The United States seems serious about forcing a sharp and rapid appreciation of the Chinese currency. So serious in fact that the U.S. Senate Finance Committee and Senate Banking Committee passed two recent bills to this effect. The action is a clear indication of the way some Americans are thinking, bringing to the fore the belief that appreciating the renminbi will ease the U.S trade deficit with China and reduce the hammering being metered out to some U.S. industries. Xia Bin, Director of Finance Research Institute of Development Research Center of State Council, indicates in an article published in China Business News that, while the world is undergoing a shift in the division of labor and the U.S. Government is overissuing dollars due to its serious structural problems, a mild appreciation of the renminbi can't fundamentally solve the lasting U.S. trade deficit. Excerpts follow:
From the perspective of the global economy and in the long term, the current problems in China's economy should be attributed to the environmental and resource pressures that results from the country's rapid development over a short period of time, the ever increasing international pressure so hard to tackle and the liquidity-related pressures on economic stability caused by the long-term net favorable balance. In the short term the economy is plagued by the "three overs" problem (overly large trade surplus, overly fast investment growth and overly abundant liquidity). The solution for these problems, from the position of trade imbalance, lies in the sharp appreciation of the renminbi to greatly curb trade surplus.
To start, just how much should the renminbi appreciate? In theory, it's possible to find an exchange rate that fully reflects the market balance, but the preconditions are the full convertibility of the renminbi under capital account and a well-developed foreign currency market. Unfortunately, China is blessed with none of these conditions.
Second, in this year's hearings before Congress, U.S. senators said the renminbi was undervalued by 40 percent, indicating a once off sharp appreciation is necessary. However, this would deal a heavy blow to China's current rapid development and its employment market, which may deprive China of a precious opportunity for development and mean disaster to the world economy. So what some U.S. senators have put forward is unreasonable.
Third, not only Chinese economists, but also many of their foreign counterparts, including those from the United States, realize that if the world economy and the Chinese economy are to be protected from any danger, while the world is in the throes of the restructuring of the division of labor and the U.S. Government overissues dollars because of its serious structural problems, a mild appreciation of the Chinese currency can never help to fundamentally solve the current U.S. trade deficit. Therefore, it's unrealistic to expect to solve the "three overs" problem while the focus is still on China's foreign trade imbalance.
To solve the "three overs" problem from the perspective of internal economic imbalance, the priority is to reform income distribution and boost domestic demand, but that's never an easy job. The Chinese Government is implementing a series of pro-consumption policies, by increasing state investment in rural development, social security, health care and education, as well as cutting the tax rate on deposit interest income. Statistics for the first half of 2007 shows a favorable turn in consumption growth. However, while China's commodity supply is mainly targeted at the huge global market, it's unrealistic to replace the international market with domestic trade over a short period of time.
From another point of view, if a further analysis of the "three overs" problem is made, it's easy to find out that the overly large trade surplus will lead to an increase in foreign currency and excess liquidity, which, in turn, gives speed to investment growth. However, as China has not done enough to curb energy-consuming and polluting industries, and the country's efforts to reform of the exchange rate regime and reduce liquidity are not fully effective, naturally, the kind of trade that should be controlled is instead restimulated, which leads to a growing trade surplus. While dollars are earned by exports, high energy consumption and serious pollution are the result for China. Thus, it's not right to blame the "three overs" problem on the trade surplus.
The excess liquidity has stimulated the overly rapid investment growth. As a result, it's hard to keep domestic prices and the economy stable. However, liquidity is not created by the central bank. It's true that the present excess liquidity should be attributed in part to the central bank's insufficient sterilization operation, but fundamentally, the problem is a reflection of the lack of investment destinations for domestic savings deposits and a product of global economic imbalance and insufficient economic restructuring in China and the United States. Recently, it is reflected in the overly high government savings rate and weak domestic demand.
Overly rapid investment growth will further increase China's trade surplus at a time when the Chinese economy depends much on the global economy. Nevertheless, given China's domestic savings rate and the supply of various factors, the current investment growth rate, 24.9 percent in the first half of the year, is not overrunning. Besides, nowadays the Chinese economy has little problems with supply. Apart from food, there is no sharp increase in the price indices for other consumer goods, or rather, the growth of the indices is still within control. In recent years, the price index for fixed assets remains stable. When there is high external demand, pushed by the current trade pattern mainly set up by transnational corporations, China's top industrial enterprises have maintained a profit growth rate of more than 20 percent for five consecutive years, and maintaining this pattern they saw an increase of 40 percent in the first half of 2007. A large proportion of investment profits sharply added to the liquidity and the growth of the trade surplus.
It's obvious that the "three overs" are intertwined. As the Chinese economy is largely dependent on foreign trade and there exist deficiencies in economic structures in China and the United States, it's almost impossible to find an instant "key policy" or "core policy" to China's "three overs" problem. Neither can we say that internal imbalance is the cause of external imbalance.