Martin Wolf’s FT economist’s forum, 11th October 2006
Andrew Smithers
Response to Martin Wolf’s FT article 11th October 2006 “How China has managed to keep the renminbi pinned down.”
Martin and I agree on the basic analysis as set out in his 11th October, 2006 column, from which a number of key questions arise.
(1) It seems unlikely that China can for long postpone having either a rising nominal exchange rate or rising inflation. Whichever choice it makes, the result will be, ceteris paribus, an increase in inflation in the rest of the world. To offset this it is likely that the equilibrium level of output will need to be lower than before and a period of below trend growth will be needed. Such periods are typically ones of falling profits. By pegging its exchange rate China has probably contributed to the current high level of profits in the rest of the world and, as this reverses, profits are likely to fall.
(2) The impact on past profits will have been asymmetrical. While allowing the total level to rise through temporarily suppressing inflation, China has driven down the relative profitability of traded goods and services compared with non-traded ones in the rest of the world. If, as seems likely, the capital/output ratio of traded products is higher (worse) than those of non-traded products, higher investment will be needed in the rest of the world for the same level of output growth to be possible.
This will be particularly acute in the US and UK which have, over the past decade or more, been the two G5 countries which have invested least and grown most rapidly. This has been accompanied and probably made possible by large and rising current account deficits, as non-traded output, with a relatively low capital/output ratio, has grown at above trend rates. The easing of current account imbalances thus requires slow growth of consumption in the US and UK, not only to finance the rise in savings that this requires directly, but also to finance a shift to higher domestic investment, without which the growth rates will decline as the capital output ratio rises.
(3) I am intrigued by Martin’s third chart. Can China really have achieved the massive sterilization shown? If so how? What distortions and consequences has this had for the domestic economy?