My Blog

November 26, 2007

MON 26 NOV 2007

Europeans in China By Michael Pettis

The timing of the various European meetings in China with my own office move has made it hard for me to keep up my blog, but nonetheless the world hasn’t stopped providing interesting things to talk about.  As we all expected, President Sarkozy’s visit included a call for accelerated RMB appreciation – he asked for currency policies to be “harmonious and fair” which meant, he explained, that China needs to accelerate the appreciation of the yuan against the euro”. 

 

He wrapped this advice in the sort of words that the Chinese love to hear – “A great country must have a strong currency” – but warned against letting “imbalances accumulate to a point where we wouldn't be able to get out of them”.  I think this is a major point that needs to be made more often – if there is indeed a monetary imbalance, it is not just a current problem that at some point can be easily resolved with a revaluation.  Rather these imbalances can accumulate, making it almost impossible at some future point to resolve them without a significant, and potentially painful, adjustment. 

 

Nonetheless the advice was quickly rebuffed by Premier Wen who said China would continue its gradualist approach.  For Wen, as for many others in the leadership, I think there is a great deal of concern that a one-two combination of slowing US growth and a sharp appreciation of the RMB could seriously damage China’s export industry.  With rumors of rising urban unemployment (the figures are hard to check) and rising college unemployment, the Chinese authorities are in no hurry to jump onto any policy that can have an adverse impact on employment growth, especially a few months before the Great Coming-Out Party.

 

Two days after President Sarkozy made his comments, a group of European Union heavy hitters seemed to raise the ante.  According to Bloomberg “European Central Bank President Jean-Claude Trichet, Luxembourg Prime Minister Jean-Claude Juncker and European Union Monetary Affairs Commissioner Joaquin Almunia will argue that an undervalued yuan is ‘triggering protectionist tendencies’.”  The threat is not very hidden.  It seems that they will be telling Chinese officials that if something isn’t done to raise the value of the RMB against the euro, Europe may be forced by its own domestic political considerations to move unilaterally and raise trade barriers against Chinese goods.  The statement is all the more dire coming a day after a seemingly nasty dispute about Chinese product safety between EU trade commissioner Peter Mandelson and Vice premier Wu Yi, indicating that anti-Chinese feelings in Europe are rising.  This is clearly a worst-case scenario for China, especially as it will make it even easier for US protectionists to follow Europe’s lead.

 

I think there is no question that China needs to move much more dramatically on the RMB.  This is not just to appease the Europeans, but more importantly to protect its own economy from an out-of-control monetary policy that may lead to real domestic problems in the next year or two.  I think, however, that the Beijing authorities are still going to be reluctant to do anything dramatic.  So far, reducing unemployment still trumps moderating money growth as a policy preference.

 

But here’s a thought.  There are two ways the RMB can appreciate against the euro.  First, the RMB can appreciate more rapidly against the dollar.  Second, the dollar itself can begin to appreciate against the euro, dragging the RMB up with it.

 

China itself has been a very big factor in the dollar’s decline against the euro. What if the authorities were to permit a slightly faster rate of appreciation against the dollar at the same time that the PBoC announced that it was planning to accumulate more “cheap” dollars?  That would cause the dollar (and the RMB) to rebound, perhaps sharply, so appeasing the Europeans. 

 

Of course any significant move in the dollar would simply throw us back into the old game of a US deficit powering Chinese growth, which as we have already seen is not a stable outcome.  That’s the problem, without a serious decision to address RMB undervaluation, it is hard to see what can be done about global imbalances except shift them around a little.  But without a serious domestic economic or political threat, it is hard for the Chinese authorities to risk slowing the economy too much.

 

In the end I suspect that this will all come down to the inflation numbers of the next three or four months.  If inflation seems to moderate, or continues to be – at least in the short term – concentrated in food prices, nothing is likely to change before the Olympics.  But if inflation numbers over the next few months turn out to be alarming enough, Beijing might finally move to address the RMB.