macroblog: Renminbi Contrarians

Renminbi Contrarians

Michael Shedlock links to a new post (of a reprinted article) by Morgan Stanley's Andy Xie. Neither Michael nor Xie think the float is coming anytime soon. From the Xie article:

I see a very low probability that the Chinese renminbi (Rmb) will revalue soon...
China’s ability to sterilize hot money inflow is still plentiful.China’s yield curve is below the US dollar’s yield curve – i.e. sterilization is still profitable. The inflationary pressure is still limited to cost pass-through from higher commodity prices. We forecast a 3.5% inflation rate for 2005. Neither the inflation rate nor the yield curve is a problem in terms of China sticking to the peg.

Xie has his own hard-landing scenario, but it involves protectionist impulses from the U.S., not a Chinese bailout on the dollar peg:

I estimate that a significant share of the profits of S&P 500 companies come from mark-ups on cheap Chinese products. If the US Congress passes a serious protectionist measure against the China trade, the US stock market could be hit hard and the property market could follow. The US economy would then plunge into a deep recession. Therefore, I believe the US is unlikely to pursue such a course despite its heated rhetoric.

And here's a point that, for my money, is often lost in the discussion.

An undervalued currency causes inflation. Hence fixed exchange rates adjust through inflation or deflation. If China’s currency is undervalued, inflation will take care of it.

That said, it's not entirely clear whether this is a point in favor of the "soon-to-float" position, or in favor of the "no-float-soon" position:

An economy should abandon a fixed exchange rate regime when inflation is too high to be tolerated. China’s inflation rate is still low and comparable to that in the US. Inflation is not yet a reason for abandoning the peg.

Inflation becomes a serious problem under a pegged exchange rate for two reasons. First, excess credit growth leads to over-consumption and trade deficit. Hong Kong experienced such a phenomenon in the 1990s. There was a property bubble associated with rapid credit growth in the territory. The consumption boom and the resultant trade deficit came from the wealth effect associated with the property bubble.
China probably has a property bubble. However, it has not triggered a consumption bubble. China can still deal with its property bubble via tax measures.

I suspect there is some room for disagreement there.

For his part Michael gives his top 10 reasons why China should not float the RMB:

1) The Chinese central bank does not want to trigger a currency crisis by floating the RMB too soon.
2) There is too much "hot money" flowing into China in hopes of making a quick killing on a currency repeg or float.
3) China thinks in terms of years or decades on policy changes. What happens over the course of the next 6 months is not relevant.
4) Chinese banks might not be in a position to take the stress of floating the RMB at this time, even if other factors were conducive.
6) Fundamentals such as slowing worldwide growth do not favor floating the RMB right now.
7) The Asian principle of "face saving" suggests that China can not be forced into premature action and that "Snowtalk' is counterproductive.
8) The peg has served China well. China did not blow up in the last Asian currency crisis because of that peg. The peg has provided stability and that stability is still useful.
9) The US has bigger problems that need addressing first.
10) Paper losses on paper currencies look far bigger on paper than they actually are in the grand scheme of things that central bankers consider.

He concludes by asking "Anyone else in the boat with Andy Xie besides myself or are we the two lone wolves?" I understand that there may be some people out there in the blogosphere that have opinions on this.

UPDATE: The Skeptical Spectator takes note of the Xie column too. He also has commentary on yesterday's jobs report.