Chinese Renminbi is well managed.
Certain sections of the US media along with US politicians and government officials continue to berate China for failing to allow the value of the Renminbi to appreciate in an upward float. The US position was outlined in a recent press release by US Treasury Secretary Henry Paulson.
“Foreign currency trading, once conducted entirely by the Chinese government, is now conducted almost entirely by commercial banks. China has introduced financial instruments to hedge foreign exchange risk.”
On the face of it these are reasonable things to be crowing about. Restrictions on the trade in currency do nothing to foster free markets, investor confidence or financial maturatity. It is good that China has relaxed capital controls and has started to normalised the behaviour of currency trade in relation to the Renminbi.
However the ambitions that the USA has for Chinese monetary policy go much further as can be seen later on in the same press release by Paulson.
“I want to be clear: Increased flexibility in the short run is absolutely necessary, but it is not sufficient. My goal is to make significant progress toward a fully market-determined, floating Chinese currency.”
What is ironic in this statement is the implication that normal currencies are “fully market-determined”. If this were true then currency market participants would not spend so much time analysing the verbal nuance of government officials such as Ben Bernanke or prior to him an official called Alan Greenspan. When the value of something is “fully market-determined” you don’t have everybody focused on the mood of one government official as a prime factor to be weighted before deciding to buy or sell. We might reasonably say that the price of bananas are “fully market-determined” but any such claim with regards to the US dollar or any major modern currency requires serious qualification.
The fallacy that underlies the rhetoric of the Americans is the presumption that they are comparing a monetary regime that is a responsible free market approach (ie theirs) and a monetary regime that is artificially managed (ie Chinas). This is simply untrue. Both systems entail government controls on the supply side of the equation. Fiat currencies are printed and produced in quantities that vary over time according to government created institutions and policies. In the USA they increase and decrease the supply of currency as is consistent with Federal Reserves interest rate targets, whilst in China the prime target is exchange rates. Neither system is more or less “free” than the other. Both entail monetary managment via the manipulation of supply in order to fix a given price signal within a narrow band. In the case of the USA that price signal is the price of credit as reflected in interest rates, whilst in the case of China that signal is the price of their currency set directly via exchange markets.
The fairest way to judge a monetary regime is by the results it achieves. And according to the CIA world factbook Chinas consumer price inflation in 2006 was a perfectly respectable 1.5%pa. This is a good result and proves that exchange rate targeting can be an effective means via which to conduct monetary policy. To suggest that this is a weak currency that needs to be strengthened seems somewhat contrived. And in terms of good governance, Chinas previous explicitly fixed exchange rate was a much more transparent approach to monetary policy compared to the US policy of running the printing presses at a speed that suits the subjective whim of Bernanke/Greenspan.
The entire rhetoric that the USA government seems to take towards matters of trade and economic management in relation to China seems to be taylored towards externalising blame for domestic issues. As is so often the case there is political mileage in convincing the masses at home that their problems are caused by evil people that live abroad.
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Neither system is more or less “free” than the other.
I disagree. The US federal reserve only sets the government rate of interest. While that is not insignificant, the market is nonetheless free to set its own rates.
The Chinese currency is fixed (within a band) by the government for all transactions, government and non-government. There is no free market external to that.
Also, although the views of the Federal Reserve chairman are closely watched, it is a market environment. People are gambling with their own money.
In China, the exchange rate is set behind closed doors by invisible officials who never give their reasons.
The relative competitiveness of countries has to be determined somehow. In the absence of a single international currency, a good method is relative currency values. It looks to me as if the Americans have a valid point – China’s relative competitiveness is not being expressed via its currency.
When the value of something is “fully market-determined” you don’t have everybody focused on the mood of one government official as a prime factor to be weighted before deciding to buy or sell
Terje – i dont think this is a valid argument. Prior to Bernanke speaking, all the relevant information about the US$ is reflected in the price. However, the reason the market focuses so much on his and Greenspan’s utterances is that this represents new and relevant information. Markets always react to new, relevant information.
However, that said, i dont really understand Paulson’s position. China merely recycles its competitve exchange rate by buying US bonds, lowering interest rates for US borrowers, such as homeowners.
Oh… not again Terje. The problem with government-controlled exchange rates is that they set the exchange rates for political reasons.
