The figures suggested that incremental adjustments by the Beijing authorities in the value of the currency, the yuan, had so far done little to alter a trade picture that has angered American lawmakers and some business groups in Washington … But the hefty surplus, which increased 27 percent from June 2006, also reflected slowing growth in imports. Imports in June expanded at a relatively modest 14 percent compared with the year before. The yuan has been allowed to appreciate by a little over 9 percent since China broke the currency’s fixed tie to the United States dollar two years ago. The Bush administration and members of Congress have pressed Beijing to allow the yuan to rise much faster, with some arguing that it be allowed to appreciate by a third or more against the dollar … Mr. Rothman said the value of the yuan was not the most important factor in the Chinese trade picture. American exports to China have increased 188 percent since 2001, a much faster pace of growth than the United States has had with any other major trading partner, despite what some economists argue is the yuan’s artificially low purchasing power.
Dean is not happy with Andy Rothman:
Andy Rothman, a business economist located in Shanghai, asserted that the value of the yuan was not a big factor in the trade deficit that the United States has with China. In other words, if the dollar fell by 20-30 percent against the yuan, and the relative price of Chinese imports to the United States rose by a similar amount, (and the price of U.S. exports to China would fall by a comparable amount), Mr. Rothman believes that there would be little impact on trade.
Brad DeLong follows up:
What is Milton Friedman’s first rule? That demand curves and supply curves are never vertical, and never horizontal. Demand curves slope down. Supply curves slope up. Quantities matter for determining what prices are. Prices matter for determining what quantities are.
But what was Mr. Rothman really saying? I think the key here is that the Chinese government has allowed the yuan to appreciate by less than 10 percent. Consider the contention of many that the yuan was overvalued by as much as 40 percent so this process of managed floating has allowed only a partial movement along the demand curve for yuan. Other events could have shifted the demand curve by more than enough to offset this.
I like the way that Brad frames this in terms of “Milton Friedman’s first rule”, which strikes me as a market-clearing approach. In other words – if the demand curve shifted upwards, then under a floating exchange rate regime the yuan would appreciate by perhaps quite a bit. But when I push this free floating view of international markets as an endorsement of U.S. fiscal restraint (aka the dollar will devalue which should encourage more net exports), folks remind me of the reality that the yuan is not allowed to freely float. So maybe Mr. Rothman’s point is that changes in relative prices have not mattered much because the Chinese has not allowed the market to determine the exchange rate. In other words – if they adopted free floating, how much would the yuan appreciate and how much of an effect on trade flows would this have? If that was Mr. Rothman’s point, the coverage of his comments in the NY Times article did not convey this very clearly.
Update: With a hat tip to AB reader Juan, let’s take a look at a discussion by Jonathan Anderson:
For those who closely follow the mainland economy, the last few years have provided another interesting spectacle. Remember that the yuan has been strengthening gradually against the dollar, by 2% in 2005, another 4% in 2006 and at a 6% year-on-year pace so far this year. At the same time, Chinese rural migrant wages, which were rising leisurely at 3% to 4% per year at the beginning of the decade, are now shooting up by 10% or even 15% annually as factories come to terms with a dwindling supply of young, single farm workers. This double-edged sword of an appreciating currency and rising labor costs should have imposed palpable damage on China’s traditional export sectors: toys, clothing, furniture, appliances and electronics processing. However, according to industrial earnings and profit statistics, overall light manufacturing margins have been as steady as a rock, with no signs of pressure so far. Why? Because exporters simply passed on the costs to overseas buyers. In a world where individual country figures rarely tally on pricing trends, one of the startling facts is that Chinese, Hong Kong, U.S., Japanese and European data all agree that mainland export prices have started to rise in the past three years. From 1995 to 2003, dollar prices in traditional manufacturing industries like clothing and toys were falling on the order of 3% to 4% per year. Since 2004, however, those same prices have been rising by 3% to 4% per year, a very visible turnaround from the previous picture. Exactly the same is true for it electronics. According to partner country data, Chinese electronics prices used to fall by 6% to 10% per year in dollar terms. Now they are barely falling at all – and mainland data actually show a sharp increase in prices since the beginning of the year.
In other words, China’s productivity has been improving in certain sectors. At first, their wages were not keeping pace but now with wages rising and the modest amount of yuan appreciation, what had been a steadily falling relative price for Chinese made goods had flat lined if not start reversing itself. Mr. Anderson makes a case for revaluation without trashing the notion that fixed exchange rates might prove beneficial in certain situations. In all, an interesting read.