I side with China on this one

by Rebecca Wilder

Yes, the renminbi (RMB) is closer to fair value. Chinese Foreign Ministry spokesman Ma Zhaoxu states:

“Our currency, the RMB, has appreciated more than 20 percent against the U.S. dollar since July 2005, when China moved to a floating exchange rate regime,” Ma said. Before 2005, the RMB was pegged to the U.S. dollar at a fixed rate.

“The RMB exchange rate has drawn close to a reasonable and balanced level, given the international balance of payments and the market supply and demand for foreign exchange,” Ma said.

The New York Times asserts that China’s currency is undervalued by 25%-40%. The NY Times, like many politicians and media channels, is entirely too obsessed with China’s exchange rate; they fail to understand that economic fundamentals are changing.

Contrary to popular belief, the level of the renminbi has become rather inconsequential to Chinese trade flows. Why? Because despite the fact that the renminbi has been pegged against the dollar since July of 2008, imports are surging.

The chart above illustrates the 3-month annualized growth rate in exports and imports and the renminbi valued against the US dollar. I use the 3-month annualized rate, rather than the year/year rate, to remove the strong base effects from the drop-off in trade last year.

The first thing to notice is that while export growth is indeed strong, “business as usual” in China, import growth is surely breaking trend. The 3-month annualized growth rate of imports – a good proxy for domestic demand – averaged 117% annualized growth per month from April (when it turned positive) to December 2009. Compared to this period in 2006, annualized import growth is up almost 80 percentage-points, while that for exports is up just 5 percentage-points (76.2% average 3-month annualized growth in exports May-December 2009 vs. 71.7% in 2006).

It’s hard to argue that the Chinese currency is so “undervalued” if the import response is this strong.

Another myth is that China is running large current account surpluses. Given the chart above, it won’t surprise you to know that China’s current account has dropped markedly since late 2008.

The thing is: since prices in developed economies have dropped relative to those in key emerging markets (i.e., China), real exchange rates are coming back in-line with a s0-called equilibrium. Therefore, the renminbi, by definition, is closer to whatever an equilibrium would be, despite the fact that it is fixed. Thus, like Ma Zhaoxu says, it’s at a “reasonable” value.

Rebecca Wilder