In contrast, America follows a system of controlled overnight interest rates… but they do it only to manage the supply of money (to control inflation).
If China (or anybody else) managed a controlled exchange rate system for the purpose of controlling money supply then that would not involve an intentional distortion. But that is not what China is doing. They are distorting the exchange market by buying US bonds that aren’t a good investment.
Effectively, China is taxing it’s people to buy an inferior asset so that their currency is weaker so that they can export more. Bad, bad, bad. But like Pommy says, the US shouldn’t really complain as they get cheaper credit. The loser is the Chinese taxpayer & consumer.
John, would there be a way to sell guns and weapons to an oppressed Chinese peasantry? One could earn much Renminbi thereby, with quantity making up for lack of quality! (I’m assuming that the Commies don’t love their citizens enough to let them buy guns.)
John – your one argument makes no sense. You say they are intentionally weakening their currency and yet their inflation results suggest otherwise. China has a low rate of inflation suggesting that it’s currency continues to provide good buying power.
DavidL – you asked about this issue in one of the comments so this thread is dedicated to you. You state in your comment above that people can buy and sell overnight credit above or below the market rate set by central bank open market operations (OMO). This assumes you can find a buyer or a seller which is precisely what the central bank mops up with OMOs. The same is true of a monetary policy based on a currency band.
Relative competitiveness does not require flexible exchange rates. Hong Kong, Saudi Arabia, Panama and loads of countries have a fixed exchange rate regime with the US dollar. Denmark has a fix with the Euro. The relative competitiveness of all these nations gets determined. It can not do otherwise.
The Chinese officials that previously formally fixed to the US dollar and now fix to a blind basket that obviously has a heavy weighting towards the US dollar have given reasons for this policy and continue to give reasons. They believe it is an effective may to ensure that they have a stable low inflation currency. And all the data suggests that it works.
Pommy – of course the market shifts when new information arrives. The fact that the bulk of new information comes from the mouth of an official is indicative of the fact that the US dollar is a managed currency. It is just managed differently to the Renminbi. I don’t object to fiat currencies being managed because an unmanaged fiat currency would be consistent with hyper-inflation, hyper-deflation or anything in between. It would be like having an unmanaged car on the highway.
In terms of whether the supply side of a fiat currency is well managed or poorly managed I think the only objective measure is the price level over time. If two currencies achieve essentially identical results you can’t label one as being managed baddly or artificially whilst regarding the other as being well managed.
I agree that the demand side of the currency market should be largely free to find it’s own way but Paulson argues that China should do more than back away from restrictions on the demand side.
Nicholas – the Renminbi is essentially fixed in value relative to the US dollar (actually a currency basket dominated by the dollar). In what way do you infer that it’s quality is inferior to the US dollar.
No Terje… inflation isn’t caused by weakening your currency. Inflation is caused by excessive money supply (over the rate of GDP growth).
China is not weakening it’s exchange rate by printing excessive money. They are weakening their exchange rate by the government taxing the people and then buying US bonds. Effectively, they are forcing the Chinese people to invest in low-yeild American bonds when the people would prefer to be investing in other opportunities. By creating an artificial capital account deficit with the US they are creating an artifiical current account surplus.
Nicholas — I’m not sure about selling guns, but when I was in Beijing last year I met a guy who had been living there selling marijuana for 18 months. Pretty risky job I thought.
John – China is not weakening it’s exchange rate. That’s the point. And their capital account is as real as anybodies capital account. The use of the word artificial in this context adds nothing useful to the discussion.
The following currencies are managed using a monetary policy based primarily on a fixed exchange rate. Most if not all achieve very good inflation outcomes.
http://en.wikipedia.org/wiki/Category:Fixed_exchange_rate
Of course a lot rides on the target currency.
Terje, a fixed exchange rate with low inflation implies low capital flows and trade.
Capital flows are managed with a fixed float by increasing or decreasing money supply. There is a choice, not a debating point: you can control money supply or FX prices. How inflation is affected depends upon trade and investment flows.
Mark – Mundells used the metaphor of a monetary arrow that can only hit one target. Essentially this says that you have one degree of freedom. If you ultimately have only one lever which is the creation or destruction of base currency (OMOs crudely speaking) then you can only maintain one target. That target may be interest rates, exchange rates or something else but all are controlled via the lever of base currency and only one can be controlled at any given time with any consistency.
