It is not often I vehemently disagree with Michael Pettis at China Financial Markets regarding trade. This time I do. Interestingly, there are some points of his recent analysis that I strongly agree with.
Via Email, interspersed with my comments please consider the following point counterpoint discussion.
Pettis:
Expect Still More Trade Intervention
Last week’s Senate bill on Chinese currency intervention predictably enough brought out all the same old arguments about international trade, and just as predictably has widened the opposing positions in the debate. Unfortunately the difference between a good outcome, intelligently negotiated, and a bad outcome, is pretty large, but with each side hardening its position I think the likelihood of a good outcome, while never high, is declining further.
The biggest problem with the debate, I think, is the muddled thinking and half-baked arguments that characterize each side. For example many of those who believe China is cheating on trade go through complicated exercises to prove the currency is undervalued and should be sharply revalued, without considering other relevant factors.
The currency may well be undervalued, but it shouldn’t be the only issue taken into account. A significant rise in the RMB, especially if it is countered domestically by an expansion in credit at lower real rates, might actually make the global imbalances worse and, more worryingly, cause China’s debt burden and capital misallocation to rise. This would make China’s eventual adjustment far more difficult and would cause more damage to the global economy.
The focus should be more general – on shifting China’s economy towards the more labor-intensive and efficient sectors – and an appreciating RMB might actually make things worse, especially if it encourages hot money inflow. It is much better, I think, for China to raise interest rates, for example, than to raise the value of the RMB. We need an internal shift in which resources are transferred from the capital-intensive SOEs towards households as well as to the more labor intensive SMEs, and a rise in the RMB will adversely affect the SMEs far more than it affects the SOEs, and would be no more efficient than in shifting wealth to households than a revaluation.
Mish:
In general I have no disagreements with the ideas presented above. However, if China raises interest rates, it will, without a doubt, place upward pressure on the valuation of the Yuan.
Interest rates are not the only factor in relative currency movements, but interest rates, and more importantly, rates of change in interest rates are two of the most important factors.
That said, I wholeheartedly endorse