Tuesday, September 15, 1998
"Some worry crisis in region may hit China's currency"
"China is eager to show the world and its own people that it is a major and stable nation."
Yuan likely to remain stable
Martin and Kathleen Feldstein
During the fifteen months since the Asian financial crisis began,
China has remained a remarkable source of stability. While other
currencies have declined by as much as 80 percent relative to
the dollar, the exchange rate between the Chinese yuan and the
dollar has been unchanged at 8.3 yuan to the dollar.
But as the financial crisis drags on and widens to include Hong
Kong and others in Asia and elsewhere, some government officials
and financial investors are beginning to worry that the Chinese
currency may also be devalued. If that happens, it would likely
start a new round of further devaluations in Thailand, Indonesia,
and other countries that compete with China. A decline of the
Chinese yuan would also make financial investors more pessimistic
about other emerging market currencies, including Mexico and Brazil.
The Chinese might be tempted to devalue the yuan to promote exports
and increase GDP. China's
growth rate of about 7 percent this year is falling short of past
growth rates and of the 8 percent predicted by the government,
making it hard to absorb the millions of workers who are losing
jobs in China's industrial
Despite this potential gain, we are betting China will not devalue
the yuan. The favorable impact of a devaluation on economic growth
would be quite small, since exports are less than 20 percent of
China's GDP and part
of the higher competitiveness that would come from devaluation
would be offset by the increased cost of imported components that
would result from the weaker yuan. These small gains would be
more than outweighed by the adverse effects on China of devaluing
the currency. China is eager to show the world and its own people
that it is a major and stable nation that rises above the problems
of its smaller neighbors. It also wants to please Western governments
by not triggering a further round of damaging devaluations throughout
Asia. It hopes that such good performance will increase its prospects
for admission to the World Trade Organization, bringing with it
easier access to world markets for Chinese products.
Less tangible, but perhaps more important, is the reputational
loss that would result from devaluing. Chinese leaders have told
the world that they would not devalue and have described that
as a "promise". While such promises are not forever,
a devaluation this year would be seen as a failure to live up
to a major commitment. Within China, the exchange rate decline
would signal a major government failure.
But even if China doesn't
choose to devalue, might it not be forced to devalue if financial
markets sell yuan just as they have forced other devaluations?
That is very unlikely for three important reasons.
First, if foreign speculators want to sell yuan, the Chinese government
has more than $140 billion of dollars and other foreign exchange
reserves that it can use to buy yuan and prevent its value from
Second, China has a substantial net trade balance with the rest
of the world, a current account surplus of 2 percent of China's
GDP, or about $20 billion in 1998. That means China does not
need credit from the rest of the world to pay for its imports.
The countries that have been attacked by speculators have been
those with large and unsustainable current account deficits that
require large foreign lending to finance their imports.
Finally, China requires private investors to have government approval
to exchange yuan for foreign currencies if they want to make financial
investments. This policy of not having full capital account convertibility
protects China from the speculative flows that have destabilized
The situation in China is complicated by the developments in recently
reacquired Hong Kong, which has pegged its exchange rate at 7.7
Hong Kong dollars to the US dollar while imposing no restrictions
on capital flows. Although that has been a successful policy
in the past, the sharp decline in the other Asian currencies has
caused the relative value of the Hong Kong dollar to rise by more
than 15 percent since 1996. Speculators have concluded that the
Hong Kong dollar is therefore overvalued and have been selling
them. The Hong Kong government has pushed up interest rates to
defend the Hong Kong dollar, despite the resulting sharp fall
in local real estate and stock market prices. Speculators are
betting the Hong Kong government will not be able to sustain that
contractionary policy and that the Hong Kong dollar will drop
when it ends. But that is far from a sure bet since Hong Kong
has very large reserves and a substantial current account surplus.
Speculators also underestimate the desire of Hong Kong authorities
to distinguish themselves from the weaker economics of their region
and to show that the return of Hong Kong to China did not lead
to a weakening of its currency.
While the situation in both China and Hong Kong will continue
to worry governments and tempt financial speculators, we're
betting that China will enter next year and perhaps the next millennium
with its currency unchanged. That may give enough time for the
rest of Asia to become more stable.
Martin Feldstein, the former chairman of the Council of Economic Advisers, and his wife, Kathleen, also an economist, write frequently on economics.