The sterling crisis of the early 1990s was essentially about such a choise between targets. They were trying to control two targets at the same time (interest rates and exchange rates) and ultimately something had to give. They subsequently had no further crisis once they decided which it was to be.
I think we essentially agree so I’m glad if there is no debate on this point. However I suspect that you have some larger point to make, but I don’t know what it is.
No Terje, a slight correction, you can only hit two out of three. However, I think fixed exchange rates are the least important objective. Nowhere else in Government policy are fixed prices important. Stability is more important.
I think private banking can hit all three (fixed eR, low inflation, free capital flows).
Fixed exchange rates are an alternative to fixed interest rates (not the only alternative). In terms of it being an important objective the question should really be about whether it is a useful intermediate objective. The ultimate monetary objective should be stability in the value of money. Fixed exchange rates may be part of a solution but it depends on many factors (eg is the target of the fix itself a stable reference for value).
Free capital flows is not what I would call a monetary target. It is more a state of affairs. So I think we are on slightly different wavelengths when we talk about a monetary target. Capital can flow freely under either a fixed exchange rate or a floating exchange rate. I think capital (like trade in goods) should flow freely and I’m taking that as a given. Paulson indicates that he wants more than just the free flow of capital and wants to used diplomacy to alter Chinas approach to monetary policy.
Do we agree that the sole objective of monetary policy (ie open market operations) should be low inflation or do you believe that there are other objectives?
Mundell says the Renminbi should not be revalued.
http://www.cbc.ca/cp/business/060609/b060980.html
Contrast his characterisation of the problem and the solution with Paulsons vision:-
No surprise that I agree with Mundell however given that I share his economic outlook in general.
p.s. I know the Mundell article is a year old but the substance of it is still valid.
DavidL – you asked about this issue in one of the comments so this thread is dedicated to you.
I’m touched. I’ve never had a thread dedicated to me before.
You state in your comment above that people can buy and sell overnight credit above or below the market rate set by central bank open market operations (OMO). This assumes you can find a buyer or a seller which is precisely what the central bank mops up with OMOs. The same is true of a monetary policy based on a currency band.
IANAE but, I don’t get that. Central bank operations simply represent a risk-free rate of return. There is nothing to prevent anyone from accepting a lower rate (if they are silly enough), while plenty seek a higher rate in exchange for higher risk. That’s a market.
The same is not true of a fixed currency. You cannot accept a different exchange rate because nobody will deal with you. Indeed, I think it is illegal to sell at anything other than the fixed rate. That’s not a market.
A manufacturer who has a choice between manufacturing in China or the USA would take into account relative costs – wages, materials and other inputs, regulatory compliance, etc, plus relative risks. Even if costs and risks in China and the US were identical, assuming materials were sourced locally in each country, it would still pay to manufacture in China because the fixed exchange rate keeps costs lower and returns higher. If the renminbi was floating, a different decision might be made. That’s market distorting.
Nicholas, there’s a very active arms manufacturing industry in China (think Norinco). So all we have to do is bribe some warehouse guards and load the truck in one town, drive to another town and sell them out the back. Easy as pie, but you can do the test marketing.
Thanks, Davo!
This arms manufacturing- it wouldn’t be a State Monopoly, would it? And can you drive on the right? Because I think that if I drove the truck on the left, as I tend to do here, the consequences would be severe.
Let’s also do drugs- buy aspirins cheap, and sell them dear!
Oh, I tried thinking “Norinco” for ages, but so far nothing has happened.
“Do we agree that the sole objective of monetary policy (ie open market operations) should be low inflation or do you believe that there are other objectives”
Yep.
Terje… if the government taxes the people and uses that money to buy foreign investments then they are artifically increasing the capital account surplus. These are all facts. Game. Set. Match.
I’m not sure that 1.5% ‘consumer price inflation’ is indicative of a healthy monetary policy. When productivity increases, prices drop – but they can be held constant if the money supply is expanded. Monetary expansion is inherently harmful as money is being created without wealth, involving exchanges of nothing for something.
