Currency Appreciation in Emerging Asia and Trade Deficit in the US
James Xiaohe Zhang
Newcastle School of Business
Faculty of Business and Law, University of Newcastle,
University Drive, Callaghan, NSW, 2308, Australia
Telephone: 612-49215034, Fax: 612-49216919
Email: James.Zhang.@newcastle.edu.au
Abstract
Despite the global trade imbalance narrowed during the current economic recession,
the improvement is not evenly distributed across different regions. While many
economists blame the US trade deficit to the undervaluation of currencies in
emerging Asia in general, and to the undervalued Chinese RMB in particular, no
consensus has been reached as yet. Since a unilateral revaluation of the RMB has
failed to reduce the trade deficit in the US, some commentators have recommended
a joint appreciation of currencies in the emerging Asia as an instrument to restore
trade balance between the US and Asia.
Based on several simulation exercises on a multi-country macro-econometric model
(the Fair model), this paper examines the likely consequence of the joint
appreciation of the emerging Asian currencies on the trade deficit in the US.
According to the results of simulations, neither a drastic unilateral appreciation of the
RMB, nor a joint appreciation of currencies in emerging Asia, would reduce the trade
deficit in US significantly.
Paper prepared for the Joint conference of Edith Cowan University and Yokohama
National University2010 Globalization, Monetary Integration and Exchange Rate
Regimes in East Asia，22 - 23 November 2010, Perth Western Australia.
Notes on Contributor
Dr James Xiaohe Zhang is lecturer in economics at the University of Newcastle
specializing in economic development and international economics. He has
published many articles in journals including China Economic Review, Journal of
Development Studies, and the Journal of the Asia Pacific Economy.
Key words: China, RMB, exchange rate, revaluation, appreciation
ACE theme: Aspects of the China Economy and Business; International Economics,
International Finance, Trade and Political Relations
JEL system: O19 (International Linkages to Development), O24 (Foreign Exchange Policy),
O53 (Asia)
0
Currency Appreciations in Emerging Asia and Trade Deficit in the US
1. Introduction
In the new millenarian, we have witnessed rising global imbalances that can be
characterized by large current account deficits for the US and large current account
surpluses for most East Asian countries and oil exporting nations. Despite the global
trade imbalance narrowed during the current economic recession, the improvement
is not evenly distributed across different regions (IMF, 2010). In economies with
large external surplus before the crisis, most notably the emerging Asia in general
and China in particular, the growth of exports remains strong, and trade surplus
keeps surging. Most interestingly, the surge in China’s exports in recent years has
been accompanied by an accumulated appreciation of the Renminbi (RMB) for more
than 20% against the US dollar in nominal terms between 2005 and 2010. When the
RMB broke 7 yuan per US dollar for the first time in 13 years, China's current
account surplus hit a historical record of US$ 296 billion in 2008, accounting for 10%
of its GDP. As a result of rapid growth in exports and trade surplus, China’s foreign
exchange reserves exceeded US$2.27 trillion by November 2009 (Chung, 2009),
more than double the foreign exchange reserves of Japan, the second largest holder
of foreign exchange reserves in the world.
As compared, the US, the largest economy in the world, has been suffering from
huge current account deficits. When China’s current account surplus increased to an
astonishing 11% of GDP in 2007, the US current account deficits reached 6.5% of
GDP in 2006 (Benhima and Havrylchiyk, 2010:107). The US absorbs an
overwhelming share of the world’s trade surplus, particularly from Asia. For instance,
the US imports from China overwhelmingly excesses its exports to China despite
both exports and imports maintained at double digit growth rates until 2008. The
surging Chinese exports in the US market makes China the largest contributor to the
US rising trade deficit with its share on the overall US trade deficit increased from
1
22% in 2000, to 25% in 2003, 31% in 2006 and 38% in 2008. Figure 1 presents
evidence that the movements in the US current account deficit have been
symmetrical with those in the current account surpluses of China.
Figure 1 China's Export, Import and Trade Balance (1978-2008)
1500
1000
US$b
500
0
1978
1985
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
-500
-1000
exports
imports
China's current account
US' current account
Sources: National Statistical Bureau of China, and US. Census Bureau. The figure is plotted in the
basis of official data obtained from China Statistical Yearbook for China (see
http://www.stats.gov.cn/english/statisticaldata/yearlydata/) and from the US. Census Bureau, 2009
Statistical Abstract (see http://www.census.gov/compendia/statab/brief.html).
Against this backdrop, the US Congress has attempted to pressure the Chinese
authorities to revalue the RMB further. At the time when this paper was written,
Premier Wen Jiabao and President Barack Obama were met in the US for the UN
general meeting. When Obama argued that the RMB is "valued lower than market
conditions say it should be" and that gives China "an advantage in trade," Premier
Wen Jiabao said a 20% rise in the RMB would cause severe job losses and trigger
social instability, putting the nation on course for a clash with US lawmakers
demanding a stronger currency.
