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China's alternative to revaluation
Source Julio Huato
Date 05/04/27/13:54

China's alternative to revaluation
By Lawrence Lau and Joseph Stiglitz
Published: April 25 2005

Western pressure has been mounting on China to revalue the renminbi,
from hardening rhetoric in the US Congress to recent calls by the
Group of Seven leading industrialised nations for more flexibility
from China. However, there is currently no credible evidence that the
renminbi is significantly undervalued, and an adjustment in its
exchange rate at this time is neither warranted nor in the best
interests of China or global economic stability.

The two symptoms of undervaluation are a large multilateral trade
surplus or high inflation. China's measured trade balance has been in
slight surplus (a surplus no doubt exaggerated by over-invoicing of
exports and under-invoicing of imports); but with the volatility of
oil prices and the international economy more generally, this could
quickly be reversed. And while China's trade surplus has grown,
China's multilateral surplus is far from the world's largest.

America blames China for the bilateral trade deficit; but America's
trade deficits are a result of its huge fiscal deficits and the fact
that Americans do not save. America's defence that it is doing the
world a service by consuming vastly beyond its means is self-serving
and rings hollow: US fiscal policies and low savings have become the
fundamental source of global imbalances.

China has experienced large capital inflows (beyond foreign direct
investment), but these are symptoms of speculative pressures that have
been so destabilising throughout the developing world. It would be a
mistake - and only a temporary palliative - to reward the speculators
by appreciating the currency.

Some in China would revalue the currency not because they believe
there is a fundamental economic problem, but to get the Bush
administration off their backs. But currency appreciation is not
likely to reduce significantly the US balance of payments deficit with
China or the world. Because the prices China pays for imports would be
lowered, and because of the high import content of China's exports to
America - as much as 70-80 per cent - even a 10 per cent revaluation
would have miniscule effects. Moreover, China should receive some
comfort from having joined the World Trade Organisation: there are the
beginnings of an international rule of law. A unilateral imposition by
the US of import duties would most likely contravene WTO rules; it is
hard to call a country that has adopted a fixed exchange rate system a
currency manipulator.

If China were to contemplate a revaluation, it should consider as an
alternative the imposition of a tax on its exports. Export taxes are
generally permitted under WTO rules. Indeed, China has already moved
in a limited way in this direction on textiles. There are several
reasons voluntary imposition of a tax on its exports may be preferable
to a renminbi revaluation. Both would have similar effects on Chinese
exports - they would make them appear more expensive to the rest of
the world. Because of this similarity, an export tax would provide an
empirical answer to the question of whether a revaluation would work.
But it would do this without some of the significant costs attendant
on revaluation.

One of the advantages of an export tax is that, unlike a revaluation,
it would not lead to financial losses for Chinese holders of
dollar-denominated assets, such as the People's Bank of China or
commercial banks and enterprises. China's central bank currently holds
about $640bn (334bn) in foreign exchange reserves. Assume that only
75 per cent is held in dollar-denominated assets. A renminbi
revaluation of 10 per cent would result in a loss of $48bn or about
400bn yuan for the central bank.

Another cost of revaluation would be possible further deterioration in
the distribution of income, including increasing the already large
rural-urban wage gap. Revaluation would put downward pressure on
domestic Chinese agricultural prices; an export tax would not. An
export tax, by contrast, would have a beneficial side effect: it could
generate substantial government revenue for China. Given the high
import content of Chinese exports to the US, a 5 per cent export duty
would be equivalent to a currency revaluation of some 15-25 per cent,
generating about $30bn-$42bn a year.

Finally, an export tax would not reward currency speculators. It may
even discourage the speculation that has complicated macro-economic
management of China's economy. If potential speculators can be
convinced that China would rather impose an export tax than revalue,
less "hot money" will flow into China. By contrast, nothing encourages
speculators more than a "victory", especially where, as here, it is
likely to do little to correct the underlying problems.

An export tax can be easily lifted if and when Chinese balance of
payments conditions so warrant. It could be stipulated that the tax
would be reduced or lifted if the Chinese current account balance
turned significantly negative. America's China policy has been driven
more by domestic politics than hard economic reasoning or thoughtful,
quiet diplomatic initiatives.

It would be better for the world if the international rule of law
prevailed - and within those rules, China could unilaterally impose an
export tax, while it is dubious whether America could impose an import
duty. Most importantly, we should not let bad politics drive out good
economics.

Lawrence Lau is professor of economic development at Stanford
University and vice-chancellor at the Chinese University of Hong Kong;
Joseph Stiglitz is University Professor at Columbia University and
Nobel laureate in economics

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