Saturday, 26 December 2009

The End of Chimerica

Welcome to this blog.

In this first post, I'd like to draw your attention to a paper by the famous Niall Ferguson and his less famous colleague Moritz Schularick.

This paper provides ammunition to the savings glut theory. The main messages from the paper are the following:
- The Chinese currency is probably undervalued to the US dollar by c. 30-50%
- This is mostly a function of a decrease in the last 10 years in Chinese unit labor costs due to productivity gains that has not been counterbalanced by an increase in China's price level relative to America's
- China has been able to operate an undervalued currency without generating high inflation through a combination of capital controls, tight regulation of credit and and a huge labor pool with very limited ability to demand wage rises
- China's undervalued currency and corresponding massive US dollar reserve accumulation contributed to lower interest rates in the US. This, in turn, has allowed the US economy to increase its leverage and thus support the excessive consumption and growth in financial assets that we've seen up to the crisis
- The authors argue that China should revalue its currency by 30-50% and that Japan and Germany are precedents for this. In the 1970's, the currencies of these countries revalued some 40% against the US dollar. This hasn't stop Germany and Japan to continue to generate trading surpluses
- They also argue that China's revaluation is desirable both for US and China. US would be able to export its way out of the slump and thus avoid "dangerous" measures to stimulate domestic demand (to keep employment). For China, a revaluation would allow it to diversify out of the US dollar (its US dollar reserves would be worth less but its massive Renminbi stock of assets would be worth a lot more). Finally, it would reduce the risk of trade frictions between the US and Asia but also between Europe and Asia (remember that by being pegged to the dollar, the Renminbi has been devaluing against European currencies).

All in all, I find it a convincing paper. I can't see how the current unbalances in the world economy can unwind other than by revaluation by China and the other Asian countries whose currencies are pegged to the dollar.

Deflation is not a desirable option in the developed world given the high degree of leverage. Deflation would require massive bankruptcies - but that's a theme for another post.

The issue is whether this is politically feasible in China in the short term. I.e., if China cannot keep exporting like crazy how is it going to keep creating new jobs for its masses when it seems it already has an extremely labor intensive service sector? And therefore, how could this be actionable without triggering dangerous social unrest in China?

Perhaps China's demographic landscape might be a positive here because at some point there will be a lot less people entering the workforce. But can we afford to wait a few more years?

1 comment:

  1. The thing is that contemporary China is not the same thing as 1970s Japan or Germany. Can we predict the employment and social nock-on effects of such a revaluation on the Chinese currency? Would it be politically wise for the Chinese goverment to agree to it, I'm not sure China would consider it so.