2
These events have also attracted tremendous academic interests on the issues of
how trade imbalance in the world economy is created, and what is needed to be
done to mitigate it if complete removal is impossible. Many, if not most, economists
blame the US trade deficit to the undervaluation of currencies in emerging Asia in
general, and to the undervalued RMB in particular. Although there is no agreement
reached on how a RMB appreciation should make to the correction of global
payment imbalances, particularly reducing the large US trade deficit, some
commentators (see for instance, Cline and Williamson, 2008, Goldstein and Lardy,
2008, 2009:51) have recommended that the RMB should appreciate for at least 25%
from its current level to cut the share of its trade surplus on GDP by half, and for 45%
to remove the surplus completely. Furthermore, Goldstein and Lardy (2009:67)
argue that “because emerging Asia plus Japan has roughly a 40% weight in the
Fed’s trade weighted dollar index, a 20% real appreciation in all Asian currencies
would translate into an 8% real depreciation of the dollar and probably a $100 billion
to 140 billion improvement in the US current account deficit”.
This proposal, nevertheless, is based on an assumption that the currencies in
emerging Asia in general and the RMB of China in particular, are seriously
undervalued, as estimated by a variety of measures. Many economists believe that
the RMB is undervalued on an order of 15% to 35% before 2005 (Frankel 2006,
Zhang and Pan, 2004, Chang and Shao, 2004, Goldstein 2007, and Goldstein and
Lardy, 2003, 2006, among others), and is still about 30 to 40% above its long run
equilibrium exchange rate, much larger than it was few years ago when the RMB
was firstly revalued in July 2005 (Evarard and Chong 2007, Bénassy-Quéré et al,
2008, and Goldstein and Lardy, 2008:51-55, 2009:26).1 Among those who believe
that the RMB is significantly undervalued, many argue that the appreciation of RMB
would be the major instrument of removing the trade imbalance at least between
China and the US. For instance, Goldstein and Lardy (2009:51) maintain that a 10%
real effective appreciation of the RMB could reduce China’s global trade balance by
a range of 2.5% of GDP, so to eliminate China’s global trade surplus of roughly 10%
3
of GDP, a minimum real effective appreciation of RMB by 40% is required.
When many, if not most, economists are in favor of a considerable revaluation, a
case against the revaluation has also emerged. The opponents include Mundell
(2006), Stiglitz (2005), McKinnon (2006, 2007), Corden (2007, 2009), and Woo
(2008), among others. Mundell maintains that a too sharp revaluation of RMB would
even cause a financial crisis because the revaluation will lead to a fall in import price
and deflation which could bring more pressures on RMB. Other adverse impacts
include slowing down in foreign direct investments, shrinkage in profit margin in
Chinese exports and increase in unemployment.
In reference to the conflict over trade imbalance between the US and China, Stiglitz
(2005) believes that even if the Chinese exports are reduced as a result of RMB
appreciation, the US trade deficit will not be removed since the other East and
Southeast Asian exporters could easily fill the gap. This view is shared by McKinnon
(2006) who believes that an expectation for RMB appreciation, along with a negative
interest rate risk premium, could create a near zero interest rate trap, a consequence
that has been experienced by Japan for a decade. He therefore suggests China
keeping its pegged exchange rate regime. While acknowledging that the
appreciation would have little effect on the current account in both China and the US,
Ogawa and Iwatsubo (2009) maintain that a revaluation of the RMB alone would
lead to improvements in the current accounts of other East Asian countries while
having little effect on the Chinese current account. Thus, the revaluation might
aggravate the current account imbalance that exists between the US and East Asia.
To remove the global imbalance, coordinated exchange rate policy among the East
Asian countries is therefore necessary and deadly required. Ogawa and Iwatsubo
(2009) maintain that since China and other Asian economies are structurally
distinctive, while an appreciation of the RMB alone would have no impact on the US
trade deficit, it is not only the Chinese RMB but also other East Asian currencies that
need to be revalued or allowed to appreciate against the US dollar in order to reduce
the current account imbalance.
4
Corden (2007, 2009) considers China’s huge trade surplus and the trade deficit in
the US as a kind of “inter-temporal trade” which may only be resolved by policy
coordination between the credit countries such as China and the debit countries
such as the US, should the restoration of world trade balance be a goal of the first
priority for these countries. Bergsten (2009) also points out that the only healthy way
to reduce the US external deficits to a sustainable level is to raise the rate of national
saving and to maintain budget rectitude.
Weather currency appreciation is an effective solution for the global trade imbalance
especially for settling the conflicts in trade between China and the US is an empirical
question that cannot be answered without some quantitative analysis on a variety of
issues. Furthermore, since the two notable proposals being offered, i.e., a
considerable once-for-all revaluation of another 25% for the RMB, plus 20%
appreciation in other emerging Asia (Goldstein and Lardy 2008, 2009), versus
implementing a fiscal stimulus in China instead (McKinnon 2008, McKinnon and
Schnabi 2009, and Ogawa and Iwatsubo 2009), are conflicting with each other, the
controversy cannot be solved without some quantitative assessment on the relevant
policy scenarios. Given the fact that empirical study in this area is still limited, this
paper attempts to fill the gap. The task is carried out through experimenting
simulation exercises on a simple macro-econometric model with the two policy
recommendations. This paper contributes to the existing literature by shedding a
new light on the issue of how the appreciation of the currencies in the emerging Asia
in general, and the revaluation in RMB in particular, affect the trade balance in the
US. This is compared with an alternative expansionary fiscal stimulus policy adopted
in China since 2009.
