from Follow the Money

Stephen Jen is right

August 4, 2006

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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That is not something I say all the time.

I suspect I am among Stephen Jen's prototypes for what he calls structural dollar bear.    And Stephen " “current account deficits inside the dollar zone don’t matter” Jen goes to great lengths to seperate himself from the structural bears.

But I agree with all three of his points on the Chinese Renminbi

China doesn’t need more than $1 trillion in reserves, it needs to slow its economy, so it should not be quite so worried about some slowdown in export-related job growth, and a bit more appreciation would offer useful insurance against a rise in US protectionism as the US economy slows.

I would add two more points.

China doesn’t just have $1 trillion in reserves.  It also has an exchange rate regime that likely implies that it will continue to add $250b plus to its reserves a year for the foreseeable future.   A bit of RMB appreciation won’t change that.  China is unlikely to allow the RMB to appreciate enough to end its need to intervene to keep the RMB from appreciating more.  Yet without a bit of appreciation, it is hard to see how China ever “exits” from a policy regime that requires adding $500b to its reserves every two years/ $1 trillion every four … 

If you haven’t noticed, the dollar (and the RMB) have slid a bit against both the pound and the euro this year.    The RMB undoubtedly depreciated in real terms in q2, at a time when China’s domestic economy was absolutely red-hot.    And if the Fed pauses and the dollar slides some more against the big European currencies later this year, China needs to appreciate against the dollar just to keep from depreciating in real terms against the world. 

Alas, if kicking into overdrive means the RMB appreciates by 2% over the second half of the year (v. something like 1% in the first half), that wouldn’t be much.   At least not in my book.   That is where I break with Jen.  I am not sure China will allow the RMB to move by 5% this year.   And even if it did, that still strikes me as a small move.   The RMB would still be down v. the euro for the year if the euro/dollar stayed constant.

I also agree with most of Roach’s points on Doha.   Particularly his argument that Doha doesn’t address the really key issue facing the trading system.   

Roach argues that organic developments – IT, containerization, changes inside China and India – matter far more.  Chinese exports have increased from something like $200b to something like $800b while Doha went no where.

Roach thinks the current US focus on China is misplaced because China’s trade surplus stems in no small part from the activities of US and European and Japanese firms that have located production in China, not from Chinese firms.   I don’t buy that argument.   MNCs wouldn’t be locating so much production in China if the RMB was allowed to appreciate more.   The fact that lots of the profits from Chinese exports to the US go to US firms has an impact on trade politics, but it doesn't eliminate the need for RMB appreciation.

I consequently agree with Roach’s general point, but disagree on the specifics. 

To me, the impact of massive currency intervention on global trade flows (and on MNCs decisions about where to locate production) simply dwarfs the impact of restrictions on agricultural trade (and agricultural subsidies).  Global reserve growth – by my measures – has been about $700b since 2004.  It doesn’t seem to be slowing down in 06 either.   The distortions created by exchange rate pegs and the resulting rapid growth of reserves seem to me to be the biggest issue facing the global trading system -- and exchange rates (correctly) were never on the Doha agenda.

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