Friday, January 18, 2008

Chinese Leaders Finally Getting It?

For years, I've been arguing that it is irrational for China to hold down the value of the yuan versus the U.S. dollar. It creates excess inflation, excess dependence on exports and give American and European politicians an excuse for implementing protectionist measures.

Still, until recently they've mainly tried to reduce inflation by the for China less effective means of raising interest rates and raising bank reserve requirements. These measures is much less effective than allowing the yuan to rise and comes at a very high cost for China. But recently the rate of gains have sharply accelerated. In the latest month (January 17 2008 compared to December 17 2007), the yuan rose from 7.3805 per dollar to 7.2245 per dollar. That's a 2.1% gain in a month, which translate into an annual rate of more than 29%.

I find it unlikely that they will keep up this pace for much longer, but it seems clear that they will raise the rate of yuan appreciation versus the dollar to much higher levels than in 2007. This is good news for China-but it will mean that the price inflation problem in America will become even greater. Not only will this further boost the boom in commodity prices in dollar terms, it will make the price of imported goods from China much higher. In the past, import prices from China were generally falling but the high rate of inflation in China combined with the higher yuan have already started to raise import prices from China, and with the accelerated pace of yuan appreciation import prices from China will likely rise even faster in the future.


Blogger Jeff said...

Do you have any support for the assertion that import prices from China are increasing?

I've "heard" that the exporters are accepting price cuts. Now granted I'm not providing any support for my statement but it makes sense as the Yuan is a restricted currency and trade with the US is denominated in dollars. It isn't easy to pass increases along so exporters have to get more efficient.

At least that is the way it has worked to date. Long-term increases in the Yuan are obviously inflationary for the U.S. and deflationary for China.

On another topic, I would be very interested in a post on velocity. It has been a couple of decades since I've taken an economics class but hasn't the liquidity provided by the Fed flowed into asset prices because consumers are not purchasing goods/services with the liquidity. Couldn't the correction simply be that asset prices plunge, wiping out significant wealth with consumers/government still managing to spend an amount that does not create inflation or significant recession? Not easy to get the goldilocks scenario but widespread inflation in consumer goods isn't an obvious result is it?

7:38 PM  
Blogger stefankarlsson said...

Jeff, just look at
the official import price index , which shows import prices from China increased 2.4% in the latest year. And this was before the most recent acceleration of the appreciation of the yuan.

As for the decline in asset prices, that will certainly help contribute to the recession as the non-existent savings rate will become unsustainable when asset prices decline.

And while the asset price decline in itself will not raise consumer prices, there are many other factors, including the weak dollar that will. The increased pessimism about asset price will in fact increase the extent to which newly created money raise consumer prices instead of asset prices.

1:36 PM  

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