This paper is organized as follows. The next section reviews briefly the empirical
studies on the relationship between the value of a currency and the global trade
balance, with a focus mainly on the RMB appreciation and its impact on the trade
deficit in the US. Section 3 presents the research methodology and summarizes the
5
simulation results. Concluding remarks and policy implications are generalized in
the final section.
2. An overview of empirical studies on currency and trade Imbalance
Despite the theoretical discussion on the relationship between changes in the value
of a currency and its impact on the trade flows and hence trade balance is well
documented, empirical studies on the real impact of joint appreciation of Asian
currencies in general, and the appreciation of RMB on the US trade deficit in
particular are still limited. The majority of studies has been based on a partial
equilibrium elasticity approach where no multi-country trade structure is specified. 2
For instance, Thorbecke (2006), employing Johansen MLE and dynamic OLS
techniques, finds that the long run real exchange rate coefficients for exports and
imports between China and the US equal approximately unity, indicating a possibility
of improving the trade balance between the two countries when the RMB is
appreciated. Marquez and Schindler (2006), using an autoregressive distributed lag
model and China’s shares in world trade, report that a 10 percent appreciation of the
RMB would reduce China’s share of world exports by half a percentage point and
China’s share of world imports by a tenth of a percentage point. After estimating
structural vector autoregressive models with contemporaneous restrictions based
on neo-classical and Keynesian theories to assess whether the main determinant of
the current account for each of the East Asian countries is GDP or the real effective
exchange rate, Ogawa and Iwatsubo (2009) distinguish China from other emerging
Asian countries from a fact that China is the only country for which domestic GDP, or
aggregate domestic demand, determines its current account whereas the exchange
rate, rather than domestic GDP or US GDP that contributes to the current accounts
of other East Asian countries. Based on this, they suggest that policy-makers should
adopt different measurements to reduce the current account surplus between China
and other East Asian countries. They thus hypothesize that the RMB revaluation
would improve trade balance of current accounts of Japan, Korea, Indonesia, and
Thailand because these countries’ trade structures are substitutable with that of
6
China, but deteriorates the current accounts of Singapore and Malaysia because the
negative indirect effect through GDP is larger than the direct effect of appreciation.
Other studies use either theoretical mathematical models (e.g., Liu and Zhang 2010,
Whalley and Wang 2010) or computable general equilibrium models (e.g. Zhang and
Fung 2006, Willenbockel, 2006, and Zhang, 2009) to assess the economic
particularly the sectoral impact of the appreciation. With the former, Liu and Zhang
(2010:12) maintain that despite its effective role in bringing down inflation, a large
nominal appreciation of the RMB brings about large fluctuation in the economy and
tends to lead large welfare losses. Whalley and Wang (2010), on the other hand,
maintains that the net impacts of RMB appreciation are elasticity dependant, means
larger substitution elasticities in preference yield larger effects on trade flows and the
surplus.
Based on the result derived from a multi-country computable general equilibrium
(CGE) model, Zhang and Fung (2006) point out that a significant appreciation of the
RMB would result in a general decline in welfare across the globe, but it would not
reduce the trade deficit in the US. Using a modified CGE model, Zhang, Fung and
Kummer (2006) conclude that RMB appreciation will have no impact on the trade
imbalance between China and the US because the Chinese exports are necessary
goods with inelastic demand. Through simulations in a 17-sector CGE model of the
Chinese economy, Willenbockel (2006) indicates that a real exchange rate
revaluation which results in a fall of 4% in China’s trade balance would require a fall
in China’s real exports by 10.7-11%, depending on different assumptions used. The
strongest negative employment effect occurs in the textile, sewing and leather sector,
which is also the sector with the strongest reduction in exports and the highest initial
export-output ratio. Machinery and equipment sector, with the highest share in total
exports and the second-highest benchmark export-output ratio also shrinks. Using a
more generalized GTAP model, Zhang (2009) derives a similar result. However, since
all these studies are based on the CGE models that are usually sensitive to the
calibration of the elasticities, their results may need to be qualified and confirmed by
7
some macro-econometric models.
As compared with the studies based on economic modeling framework for the Chinese
economy, the empirical studies using applied empirical models for the emerging Asia
are even more limited. Using a dynamic general equilibrium (DGE) model of the world
economy, Cova et al (2009) attribute the growing trade imbalance between the
emerging Asia and the US as a result of productivity deceleration in the nontradable
sector and the desired net foreign asset increase in the emerging Asia. Using a panel
dataset including China’s exports to 33 countries, Thorbecke and Smith (2010) find that
while a 10% RMB appreciation would reduce ordinary exports by 12% and processed
exports by less than 4%, a 10% appreciation of all other East Asian currencies would
reduce China’s processed exports by 6%. Rahman and Thorbecke (2007), based on a
generalized method of moments techniques, indicate that while a joint appreciation
would significantly reduce China’s exports, a unilateral appreciation would not.
