The gold bugs over at the National Review have been arguing against letting the yuan float. Mark Thoma provides one review of Lawrence Kudlow as Mark points to Milton Friedman as a proponent of currency stability. Friedman is also seen as a proponent of floating exchange rates and his recent comments point out that fixed exchange rate are neither a necessary nor a sufficient condition for low and stable inflation rates.
Kudlow was reflecting on Saying Goodbye to Mr. Greenspan by Keith Bradsher:
Bradsher also writes that China’s tight peg of the yuan to the dollar, which has been the case for more than a decade, generated “impressive stability [that] helped prompt business executives and entrepreneurs from around the world to invest $60 billion a year in new factories and other operations in China. These investors were confident that they knew what those businesses and their exports would be worth in dollars.”
Broad money M2 grew by 19.6 percent to RMB22.1 trillion yuan at the end of 2003.
Kudlow seems to be suggesting that a fixed exchange rate regime leads to less business risk. Friedman’s point seems to be akin to saying that nominal exchange rate certainty is not the same a real exchange rate certainty. I would suspect most financial economists would further argue that real exchange rate variability plays at best a modest role in accessing the overall systematic risk facing any particular enterprise. Given the opening of international markets and the low cost of labor in China, one might wonder why there is not much more foreign investment in China as high expected returns would tend to compensate for a modest amount of systematic risk. Of course, one could argue that there are substantial political risks in investing in enterprises in the People’s Republic of China.
If Kudlow thinks $60 billion of investment is a substantial contributor to China’s growth rate, I’d suggest he compare this figure to China’s overall economy and investment. This source, for example, puts China’s GDP at $7262 billion and its overall investment at 46% of GDP. Foreign investment is therefore about 2% of total investment. Furthermore, China is running a current accounts surplus, which means China’s national savings exceeds its domestic investment. In other words, China is doing more investment in foreign assets than foreigners are investing in Chinese assets.
John Tamny suggests that dollar devaluations have historically not increased U.S. net exports:
Indeed, conventional wisdom 20 years ago argued that a weaker dollar would reduce Japan’s trade surplus with the U.S., and along the lines of Ip’s thinking, push the “global economy closer toward balance.” The “experts” in the ’80s hadn’t done their homework. Just as major dollar devaluation in the 1970s failed to reduce our trade deficit, the deflation forced on Japan in 1985 similarly failed to reduce our trade “imbalance” …
Let’s remember that the period from 1985 to 1989 was one of strong economic growth for the U.S. (in my view, reversing the weak aggregate demand growth during the first half of the 1980’s) so it is not surprising that import demand continued to rise. What Tamny fails to mention is the fact that export demand growth was also very high. As shares of GDP, exports were 7.2% of U.S. income in 1985 as opposed to an import share equal to 9.9%. He is correct to suggest that the import share rose over the next two years faster than the export share with imports being 10.8% of GDP and exports being 7.7% of GDP. The import share rose to 10.8% by 1989, while the export share rose to 9.2%. In other words, net exports did increase by 1989.
But Tamny has to support the National Review’s gold bug drive by misrepresenting what the evidence says.
For a very good discussion of the yuan issue, see the debate between Nouriel Roubini and David Altig.