China now confronts the risk of the same sequence of events. Its booming exports in the mid-2000s led US officials to threaten trade retaliation unless the Chinese authorities took steps to restrict exports, cause the
renminbi to appreciate, and shift to “consumption-led growth.” This is the same message once given to Japan. The US insistence on renminbiappreciation intensified after the onset of the 2008 financial crisis.
The results to datecan be seen in Figure 3, which maps China’s real exchange rate from the start of renminbi current-account convertibility (1996) until today. The Currency began appreciating sharply in 2007. As in Japan, the appreciation sparked destabilizing capital flows into China on the assumption that the renminbi, like the yen before it, had nowhere to go but up.
As in Japan, a financial bubble accompanied the currency appreciation. Yet, as Figure 4 shows, the real appreciation led to a rapid collapse of China’s annual export growth, from above 15% (smoothed over three-year intervals) to below 10%, and now to a financial slump as well.
From 2007 to 2014,the renminbi appreciated by 32% in real, trade-weighted terms; by May 2015 (the most recent month of the reported index), its total appreciation had reached 40%. This partly reflected nominal appreciation against the US dollar, together with effective appreciation against the euro, yen, Korean won, and other currencies as the US dollar strengthened relative to them.
The renminbi remains highly overvalued, despite August’s modest 3% nominal depreciation against the soaring US dollar. The renminbi’s real appreciation should be compared with the recent movements of the yen and won. As of May 2015, the yen had depreciated in real terms by around 7% since January 2007, and the won by around 3%, thereby exacerbating the cost pressures on China’s exporters relative to their Asian competitors.
Further depreciation of the renminbi seems necessary if China is to bolster its flagging economic growth and avoid a long-term “Japan trap.” It is important to note that many of China’s increased exports would find their way not to the US and Europe but to Africa and Asia, especially in the form of infrastructure equipment and other machinery. Nonetheless, political pressures from the US and Europe, manifested as charges of currency manipulation and unfair trade practices, as well as misguided ideas in China about the renminbi’s “prestige,” might lead China to resist any meaningful exchange-rate correction.
A month after the renminbi’s 3% depreciation, Chinese President Xi Jinping commented
that, “Given the current economic and financial conditions at home and abroad, there is no basis for sustained depreciation of the RMB.” In recent weeks, the People’s Bank of China has been defending the currency’s valuation through foreign-exchange sales.
Earlier this year, The Economist
offered the conventional Western thinking
.Don’t let the renminbi depreciate, it wrote, for four reasons:depreciation might provoke a currency war in Asia; China’s companies are awash in dollar-denominated debt; depreciation might lead to renewed US charges of currency manipulation; and depreciation might reverse China’s progress in making the renminbi an international reserve currency.
Such misguided reasoning is precisely what led to a generation of unnecessarily slow growth in Japan. It could happen again in China.
Jeffrey D. Sachs
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