Ezrati’s Economic Outlook: China’s Currency Shift?

Recent comments reflect a new focus on domestic demand.

Recently the head of China’s central bank, Zhou Xiaochuan, made comments that drew less attention than they deserve. First Governor Zhou suggested that market forces would play a bigger role in setting the value of China’s currency, the yuan or renminbi. Then he mused that the yuan should rise further against the dollar and on foreign exchange markets generally.

There is room for two responses to this seemingly new Chinese position, one cynical and the other much more positive and hopeful.

The cynical view reflects history. China has long strived to promote its exports by keeping its yuan cheap to the dollar and other major currencies. The global pricing advantage this policy gave Chinese goods enabled the country famously to raise its share of global exports from nearly zero in the early 1990s, when it initiated the policy, to upwards of 12% more recently.

The accompanying business and employment opportunities have propelled China to enviable aggregate growth rates throughout this time.

For more than two decades, China’s relentless adherence to this policy has led Beijing to resist all pressure for yuan appreciation, whether from the United States, the European Union, or others. Beijing’s leadership set the tone in the early 1990s. In 1993, when Under Secretary of the Treasury Larry Summers demanded currency revaluation on behalf of President Clinton, Beijing, far from bowing, devalued the yuan not six months later, and by a massive 60%.

It then locked the currency in at that cheap price against the dollar. The move undercut pricing in most of the rest of Asia and ultimately contributed to the Asian crisis of 1997-98, commonly referred to  as the Asian Contagion. It was not until 2005 that Beijing allowed some upward movement in the yuan’s foreign exchange value, and even then it kept tight control, allowing only the most frustratingly slow and slight appreciation.

Such a backdrop makes it easy to dismiss Governor Zhou’s comments as just so much rhetoric. After two decades of tight control, it is hard indeed to see China accepting much market influence on its currency. And since the yuan today remains 11% cheaper against the dollar than it was before China’s first grand devaluation, Governor Zhou’s speculation about whether market forces might raise its value further looks less insightful than obvious.

The yuan’s modest depreciation so far this year raises still more questions about such a market-oriented commitment. Of course, market forces always move in uneven patterns, but it is nonetheless suspicious that, in 2010 and 2011, when Beijing aimed to slow the country’s growth rate, the yuan appreciated gradually, in its usual controlled way, but now that Beijing wants to promote growth, the yuan has suddenly gone the other way. The pattern certainly speaks less to market forces than to Beijing’s usual currency management.

Still, cynicism aside, Governor Zhou’s comments may well contain a more positive forward-looking aspect. Most encouraging is the link he made between the yuan’s value and China’s now clear efforts at internal development.

Beijing has come to recognize the vulnerabilities of export-oriented growth policy, especially after the 2008-09 global recession. It has begun to think increasingly about internal development as a second engine of growth and as a way to spread the benefits of economic development and avoid social unrest. As papers posted on the Websites of China’s central bank and government make clear, Beijing realizes that the country cannot look to increase its global export share over the next 20 years at the same rate as it has in the past.

China’s great success with its 2008 stimulus package has further encouraged the domestic development decision by proving the huge potential returns it offers. But Governor Zhou’s remarks are the first time Chinese officials have publicly recognized that the shift requires a rise in the yuan’s foreign exchange value.

Matters will surely unfold slowly. For the sake of jobs and incomes, China will continue to support its exports until it has achieved a critical mass of internal development, including a broader consumer sector to support aggregate growth.

But the governor’s comments should build conviction here in the United States and elsewhere in the world that China clearly plans to move along this path. Because it will be more difficult to generate rapid growth with broad-based domestic development than with exports, it’s reasonable to expect that China will exhibit slower growth going forward than it has in the past.

At the same time, the prospect promises increased opportunities for producers in the U.S. and elsewhere in the world to sell into a growing domestic Chinese market. It also promises that, in time, global trade patterns will find relief from the imbalances previously imposed by China’s once single-minded focus on exports.



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