CHINA: ECONOMICS: Protectionism and the RMB
The interplay between China and the US over RMB revaluation would be a very interesting game scenario to set-up. The implications and players are not only economic but political as well. As Capitol Hill continues to reject US economists arguments that revaluation would not be in the best interest of the US economy, more and more protectionist measures will be put into place. China does not have enough control over its monetary policy and isn't sterilizing enough of the invesments that it needs to be.
China views this issue as not just economic or political, but almost an issue over sovereignty. If China capitulates to US pressure, it will open the floodgate to pressures over other issues.
The US views this as a matter of national pride and global supremacy as the US has been the focus of world markets and politics for the better part of the past two centuries, with its policy directing global policy.
I will expound upon the main positive outcome and the main negative outcome of RMB revaluation (The model I present utilizes only three of the major determining factors):
The main positive outcome would result from China moving to a flexible exchange rate (target band) and at the same time, the US takes measures to lower it's deficit. This would result in a soft landing.
The main negative outcome would be if China moves to float its exchange rate and the US does not reduce its deficit. This would result in a hard landing as US interest rates would shoot up.
How exchange rate and deficit are tied is through US Treasury bonds. Because of the fixed peg, China is buying at a premium US Treasury Bonds, which in turn finances the US trade deficit, and is in a way contributing to low US interest rates. China's currency is accepted to be undervalued, and in the case of adjusment, the RMB would strengthen and the USD weaken. This would cause China to lose on its current Treasury Bond holdings and in turn may cause China to purchase less US Treasury bonds. Now if the deficit is not properly reduced, inflation rates will likely rise considerably.
China views this issue as not just economic or political, but almost an issue over sovereignty. If China capitulates to US pressure, it will open the floodgate to pressures over other issues.
The US views this as a matter of national pride and global supremacy as the US has been the focus of world markets and politics for the better part of the past two centuries, with its policy directing global policy.
I will expound upon the main positive outcome and the main negative outcome of RMB revaluation (The model I present utilizes only three of the major determining factors):
The main positive outcome would result from China moving to a flexible exchange rate (target band) and at the same time, the US takes measures to lower it's deficit. This would result in a soft landing.
The main negative outcome would be if China moves to float its exchange rate and the US does not reduce its deficit. This would result in a hard landing as US interest rates would shoot up.
How exchange rate and deficit are tied is through US Treasury bonds. Because of the fixed peg, China is buying at a premium US Treasury Bonds, which in turn finances the US trade deficit, and is in a way contributing to low US interest rates. China's currency is accepted to be undervalued, and in the case of adjusment, the RMB would strengthen and the USD weaken. This would cause China to lose on its current Treasury Bond holdings and in turn may cause China to purchase less US Treasury bonds. Now if the deficit is not properly reduced, inflation rates will likely rise considerably.
posted by howa at
6/07/2005
