Renminbi Peg: On Again, Off Again
On June 19, the People’s Bank of China indicated—once again—that it would loosen its grip on the renminbi-dollar exchange rate and allow the renminbi to appreciate against the dollar. Since then, the renminbi has appreciated a meager 0.7 percent against the dollar. All else constant, a renminbi appreciation should raise the dollar price of Chinese goods, lower the renminbi price of U.S. goods, and whittle away at our trade deficit with that country. Still, unless the exchange rate moves by a substantial amount, we probably will not see much of an effect.
Between mid 2005 and mid 2009, when the People’s Bank of China previously loosened its grip on the renminbi-dollar exchange rate, the renminbi appreciated approximately 20 percent on both a nominal and a real basis against the dollar. (The real basis is what matters for assessing competitive patterns, because it accounts for price pressures in both the United States and China.) If this appreciation had any effect on the U.S. merchandise trade deficit, it is imperceptible in the data. The U.S. merchandise trade deficit with China continued to grow from $17.6 billion in June 2005 to around $21 billion as the global economic slump settled in and dampened worldwide trade.
Over this same time period, China’s current-account surplus rose sharply. It reached 10 percent of GDP in 2007 before narrowing in 2008 and 2009. As a result, foreign-exchange reserves flowed into the People’s Bank. When the bank acquires foreign exchange, it pays out renminbi, which should expand China’s monetary base. The People’s Bank of China, however, does not let this happen. To avoid the inflationary consequences of a rapidly expanding monetary base, the bank sells bonds into the banking system, thereby offsetting the consequential rise in the monetary base. Between 2005 and 2009, the People’s Bank of China prevented 43 percent of its acquisition of foreign exchange reserves from passing through to the monetary base. Had it not offset the impact of reserve accumulation on the monetary base, inflation in China would have been higher, and China’s competitive position would have been weaker.