Is the RMB going to depreciate?

After reporting the highest amount of trade surplus in 18 months, and hearing an expected cacophony of calls for RMB appreciation, the spot Yuan rate has actually traded down. The dramatic fall in foreign currency loans undertaken by Chinese exporters has also indicated sharply lowered expectation for any appreciation, if at all.

According to the Century Weekly, foreign currency loans plummeted by USD5.6bn in July, on the heel of USD0.7bn and USD1.4bn declines in June and May, respectively.

Chinese exporters traditionally take out these loans to supplement their income if they expect the RMB to appreciate. The last time these loans fell was during the 7/2008-2/20009 period, at the height of the financial crisis. In fact the RMB was even expected to depreciate in late 2008.

Could this be a rerun?

Sparring of words over the RMB

All focus has been on the “unusually uncertain” comment by Bernanke, though the hearing touched on Chinese currency issue as well. As reported by Reuters:

Under questioning by one of those lawmakers, Senator Sherrod Brown, Bernanke answered “yes” when asked if he stood by a statement he made several years ago calling China’s exchange-rate policy an effective subsidy.

When pressed how much China’s yuan was undervalued, Bernanke said: “The numbers that you see in the literature range between the 10 and 30 percent range.”

As November approaches, it’s only expected that the US will push harder on this front. But are they going to get their wish fulfilled? This one is from AFP:

“The exchange rate of the currency will decline if it becomes necessary to support exports,” Zhou [Qiren, a member of the central bank’s monetary policy committee] told the Asahi Shimbun [of Japan] in an interview, according to the paper’s English-language website.

I don’t know about you, but I think Chinese exports will weaken substantially in H2 as the US non-recovery recovery sputters and European austerity kicks in. China’s own stimulus is also losing steam, so much so that the banks are quietly relenting on strict lending restrictions.  If you think China’s going to become a good Samaritan in this environment, I’ve got a bridge to sell you.

The use of nuclear option

From Reuters:

The U.S. Treasury Department again declined to label China a currency manipulator in a long-delayed report issued late on Thursday that is likely to provoke Congressional calls for tougher methods with Beijing.

So this was what all that chatter of China’s Treasury holdings as the nuclear option was  about. The blogosphere was rife with snarks of how China would be suicidal by going nuclear. But the use of nuclear weapon has always been in deterrence. NOBODY really goes nuclear, but it helps to have it to scare the other guy into cutting you some slack.

Chinese labor disputes and consumption

The AP has a nice article on the recent labor disputes, in the context of the transition of Chinese economy.

Boosting wages fits in with Beijing’s strategy of closing the income gap and promoting more equal growth in coming years, said Liu Shanying, an analyst at the Chinese Academy of Social Sciences’ Institute of Political Science in Beijing.

“If incomes won’t go up, how can domestic demand be boosted? Strikes for better pay are very much in line with the big trend of Chinese economic development,” he said.

One reason behind the more assertive work force is a shifting job market since China pumped up its economy with massive stimulus spending to fend off the global recession. Manufacturing has begun to expand into the Chinese interior, leaving traditional industrial enclaves on the coast competing for labor and giving workers a stronger bargaining position.

Workers “have the upper hand, and also sense the government is trying to address inequalities, so the workers feel more comfortable in pushing for high wages,” said Lee. [Chang-Hee Lee, a specialist on industrial relations at the International Labour Organization’s Beijing office.]

As I said before, all these are part and parcel of China’s push to rebalance its economy geographically (away from the Eastern coast) and structurally (towards households and consumption). Therefore, China is going down the path of internal revaluation rather than external adjustment via the currency. As a result, we are going to see an explosion of Chinese consumption in the coming decade. But GDP is likely to be more moderated. There already have been discussions on the viability of the current 8% “minimum growth target”. Not that China needs that high a growth rate anymore, with less people entering the workforce due to changes in demographics.

Does this mean the recent change in currency regime is nothing but a hoax? Yes if you are an exporter competing against China. But for China, this is just a necessary step towards turning the RMB into a reserve currency in the future. With substantial internal revaluation and the elimination of many export subsidies, some punters are already calling the RMB overvalued. Li Dao-kui, a member of the Chinese Monetary Policy Committee, suggested that it would take the RMB 10-15 years to be fully convertible and competitive as a reserve currency.

The real Chinese revaluation story

The media has been busy propagating and debunking the RMB revaluation story, but I think both narratives are off-target. Yes, China is having a significant revalution, just not with its currency.

Instead, China has chosen an aggressive program of internal revaluation, i.e. raising costs for the exporters internally, by inducing wage-led inflation, cutting export subsidies, and stiffening environmental regulations etc.

Most of the recent coverage of China’s labor disputes have focused on the workers’ being simply more demanding in sharing the spoils. But one should also note the subtle, and very important, support that the Chinese government is giving them. Besides rallying behind the workers in state media, labor activists have been allowed to organize freely (rare for China’s pro-capital government), so long that they train the target on wage demand only. Raising the minimum wage is also a cue for the workers that their action is being sanctioned by the state.

Why is China going this route instead of currency appreciation recommended by the developed economies? Well, this is simply a better way of adjustment for China. With currency appreciation, the losses to Chinese exporters become gains for exporters in other countries, i.e. a net loss of wealth for China. With internal revaluation, the benefits go towards Chinese workers, i.e. only a redistribution of wealth within China. This later approach also helps in building up a middle class and reorient the economy towards more consumption.

Another way to achieve internal revaluation is by cutting export subsidies. China has announced cutting export rebates on over 400 types of products deemed energy-intensive or polluting. This allows the government to target only industries deemed inefficient and force them to upgrade, and helps soothing trade relations with the West as a bonus.

The implementation of environmental regulations has also been tightened, to the benefits of future generations of Chinese. Again, this is an area that simple currency appreciation may not be as effective.

At the end of the day, although China has decided to bite the bullet and pony up for rebalancing its economy, it still seeks to minimize the costs and maximize the benefits. It’s just that their preferred method may not be the most desirable one from the POV of the developed economies.