The Ministry of Commerce explained why it is opposed to an early increase in the RMB's exchange rate. There are arguments for revaluation that other sections of the Chinese government may be considering. One is the struggle against inflation – which revaluation could help by cutting import prices. Since foreigners are not privy to how the Chinese government resolves issues of economic policy, Jim O'Neill of Goldman Sachs may be right that "something is brewing" regarding the exchange rate. But if there are arguments for revaluation, they are unrelated to trade.
China's exporters have not fully recovered from the international financial crisis. Taking a three month moving average, China's monthly exports peaked at $136 billion in September 2008. In January 2010 they were still 13 percent down at $118 billion.
The statement by the Ministry spokesman that exports "cannot reach pre-crisis levels for two to three years" may be pessimistic – it will probably take two to three years from the previous peak, rather than from today, for exports to recover. But the exporters are clearly facing unused capacity, inability to spread fixed costs resulting in pressure on profitability, and other problems.
An increase in the RMB exchange rate would slow the recovery of exports. From China's viewpoint, therefore, avoiding a premature revaluation is justified – particularly as the dollar, to which the RMB is pegged, has risen recently under the impact of the Greek crisis and other factors.
Of course other countries cannot be expected simply to judge issues from China's viewpoint. If there is to be a "win-win" outcome, to use a favoured Chinese government phrase, others must also gain. And on this point, of how to reduce China's trade surplus and how this is benefitting other economies, the Commerce Ministry outlined its position very coherently.
Ministry spokesman Yao Jian noted that China's trade surplus has shrunk significantly – by 35 percent in 2009. Taking a three month moving average, the monthly surplus fell to $17.2 billion in January 2010 from $39.4 billion in January 2009. The 2009 surplus was $190 billion compared to $290 billion in 2008 – transmitting a $100 billion increase in net demand to other economies.
Asia's rapid recovery from the crisis compared to other regions is in significant part due to the stimulus provided by the net rise in China's imports. It will strongly aid the international recovery if China's trade surplus continues to decline.
RMB revaluation would clearly, in the short term, have the opposite effect. While there is disagreement among economists regarding the long term consequences of revaluation for China's trade surplus, there is little doubt that the short term effect would be to increase the surplus.
This is because revaluation means export prices increase and import prices fall. As it takes time for demand to adjust, the initial effect would increase China's trade surplus – this is a mirror image of the well known "J curve effect" whereby if a country devalues, its trade deficit initially widens as import prices rise and export prices fall. In the present international recession, even a short term increase in China's trade surplus, the recent shrinking of which has been a significant source of world demand, is among the least useful things imaginable.
If China's exports continue to recover, and an RMB revaluation would increase the trade surplus in the short term, the only way to continue reducing China's surplus, as Yao Jian says, is to take "measures to stimulate imports." This however requires rapid economic growth.
China's imports rose faster than exports in 2009 because its economy grew more rapidly than others. While other markets stagnated or declined, China grew at 8.7 percent, and sucked in imports. The most effective way to maintain the import surge is rapid growth.
Here trade intersects with domestic economic policy. The most immediate threat to growth in China is inflation. Inflationary capacity constraints, of physical plant and labour have already emerged – and public concern about inflation led Premier Wen Jiabao to devote part of a recent internet Q & A to it.
Fortunately China's 2009 growth pattern puts it in better shape to deal with inflation than if it had followed some of the advice it was offered. Many commentators who called for revaluation also favoured expanding domestic consumption, but not investment – citing the threat of "overcapacity". If this policy had been pursued, China would be facing much greater inflationary capacity constraints – threatening economic growth and imports. Happily, China expanded both domestic consumption and investment. The increased capacity that resulted will allow faster growth than would otherwise have been the case, increasing demand for imports.
So a coherent strategy both from China's point of view and for creating a "win-win" situation means avoiding an early RMB revaluation. This will allow China's exporters to recover and avoid a short term increase in China's trade surplus. Rapid growth is not just good for China but also boosts imports. And to make rapid growth possible without inflation China needs to boost domestic investment as well as consumption. Investment, in turn, boosts imports of machinery and equipment. Foreign countries should argue for China to maintain the existing RMB exchange rate in the short run, maintain rapid growth, and, to underpin growth, undertake high levels of domestic investment. This is the combination that will create a "win-win" situation.
By contrast, an early RMB revaluation would create a "lose-lose" scenario. It would hit China's exporters, lead to a short term increase in China's trade surplus, withdraw an economic stimulus in a recessionary international economic situation and, linked to reducing investment, would exacerbate inflationary capacity constraints.
It may be that other economic considerations, notably the fight against inflation, will force China into a premature increase in the RMB's exchange rate, but from the trade point of view, and that of international economic recovery, this would be undesirable. Not for the first time the Ministry of Commerce is notably more coherent than some of its foreign critics.
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This article originally appeared on the website www.china.org.cn.
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