Adrian – I don’t agree with your point but lets pretend for a minute that I did. Such a “harmful” expansion of the money supply is not unique to China and it is also practiced by nations such as the USA that don’t use a fixed exchange rate as a monetary policy instrument.
DavidL,
You raised several key points and I think they involve some misconceptions. If I go overboard in my answer and end up explaining how to such eggs please forgive me.
There are three types of credit that I think we should differentiate between for clarity.
1. Treasury can issue bonds to the public (often via an auction to financial institutions). These bonds may for example be a promise to repay the principle in ten years time plus some fixed annual rate of interest. The prevailing yield on such bonds is often refered to as the “risk free rate of return” because with the power of taxation governments are regarded as being a fool proof debtor. Of course anybody that trades in junk bonds will know that not all governments honour their debts so the term is sometimes a misnomer.
2. Central banks can lend money to banks. This is generally as a lender of last resort and the rate at which they lend in this instance is higher than the prevailing nominal market rate and banks almost never resort to using this fascility as it is indicative of a problem with their credit rating. This fascility is not really very key to monetary policy.
3. There exists a short term money market in which banks borrow and lend cash from eachother. They will lend cash short term to earn a return and make profit. They will borrow cash short term to meet their cash flow requirements and make sure that there is enough cash in the till to avoid disappointing their depositors who might try to withdraw funds the next day. Disappointing such depositors is exceedingly bad for a banks credibility.
The interest rate that the central bank (eg RBA or Federal Reserve in the USA) targets is this third one. It maintains the target by a participating in the general financial market place essentially as any private party would (except with huge market power). If the interest rate is above their target (ie credit is getting too expensive) they will inject currency into the market place by buying something with their stock of freshly printed notes*. Typically they will buy second hand treasury bonds but they may also buy foreign currency, gold or other financial instruments. If the interest rate in this market falls below their target they will take currency out of the market by selling something (eg gold, second hand bonds or foreign currency).
So yes you can attempt to buy or sell in this particular market at above or below the market rate but you and I do not have the market power to influence the market rate. The central bank does have the magnitude to influence the market rate and it uses that market power to maintain the price of short term credit between an upper and lower price band.
* N.B. reality is slightly more complex but it is not overly material to this discussion.
If a currency is fixed merely by decree then a black market will emerge and there will be a market price that is divergent from the official price. This does happen in some places but it is not the situation I am refering to. Paulson makes the point that China has eased capital controls and I agree with him that this is a good thing essentially because it lessens the impedious for black market transactions.
A fixed currency that is fixed as part of a monetary policy process (as in the case of China) as opposed to a mere decree, involves the same types of market intervention as outlined above when central banks target short term interest rates. The only principle difference is that they target the exchange rate to keep it within a narrow band instead of targeting short term interest rates to keep them within a narrow band. The process still entails the central bank participating in the market place and using it’s market power to influence a price target. If the currency is rising relative to the exchange rate target they will inject currency into the market place by buying second hand bonds, gold or foreign currency. And if the currency is falling relative to the exchange target they will remove liquidity by selling second hand bonds, gold or foreign currency.
In both cases a market exists and in both cases the central bank uses it’s market power (that exists by virtue of the printing press) to move the market to the target price that meets it’s policy objective. Both systems entail a market. Neither market is free in so far as there is a big player in the market (ie central bank) with government created powers (ie printing press).
A fixed exchange rate is no more distorting than a floating exchange rate. All that changes is the point at which adjustment occurs. It does not make sence to lower or increase the price of everything in China (via exchange rate movements) if the adjustment process should be occuring in a select set of industries. Exchange rate movements are a crude means of adjustment.
Regards,
Terje.
Peter Costello taxes the people and uses that money to buy foreign investments. He calls it the future fund.
In the USA the government borrows foreign capital and spends it on the people.
What you are refering to is largely irrelevant in regards to monetary policy.
Game. Set. Match. Tournament!!
“A fixed exchange rate is no more distorting than a floating exchange rate.”
That indeed depends upon where you live. But long term rates and internal price movements are in fact stable. We can hedge for FX. We can’t hedge internal price movements.
Most places are better off with external balancing.
“Exchange rate movements are a crude means of adjustment.”
