US-China Trade balance and RMB

Tyler Cowen has a nice piece on NYT today (cached below), speaking out the obvious about RMB and US trade balance.

• "The United States should not be spending its international political capital on yuan revaluation, which is at best a nonevent."
  

Harvard's Greg Mankiw's agrees. Brad DeLong commented on a highly hypothetical worse case what-if scenario of China stop buying US treasury. He perhaps worried too much.

• 1) Where else would China realistically put the cash? The weight of US Treasury in China's portfolio may drop gradually. But it will not be abrupt nor it will be.
• 2) As Mankiw and DeLong both agreed, equoted, China is doing a big favor to the US, both by selling at a very low price and financing the US at very low interest rate. Even if you take the latter away, there is still the former. China did that not for charity, but because US provided what China needs: an opportunity to practice its capitalism and technology upgrade, and a low-risk option for investment. Fair trade in free market.
• 3) Cowen is right in that, the revaluation, is therefore, a non-event for US. (Hence not worth the wasting of its political capital
  

In an ideal world, US may be able to assist or micro-manage China's economy, as Brad DeLong hoped. In reality, even the PRC government cannot control the rhythm of dragon heartbeat! Therefore, Cowen is spot on in that US should not try to micro-manage China. Instead, what US should do is to offer technical advice and warning to help China handle the challenge. In a globalized world economy, China's success in managing its economy has positive impact on US, and vice versa.

Brad Sester diagrees. But I do not think Cowen's conclusion and proposal contradicts with any of the facts in Brad's testimony. Because,

• Brad's 4 points in his testimony
  1) "RMB significantly undervalued." I think RMB is undervalued. But how significant it is is a debated question, some said 40%, some said 10-15% a year ago. With the drift in the past 14 months it is now 5-10% vs 35%. The more relevant question is, what to do with it? or does it really matter what is done (to China, vs to US, vs to the world)?
  2) "China has 'heavily' intervened". Yes, any system other than free floating requires quite heavy intervention, if that is what "heavy" means. Again, I would say most of the impact/consequence (and risks) of the intervention are on China itself. If the world should worry, it should worry that China destabilizes itself and the consequence ripples through the world system
  3) "China's surplus generated impact on US financial system." Yes, low interest rate kept down by high demand on Treasury notes by China, Russia, OPEC countries, in the same order of magnitude. China isn't alone in this. Why picked China?
  4) "China's current account surplus need to be reduced for the sake of global economy". It is not obvious why china's current account surplus is neccessarily a bad thing. it certainly represents an inefficient allocation of capital/resource on china's part. It is not good for China. But the implication on US or the world is not that clear-cut. I think this is one of Cowen's key points.
  
  My take on Cowen is that his view is probably is similar to mine regrding the 4 points above, no fundamental disagreement, but somewaht different interpretation. The conclusions are
  1) taking into account the total impact (i wish someone with good access to the data can do a quantitative sum up) of US export, price inelastic segment of the import vs price elastic segment to US, the net effect of RMB reval on US-China merchandise trade may be quite insignificant, even though it may be in the same direction as Brad predicted
  2) as commentator Dor (in Brad's blogpost) pointed out, the job loss in US is tiny, 150k/150M =0.1%; if one takes into account the job creation/retention in Boeing/etc, it is even smaller.
  3) taking into account US business stakes in businesses in Chinese (eg eg iPOD produced in China sold to EU/Japan, KFC's profit in China market) and hence ths profit repatriated to US, the trade balance could narrow significantly. It is important to differentiate total "trade" (cashflow, including merchandise, service, investment, expatriate, etc) vs the often discussed "merchandise trade"
  
  Therefore,
  a) is it worthwhile to waste US political capital on an issue that is questionable to the overall US business/economic interests?
  b) it is not efficient for US to micro-manage China's economy, and micro-management from a distance often get things wrong or drive things opposite to one's original intention.
  

(To be continued)

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China Is Big Trouble for the U.S. Balance of Trade, Right? Well, Not So Fast

By TYLER COWEN

Published: September 7, 2006

CONTRARY to popular opinion, China may be good for our trade balance. American consumers seem determined to spend money, and Chinese businessmen have made the bill cheaper.

