Thursday, September 30, 2010

Chinese Manipulation?

House Passes Bill Aimed At Chinese Currency: Listen here and read article here.
"The Chinese ought to be aware that Congress is serious about confronting their currency manipulation," Schumer said in a statement.
Apparently when China engages in active monetary policy it is called manipulation. What is it when the US does it? I do not believe currency interventions can persistently affect the real exchange rate for long periods. If the Chinese currency is truly undervalued, the process of selling RMB and buying dollars has to dramatically increase domestic Chinese inflation.

But maybe the currency isn't really that undervalued? Here is one paper which suggests that its not. Here is a more recent paper by Menzie and others. Their conclusion:

To sum up, absolute PPP suggests (log) undervaluation of about 50% (67% using Mac
parity). The Penn Effect suggests essentially no misalignment (our estimates), or between 13.5% to 38.8% undervaluation (according to Subramanian). The Goldman Sachs BEER implies slight undervaluation against the dollar, and 23.1% against the euro. The Cline-Williamson FEER based estimate implies a 33% undervaluation, while the Goldstein-Lardy estimate is for 22.3% to 28.8% (for zero current account surplus), or 12.8% to 17.4% (for halving the surplus). These estimates are summarized in Figure 3.
The real test? If you think the RMB is undervalued have you mortgaged your house to go long on it?

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