Global Rebalancing: A Modest Role for the RMB

At the forthcoming Franco-Chinese colloquium  Croissance et déséquilibres mondiaux. Approches chinoises et européennes, I plan to argue that growth-oriented global rebalancing on current accounts can – and should - rely to only a very limited extent on RMB appreciation. That role has almost certainly to be smaller than most economists assume, so my thesis is likely to stir debate.

First, consider the history of US-Sino imbalances. As large emerging countries integrated for earnest into the world economy over the past 20/30 years, a global convergence process started – Shifting Wealth. This process depressed low-skill goods prices and wages (through the Stolper-Samuelson effect). The corresponding super cycle in raw material prices shifted purchasing power and wealth toward oil, iron ore and copper exporters. The switch from net debtor to net creditor positions of many emerging countries, based on oil or sweat, depressed US treasury rates as most of the underlying trade surplus was invested in the deepest, most liquid financial market.

The US Federal Reserve led by Alan Greenspan clearly misread Shifting Wealth as cheap goods and cheap savings from China & Co nourished the illusion of permanently depressed inflation. So while the natural interest rate – the real return on capital – was rising in a world of Shifting Wealth, the capital market rate was falling. Austrian overinvestment theories*  from Knut Wicksell to Friedrich August von Hayek provide two reasons for a fall of the capital market rate below the natural rate: First, the central bank supplies more liquidity at unchanged rates via money creation, underestimating future inflation. This allows for accelerating credit growth of the banking sector and low capital market rates. Second, the banking sector (or capital market) keeps interest rates low via money creation, thanks to financial deregulation in the US. The consequence of this configuration was a strong drop in US household savings that started in the mid 1990s. China’s current account meanwhile remained fairly balanced until the early 2000s, from when reserves started to explode.

Second, consider the  size of US-Sino imbalances, in other words the size of the transfer problem in order to get current account rebalancing. In 2006, the China’s surplus on the current account was equivalent to 8% of its GDP, the US deficit 6%. In 2010, both countries have been running a surplus, resp. deficit, closer to 3% of their respective GDP. This rebalancing has mostly been caused by the crisis; debt limits on further rises in US household consumption; and China’s  huge fiscal stimulus to cope with the global crisis and temporary export slump.  While China is gradually correcting its (far from outlandish) currency undervaluation, most of the remaining US-Sino imbalances are arguably of structural nature: US credit culture and financial system; China’s surplus household and corporate savings. Overall, however, the graph shows clearly that global imbalances have become less US-Sino centric. All these considerations point to a modest role for RMB appreciation, mostly to lower its corporate savings surplus.

Third, for global rebalancing to be growth-conducive, the speed and size of RMB appreciation has to be slow and low, best driven by further income convergence. Homi Kharas, in his excellent

OECD Development Centre Working Paper No. 285 “The Emerging Middle Class in Developing Countries” (2010) has made two crucial points. He didn’t link them to the RMB debate but they can be used in the context of RMB appreciation and global rebalancing:

• Strong currency appreciation in the convergence process usually picks up once countries reach 30% of US per capita income levels. China is at half that level. It is a country much poorer than Germany and Japan were in the 1970s when their currencies appreciated 40, resp 60% against the dollar.
• The debt-limited US consumer can be replaced by the emerging middle class in China and elsewhere, provided these countries are allowed to grow fast enough to transfer their poor segments to the middle class, defined as > 10$_PPP/day/capita.

Further reasons that growth and rebalancing can hardly be reconciled with strong RMB appreciation is Dani Rodrik’s (2010) finding that currency undervaluation stimulates growth more in China than in other developing countries. RMB appreciation translates into more competitive currency valuation elsewhere, but there it tarnslates into lower growth than it did in China. And as OECD Development Centre research has recently shown, China has become the growth engine to emerging and developing countries alike during the past decade, replacing the G7 countries.

* Schnabl, G. and A. Hoffmann (2008), “Monetary Policy, Vagabonding Liquidity and Bursting Bubbles in New and Emerging Markets: An Overinvestment View”, The World Economy,  Vol.31.9, pp 1226-52.