Is the Chinese currency, the renminbi, dangerously undervalued and a threat to the global economy? Over thirty important experts offer their views

International Economy, The, Spring, 2003

Yes, but state controls prevent this adjustments.

EDWARD N. LUTTWAK
Senior Fellow, Center for Strategic and International Studies

In spite of all evidence to the contrary, including the most dramatic case of Argentina, dominant opinion holds that only market forces matter, not the institutions and policies that constrain and deform market forces.

Yet for at least forty years, economic theory (notably the general theory of the second best) has explained why partially free markets need not achieve a like part of free-market optimality, and may to the contrary be worse than markets that are even less free.

There are no homogeneous ordinal levels below perfection, but rather complex interactions--and that indeed is why we need complex economic policies. Or more simply: a 90 percent solution may be worse than a 70 percent solution.

China today is a case in point, and by far the most important. There is a large scope for market forces in the Chinese economy, but there are also powerful state controls. As a result, the renminbi is greatly undervalued. That of course results in huge trade surpluses which should generate a corresponding demand for the renminbi, increasing its relative value, making Chinese exports more expensive. But state controls prevent this adjustment, hence China is experiencing "high speed" growth by selling deliberately undervalued exports.

Of course China is only copying the Japanese model of the 1960s, the Taiwanese model of the 1970s, the Korean model of the 1980s.

But China is not Taiwan, Korea, or even Japan. Its labor market is many times larger than Japan's in the 1960s and of an altogether different dimension as compared to Taiwan or Korea. Having started with the most manpower-intensive, lowest added value products--textiles and such--China is now ascending steadily through the categories, but without the limitations of scale of its predecessors. So long as there is no counter-intervention to correct the imbalance caused by the deliberate undervaluation of the renminbi, Chinese exports will continue to have a deflationary impact world-wide. Chinese high-speed growth and a global economic slowdown are not only compatible but congruent phenomena. It is high time to cast aside dogma to take action.

Revaluation without reform of the financial system would cause confusion.

TAKESHI OHTA
Chairman, Daiwa Research Institute, Inc.

No doubt the Chinese currency (the RMB) is undervalued judging from various data, e.g., its purchasing power parity set by the International Monetary Fund and the International Bank for Reconstruction and Development (2 yuan/$), the Big Mac Index (3.7 yuan/$), the daily official intervention in the market to manipulate stability of its de facto fixed exchange rate (8.3 yuan/$), and the resultant accumulation of the official reserves ($270 billion).

China's continued fixed investments have resulted in high productivity and enormous production capacities. Thus Chinese consumer goods, becoming cheap and good in quality, have driven competitors out of the export market. A risk to upset a global demand-supply balance, putting a downward pressure on the prices of tradable goods, is looming large. But on the other hand, China is now a most important recipient of neighboring countries' exports as Japan used to be in the 1980s. At the same time, it has become a global factory for the world major manufacturing companies. From Japan, many large- and mid-cap companies are rushing into China. Examining these developments, I would conclude that the RMB should not be considered as a threat to a global economy, although it poses problems to some consumer goods manufacturers in the world markets and may exert a deflationary impact in the future.