By Jomo Kwame Sundaram
KUALA LUMPUR, Malaysia, Jan 14 2020 – Many argue that China’s impressive growth for last four decades has been due to deliberate exchange rate undervaluation, promoting exports and discouraging imports. Last year, the Trump administration accused China of engaging in currency manipulation.
Post-war US hegemony
When the US Treasury Department accuses a country of ‘currency manipulation’, it authorizes retaliatory US action for ostensible exchange rate management intended to gain ‘unfair’ advantage in international trade.
After it came through the Second World War relatively unscathed and primed, the US current account and trade deficits have grown since the 1960s saw the end of its early post-war surpluses after European and Japanese economic recovery, reconstruction and industrialization.
Since then, US dollar (USD) foreign exchange (forex) reserves accumulation – especially by Japan, China and oil-exporting states investing in US Treasury bills – has long financed the US current account (consumption over production, and investments over national savings) and fiscal (government spending over revenue) deficits.
Chinese exchange rate undervaluation
China’s rapid export-led growth with low wages, raising savings and investments from profits, has been attributed by some to rapid forex reserves accumulation to keep its exchange rate low.
Like most other developing and ‘socialist’ economies, following the end of the Bretton Woods arrangements under President Nixon’s watch in the early 1970s, the renminbi (RMB) real exchange rate during the 1980s was weak, arguably reflecting its trade account then.
The RMB exchange rate was considered undervalued for much of the 1990s. Initially, it declined until 1993, then strengthened over the following three years, before weakening again with other East Asian currencies during the 1997-1998 regional financial crises.
Chicken and egg economics
China’s exchange rate competitiveness’ contributions to export growth and the current account surplus are undeniable. However, the evidence that its export-led industrialization was due to deliberate exchange rate undervaluation – owing to forex reserves accumulation – remains weak.
Instead, China’s exchange rate competitiveness was mainly due to its efforts to achieve exchange rate and currency stability by managing an informal peg of the RMB to the USD. Following the Hongkong dollar’s seemingly successful USD peg from 1983, and the failure of various earlier exchange rate arrangements, the managed peg became policy as China’s growth stalled in 1989, the year of the Tiananmen Square incident.
Although the resulting exchange rate competitiveness undoubtedly enabled rapid industrialization and growth, with exports supplementing domestic demand, there is no strong economic rationale for insisting that forex reserve accumulation is most growth-enabling.
China reluctantly gave in to US-led pressures for the RMB to appreciate from the early 21st century. Long dominant in the Bretton Woods institutions, the G7 and the G20, the US accused China of ‘currency manipulation’ to gain an ‘unfair’ advantage in international trade, causing ‘global imbalances’, including the huge US current account deficit.
The RMB appreciated from 2002, as the ratio of Chinese to US prices increased from 22% in 2002 to over half during 2011-2018, reducing China’s export competitiveness, lowering its exports/GDP and investment/GDP ratios, thus slowing growth.
The RMB’s real exchange rate – understood as the ratio of Chinese to international prices, as measured by the ratio of its dollar GDP at the official exchange rate to its purchasing power parity GDP – then rose for over a decade during 2003-2013, especially during 2006-2011.
China’s growth slowdown
As growth and trade fell in the 2008-2009 Great Recession, China’s domestic stimulus response accelerated the transition to greater domestic consumption, as wage incomes rose, profits slipped and RMB appreciation slowed. These developments undoubtedly reduced China’s economic, export and forex reserves growth, as the RMB’s real exchange rate strengthened.
After China’s exports’ share of GDP peaked at 35% in 2005, the RMB real exchange rate appreciated fastest during 2006-2011, causing the RMB to be over-valued for a decade until its 2018 depreciation in response to Trump’s trade war.
RMB appreciation has undoubtedly reduced export competitiveness, export/GDP ratios, externalities from exports, and export-led growth. Meanwhile, China’s reserves to GDP ratio has been declining as forex reserves accumulation ended a decade ago.
Meanwhile, declining unemployment and underemployment, with rising labour force utilization, have improved wage remuneration and working conditions, eroding into profits from previous, largely uncompensated labour productivity increases.
Savings, investments and growth have thus declined as domestic consumption has risen. Excessive RMB appreciation over the last decade has thus slowed rapid Chinese growth, but its modest depreciation after 2018 may not reverse this adverse effect sufficiently.
The story has changed
Contrary to the popular narrative of a continuously and deliberately weakened RMB exchange rate, China was forced by US-led international pressure to reverse RMB undervaluation almost two decades ago.
Higher incomes, reduction of earlier fast-rising income inequalities and the stronger RMB have significantly increased Chinese mass consumption, with less left for corporate profits, savings and investments, as slowing Chinese growth over the last decade suggests.
As RMB overvaluation for much of the last decade until 2019 was not demanded by the US or others, there has been no support from US allies for the Trump administration’s latest charge of ‘currency manipulation’ by China.