Yes they are. But all prices change as well if your Government increases money supply to hold the price of your currency stable. Private currency and banking would reflect the industry specific scarcities better. The gold standard probably was a bit closer to a better form of adjustment, but private currency would do it best.
Robert Mundell did much of the foundation work on optimal currency areas (OCAs) in which he looked at the question of adjustment in detail. He does not agree with your assesment and I don’t either.
http://en.wikipedia.org/wiki/Optimum_currency_area
See also the intro to his 1961 paper:-
http://www.robertmundell.net/books/main.asp?Title=A%20Theory%20of%20Optimum%20Currency%20Areas
The notion that we can’t hedge internal price movements is simply wrong. Futures markets exists precisely for this purpose. People can use inventories. People can strike long term contracts.
We don’t have optimal currency areas yet though Terje. OCAs are just proxies to competitive private banking.
“People can use inventories. People can strike long term contracts.”
1. Physical working capital.
2. Wages.
Allright on the supply side.
Demand side/disposable incomes:
1. …
2. …
3. …
???
Whereas internationally traded goods are hedged by exporters and importers.
Mark – Not sure what you mean in this context with regards to the supply side and the demand side. People can both buy and sell physical capital and labour and both buyers and sellers can use the instruments I outlined.
Terje, thank you for the explanation.
I understand your argument to be that governments can target either exchange rates (eg China) or interest rates (eg USA and Australia), thus rendering them equally bad on the Terje scale.
In that case I don’t understand why the Reserve Bank seeks to influence exchange rates when it deems the dollar to be too high or too low. Does it switch from exchange rates to interest rates from time to time?
Also, isn’t it true that the Reserve Bank lacks the financial horsepower to actually achieve its targets? At best it can “smooth” things a bit?
I was also under the impression George Soros made his billions by betting against the Bank of England, which was attempting to achieve a targeted exchange rate.
So doesn’t that mean the market actually operates in spite of the intervention of central banks? Except that in China it’s not legal to bet against the central bank?
The future fund invests domestically and internationally and it invests for the purpose of maximising return. I think the FF is a bad idea, but it is not being used to influence the currency markets.
In the case of China the government is quite intentionally buying US bonds for the purpose of influencing the currency market.
I agree that this issue isn’t central to monetary policy. But we’re not discussing monetary policy. Perhaps you’re confusing discussions?
This discussion is about the Chinese policy towards their exchange rate. And the reality is that the Chinese government pursues an international policy of buying US bonds to keep the RMB low.
Which bit are you denying? Are you denying that the Chinese government is buying huge amounts of US bonds? Are you denying that this will impact on the currency? Neither denial would make sense.
I would have said equally valid, not equally bad. Although neither represents the ideal that I would prefer.
It rarely does this and when it does it is short term. In theory at least this may work because there are transmission delays between various parts of the economy. In practice they sterilise their own action and I suspect that the bulk of the effect flows from jawboning.
Absolutely not. They effectively have infinite currency at hand. It is called a printing press. And if they want to push things the other way they have sufficient assets to essentially redeem all currency that has been issued. If they wanted to use this power to make the Aussie worth US$5 next week then there is no lack of technical capability. Likewise they could drive it down to US$0.20 if that was there intent. Both would have horrendeous consequences and the governor would get the flick but the technical capacity and exists. They have enormous market power because it is a fiat currency.
From memory he made a lot of wealth on that bet but later lost a lot of wealth on a similar bet in relation to Malaysia. The Bank of England was trying to hit two targets at the same time (an exchange target and an interest rate target) and Soros essentially took a bet on which target they would give up on first. His bet was based on a technical reality and a hunch about which way the Banks masters would have it jump.
Yes it does. But the market power of the central bank is such that they can take the relevant action to determine the final price the market arrives at.
It is not illegal to bet against the central bank. It is just exceedingly stupid. In Australia the equivalent would be to bet that overnight cash interest rates will be 6.8% next week even thought the RBA official target is 6.25%.
http://www.rba.gov.au/Statistics/cashrate_target.html
To see the target cash rates for Australia superimposed on the actual market rate take a look at the following chart:-
http://www.rba.gov.au/MonetaryPolicy/_Images/cash_rate_100107.gif
RED = target, BLACK = actual.
Sure. But you accept that it does influence currency markets.
