In a very bad bit of news for the US, the Los Angeles Times (hat tip Lune) reports that the Chinese policy of letting the yuan appreciate has not succeeded in reducing the country’s massive increases in foreign reserves. In fact, the situation is getting worse rather than better.
Normally, when a country’s currency appreciates, its current account surplus drops, as does foreign direct investment (the notion being it will be a less competitive exporter). But in China’s case, the usual pattern isn’t operating. From the Los Angeles Times:
In 2006, the yuan rose just 3.24% against the dollar. But since the second half of last year, the appreciation has accelerated amid a sharply falling dollar and surging inflation in China. Chinese policymakers figured a stronger yuan would boost imports and curb excess exports, thus slowing the growth of China’s trade surplus and the flood of dollars into China that has pushed up inflation.
So far, though, the yuan’s sharp rise hasn’t staunched the massive inflows of cash. In fact, China’s foreign reserves, the largest in the world, have ballooned to $1.65 trillion this year, with about $60 billion added in January and in February — up from a monthly average of about $40 billion in 2007.
With the yuan appreciating quickly, speculators are continuing to pour money into China, says Michael Pettis, who teaches finance at Peking University. Nor is there clear evidence, he says, that the stronger yuan is reducing China’s trade surplus, even though lower demand for goods from the U.S. appears to have slowed China’s export growth recently…
Although the stronger yuan makes U.S.-made goods cheaper for customers in China, Zhang Renren, manager of a U.S.-based wood exporter, said that hadn’t translated into a noticeable pickup in orders from China.
The article does report that Chinese firms are looking at moving operations into lower-cost Vietnam and also observes:
Wessco [a US company that has its products made in China] also hopes to move up the value chain and take advantage of China’s growing pool of skilled and creative talent — still cheap by Western standards. Two months ago, Sakkis said Wessco opened a design office in Shanghai with a staff of 10.
With the yuan and other costs rising, he said, China as a production base for low-value goods is yesterday’s news. “We’re shifting how we look at China,” he said.
Note that Wessco is hardly alone in looking to China for higher-value added manufacture; this repositioning was frequently mentioned at a recent presentation at Asia Society.
Where does this leave the US? Not in a pretty position at all. Having become a service economy and sent so much manufacturing overseas, a cheap dollar may not produce the benefits the US hoped to achieve. Indeed, the US trade deficit widened in February, contrary to expectations. Even though economists argued that this month was a one-off due to unexpectedly high import demand, the confidence that this pattern will change soon may be misplaced. The main contributors to the blip up were purchases of foreign cars, computers, and oil. The oil part of the equation won’t change, computer manufacture is offshore and thus not likely to shift soon either. The buys or non-US cars and computers reflect consumer preferences that may prove stubborn as well.
With a limited manufacturing base, it remains an open question how much improvement we will see in the balance of payments even with continued debasement of the currency.
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I have never understood how the idea got traction that a lower dollar would boost US _manufacturing_ exports and thus restore our Im/Ex imablances, for just the reasons you say, Yves. We manufacture just so much less of what the world wants now, except military hardware (which we give away cut-price or free to our protectorates much of the time). Where do we get the pick up in demand ‘held back by the high $?’ Yes, US exports went up in value in ’07 as the $ declined; it would seem from some accounts, though, that the fat part of this new income was from price rises in US _grain commodity exports_, i.e. soybeans, wheat, and corn. In otherwords, the sinking $ makes us look less like Deutschland and *cough* Taiwan than it does like Australia and Canada, whose commodity exports—ores, grains, and for CAN timber and some oil—give them leverage over their Im/Ex balances: we’re moving downmarket, not laterally. We need a soft reindustrialization, but nothing in the FIRE economy will get us there, and a change is a decade long undertaking if we start tomorrow morning. It is a laugher that we have committed totally to a computer-dependent service and manufacturing economy while shipping all of our _computer manufacturing capacity_ offshore, where it will now cost us FAR MORE to import with a sinking $, thus cancelling out and more the putative ‘productivity rises’ resulting from said computerization. (Yes, _we_ did this, no one twisted our pudgy, sweaty arm.)
On China, I don’t claim to know what their next ten years of development looks like, nor what their closely held development macropolicy is. That said, I do not grasp, either, why most discussions about China seem prefaced on the idea that they will remain for the mid-term a low-price, low-value added exporter with limited domestic demand. The notion strikes me as reading the past and not the future, or in other words as more standard macrofinancial analysis as presently practice. China looks for all the world to be following the textbook on growing an industrialized and financially developed economy: a) limit imports to allow local firms to get competitive on small scale production they can handle, b) export at the cheap end to accumulate capital and build commercial networks, c) train the work force and the factories to move up chain, and d) get a banking and security system floated and more or less under the control of central authorities. The next logical steps are to move manufacturing to higher value exports for better money and leverage, and to grow domestic demand to put a floor under their economy and grow their _wholly controlled_ capital base. It would appear that this is the implied policy trajectory in China, but we seem to be fully pricing in this approach: not More of the Same, but New and Improved.