It is not the case that China is simply draining the United States of money. Most of the growth in Chinese exports to the United States has come from switching manufacturing and assembly from other, more expensive, Asian countries. In 1985, China, Japan, Hong Kong, Taiwan and South Korea accounted for 52.3 percent of America’s trade deficit. By 2005, this percentage had fallen to 40.9 percent, in part because of cost savings from buying Chinese.

From 1986 to 1988, Taiwan and South Korea accounted for 60 percent of American footwear imports; China was only 2 percent. By 2001, market positions had reversed; China produced about 60 percent of the total and Taiwan and South Korea about 2 percent. Toys and sporting goods show similar gains by the Chinese, again driven by lower prices. (For these and related figures, see “China’s Embrace of Globalization” by Lee Branstetter, professor of economics at Carnegie Mellon University, and Nicholas R. Lardy, senior research associate at the Institute for International Economics, at http://www.nber.org/papers/w12373.)

American policy makers are nonetheless concerned about cheap Chinese imports. Treasury Secretary Henry M. Paulson Jr. will visit China this month, in part to pressure the Chinese to allow their currency, the yuan or renminbi, to rise in value on world markets. C. Fred Bergsten, director of the Center for International Economics, has been calling for a revaluation of the yuan for years, in the hope that a more valuable currency will make Chinese exports more expensive.

The belief is that if the dollar has less value in China, Americans will spend less on Chinese products to offset the prices they pay per item. But even if the numbers work out so that the flow of dollars to China diminishes, American consumers will pay higher prices and see fewer goods from China. Yuan revaluation is unlikely to benefit the United States, even if it does lower its trade deficit.

The trade effects of a revaluation of the yuan are unlikely to be large, in part because many Chinese exporters specialize in assembly. China sends out money buying components like semiconductors and turns them into finished goods, thereby running a trade deficit with East Asia. A new and higher value for the yuan would largely be a wash for these activities. With a stronger currency, China would have a harder time selling its electronic goods, but this would be offset by its greater purchasing power over the semiconductors. It would not do much damage to the Chinese competitive position.

The Chinese keep the yuan low, relative to the dollar, by buying up United States Treasury securities; as of early 2006, the Chinese central bank held up to $470 billion in Treasury securities. This huge accumulation of relatively low-yielding assets is the investment strategy of risk-averse bureaucrats, but it may bring longer-term benefits. Those assets can someday be sold or otherwise transferred to underdiversified Chinese financial institutions. The accumulation gives the Chinese a stake in American prosperity and signals that the Chinese are committed to long-term participation in the global economy. On the American side, the Treasury market is more liquid and the budget deficit can be financed at lower cost.

The yuan should not, as matters stand, float freely with free capital movements. Large quantities of Chinese savings, currently restricted to the domestic currency, would probably flee the country, worsening the serious solvency problems at Chinese banks. The Chinese must first clean up their banking system before they can have free capital markets. Contrary to the conventional wisdom, a market-determined value for the yuan might well be lower than today’s exchange rate, not higher.

To the United States, the primary gains from yuan revaluation would come from the increased spending by Chinese consumers on American exports. But the Chinese are, and should be, extremely cautious. In addition to saving about 50 percent of their incomes, they are spending most of the rest on local basics, like food, cheap cars or education. Health care is a probable growth sector. China is still a poor country, and its potential to drive American export success is modest for the foreseeable future.

Revaluation advocates claim that the Chinese need a stronger currency to prevent their economy from “overheating.” China may indeed not be stable. But it is unlikely that the United States government can successfully micromanage another country of 1.3 billion people into a soft landing. Chinese economic data is very poor and Americans do not have a good record in advising transition economies. The Chinese recipe for economic growth, which encouraged exports, seems to be working, although it ran counter to efforts by American economists and policy makers to promote the privatization of state-owned companies.

The climb of the Chinese economy out of Communism and into prosperity has brought the world, and the United States, a free lunch. Consumer goods of many kinds are cheaper and the Chinese are likely to generate many scientific and technical innovations. Steering the value of the Chinese currency — from Washington — is unlikely to increase those gains. The United States should not be spending its international political capital on yuan revaluation, which is at best a nonevent.

Tyler Cowen is a professor of economics at George Mason University. He is co-author of a blog at www.marginalrevolution.com. He can be reached at tcowen@gmu.edu.

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