Incipient Chinese Yuan Depreciation in Context

Plenty of breathless commentary on how Chinese yuan depreciation against the dollar might trigger conflict. From Barrons:

Reality Check for China


The currency’s decline could dampen foreign speculators’ enthusiasm

Last week, China’s currency, the renminbi, juddered to its biggest one-day decline against the greenback since Beijing began a managed float in 2005.

Says Win Thin, a currency economist at Brown Brothers Harriman: “The prospect of appreciation is off the table for now.” Morgan Stanley now expects China to depreciate its currency by 5% to 10% in the coming year. The current rate is 6.88 to the dollar.

The renminbi can float in a trading band of 0.5% on either side of the U.S. dollar and has gone up 20% against the buck in the past three years. To trim China’s fat trade surplus with the U.S., Treasury Secretary Henry Paulson is pushing for further appreciation, and the Obama administration will probably hew to the script.

The dollar’s recent jump has pulled the renminbi up sharply against the euro and the currencies of Korea, Taiwan and Indonesia. That’s bad news for China. Its exports account for just 8.8% of GDP, but nearly 20% of growth. Now, China is slashing rates and spending $586 billion to stimulate its economy. Last month, Brown Brothers notes, People’s Bank of China Gov. Zhou Xiaochuan said he couldn’t rule out weakening the renminbi to boost the economy.

While there is nothing wrong in this article, it does miss the context of the predicted RMB depreciation by focusing on the bilateral rate. On a trade weighted, inflation adjusted basis, one can see why Chinese authorities might want the RMB to depreciate.

rmbdep1.gifFigure 1: Log trade weighted value of the RMB (blue) and log USD/CNY exchange rate (red). Dashed line at the float of the RMB in July 2005. Source: BIS, St. Louis Fed FRED II and author’s calculations.And why has the RMB appreciated? Because the dollar has appreciated so drastically.

rmbdep2.gifFigure 2: Log trade weighted value of the RMB (blue) and log trade weighted value of USD against broad basket of currencies (red). Dashed line at the float of the RMB in July 2005. Source: BIS, Federal Reserve Board and author’s calculations.Now, there is a separate issue of whether China should try to make the RMB depreciate against the dollar — that is there is a difference between understanding why the Chinese authorities are pursuing this policy, and supporting it. Brad Setser argues that — given China’s large and growing trade surplus and forex reserves — it shouldn’t allow RMB depreciation against the dollar. I tend to agree. But I doubt that RMB depreciation against the USD is the biggest issue facing the world economy.

So when you see a headline like Renminbi Depreciation May Stir Trade War, well, it may prove to be true, but then again it might not.

Originally published at Econbrowser and reproduced here with the author’s permission.