Applying a multi-country macro-econometric model developed by himself for more
than a decade, Fair (2010) finds that even with a drastic appreciation of 25% of the
RMB in the early 2000s, the estimated effects on US output and employment are still
modest. When the international repercussion effect is taking into account, the
positive effects of output from a decrease in imports from China are offset by the
negative effects on US output from increased inflation and from a decrease in US
exports to China because of a Chinese contraction.
Since there are many links among countries, and these links must be taken into
account for analyzing the effect of exchange rate changes, the use of a multi-country
macro-econometric model seems appropriate. The Fair model which permits
changes in a large group of countries and a variety of national and regional
macroeconomic variables including the exchange rate, interest rate, government
spending and taxes, is one of the best models that one can use to carry out a
quantitative analysis for the currency appreciations in the emerging Asia.
8
3. The Model, the Scenarios and the Results
3.1 The Model
In order to assess the effectiveness of currency appreciation on trade imbalance
between the emerging Asia and the US, a multi-country econometric model (MC) of
Fair (2004, 2009, 2010) is used. The MC model is presented in Fair (2004), and the
last version of the model is called MCE which was updated January 30, 2010. There
are two parts in the model, the “US model,” and the rest of the world (ROW). The
ROW model consists of estimated equations for 37 countries which include most
countries in the emerging Asia. There are up to 13 estimated equations and 16
identities per country, totalizing 274 estimated equations in the ROW model. The
estimated equations explain total imports, consumption, fixed investment, inventory
investment, the domestic price level, the demand for money, a short term interest
rate, a long term interest rate, the spot exchange rate, the forward exchange rate,
the export price level, employment, and the labor force. The MC model is completely
estimated (by 2SLS) from historical data and there is no calibration at all.
In the MC model, any changes in one or more exogenous variables in a country will
make a difference between the projected dataset and its original benchmark dataset
which is based on econometric regression of long term historical statistics
(1960-2008) for each variable and for each country. After the model is solved and the
results obtained, one could compare the new dataset with the benchmark dataset
and take the divergence between the two datasets as the “net impact” of the
proposed policy. A group of endogenous macroeconomic variables including GDP
growth, inflation, consumption, investment, export, import, current account and
employment could be then compared and analyzed.
The latest version of the MC model allows its users to forecast some proposed policy
changes such as revaluation of currency and a fiscal stimulus policy for a country for
a future period between 2010 and 2020. In its dataset, the exchange rate is defined
9
as local currency per US dollar, so a decrease in the exchange rate is a revaluation
against the dollar.
3.2 The scenarios
The macroeconomic setting of the effect of revaluation under a fixed or pegged
exchange rate regime is well documented in economic literature. When a country
revalues its currency, the export price level will rise in terms of foreign currencies in
international market and the price of imports will fall in terms of domestic currency in
domestic market. Since the foreign demand for the country’s exports falls when the
price of its exports increases, the revaluation will lead to decrease in demand for the
country’s exports. Opposite consequence occurs simultaneously for imports. The
revaluation is thus contractive and deflationary: the level of exports falls, the level of
imports rises, and the domestic price level decreases. This in turn, through the trade
and price links of the MC model, affects the production and international trade of all
other countries in the rest of the world. Furthermore, so long as the sum of export
elasticity and import elasticity is greater than unit, a situation defined as the
Marshall-Learner condition in international economics, the current account surplus
of the country will be reduced as a result.
However, the fall in export of a country that appreciates its currency, will also result in
a fall in its real GDP, which in turn, reduces the domestic aggregate demand
including demand for imports. If the fall in domestic aggregate demand is big enough,
the price effect of the appreciation could be more than offset by the income effect.
One of the advantages of using multi-country macro-econometric model is its ability
to identify not only the price effect but also the income effect of a currency change,
through the model’s price and financial links among a large group of countries.
The following three experiments attempt to simulate and examine the overall impact
of the two notable policy recommendations offered by Goldstein and Lardy (2008,
2009) that China should lead a joint appreciation in currencies of the emerging Asia
10
to help the US restore its trade balance, and by Stiglitz (2005), McKinnon (2006,
2007), and Ogawa and Iwatsubo (2009) who believe that the appreciation of RMB
will have little impact on the US trade deficit, but an expansionary fiscal stimulus
policy may alternatively do a better job.
Scenario 1: unilateral RMB revaluation. The RMB rate is revalued by 25% in 2010
and then the new rate of 5.123 yuan per dollar would be maintained for the whole
period between 2010 and 2020. Since all other things remain the same, it is termed
as unliterary revaluation, a policy option proposed by Goldstein and Lardy (2008,
2009), among others, as a first step to restore the world trade imbalance, particularly
aimed at reducing the US trade deficit.
Scenario 2: fiscal stimulus in China. Since China would spend 4 trillion yuan ($586
billion) to stimulate its domestic economy by funding extensive infrastructure
construction, aiding poor farmers, and cutting export taxes, it is assumed that the
stimulus fiscal expansion plan would result in a 25% increase in government
purchases between 2009 and 2012.3 This is a policy package advocated by
McKinnon and Schnabi (2009), Krugman and Obstfeld (2009: 655), and Ogawa and
Iwatsubo (2009).