Yes. That is their policy. Their stated monetary policy position is to maintain a fixed rate of exchange with a currency basket that is dominated by the US dollar. You may not like that policy. Perhaps like Paulson you think some other policy would be better. However so long as that is their policy you must see that maintaining it entails the need for certain market actions, just as a policy of targeting a given interest rate entails a need for certain market actions.
Maybe your not discussing monetary policy but if that is the case you’re the one confusion discussions.
In any case they don’t keep the value of the currency low relative to the US dollar, they keep it fixed (approximately).
I am not denying either. And your point is?
And just to be symmetrical:-
Are you denying that the US government is selling losts of US bonds? Are you denying that this will impact on the currency? Neither denial would make sense.
Semantics Terje. Of course they keep it fixed (actually, floating in a small band) but they keep it artificially lower than what it would be if they weren’t intervening.
The future fund is a distraction. The Australian government is not running the future fund (FF) intentionally to change the exchange rate. The Chinese government is running a sort of FF with the sole purpose of influencing the exchange rate. Consequently, while the Aust FF tries to maximise returns, the Chinese FF does not maximise returns. That’s bad for the Chinese taxpayers.
You have made the point that managing the exchange rate for the purpose of controlling inflation is just as legitimate as managing the overnight interest rate for the purpose of controlling inflation. Fine. But that is NOT what China is doing. On the contrary, their intervention is aimed at maintaining their current account surplus.
Do you agree that the government should not be intervening to control the current account balance?
I am denying that the US are selling bonds for the purpose of controlling the current account balance.
It is what they say they are doing.
http://www.pbc.gov.cn/english/huobizhengce/objective.asp
Are you in touch with a higher power?
Terje — if the Chinese government uses taxpayer money to buy US bonds that is NOT monetary policy.
John – if the US government sells bonds so it can spend on US citizens that is NOT monetary policy.
What’s your point?
The chinese government is pursuing a policy of buying US bonds for the purpose of maintaining an artificially low exchange rate. That is bad.
Artificial?
Look lets get things straight.
1. The central bank of China has a monetary policy that entails a fixed exchange rate. That is their policy for better or for worse. Agree?
2. In order to achieve their policy aim they have to buy and sell financial instruments which happen to include US bonds, foreign reserves etc.
3. If they decided to appreciate the currency by say 50% tomorrow they would still need to buy and sell financial instruments to maintain the new fix. So any notion that a central bank buying and selling financial assets causes the value of their currency to be artificial is farcical. Our central bank buys and sells financial assets (as does our government directly) and you don’t refer to our exchange rate as being artificial.
If the notion of artificial does not stem from the fact that they buy and sell financial instruments then it must stem from some idea that the currency would be worth more if they had a different policy. Which is a rather hollow claim because we could easily imagine a third policy under which their currency was worth less.
Your claim is essentially that the Renminbi is artificially under valued because under some other monetary policy it would be worth more.
It could just as easily be claimed that the Renminbi is artificially over valued because under some other monetary policy it could be worth less.
Just for fun you can see the growth of foreign assets held by the central bank of china for 2005 on the following page:-
http://www.pbc.gov.cn/english/diaochatongji/tongjishuju/gofile.asp?file=2005S2.htm
The issue is not the buying and selling of foreign financial assets. All countries do that. The issue is the buying and selling of foreign assets for the purpose of controlling your exchange rate.
This is possible with a flexible exchange rate and the US has been accusing Japan of doing it too. If the Australian government wanted to depreciate the AUD they could run a nice big surplus and buy lots of foreign financial assets. Thankfully, our government doesn’t pursue this policy.
It is the act of trading foreign financial assets for the purpose of influencing the exchange rate that makes the exchange rate artificial.
The question is where does China find the money to buy foreign financial assets? I was under the impression that they used government money.
Okay if all fixed exchange rates are defined as artificial your assertion is merely a tautology.
So by your definition of artificial they could appreciate by 90% tomorrow or depreciate by 90% tomorrow and so long as they then fixed at the new rate you would refer to it as being artificial. It is not the semantics that I would use but if you define a given exchange rate to be artificial then low and behold it turns out to be artificial.
However what you have not dealt with is how you determine that a fixed exchange rate is too high or too low. By what objective measure do you make that conclusion?
