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The exchange rate is the ratio at which two currencies are converted into each other. It is a common view that the exchange rate is closely linked with exports and imports.
Theoretically speaking, other factors being the same, a currency depreciation will improve the price competitiveness of domestic commodities, and therefore stimulate exports, restrict imports and vice versa.
With regard to the renminbi exchange rate policy, there are currently two fairly influential views among both Chinese and US economists.
One view holds that the strong growth in Chinese exports and the nation's continued trade surplus illustrate that the renminbi is undervalued, therefore justifying a revaluation.
The opposition holds that if the renminbi appreciates, it will affect China's exports as well as economic growth and employment. Therefore, the renminbi should not be appreciated but kept stable.
The two views are differing, but share a common ground - that exchange rate plays a determining role in foreign trade, but reality may prove otherwise.
Let us first look at international experience. An exchange rate appreciation may not necessarily eliminate a nation's trade surplus.
In the 1960s and 1970s, Germany and Japan experienced persistent trade surpluses, which, in combination, were approximately equal to the US trade deficit.
Both nations faced huge pressures to appreciate their currencies. The Deutsch mark rose to 1.58 against the US dollar at the end of 1987, while the Japanese yen firmed to 123 per dollar, which was 166 percent and 193 percent respectively of their original fixed level.
However, Germany and Japan continued to see trade surpluses.
As for the United States, although the dollar weakened considerably immediately after World War II, its trade deficit situation remained unchanged. Instead, after it became a net debtor in the mid-1980s, the United States saw its foreign liabilities inflate continuously.
Now let's look at today's unique situation in China. The composition of Chinese foreign trade makes the influence of the exchange rate quite limited. The reasons are as follow:
Firstly, commodities exported from China do not have much value added in the country. Unlike Japan, which imports raw materials for processing and exporting, China imports huge amounts of parts and semi-manufactured goods before they are assembled here and exported.
Processing trade now accounts for more than 60 percent of China's exports. Many domestic enterprises get only US$15 in rent and processing commissions from every US$100 exported. And some 80 percent of exports by foreign-invested companies operating here comes from processing trade.
The influence of exchange rate on this segment of exports can be seen as basically neutral.
Secondly, labor costs in China are very low. According to the International Labor Organization, the labor costs in China are less than 3 percent of that in the United States. This is a major consideration when multinationals stream into China to build factories and make the nation their manufacturing base.
Although the goods are produced in China, the most profitable business of design, brand name and sales has always been in the hands of foreign companies.
Thirdly, the FOB (free on board) prices of Chinese export commodities account for only about 25 percent of the final sale price or retail price. That is to say the exchange rate can only influence one quarter of the price in foreign markets. Therefore neither a currency appreciation nor depreciation will have a great impact on the price competitiveness of Chinese goods.
Foreign dealers and consumers are the biggest beneficiaries of trading with China.
According to estimates by the World Bank a few years ago, the United States would pay an additional US$15 billion every year if it did not export from China.
China substantially devalued the renminbi quite a few times before the exchange rate integration in 1994, which had a rather obvious effect of stimulating exports and restricting imports.
But after 1994, the linkage between China's foreign trade and renminbi exchange rate levels weakened noticeably. While the renminbi's nominal exchange rate against the US dollar appreciated by 5.1 percent between the beginning of 1994 and the end of 2003, and the real effective exchange rate rose by 20.1 percent, China's exports grew by an annual average of 13.2 percent.
As the renminbi's nominal exchange rate against the US dollar remained largely unchanged after 1998, Chinese exports witnessed rapid growth rates of 27.9 percent, 22.3 percent and 34.6 percent in 2000, 2002 and 2003 respectively.
The reason for such phenomena is due to many factors such as economic activity, capital inflows, domestic reforms and tax policy adjustments, all having an important influence on import and export.
In a given period of time, such factors may have a bigger effect than exchange rate changes, therefore moving foreign trade in a direction opposite to what is theoretically expected.
Positivist studies by many scholars indicate that China's export growth and import growth is most sensitive to external demand and domestic demand respectively.
The above mentioned years of rapid export growth were years when the world economy was recovering, and the fast import increases in recent years were related to the strong growth momentum of the domestic economy.
Due to overheated domestic investment, China's imports growth climbed as high as 42.4 percent during the first four months of this year, outpacing export growth by 8.9 percentage points and resulting in a US$10.7 billion deficit.
May witnessed this year's first monthly trade surplus thanks to the macro management efforts, bringing the deficit for the first five months of the year down to US$8.7 billion.
The reason, in an economic sense, that Germany and Japan experienced persistent trade surpluses, is because their savings far outweighed investment, a trend that their currency appreciations hardly corrected.
The US savings rate kept declining, but could not reverse its current account deficits despite a repeatedly weakening dollar.
China, as a country of high savings, had a 40 percent savings rate during recent years, so it's no surprise that it is experiencing trade surpluses.
Even if the renminbi appreciates, should no essential change occur in China's aggregate spending, savings will still be bigger than investment and the nation's trade surpluses will continue.
By looking at the past 10 years, we can see the relationship between the renminbi exchange rate and export and import is not a simple see-saw. The renminbi's exchange rate against the US dollar changed only slightly during the past 10 years.
If the renminbi's exchange rate started to change now against the US dollar, we believe China's exports may not necessarily behave the way the two views suggest.
Surely the influence of the interest rate on imports and exports has quantitative limits. Within certain limits, exchange rate changes may have a positive influence on imports and exports, or a not-so-significant negative influence.
But beyond the limits, exchange rate changes may have a negative influence, or do major damage.
For a developing country, it may be the best for its trade development to keep its exchange rate stable.
(China Daily October 13, 2004)
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