Scenario 3: joint revaluation in emerging Asia. This is a scenario proposed by
Goldstein and Lardy (2008, 2009), and Ogawa and Iwatsubo (2009) who believe that
the appreciation of currencies in Asian economies collectively may help to restore
the global trade balance. Four Asian emerging economies, namely China, Thailand,
Malaysia and the Philippines where national data are available in the Fair model are
chosen for the following experiment: each country revalues its currency by 20% from
its 2010 level and the new rate remains constant over the projected period between
2010 and 2020.
3.3 The Results
11
The experiments of a drastic unilateral appreciation of RMB by 25% in 2010, an
expansionary fiscal policy of increasing 25% of government purchases in China
between 2009 and 2012, and a joint appreciation of all of the four emerging Asian
currencies are separately simulated. To assess the international repercussion for the
policy change in China and emerging Asia, the US and Japan are chosen as
reference countries in the world economy for comparison and analysis. The
percentage change of five major macroeconomic variables, namely GDP, GDP price
index (as a proxy of inflation), export, import, and trade balance which is defined as
the difference between a country’s export and import for all countries are reported in
the following three tables.
Interestingly, as one can see from the first two tables, the two policy packages of a
drastic unitary revaluation of the RMB and a fiscal stimulus in China create quite
different sequences in almost every aspect. While the revaluation policy is
contractive and deflationary, the fiscal stimulus is expansionary and inflationary.
When the overall impact of RMB revaluation on production and trade in China and
the rest of the world including the US is generally negative, though quite moderately,
the impact of the fiscal stimulus policy is more constructive not only in boosting
domestic economic growth, but also for improving the external trade imbalances
between the two countries.
As displayed in Table 1, there are modest drops in GDP and trade in all countries in
the unilateral RMB revaluation scenario. While the impact is contractive and
deflationary for China, there is a stagflation effect in the US. While the trade surplus
in China and trade deficits in the US both fall moderately, the trade deficit as a share
of GDP keeps growing in the US over time. With the 25% revaluation of the RMB, the
trade surplus as a share of GDP falls marginally in China within a range of only a half
to one percentage point over time.
12
Table 1 The Impact of 25% Revaluation of the RMB on Global Trade Balance
(Percent Changes as Compared to the Benchmark Database) a
GDP
Price Index
Exports
Imports
Trade Balance
Trade
Balance
b
on GDP (%)
China
2010
-0.92
-0.083
-1.54
-0.31
-7.49
6.92
2011
-1.73
-0.123
-2.66
-0.88
-11.63
6.69
2012
-2.06
-0.142
-2.96
-1.48
-10.79
6.77
2013
-2.12
-0.151
-2.97
-1.94
-8.63
6.92
2014
-2.06
-0.155
-2.87
-2.24
-6.57
7.03
2015
-1.97
-0.156
-2.78
-2.38
-5.31
6.85
2020
-1.6
-0.153
-2.34
-2.23
-3.32
6.02
2010
-0.17
0.004
0.03
-0.69
-3.79
-2.63
2011
-0.15
0.005
-0.07
-0.98
-5.01
-2.66
2012
-0.11
0.006
-0.16
-1.01
-4.60
-2.91
2013
-0.09
0.006
-0.23
-0.94
-3.70
-3.33
2014
-0.08
0.007
-0.26
-0.85
-2.95
-3.78
2015
-0.08
0.007
-0.28
-0.77
-2.46
-4.17
2020
-0.06
0.007
-0.26
-0.55
-1.81
-4.16
2010
-0.06
0.001
-0.29
0
-0.75
5.91
2011
-0.11
0.001
-0.48
-0.01
-1.06
7.11
2012
-0.17
0.001
-0.65
-0.03
-1.32
7.98
2013
-0.22
0.002
-0.8
-0.05
-1.53
8.69
2014
-0.27
0.002
-0.93
-0.08
-1.69
9.36
2015
-0.31
0.002
-1.11
-0.11
-2.06
8.88
2020
-0.5
0.003
-1.75
-0.24
-3.16
9.17
2010
-0.06
0.002
-0.06
-0.01
-1.26
3.23
2011
-0.1
0.003
-0.1
-0.02
-1.70
3.89
2012
-0.13
0.003
-0.13
-0.03
-1.88
4.32
2013
-0.15
0.003
-0.16
-0.05
-1.95
4.63
2014
-0.16
0.003
-0.18
-0.06
-1.96
4.89
USA
Japan
Thailand
13
2015
-0.17
0.003
-0.2
-0.08
-2.10
4.70
2020
-0.22
0.002
-0.28
-0.14
-2.86
4.41
Notes:
a. The percentage change indicates the difference in values between the variables in the new dataset and their
counterpart in the base dataset. While China’s data is shown annually, the fourth quarter of the US data is
displayed.
b. The trade balance is defined as the difference between export and import, i.e., net export. Since China has
trade surplus and the US has trade deficit, a positive figure in the current account indicates an increase in the
surplus (deficit) of the corresponding country.
