Saturday, April 19, 2008
Here is more discussion between my friend Josh Goldstein, currently in Beijing on leave from USC, and myself. Again, please chime in with comments. I am far from the leading authority on this issue.
Josh: It seems he's saying there are two fairly distinct policy choices: pegging the RMB and low domestic spending. It seems that you are saying these two are strongly linked: that increasing domestic spending would be directly linked to currency
revaluation. So why is that? Because it would be increasing production and construction even more and also throwing even more money into the economy and all that would lead to even more inflation somehow? Is that money that would
be spent RMB or dollars or both, and does that matter (would converting China's dollar holdings back into RMB, if that is what domestic spending requires, raise the RMB value vs. the dollar?) Please elaborate, or is the domestic spending issue distinct from the revaluation issue (as he presents it)
Me: When there is revaluation, Chinese people's purchasing power in the world goes up. This may not lead to more domestic spending (since purchasing power for non-tradable is the same), but may prompt Chinese to buy more imported goods and travel more abroad. This is a reason why the US Congress wants China to revaluate. A nominal appreciation of the RMB would decrease demand for RMB and lessen inflationary pressure. Again, I am not sure if I agree with Fallows that this leads to more inflation. In fact, the causal arrow is the reverse: if there is high domestic inflation, China's real purchasing power increases given fixed exchange rates. Think about it this way: suppose that RMB to dollar is fixed at 8 to 1, but due to inflation, everyone in China now gets paid 10% more in salary. Within China, a Chinese wouldn't be able to buy more because of inflation, but since the exchange rate is fixed, you can buy more stuff overseas because you now have 10% more RMB.
Josh: Even so, the explanation he provides seems rather vague: I get the logic of something like: more sewage treatment plants etc. would raise the costs on goods (like paper, plastic etc.) and make poor farmers even that much more economically distressed. I suppose that is somewhat true. But I'm not sure I follow the logic about why building beneficial infrastructure for the poor (clinics, schools, whatever else you spend 1.4 tril on) hurts them so much. Why would such things cause inflation? And these folks don't buy lots of stuff anyway, and in many many areas depend on migrant workers in the city for their case...workers who MIGHT get higher wages because the cost of living in the city would also go up with inflation (I say might cause it doesn't always work that way, like over the past 5 years, migrant labor earnings haven't kept up with inflation). His vagueness here makes me think you are right...but how exactly domestic spending as he's describing and currency revaluation are linked is unclear to me.
Me: Here, I think Fallows is talking about two different things that may or may not be linked with each other. First, revaluation would make Chinese goods less competitive, thus decreasing the number of manufacturing jobs. This may be bad for the income of farmers, especially those households with migrant workers. Second, if the central government spends more money on welfare, farmers may have it so good that they have fewer incentive to travel to cities to work. This would drive up labor costs in China on top of the revaluation. It is true that if the government uses its foreign exchange reserve (1.5 trillion) directly on domestic spending (like hospitals...etc.) it would have an inflationary effect. Much of the 1.5 trillion in the fx reserve has been "sterilized" meaning that bonds were issued to make sure the domestic money supply does not increase due to this surplus. If you turn around and use this money in the domestic economy, domestic money supply would increase once again. Fallow, however, is making a straw man because inflation would happen regardless of what the central government uses the fx reserve on domestically. It would be inflationary if Beijing used the fx reserve to build a stadium.
Josh: About the private property issue...I think I disagree with you...I think it would be real bad. Peasants having land has been pretty much the backbone and engine of this economy (both before and even more so after the 78 divide) and China is
not ready (I don't think), to get rid of it...not in places like Shaanxi, or even Sichuan and Henan. But you should talk to my friend Shi Yaojiang about it...he's the rural survey guy and he's convinced that with property up for grabs local party
strongmen would make a killing and decimate communities in short order. And finally, there is at this very moment a global food crisis...food markets are unstable, prices are skyrocketing, and food markets are due to become much more unstable (and higher priced) in the coming years, so I'm not sure it is irrational to keep farmers on their land and avoid detaching hundreds of millions of folks from their safety (or in many places basic everyday) food supply.
Me: Yes, this is the Chinese government thinking now. But farming in China is extremely unproductive now because of the prevalence of small scale farming, which may make sense in some places. However, in other places, China would produce much more if farms were consolidated and farmers instead went to the cities to work for factories. If the government can come up with a credible rural welfare scheme, which is in the works now, I would argue that farm consolidation wouldn't be so bad (look at the US, we went through this painful but ultimately beneficial process).
