Menzie Chinn is reviewing recent developments. Here are the pertinent aspects (October 25, 2012)
(1) the Chinese currency has
appreciated considerably since 2005 to arguably near equilibrium levels, and
(2) Chinese reserve accumulation has
tailed off; in particular accumulation of USD has stabilized.
First, to the point of Chinese
currency appreciation. Figure 1 shows the nominal bilateral USD/CNY exchange
rate, with Deutsche Bank forecasts, and the trade weighted real CNY exchange
Figure 1: Log trade weighted real (CPI deflated, broad basket, 2010=0) CNY index (blue, left scale), nominal USD/CNY exchange rate (dark red), as of 10/24 (dark red triangle), and forecasts from Deutsche Bank (Oct. 3) (red +). Sources: BIS, St. Louis Fed FRED, and Deutsche Bank, Exchange Rate Perspectives(October 3, 2012).
Figure 4. Source: “Capital Inflows Become Outflows in China, WSJ Analysis Shows,” WSJ Real Time Economics (October 16, 2012).
In general, the trade weighted real exchange rate (blue line) is the most relevant one for assessing China’s role in the world economy; it has appreciated substantially since the end of the Great Recession. The BIS (and IMF) trade weighted exchange rates are CPI-deflated. One might reasonably argue that this measure of competitiveness (see Chinn (2006)for definitions) is not the most appropriate. It turns out that using unit labor costs does not change the conclusion considerably. Figure 2 shows that the IMF CPI deflated measure and the unit labor cost deflated to do not differ substantially (and in fact has exhibited greater appreciation since 2009Q2).
Figure 2: Excerpt from Figure 4 of IMF, Staff Report for Article IV Consultation: People’s Report of China (July 2012).
[Some argue] China is keeping the exchange rate weak in order to gain competitive advantage, presumably by intervening in foreign exchange markets. However, the evidence for massive intervention is quite limited, insofar as we can infer from the data.
Figure 16 from Deutsche Bank, Exchange Rate Perspectives (October 3, 2012).
Total reserves are barely rising, while the share of reserves held in US dollar assets is estimated by DB to be declining over time. Moreover, it is not quite right to equate reserve accumulation with the trade surplus, as shown in the below figure from the Wall Street Journal Real Time Economics:
Would it be better for the U.S. and world economy if the Chinese allowed the currency to appreciate more rapidly? Most likely; as I’ve argued, this would help re-allocate aggregate demand away from China and to the rest-of-the-world.