Table 2 The Impact of A Fiscal Stimulus in China on the Global Trade Balance
(Percent Changes as Compared to the Benchmark Database)
GDP
Price Index
Exports
Imports
Trade
Balance
Trade
Balance on
GDP (%)
China
2009
2010
2011
2012
2013
2014
2015
2020
USA
2009
2010
2011
2012
2013
2014
2015
2020
Japan
2009
2010
2011
2012
2013
2014
2015
2020
3.26
2.70
2.13
1.67
-1.44
-0.97
-0.56
0.00
0.02
0.03
0.03
0.02
0.00
0.00
-0.01
0.00
-0.18
-0.37
-0.47
-0.48
-0.34
-0.19
-0.09
-0.04
3.97
6.19
7.21
7.49
3.55
1.36
0.31
-0.09
-19.46
-32.14
-39.26
-42.62
-21.90
-9.21
-2.62
0.46
5.70
4.90
4.42
4.20
5.87
6.75
6.95
6.16
0.05
0.07
0.09
0.09
0.03
0.00
-0.01
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.29
0.50
0.62
0.69
0.41
0.23
0.12
-0.06
-0.04
-0.05
-0.07
-0.09
-0.10
-0.13
-0.14
0.08
-1.49
-2.44
-3.11
-3.38
-2.08
-1.43
-1.03
0.67
-2.55
-2.66
-2.71
-2.94
-3.38
-3.84
-4.23
-4.26
0.21
0.40
0.54
0.66
0.43
0.24
0.11
-0.05
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
1.11
1.89
2.36
2.66
1.46
0.69
0.25
-0.13
0.01
0.04
0.08
0.14
0.18
0.20
0.19
0.07
3.32
4.80
5.21
5.40
2.70
1.12
0.30
-0.22
5.00
6.21
7.51
8.45
9.00
9.57
9.06
9.40
14
Thailand
2009
2010
2011
2012
2013
2014
2015
2020
0.46
0.80
1.01
1.11
0.49
0.04
-0.22
-0.11
0.00
0.00
0.01
0.01
0.01
0.01
0.01
0.00
0.48
0.83
1.06
1.21
0.62
0.23
0.00
-0.07
0.05
0.14
0.25
0.37
0.42
0.39
0.31
-0.03
15
16.17
16.81
16.40
15.42
3.80
-2.18
-4.88
-0.85
2.43
3.79
4.56
5.01
4.87
4.87
4.57
4.50
Table 3 The Impact of A Joint Revaluation in the Emerging Asia
GDP
Price
Index
Exports
Imports
Trade
Balance
Trade
Balance on
GDP (%)
China
2010
2011
2012
2013
2014
2015
2020
Malaysia
2010
2011
2012
2013
2014
2015
2020
Thailand
2010
2011
2012
2013
2014
2015
2020
Philippines
2010
2011
2012
2013
2014
2015
2020
USA
2010
2011
2012
2013
2014
2015
2020
-0.72
-1.37
-1.63
-1.68
-1.63
-1.55
-1.26
-0.06
-0.10
-0.11
-0.12
-0.12
-0.12
-0.12
-1.21
-2.10
-2.35
-2.35
-2.27
-2.19
-1.84
-0.24
-0.70
-1.17
-1.54
-1.77
-1.88
-1.75
-5.87
-9.21
-8.58
-6.84
-5.17
-4.14
-2.62
7.02
6.85
6.91
7.02
7.10
6.91
6.05
-4.99
-7.89
-7.90
-7.29
-6.80
-6.69
-7.77
-0.06
-0.09
-0.10
-0.10
-0.10
-0.10
-0.11
-3.99
-6.56
-7.12
-7.21
-7.26
-7.43
-8.61
-0.78
-2.05
-3.20
-4.01
-4.51
-4.83
-5.81
-16.25
-23.50
-21.81
-19.25
-17.65
-17.55
-20.85
20.45
19.80
20.57
21.37
21.92
21.85
21.30
-1.68
-2.76
-2.93
-2.77
-2.53
-2.37
-2.53
-0.04
-0.07
-0.10
-0.11
-0.12
-0.13
-0.14
-1.76
-2.85
-3.08
-3.06
-2.98
-2.96
-3.34
-0.17
-0.48
-0.82
-1.11
-1.33
-1.48
-1.78
-38.41
-47.55
-41.39
-33.84
-27.92
-26.65
-32.16
2.05
2.13
2.65
3.21
3.68
3.60
3.15
-0.01
-0.03
-0.03
-0.02
-0.01
0.01
0.05
-0.04
-0.07
-0.10
-0.11
-0.12
-0.13
-0.14
-0.01
-0.02
-0.02
-0.02
-0.02
-0.02
-0.01
-0.01
-0.04
-0.07
-0.10
-0.12
-0.14
-0.12
-0.16
-0.97
9.92
2.49
1.89
2.10
1.27
-2.63
-1.14
0.26
1.61
2.93
3.31
5.64
-0.16
-0.14
-0.10
-0.08
-0.07
-0.07
-0.05
0.00
0.00
0.01
0.01
0.01
0.01
0.01
0.09
0.00
-0.10
-0.17
-0.21
-0.23
-0.22
-0.69
-0.98
-1.02
-0.95
-0.86
-0.78
-0.54
-4.07
-5.31
-4.87
-3.96
-3.19
-2.68
-1.95
-2.63
-2.65
-2.90
-3.32
-3.77
-4.16
-4.15
16
The reasons for this unusual consequence can be explained by examination of the
different repercussion effects embodied in the equation systems of the Fail model for
the two nations when the RMB is revaluated. After a careful analysis of the figures in
the table, and checking the stochastic equations and the coefficients of the
regressions in the Fair model, the following explanations are generalized.
