coastal Chinese manufacturing industries.  And though some Chinese firms have relocated in the poorer provinces inland where wages are lower, they are finding that the costs of transportation to the coastal ports offsets much of the savings. 

And so, despite the slow rise of the Yuan's nominal value in $US, the costs of Chinese exports are rising faster than that.

2) As the rate of inflation continues to rise and threaten the stability of the Chinese economy --- not to mention the growing discontent of wage-earners as the prices of their consumer goods rise --- you'd think that at some point the Chinese authorities would consider a revalued Yuan (RMB) as a sound anti-inflationary policy.  It would make the imports of commodities and consumer goods produced abroad cheaper to both businesses and consumers.  So far, though, those authorities have clung to a very slow upward value of the Yuan for trade, relying instead on another anti-inflationary policy: an increase in domestic interest rates.  

Whether that increase will suffice to  reduce the inflationary pressures building up in the Chinese economy is, however, doubtful.

Back To What the US Can And Should Do:

Enter the best analysis of the Chinese economy --- and what is going on and likely to happen in the future to its export-driven growth (and hence excessive national savings, with consumption only 36% of China's GDP) ---that prof bug knows about.  Set out by Professor Michael Pettis, an economist specializing in international monetary matters who holds a post both at a Chinese university in Beijing and with the Carnegie Foundation in this country, it's entitled Currency Manipulation.  His  impressive analysis, which appeared about a week ago, is both remarkably informative and lucidly written . . . so much so that you should have no trouble, whatever knowledge you have of international finance and currencies and economics in general, following his argument.  In case it helps, you might begin before you read Professor Pettis' commentary to look at a fairly lengthy buggy post and his answer to prof bug's questions there.

Click here for the Pettis post.  Scroll down to post 40 for the buggy stuff, and 43 for his reply.  You might also find unusually informative Prof Pettis' January 29th, 2011, post that looks at the soundness of Chinese statistical data for measuring its GDP and its GDP-growth --- both in real, inflation-adjusted Yuan-terms and in USA dollars using Purchasing Power Parity conversion of the existing Yuan/$US exchange rate.