Chinaīs Fixed Exchange Rate - Pathway to Growth
Letīs Do Some Economics
most infamous example of a country using a fixed exchange rate system
to accelerate economic growth is China during the last decade. These
days most countries manage their exchange rates to some extent but to
actually fix the exchange rate for a period of time is too
controversial. Read this article from 2010 to see why.
China's Exchange Rate Policy: The Heat Is On
Author: Steven Dunaway
February 18, 2010
year was good for China. The country managed to maintain relatively
fast economic growth, became the leading exporting nation, and at the
end of the year stood on the brink of becoming the second largest
economy in the world. China's status in key world economic forums rose
substantially, to the point that commentaries frequently talked of a
new G2--China and the United States--playing the dominant role in
international economic policymaking in the years to come.
thus far in 2010, however, suggest that China will continue to face
significant challenges in trying to sustain relatively rapid growth.
Domestic demand will have to be restrained to avoid excesses
developing, while the strength of external demand will remain highly
uncertain, reflecting the strength of economic recovery and policies in
China's major trading partners. The severity of these challenges will,
in many ways, depend on whether China insists on maintaining its policy
of keeping a stable exchange rate between the yuan and the U.S. dollar.
robust health of China's economy stands in sharp contrast with the weak
and uncertain recoveries in the economies of other major countries.
While China is concerned about reining in economic activity to ensure
that it does not get out of hand, the developed countries struggle to
keep their economies growing. In these diverse circumstances, the
authorities in these countries are coming to see China's exchange rate
policy as an important distortion in the world economy that will hold
back adjustment of global imbalances and slow the recovery of other
economies worldwide. Quietly, many developing countries, particularly
those in East Asia, are coming to a similar view, as they face strong
competitive pressures from China.
Flawed Arguments for a Stable Yuan
pressure growing on China to allow the yuan to appreciate, some
familiar old arguments are being trotted out to fend off pressure and
delay currency appreciation by Chinese officials and some analysts
working on China. These faulty arguments should be ignored, and the
heat should remain on China for a needed change in exchange rate policy.
first old argument making a comeback is that a stable yuan is not only
good for China, but is good for the rest of the world. The roots of
this argument go back to the Asian financial crisis of 1997-98. At that
time, China was persuaded to keep its exchange rate fixed against the
U.S. dollar when its currency was facing downward pressure to prevent
setting off a round of competitive devaluations among the
crisis-stricken countries in the region. While at the time this was a
very important policy decision by the Chinese authorities, any
competitive disadvantage that China may have suffered was quickly more
than offset in the period after the crisis by the rapid growth in
productivity in China relative to its competitors. Nevertheless,
despite a burgeoning trade surplus, China continued to defend a pegged
exchange rate until July 2005 (when the rate was revalued slightly and
allowed to appreciate gradually until August 2008, at which time the
rate was effectively repegged to the U.S. dollar) as being in the best
interest of China and the rest of the world, just as it had been in
actions in 1997-98 are being invoked by officials in Beijing as
justification for China's decision during the current economic and
financial crisis to maintain a stable exchange rate against the U.S.
dollar. It is argued that this policy helped to support China's growth
during the recession and that it is good for the rest of the world
because strong growth in China's economy makes a major contribution to
recovery in the world economy.
authorities in [developed] countries are coming to see China's exchange
rate policy as an important distortion in the world economy that will
hold back adjustment of global imbalances and slow the recovery of
other economies worldwide.
is truth to this claim from a narrow statistical point of view. As the
second or third largest economy in the world, if China grows faster,
then that would, of course, raise the average rate of growth for the
world economy. But that does not mean China's growth is adding
measurably to the growth of other countries. That impact depends on how
much growth in China's demand is contributing to stimulating growth in
other countries. The reality is that China with a large trade surplus
sells substantially more to the rest of the world than it purchases,
and therefore, it continues to subtract significantly from net world
demand. Thus, the rest of the world as a whole is not benefitting much
from China's strong growth.
countries (particularly those in Asia and commodity producers) may be
benefitting, and the decline in China's trade surplus in 2009 means it
took less away from net world demand than in previous years.
Nevertheless, China's contribution to the rest of the world's growth
has not been much, and it will diminish in 2010 and the years beyond as
China's trade surplus is expected to start rising again.
China's Competitive Advantage
old argument still making the rounds is that even if the yuan were
allowed to appreciate significantly, it would not materially change the
pattern of imbalances among the world's major economies because it is
not the root of the problem. Even with a higher value for the yuan,
China would continue to be the world's leading exporter because it has
a major competitive advantage in manufacturing. Manufacturing in the
developed countries would not recover. Therefore, the argument
concludes, changing China's exchange rate cannot be expected to make a
major contribution to boosting the net exports of developed countries.
instance, some analysts argue that even if China's currency were
allowed to appreciate such that China's current account surplus would
decline by 4 percent of its GDP annually and return to a level more in
line with the country's long-term fundamental saving and investment
balance, this would directly contribute only about a half percentage
point to annual growth in the developed countries. Such a boost to
these countries' economies is characterized as being small and not
critical to addressing global imbalances.
when the developed countries are looking at prospects for annual growth
of 1-2 percent, an extra half percentage point boost to growth that
would come from China permitting its exchange rate to adjust is no
small matter. In addition, this half percentage point addition to
growth from foreign demand would further stimulate economic activity in
the developed countries so that, ultimately, the impact of such a
change in China's exchange rate policy would be even greater. Also, the
boost to developed country growth would permanently raise the level of
incomes and employment in the developed countries.
contribution to rest of the world's growth has not been much, and it
will diminish in 2010 and the years beyond as China's trade surplus is
expected to start rising again.
a world economy looking for new sources of stimulus to spur demand
growth (and developed countries as a rule having little scope to make
further use of fiscal policy), the old argument is clearly wrong. A
change in China's exchange rate policy is a critical element in the
world economy's recovery.
The Need to Press Beijing
there is the grand old argument that the Chinese authorities do not
respond well to external pressure for policy change. Changing exchange
rate policy in China is a political decision made at the highest level
of government. Accordingly, China's leaders do not want to be seen as
bowing in the face of foreign pressure. This is said to be particularly
true at the moment because relations between China and some of the
developed countries, especially the United States, have become
increasingly tense. In these circumstances, the Chinese authorities
could choose to cling to the current fixed exchange rate policy to
project strength. The suggestion from this argument is that the rest of
the world should ease pressure on China, and a change in China's
exchange rate will come at a more appropriate time.
reality is, however, that without pressure being exerted to encourage a
change in its exchange rate policy, China will have no reason to
move. And when patience grows thin and pressure rises again, this same
argument will be trucked out once more to try to further postpone
are no good reasons for other countries to diminish their pressure on
China to change its exchange rate policy. The heat is on, as indicated
by President Barack Obama's concerns about the value of the yuan
expressed in recent remarks. And the heat needs to stay on.
authorities recognize that China needs to change its growth model and
rebalance its economy away from heavy reliance on investment and
exports to generate growth toward greater reliance on consumption. That
will not be accomplished unless greater flexibility and an appreciation
of the exchange rate are permitted. It is understandable that a country
might resist being called on to make a policy change that would entail
a sacrifice to benefit of the rest of the world. But that is not the
case in this instance. Increasingly, other countries will feel
justified in strongly pressing China to change its exchange rate policy.
China continues to resist, other countries will ramp up pressure and
are likely to choose to retaliate against China's exports to try to
force a change. China has to act soon and in a decisive manner to avoid
doing itself great harm.
Discussion: Could Brazil use the same tactic to generate economic growth? Why? Why not?