Thursday, 13 January 2005

China's record reserves may not mean renminbi revaluation

China's foreign reserve hits US$609.9 billion at the end of 2004 and the United States' trade deficit hits $60.3 billion in November. With China's trade surplus hitting a nine year high in December, you can be sure that there will be greater pressure on it to revalue the renminbi.

Andy Xie of Morgan Stanley, however, thinks that a renminbi revaluation is unlikely to work and is therefore unlikely to happen in 2005.

Revaluing the currency, in theory, gives more purchasing power to households by decreasing consumption prices. I seriously doubt that this would work. China's consumption weakness is due to 1) a labor surplus that keeps wages down, and 2) a low level of wealth due to a short history of market economics. Revaluation would not solve either problem.

Instead, Xie thinks a rise in China's interest rates in tandem with those in the US is the key.

If it raises interest rates gradually and keeps its exchange rate stable, the dollar would stabilize, commodity prices would decline, and the global economy might achieve a soft landing... The global economy is experiencing over-consumption in the US, over-investment in China, and massive speculation in financial markets. In my opinion, only if China and the US both raise interest rates gradually can the global economy achieve a soft landing.

In any case, General Glut thinks that the exchange rate of the US dollar has little impact on its trade deficit. He points out that the US trade deficit has continued to deteriorate even as the value of the US dollar has fallen in the past few years.

The point should not be overstated, though. It is true that the exchange rate is only one factor behind the deteriorating trade balance; the deteriorating US budget deficit of the past few years has also played a crucial role.

However, unless and until the budget makes a clear move towards surplus -- or at least a substantial narrowing of the deficit -- the trade balance will need all the help it can get from the US dollar.

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