Firstly, it is found that the partial price elasticity of the Chinese traded good is actually
inelastic. This can be verified by comparing the trade volume data with the price data
in both exports and imports for both China and the US. While the US price elasticity
is somewhere in the elastic range, the Chinese price elasticity is almost trivial. More
interestingly, the positive sign of the partial price elasticity of imports for China
suggests that when the revaluation is fully incorporated into the price of import in
China, the volume of imports actually falls. This is consistent with the observations of
the US Department of Labour that when the RMB appreciates 18% against the US
dollar between June 2005 and March 2008, the price of Chinese goods imported to
the US rose only 2.5% (Goldstein and Lardy, 2009:61). This reveals that there are
some factors that have dampened the pass-through of the RMB appreciation.
Goldstein and Lardy (2009:61) explain this as a result of sufficient productivity
growth in the exporting firms in China over the same period. They thus speculate
that the export surge after 2004 is created by increased ability of the Chinese
exporting firms to absorb the adverse effect of RMB appreciation, when the growth
of productivity in Chinese exports exceeded the pace of nominal appreciation over
the same period.
Secondly, after examining the specification of the Fair model for the coefficients of
import demand functions, it is found that the Chinese imports are dominated mainly
by income effect. In the database where the Fair model is constructed, China’s per
capita marginal propensity of imports with respect to domestic aggregate demand
per capita is as high as 0.81, ranking at the fourth highest in a group of 35 countries
(Fair 2009:11). This indicates that the Chinese imports are overwhelmingly
determined by domestic wealth or income effect. As a result, when China’s GDP falls
17
from its potential level as a result the drastic revaluation of the RMB, its imports falls
with a faster pace. This is consistent with the finding of Baak (2008) that 1%
depreciation of the RMB raises the Chinese exports to the US by 1.7%, while 1%
depreciation of the US dollar raises the US exports to China by merely around 0.4%.
Thirdly, even if the price elasticity of the US traded goods is elastic so the
Marshall-Leaner condition may hold, the improvement in its trade balance would still
be limited because the large import content in Chinese exports which is believed to
be at a range of 30-35 % of the export value (Goldstein and Lardy 2008:21).4 These
inputs are primarily imported from China's more advanced East Asian neighbors
such as Japan, Korea, and Taiwan (Lemoine and Ünal-Kezenci, 2004, Tong and
Zheng, 2008). Should this estimate be accepted, it would indicate that the import
content of China’s exports could be as high as 44% in the mid 2000s.5 When the
import content is taken into account, RMB appreciation will lead to a smaller export
price increase than when exports had no import content. If the import component is
extremely large, however, the overall impact of RMB revaluation may be totally
neutralized.
Perhaps for the some reason, the appreciation of the RMB, no matter if it is with or
without the joint appreciations of other Asian currencies, will not boost exports and
trade surplus in the other Asian economies. This invalids the hypothesis of Ogawa
and Iwatsubo (2009). As the second largest economy and largest exporter in the
world, China now has unprecedented larger influence on the world economy than it
had before. So when its growth rate slows as a result of a drastic appreciation of the
RMB, it will also bring negative impact not only to the developed countries such as
the US and Japan, but also to its raw materials suppliers such as the other emerging
Asian countries and Australia.
One of the explanations for the limited impact of RMB appreciation on trade balance
refers to the “J curve” effect.6 The implication is that China’s trade surplus should
increase immediately after the RMB appreciation due to instant improvement in its
18
terms of trade (Goldstein and Lardy, 2009:52). But the trade surplus will fall after a
time lag when the price effect is fully passed if the Marshall-Lerner condition holds.
However, the “J-curve” effect has not been found in the simulation results because
there is no significant fall in both the surging trade surplus in China and the growing
trade deficit in the US for the next decade, after a 25% revaluation of the RMB, both
unilaterally and jointly with the other emerging Asian countries.
The result seems to support the Stiglitz-McKinnon conjecture that the RMB
revaluation affects the Chinese economy adversely, yet it has little impact on the
trade imbalance in the rest of the world, particularly in reducing the trade imbalance
between China and the US.
In a sharp contrast, the result of Table 2 which shows the impact of the fiscal stimulus
scenario brings a much more promising consequence in almost every aspect: GDP
and trade grow faster in all countries without significant inflation threats for most of
the years. When consumption and investment in China and saving rate in the US
increased, and the federal government budget deficit in the US reduced, the global
trade balance would be improved in such a way that when the China’s trade surplus
falls significantly, the US trade deficit is also reduced.
Table 3 shows the joint appreciation scenario which does not generate any
significant impact to the global trade imbalance and the US trade deficit. When all
the four countries revalue their currencies by 20%, the overall impact of the
appreciation is generally negative and the falls in the US trade deficit is only
marginally larger than the unilateral revaluation of the RMB scenario. This casts
doubt on the policy recommendations offered by Goldstein and Lardy (2008, 2009)
and Ogawa and Iwatsubo (2009).
