Greenspan on the Renminbi

I’ve broken this into two posts, since it was getting rather lengthy. First, let me point out some interesting remarks by Alan Greenspan yesterday. He was, at least to me, surprisingly blunt:

Fixing the renminbi to the dollar is beginning to significantly work to the detriment of Chinese economy. I think there is no question that two things are happening.

One is, in order to sustain the value of the renminbi to the value of the dollar, they’ve been purchasing very significant amounts of U.S. treasury issues.

In so doing, in order to prevent an inflationary money supply increase, they do what central bankers call sterilizing the purchase of foreign reserves… and they do this by selling bank issues, bank liabilities, denominated in their domestic currency, and so as they do that, that tends to prevent purchases of foreign reserves from expanding the money supply.

However, because there are interest rate caps in China, they’re finding some difficulty in selling an adequate amount of domestic-currency-denominated debt to absorb the excess. And that is creating imbalances that suggests that sooner rather than later, they are going to have to, for stability purposes, move their currency.

Secondly, they’ll also, by holding their exchange rate down, create a misallocation of resources in China in the sense they are subsidizing the capital stock associated with very large numbers of workers… [This] prevents standards of living from rising, because their intellectual technical capabilities are rising and if the exchange rate began to rise they would start to move capital into more efficient types of uses, which essentially would mean that output per hour would rise.

Holding their exchange rate where they are is preventing the growth in the terms that would be most valuable for China in the decades ahead. So as far as I’m concerned, it is very much in their interest to move.

And as you can imagine, we in U.S. government have been in conversations with them to indicate that, in our judgment and in our experience, they should be moving sooner rather than later. And there is debate going on within China on this issue. I have no way of projecting when they will move. That they will move, I am reasonably certain.

First, a question: why is China still holding on to its dollar peg if it’s not in its own interest? I actually agree with Greenspan (and many others) that it is in China’s long-term best interests to revalue the yuan, but doesn’t this beg the question of why China isn’t doing it? I haven’t come to any better answer to that question other than that the PBOC must figure that the substantial costs to dropping the dollar peg outweigh the substantial costs to keeping it. They won’t revalue until that calculus changes. Figuring out what will tip the balance on this cost-benefit analysis is the $64,000 question.

In my next post I want to tackle another relevant question.