It seems to me that your argument is essentially circular. It runs like this:-
1. If they used my prefered monetary policy they would get result X.
2. But they use a fixed exchange rate monetary policy so they get result Y.
3. X is higher than Y so therefore Y is too low.
4. Because their policy gives a Y that is too low it is a bad policy.
Interesting that you mention Japan. Of course they have been buying foreign assets. It is the only way they could get out of a zero interest rate deflation trap that was brought on by zealots in the USA and gullible fools in Japan that insisted in the early 1990s that the Yen must appreciate. Much as you are now arguing for in regard to the Renminbi.
Targeting interest rates is pointless once you go into deflation. Nominal rates can hit zero even whilst real rates remain too high to escape deflation. You have to abandon interest rate targeting once you enter that zone.
Here is the maths.
Firstly some definitions:-
RIR = Real Interest Rate
NIR = Nominal Interest Rate
INF = Inflation Rate
RIR = NIR – INF
So for example if:-
INF = -10% (ie severe deflation).
NIR = 0% (ie as low as they can go)
RIR = 10%. (ie you’re now stuck with a tight setting in the midst of deflation).
To escape such a deflation trap you have to move to quantitative easing. Which essentially translates into exchange rate targeting or commodity price targeting.
That’s not what I said Terje. I said that an exchange rate is artificial if the government is trading foreign financial assets for the purpose of influencing the exchange rate. This can be true under either fixed or floating and it is theoretically possible for either fixed or floating to also be non-artificial.
It so happens that the Chinese government is trading foreign financial assets for the purpose of influencing the exchange rate. Ergo… artificial.
I note that the Chinese government also controls the interest rate, and they have been tightening their monetary policy recently in response to inflation fears. This is what we would expect if their exchange rate was set too low and they were buying US bonds out of new money (instead of taxpayers money).
Which interest rate do they control and how do they control it?
Japan escaped their deflation by introducing a quantity rule instead of an interest rate rule so they could increase money supply. The goal was controlling money supply.
That is totally separate from the question of whether the Japanese government is trading in foreign financial assets with the purpose of influencing the exchange rate. Note that I haven’t accused them of that. I just brought up that accusation because you were confused about my definition of “artificial”.
Hey — you’re the expert on Chinese monetary policy. You tell me!
They just put up rates by 0.18 and introduced higher deposit requirements. This is the fourth rate increase in the past 12 months.
http://www.komotv.com/news/business/7575442.html
Of course, if they were using managed exchange rates for inflation targetting (as you hope) they wouldn’t be controlling interest rates. This indicates that they are using exchange rates to target something else.
I know what it is. Do you? I’ll give you a clue. It rhymes with “murrent account balance” and starts with “c”.
You’re essentially wrong but just for the moment lets assume that you’re not. Lets assume that they are using market intervention to target domestic interest rates and they are using market intervention to target exchange rates. Don’t you think we should call George Soros and a few of his buddies and position ourselves to make a killing?
I like this assumption. What position do you want to take? And what does your wife think of you playing on the computer at 1:00am?
The overnight cash rate in China can be viewed here:-
http://www.shibor.org/shibor/shiborChartShow.do?termId=O/N
It’s not in English but you can make out the relevant data and see that the overnight lending rate is free to roam.
By the magic of the Internet it is now 8am.
My position would be that anybody betting on an appreciation of any significance is going to lose that bet. George Soros lost when he bet against Malaysias central bank and he had to blink first.
If you want a wager then I’m betting that 12 months from now the Renminbi will be worth about one eighth of a US dollar. What odds will you give me?
The RMB has already been trending up. They put it up 2.1% in 2005 and it has since edged up over 5% under the heavily controlled managed float arrangement. I imagine the international market is already positioned to expect a continued soft appreciation.
I think the RMB will continue a soft appreciation, but I don’t think it will be dramatic because (1) the Chinese government won’t let it happen; and (2) I don’t think it is significantly under-valued.
I agree that the issue is being over-played on the American side to argue for protectionism, and that their CAD with China would exist even with a market exchange rate.
There are many ways for a government to control money supply & interest rates and the Chinese government is clearly using them. Otherwise why did they announce that they were putting up interest rates by 0.18%?
