March 23, 2010

A Chinese Currency Revaluation is Just Part of a Needed Rebalancing of the Global Economy

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Michael Pettis explains how a chinsese currency revaluation would play out.

Michael Pettis is a professor at Peking University’s Guanghua School of Management, where he specializes in Chinese financial markets, and a Senior Associate at the Carnegie Endowment for International Peace.

* A revaluation shifts wealth from the Chinese government and the manufacturing sectors (and some wealthy Chinese) to Chinese households — which, by the way, is pretty much what is meant by “rebalancing” in the Chinese context.

* There are many other ways besides revaluation to shift income this way. The PBoC can raise deposit rates, wages can rise faster than productivity, companies can be privatized by giving away shares to the public, and so on. They all have the same effect. They shift resources to households and away from producers, infrastructure investment, and real estate developers. This allows household income to grow relative to national income, which ultimately increases the consumption share of GDP.

* rebalancing cannot happen too quickly without risking throwing the economy into a tailspin.



* If we abstract for a moment, and call all trade-deficit countries the United States, and all trade-surplus countries China, there are broadly speaking two ways the system can adjust. The rebalancing in China will force an equivalent rebalancing in the US. As the price of Chinese goods rise, the net impact will be to transfer resources from US consumers, who have to pay more for their imports, to US producers (US producers become more globally competitive).

* There are several countries with structurally low consumption and high production — Germany, Japan and China being the most important (and I leave out the OPEC countries for obvious reasons)

* if we want to resolve the global imbalances in an optimal way that maximizes global growth and equity, we would need all the major problem countries to work out a program, perhaps over 8 to 10 years, in which China, Japan and Germany take concrete measures to shift subsidies away from manufacturers and return the income to households, and the US, the UK and other deficit countries shift income from households to investment.

Of course the cynic in me says getting a global solution will prove impossible. Each country that benefits in the short term from stonewalling on any aspect of the complex adjustment process will do so. So I guess that just leaves trade war.


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