Apr 30 2006
RMB Debate: A liquidity trap as in Japan?
Economist (the magazine, of course) is getting ever more loveable … many quotes are properly linked. Awesome!
Anyway, there is an article reminiscing Plaza Accord and fantasizing another.
It refers to another article by Ronald McKinnon from Stanford.
Quotes:
Twin deficit: implies U.S. financed government spending was financed by Japanese money (is it true?)
Why then is China bashing in the U.S. now so much more intense than Japan bashing or Germany bashing when the latter two countries still have larger manufactured exports and larger overall current account surpluses than China’s?
Stressed the difference between bilateral and overall account surplus (not sure why that makes difference to American politicians)
Why the obsession with currency? “industry. Rather than being concentrated in particular heavy industries, (Chinese imports) are spread across the board,”
Key assumption: If a discrete exchange rate appreciation is to be sustained, it must reflect relative monetary policies expected in the future: relatively tight money and deflation in the appreciated country and relatively easy money with inflation in the country whose currency depreciates.
Why: Price level/Real Exchange Rate, “A substantial appreciation makes the country look like a more expensive place to invest,” particularly FDI, and depreciation of dollar assets (which China has plenty).
He advocate fixed exchange rate as monetary anchor.
Problem if RMB revalued:
Because most East Asian countries invoice their trade in dollars, these countries collectively are a natural dollar area–loss of price competitiveness in Asia.
Very interesting idea: poor banking system in China makes exchange rate a better indicator than interest rate. Because in order to maintain the fixed rate, CB has to maintain stable money supply.
China’s recent history “However, the data are consistent with my hypothesis that fixing the nominal exchange rate provided the much needed anchor.”
Liquidity Trap:
In the face of undiminished foreign exchange risk, i.e., the probability that the renminbi could appreciate, a near zero interest rate liquidity trap is possible—even likely. (plus data)
In conclusion, he advocates, “retaining capital controls on inflows of highly liquid “hot” money from dollars into renminbi, and continuing to peg certain interest rates such as basic deposit and loans rates in China’s banks.”
Thoughts/Notes:
1. It compares today’s China to yesterday’s Japan.
2. A good monetary analysis that is simple enough for an undergrad (level) person to understand.
3. Some very interesting data/charts to back up his hypothesis.