Martin Wolf on China’s exchange rate policy: Jim O’Neill and Dani Rodrik reply

Here are some of the responses to Martin’s column on China’s exchange rate policy:

Jim O’Neill, chief economist at Goldman Sachs:

Like many others, I often, all so easily, fall into the camp that the Chinese exchange MUST still be undervalued, and cite the reserves fact and its growth as evidence, but I am not so sure when I really analyse it. We have a model for estimating fair values for many currencies, our so called GSDEER, and it did used to suggest that the CNY was undervalued. However as a result of the approximate 20pct appreciation of the past 4 years, and higher prices than many other countries, our model suggests it is no longer so clear. Now FX models are FX models, and having spent so much of my career on them, I know only too well that it is subject to even more risks for somewhere like China. But when I see our own- objective -model saying things like this, observe surveys showing that Mexico is now back to being the no 1 place to produce heavy industrial goods, and China’s imports rising much more sharply than exports, I stop to question my underlying tendency. On top of this, and Martin, as many others, never seems to address this, China’s current account surplus this year is going to be close to about half what it was a year ago amidst lots of evidence that domestic demand, especially consumption, is roaring away. Yesterday, we got news that in November, Chinese auto sales rose by 92pt year on year. They are so strong, that they are now importing some directly from overseas. You see similar evidence when you look at LCD TV sales and almost anything else. As some Chinese policymakers point out, this is almost definitely more important than the exchange rate issue that so many are still rather perhaps excessively focused on.

Dani Rodrik, professor of international political economy at Harvard University:

To Martin’s two questions at the end of his piece, one must add a third:  What would be the consequence if China’s economic growth were to decline significantly as a result of the currency appreciation that the rest of the world is urging the country to undertake?  Answer: a tragedy for the world’s most potent poverty reduction engine, and potentially a disaster in terms of social and political stability in the world’s most populous country.

What people seem to overlook is that China’s growth is directly linked to the performance of its tradables.  What drives rapid growth is the flow of labor to high productivity manufactures in urban areas from the rest of the economy.  A conventional rebalancing of the economy will work to the advantage of non-tradables and the detriment of tradables. Before joining the WTO, China promoted its tradables through trade and industrial policies.  It has since shifted to exchange rate policy, since WTO rules prevent it from pursuing those old inducements.  It is no coincidence that China’s current account deficit began its inexorable rise in 2001, the year that China became a WTO member.

According to my back-of-the-envelope calculations, China’s growth would be reduced by more than 2 percentage points if its currency were to appreciate by 25 percent in real terms (which is roughly how undervalued it is).  This would put the economy below the 8 percent growth threshold that its leadership thinks is critical to maintain domestic social peace.

So while I think Martin is right that we are headed towards a train wreck, China is not the evil and misguided party that commentary of this sort makes it seem.  It does face a serious dilemma.  And nobody is offering any helpful ideas on how to get the country out of it.