Josh: It seems he's saying there are two fairly distinct policy choices: pegging the RMB and low domestic spending. It seems that you are saying these two are strongly linked: that increasing domestic spending would be directly linked to currency
revaluation. So why is that? Because it would be increasing production and construction even more and also throwing even more money into the economy and all that would lead to even more inflation somehow? Is that money that would
be spent RMB or dollars or both, and does that matter (would converting China's dollar holdings back into RMB, if that is what domestic spending requires, raise the RMB value vs. the dollar?) Please elaborate, or is the domestic spending issue distinct from the revaluation issue (as he presents it)
Me: When there is revaluation, Chinese people's purchasing power in the world goes up. This may not lead to more domestic spending (since purchasing power for non-tradable is the same), but may prompt Chinese to buy more imported goods and travel more abroad. This is a reason why the US Congress wants China to revaluate. A nominal appreciation of the RMB would decrease demand for RMB and lessen inflationary pressure. Again, I am not sure if I agree with Fallows that this leads to more inflation. In fact, the causal arrow is the reverse: if there is high domestic inflation, China's real purchasing power increases given fixed exchange rates. Think about it this way: suppose that RMB to dollar is fixed at 8 to 1, but due to inflation, everyone in China now gets paid 10% more in salary. Within China, a Chinese wouldn't be able to buy more because of inflation, but since the exchange rate is fixed, you can buy more stuff overseas because you now have 10% more RMB.
Josh: Even so, the explanation he provides seems rather vague: I get the logic of something like: more sewage treatment plants etc. would raise the costs on goods (like paper, plastic etc.) and make poor farmers even that much more economically distressed. I suppose that is somewhat true. But I'm not sure I follow the logic about why building beneficial infrastructure for the poor (clinics, schools, whatever else you spend 1.4 tril on) hurts them so much. Why would such things cause inflation? And these folks don't buy lots of stuff anyway, and in many many areas depend on migrant workers in the city for their case...workers who MIGHT get higher wages because the cost of living in the city would also go up with inflation (I say might cause it doesn't always work that way, like over the past 5 years, migrant labor earnings haven't kept up with inflation). His vagueness here makes me think you are right...but how exactly domestic spending as he's describing and currency revaluation are linked is unclear to me.
Me: Here, I think Fallows is talking about two different things that may or may not be linked with each other. First, revaluation would make Chinese goods less competitive, thus decreasing the number of manufacturing jobs. This may be bad for the income of farmers, especially those households with migrant workers. Second, if the central government spends more money on welfare, farmers may have it so good that they have fewer incentive to travel to cities to work. This would drive up labor costs in China on top of the revaluation. It is true that if the government uses its foreign exchange reserve (1.5 trillion) directly on domestic spending (like hospitals...etc.) it would have an inflationary effect. Much of the 1.5 trillion in the fx reserve has been "sterilized" meaning that bonds were issued to make sure the domestic money supply does not increase due to this surplus. If you turn around and use this money in the domestic economy, domestic money supply would increase once again. Fallow, however, is making a straw man because inflation would happen regardless of what the central government uses the fx reserve on domestically. It would be inflationary if Beijing used the fx reserve to build a stadium.
Josh: About the private property issue...I think I disagree with you...I think it would be real bad. Peasants having land has been pretty much the backbone and engine of this economy (both before and even more so after the 78 divide) and China is
not ready (I don't think), to get rid of it...not in places like Shaanxi, or even Sichuan and Henan. But you should talk to my friend Shi Yaojiang about it...he's the rural survey guy and he's convinced that with property up for grabs local party
strongmen would make a killing and decimate communities in short order. And finally, there is at this very moment a global food crisis...food markets are unstable, prices are skyrocketing, and food markets are due to become much more unstable (and higher priced) in the coming years, so I'm not sure it is irrational to keep farmers on their land and avoid detaching hundreds of millions of folks from their safety (or in many places basic everyday) food supply.
Me: Yes, this is the Chinese government thinking now. But farming in China is extremely unproductive now because of the prevalence of small scale farming, which may make sense in some places. However, in other places, China would produce much more if farms were consolidated and farmers instead went to the cities to work for factories. If the government can come up with a credible rural welfare scheme, which is in the works now, I would argue that farm consolidation wouldn't be so bad (look at the US, we went through this painful but ultimately beneficial process).
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