from Follow the Money

Renminbi hits multi-month highs v euro, yen

November 7, 2005

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Do not let anyone tell you that China's economy requires a stable exchange rate, and consequently, it must remain pegged to the dollar.    China now trades almost as much with Europe as with the US, and the renminbi/ euro has been anything but stable over the past few years.

A little known fact: in dollar (and renminbi) terms, China's exports to Europe have grown faster than its exports to the US since 2002.  Wonder why?

This year though, rather than following the dollar down, China has followed the dollar up.  On Friday, the dollar reached a 18 month high v. the euro, and a 24 month high against the yen.   Stephen "current account deficits don't matter for the dollar" Jen has been right.

China seems to have followed the dollar up even since July, when China theoretically shifted to a basket peg.  In a true basket peg, if the dollar appreciated v. the euro, the renminbi should depreciate against the dollar to limit the renminbi's appreciation against the euro.  China has had the good sense not to do that.  The renminbi/ euro has tracked the dollar/ euro pretty closely ....  Compare this chart (CNY/ EUR) with this chart ($/ EUR)

The recent rally in the dollar-renminbi against the euro and yen consequently poses two questions:

1) What impact will it have on Chinese export growth?   Personally, I would expect to see some reduction in the rate of expansion of China's exports to Europe in 06/ 07.

2)  What impact will it have on US export growth in 2006?  Personally, I would expect to see some reduction in the rate of expansion of US exports as well.  Dollar appreciation works with a lag.

That suggests that even if the US economy slows in 2006 (housing, oil) and non-oil import growth stays subdued, the trade deficit might not fall.  Remember, to keep the trade deficit from widening, exports have to grow by 50% more than imports.  6% import growth and 8% export growth implies a bigger trade deficit, given the much larger US import base.   And to keep the current account deficit from growing, the trade deficit needs to shrink substantially.  The US external interest bill next year is likely to increase by more than $50 billion dollars.  That is what happens if you run a $800 b plus current account deficit in a rising rates environment.

One last point: the "euro" data on eurozone imports from China and the US (i.e. US exports to Europe and Chinese exports to Europe) is rather interesting.  In euro terms, European imports from the US have fallen substantially since 2002.   Call it better terms of trade - one euro buys more from the US than it did then!  In 2002, the eurozone bought euro 125.6 billion from the US; in 2004, only euro 113.7 billion.  That was not because overall euro denominated imports were falling - they rose from euro 985 billion to euro 1072 billion over that period.   And  during that period imports from China grew from euro 62 billion to euro 92 billion (do the dollar conversion - it is a huge increase in dollar terms).  

What is happening this year?  In q2 2005, eurozone imports from the US were flat - precisely where they were in q2 2004 (euro 29.7 billion) while Euro zone imports from China were up about 23%, to euro 27.5 billion.   In July monthly eurozone imports from China were equal to those from the US.  In 2006, the eurozone will almost certainly import more from China than the US.  

That is what happens when one country invests heavily in manufacturing plant and equipment, and another invests heavily in residential housing.  Both China and the US had an exchange rate edge in Europe over the past few years.

See p. 156 of the ECB bulletin.

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