Is the Renminbi Undervalued?

100 Yuan

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U.S. Treasury Secretary Timothy Geithner certainly thinks so. So do Democratic Senator Chuck Schumer and Republican Presidential hopeful Donald Trump. They all point to the massive trade deficit that the United States is running with China as evidence that the Middle Kingdom’s currency policy is giving Chinese manufacturers an unfair competitive advantage.

As we’ve reported in MTD, Trump goes even further. He says that China is “ripping off” the United States, and that if he’s elected President, he’ll slap a 25 percent tariff on all Chinese goods.

Democrats and Republicans alike — it doesn’t make much difference. If the U.S. economy is still struggling with high unemployment, and perhaps rising inflation, in the run up to the 2012 presidential election, everyone will be looking for scapegoats. And what better one to blame for all that ails the American economy than China?

But is the renminbi really as undervalued as Geithner, Schumer, Trump and many others say? If you look at it solely through American eyes, it certainly seems that way. But when you look at it on a global basis, recent trade statistics suggest that this may not be the case, and that the renminbi may, in fact, be more or less in line when all currencies are taken into account.

During the first quarter, China reported a quarterly trade deficit for the first time in seven years, as imports soared to an all-time high. Granted, seasonal factors played a role as first quarter results were negatively impacted by the $7.3 billion that the country reported in February due to factory shutdowns and lower exports during the Spring Festival holiday. However, China did not rebound in March with a large surplus, as trade was almost evenly balanced. During the month, exports barely exceeded imports by $140 million.

For the first quarter, China’s exports were up a healthy 26.5 percent, but imports rose at an even faster 32.6 percent year on year. The rising cost of imports added significantly to the overall figures, as iron ore imports were up 83 percent in value during the quarter, with soybeans up 25 percent, crude oil up 39 percent, and metal-cutting machinery up 72 percent in value. While Andy Rothman, China Macro Strategist for CLSA Asia-Pacific Markets, does not expect China to run a trade deficit for the full year, he does not expect the country to run a large trade surplus either. All of this suggests that the value of the renminbi may be just about right in global terms.

Some observers were quick to speculate that China could be fudging the numbers in response to criticism from the United States and other developed nations. This is a common criticism when China reports numbers that conflict with popular views about the country’s economic progress. Instead of disputing the numbers, though, I would credit China’s government for knowing what makes its economy tick.

China has pursued a “go slow” approach to re-valuing its currency because it understands that export growth will be moderate as demand in key markets cools off, and that its own economy is transitioning from one that is export-driven to one that will be driven increasingly by domestic consumption. In fact, weaker export markets and higher imports due to increasing domestic consumption, in addition to higher prices, were the three reasons given for China’s first-quarter trade deficit.

While a higher-valued currency would have blunted some of the rise in commodity prices, the Chinese government also understands that a complicated economy like China’s can’t be controlled by focusing on one variable alone, even one as important as inflation. Likewise, one country’s relative competiveness with another cannot be explained by one factor alone, such as the exchange rate. A country’s educational system, tax rates, industrial policy, regulatory environment, among others, all play a role as well.

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