Finally — the only gambling I do is texas hold’em poker. And I play for sheep stations.
There are a lot of interest rates that are decreed in China. This is different to using OMO to determine a market rate. Where the decree is for a floor price or a ceiling price it may or may not have any broader effect. Where it is on central bank deposits then likewise. Where it involves dictating to private banks making private loans then banks may adjust the quality of loans to accomodate. None of this is ideal and I agreed in my article above with the criticisms that Paulson made about China in this regard. What I object to is his broader assault on Chinese monetary policy and the false logic that gets employed.
The Chinese government specifically said they were increasing interest rates to combat fears of inflation. They also increase the reserve requirement.
I also note that the Chinese government owns most of the banks that operate in China. I don’t have much trouble believing that the Chinese government has had (and continues to have) a firm hand on the domestic money supply & credit multiplier.
Meanwhile, all of this debate and potential conflict could be avoided if they targetted inflation by controlling the overnight interest rate. You agree that this is equivalent to other forms of inflation targetting… but at least it would remove the temptation or apperance of tampering with the exchange rate. The resultant change (or non-change) in the exchange rate would show whether the governmet actually was intervening in the exchange rate.
They are not tampering with the exchange rate. They are fixing it. Tampering implies secretly manipulating. There is no such secret.
Ok… not tampering. How about molesting the exchange rate, or sodomising the exchange rate, or massaging their exchange rate for the purpose of controlling the CAS.
Why would they want to control the CAS in the way you imply?
It makes Chinese goods more competitive on the international market, and therefore helps their export sector. Mercantilism is alive and well in the world.
The Chinese government are quite explicit that they don’t want to increase the RMB because they’re worried about the impact on their exports. This is the same reason that Americans want the USD to depreciate against the RMB.
Mercantilism you reckon. So in your opinion does this approach succeed in defying the fundamentals and actually lead to a sustained increase in exports?
Not my opinion. Artificially increasing your KAD (which is what I’m accusing China of doing) increases the CAS by definition. This is because KAD = CAS.
But as I’ve already said, I don’t think it’s a good idea. The chinese people are paying for it either through paying too much tax (which is being spent on foreign financial assets) or through higher interest rates (as the extra money supply is being channeled through foreigners into consumption instead of being available as loanable funds).
Yes but if you maintain the fixed currency ultimately you will get an increase in the Renminbi price of exports if the Chinese people have a preference for more domestic consumption and domestic investment over exporting goods and investing abroad. In which case CAS = KAD and the exchange rate is still fixed but CAS could be lower. Fixing the exchange rate provides certainty regarding the value of money without removing the markets freedom to adjust. What you seem to be asserting is that a fixed exchange rate will force people to export when in fact they may instead choose to raise export prices.
If the chinese people all decided tomorrow to start buying foreign goods then the central bank would have to adjust if it wanted to keep it’s currency target. As such they are not forcing people to export or to save. You are infering coercion where none exists.
Fixed exchange rates don’t stop prices adjusting. In that sense they don’t let you alter trade fundamentals in any sustainable way.
In comment 49 you referred to the Chinese central bank altering reserve requirements and changing the base rate. You did not offer any source or context for these claims. My own reading indicates that neither involves OMO. This is obvious for alterations in reserve ratios (we don’t regulate these in Australia but they do in the USA). However the reference to the base rate is perhaps ambiguous because in places like Australia and the USA this would generally be interpreted as the target interest rate for OMO. In the context of China it most likely refers to the regulated floor and ceiling price on commercial bank interest rates. It represents a ceiling price on the interest paid on deposits and the floor price on loans is taken as 0.9 of the base rate. I’m not certain if this is an administrative rule applying to government owned banks only or if it applies to all banks. In any case it seems that adjustments in this rate are made with a close eye on interest rate differentials with other nations (eg USA) and as such it does relate to fixing the exchange rate. It is also a ceiling/floor and not a taget market clearing price achieved via OMO.
There is a similar article about this at the “Institutional Economics” blog:-
http://www.institutional-economics.com/index.php/section/chinas_monetary_and_exchange_rate_policy/
That article links to a BOJ paper that details some of the technical aspects of Chinas monetary policy. Specifically on page 7 of that paper is says:-