It would _appear_ that the higher-ups in China want the zaibatsu model of Japan rather than a ‘free market’ economy a la Malaysia, Singapore, or the West; that is with industry, the banks, and central planning large, highly concentrated, and fully integrated while the population is kept in enforced docility by low wages, lack of labor mobility, and minimal pensions. China couldn’t meet domestic demand on a scale we see even in Japan, not to say Europe or the US, so that is a further reason not to try to grow themselves by strongly stimulating domestic demand and its accompanying expectations as opposed to modestly stimulating home demand. It took Japan 30 years to go from 1945’s economy to 1975’s. China won’t take the whole country as far but China started the clock in 1989, and it won’t take them 30 years. In fact, they may just be there, well, now.
The idea that US or EU macroecon policy toward China should see be based upon China 02, a ‘Made in Japan’ exporter financed by the skim-off from peasant farmers, is a fool’s play: China 08 is well beyond that. And the real issue for China isn’t ‘preserving its foreign capital reserves,’ it’s growing the manufacturing economy and supporting it’s trading network (China has gone a long way to work itself structurally as _the_ merchant intermediary to much of Africa and Lattin America will the US has been busy murdering SW Asians of many cultures). China’s foreign reserves are shrinking in value anyway; the issue is to shink them gradually at a pace that their manufacturing base can roll with the punch. That base and those networks are the prizes, not mountain of our mouldering debt and Fed notes.
China will have many difficulties with the reweighting of international trade and currencies, but as far as I can tell China far better positioned to ride out and even gain from turmoil than are we in the US. If this is a ‘race’ or a ‘game’ we’ve already lost, just no one’s put up the number on the scoreboard yet.
*aargh* Typos. I’ll give this personal note just one: I’ve had a mild neurological disorder for seven years, besides which I can’t proof effectively on the scree. I pains me deeply to turn out pock-marked prose, but I have to live with it. My apologies.
Yves — the pick up in US export growth from 2003 on is clearly tied to the fall in the dollar, so I am a bit more optimstic than you are. Moreover, without a fall in the dollar, there is little incentive to reindustrialize the US. German auto makers are investing in the US now; they weren’t in 2001 and 2002. The rise in the RMB also seems to have slowed the increase in Chinese exports to the US (compare uS imports from China to Europe’s imports from China), so I am more optimistic there as well. I would tho caution that the us slump explains most of the slowdown in us imports from china.
The deindustrialization reflected at least in part the strong $ of the 90s and the artifically weak RMB of this decade; reversing course requires painful adjustments — and a weak dollar is part of the pain.
brad setser
Greetings Yves
I have to disagree with you. I see the FIRE economy as flamed out. It cannot right the balance of trade and currency no matter how hard we try. Our current mode with the FIRE economy is to sell our real estate and assets to make up for loss of productivity. The services that we sell, so called financial products depend on them not containing toxic waste to be marketable. Financial products are only viable if they can deal with some sort of stable currency, and they cannot pay for massive consumption.
We are left with the picture of selling our furniture and homes to pay for our dinners out and plasma TVs and imported WalMart goods and fuel. The only means to right this ship is to become a productive society again and produce items of value to the rest of the world, and produce our consumer items ourselves.
What we lack is access to capital for prodcution. All our capital has been consumed in housing, finance, speculation, health care and consumption. Modern day production is capital intense and mitigates the need for low wages. If you doubt this, look at Germany with 5 profitable car companies, and the US with 3 bankrupt ones. Look at Japan and Korea with any number of successful auto firms. Japan certainly has a higher wage base than the US.
Until the US can allocate more capital for production we will remain a poor country, begging others to take our currency in return for their goods.
To that end, I am one of the few that blames Volcker for this travesty. The destruction of manufacturing capital and redirection to FIRE began with the “strong dollar” policy of Volcker. It put finance at the nexus of access to foreign capital by shipping our investments to cheaper countries, and our purchases overseas. Our balance of trade and accounts became permanently negative and has not been positive since then.
Since the world went off the gold standard, the notion of tariffs has been taboo. What has happened is that various countries have used monetary policy and weak currencies as a substitute for tariffs. The US through its reserve status has been able to avoid righting its BOT and BOP.
Bottom line, it will take a generation to get over the lack of manufacturing and production capability, both due to lack of capital, and lack of a labor force capable of production. The lack of capital is exacerbated by baby boom retirements demanding capital to live on, and for their health care. That is what will stretch out this recovery more than those before. This is shaping to be generation depression.