Sunday, November 4, 2007

The Two Brads on the Overvalued Yuan

A few months ago, Brad Setser noted the lack of real appreciation of the yuan on an overall basis despite rising Chinese inflation. Today, Brad DeLong discusses the implications.



Under two scenarios - both concerning China - the unwinding of global imbalances could cause regional if not global depression. In the first scenario, China keeps up its attempt to maintain full employment in Shanghai, Guangzhou, and elsewhere not by stimulating domestic demand but by trying to boost exports further by keeping the yuan stable against the dollar and falling in value against the euro. The effort to maintain the dollar-yuan exchange rate at a level approved by China's State Council has already led to an enormous increase in the Chinese economy's financial liquidity. The consequences of this are now manifested in property and stock market inflation, but not yet in rampant and uncontrolled consumer price inflation - at least for now. But if China does not accelerate the yuan's revaluation, the world might see a large burst of consumer inflation in China in the next two or three years.


Which means China should let the yuan appreciate and maintain full employment by stimulating domestic demand. But I interrupted Brad:

The second scenario is more dangerous for the entire world. In this scenario, once again China continues to attempt to maintain full employment by keeping the yuan undervalued. But this time, the Chinese government manages to restrain domestic inflation, so the US' trade deficit with Asia stops falling and starts rising again.


Which has basically been the Chinese approach to date. Again – it would seem a change in Chinese macroeconomic policy with more domestic demand expansion and less emphasis on net export demand is in order. The two Brads appear to be strongly arguing that the yuan revaluation should accelerate.

1 comment:

The Animal said...

I think you mean undervalued.