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Renminbi RX

28.12.09

Dean Baker is right : it’s bizarre to report that Chinese officials are (a) worried about inflation and (b) determined not to let their currency appreciate without noting that these are contradictory policies.

Consider the real exchange rate, defined as RX = EP*/P, where E is the exchange rate measured as the domestic currency price of foreign currency (so an appreciation of the renminbi is a fall in E), P* is the foreign price level, and P the domestic price level. Basic international macro says that there is a “natural” level of the real exchange rate, determined by trade competitiveness and international capital flows. And the economy “wants” to get to that real exchange rate.

If you have a floating exchange rate, you get there via a rise or fall in E. But if you have a pegged rate, there’s pressure on prices instead. By deliberately keeping E higher than it would be under floating, China is creating pressures for P to rise; the inflationary pressures are directly related to the exchange rate policy.

This isn’t a new story. The proximate cause of the breakup of “ Mmm, maybe. But I think the driver is more along the lines of Sinclair's quip, "It is difficult to make a man understand something when his salary depends upon his not understanding it". The "scientist conspiracy" attitude has plenty of precedent, where economic impact is large. Remember the marine biologists who were demonized by fishing interests in the 80s for claiming that the Northeastern fisheries were crashing? All those fishing boat proprietors _knew_, without a shadow of a doubt, that the fish were fine, and that this was all a plot to get the government to tell them how much fish they could take. The fact that the fishery eventually nearly collapsed didn't change a lot of minds. Or remember the "Tobacco Institute"? The tobacco industry actually went and funded its own "deniers", whose "academic" "papers" actually influenced the political debate over tobacco policy for a very long time. Everyone is for scientific research, when the answers don't threaten livelihoods. When they do, it requires a special kind of intellectual integrity to accept those answers. That integrity is a scarce commodity among humans.”

Source: New York Times (blog)