5. Conclusion
19
In the basis of a brief review of the current literature, this paper assesses the major
impact of a joint appreciation of emerging Asia currencies in general and a unilateral
revaluation of the RMB in particular on the global trade imbalance particularly the
huge trade deficit in the US. The appreciation scenarios are also compared with a
fiscal stimulus policy in China, which is considered as an alternative policy for
achieving the same objective. After examining and contrasting the two popular policy
recommendations through running simulation experiments in a multi-country
macro-econometric model (the Fair Model), this paper casts doubt on the
effectiveness of using appreciation or revaluation as an instrument for removing the
global trade imbalance, particularly for settling the trade conflicts between China and
the US. The results of simulations seem to support the Stiglitz-McKinnon conjecture
that a significant revaluation of the RMB brings mainly adverse impact not only for
China but also for the rest of the world, yet has no significant impact on the global
trade imbalance, particularly on reducing the huge trade deficit in the US. As
compared, the fiscal stimulus policy could bring a much better consequence even
though the improvement in the trade balance is merely a by-product of the stimulus
scheme. In order to generate a more constructive consequence, the fiscal stimulus
policy is more preferred than a drastic revaluation of the RMB, no matter if it is with or
without a joint appreciation of currencies in the rest of the emerging Asia.
Furthermore, through exploring the unusual responses of China’s export surge after
the RMB appreciation, this paper discovers some particular features of the Chinese
external economy, namely a rigid or sluggish price elasticity for exports and high
marginal income elasticity for imports. It reveals that when the terms of trade effect
dominates the export growth after the appreciation, the wealth effect of a fall in
domestic demand dampens imports. This could be a more plausible source of the
ineffectiveness of appreciation of RMB on improving the global trade imbalance.
Despite the strong policy implications of the simulation results, the projection
generated from the experiments should not be fully accepted unless a certain
degree of caution is given. This is because the simulation result is derived from a
20
model where the Chinese economy is constructed in a rather simple way. As a result,
some of the changes could have been exaggerated. The projection could be greatly
improved if the model is modified to include more dynamic variables and more
appropriate equations particularly in approximating the real exchange rate changes.
More researches are therefore encouraged toward these directions.
To conclude, this paper questions the effectiveness of using either a sustainable
drastic appreciation of the RMB, or a joint appreciation of currencies in emerging
Asia as a main instrument of restoring the global trade balance, and settling the
conflicts in trade between the US and emerging Asia. Instead, it is in favor of some
alternative policy measures including an expansionary fiscal policy and/or
expansionary supply side policies to be adopted in the emerging Asia to obtain an
overall balance.
21
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Endnotes:
1
Despite most commentators believe that the RMB is still undervalued, the estimation on
the degree of undervaluation differs from one to another. Among the 18 studies listed in
Cline and Williamson (2008), the gap between the equilibrium exchange rate and actual
rated varies from an undervaluation of 56% (Frankel, 2006) to an overvaluation of 5%
(Wang 2004). Moreover, all these estimations are challenged by Dunaway et al (2009)
because they are all too sensitive to pass the sensitivity test, i.e., a small change in model
specification, variable definition and time period used in the estimations would lead to very
26
substantial differences in the equilibrium exchange rate reported.
2
According to conventional textbook version of international economics, the
Marshall-Learner condition states that if the sum of export elasticity and import elasticity is
greater than unit, the current account surplus will decline as a result of currency appreciation
(See Carbaugh 2010).
3
Since the proposed increase in national spending is 7.635 trillion yuan in 2009, up 22.1% in
2009, it seems that the increase in government spending by 25% and spend the 4 trillion
stimulus package over four years between 2009 and 2012 is a reasonable estimate.
4
It is estimated that about half of Chinese exports were processing activities where the
import content was as high as 55% in 2007 (Dunaway et al 2009:364, Ma et al 2009). The
share of processing exports (i.e. exports conducted under the processing regime) in China's
total exports has risen from 30% in 1988 to 55% in 2005. According to a recent estimation by
Koopman et al (2008), only 20% of China's processing export value is produced in China,
while the remaining 80% consists of the value of imported inputs.
5
For this reason, Bagna (2009) has argued that any attempt at dampening Chinese exports,
to the extent that it proves successful, would also dampen Chinese imports, with an
offsetting effect on the Chinese external accounts. Hierzkowski and Chen (2010) estimate
that approximately two-third of the US trade deficit would disappear in 2003 should the
imports of parts and components by both the US and China be absent. In the basis of value
added terms, the US-China ‘true’ trade deficit was about US$30.2 billion, approximately half
of what is reported. This would limit the real effectiveness of the RMB revaluation further.
6
The “J-curve” effect refers to the trend of a country’s trade balance following a change in
the real exchange rate. An appreciation in exchange rate initially means exports are more
expensive, or equivalently imports sell for less domestic currency, making the current
account improve (a bigger surplus or smaller deficit). After a while, though, the volume of
imports will start to rise because of their lower more competitive prices to domestic buyers,
and foreign consumers will buy fewer of the costlier exports. Eventually, the trade imbalance
should improve on what it was before the appreciation.
27