Executive Director of the East Asia Global Center and non-resident senior fellow at the Brookings Institution, Geng Xiao, was recently featured in a number of international media venues (CCTV, China Daily, “China: The Next Twenty Years of Reform and Development”, etc.) discussing his views on the economic challenges and likely policy responses for China in upcoming years.
According to Professor Xiao, in the broadest sense the macroeconomic challenge facing China today revolves around managing its exchange, interest and inflation rates to facilitate the stable and “harmonious” growth that has been so heavily emphasized by Chinese leadership, as Western economies shrink in size relative to emerging markets.
He points to prices in Chinese non-tradable goods— unskilled labor wages, property values, etc.— rising in comparison to tradable goods, whose price are dictated by the global market. Following this trend, he predicts that over the next few decades Chinese price levels will converge toward those of the US through structural inflation or structural revaluation of the yuan— or both.
Here Professor Xiao takes a stand: that structural inflation is the better of the two avenues, and that China must in fact permit a reasonable degree of structural inflation.
As a positive claim, this approach prioritizes employment, productivity gains, wage growth and price liberalization, while preserving the benefits of a stable exchange rate in curbing speculative capital inflows and the short-term shocks that they often carry.
In a more negative sense, Professor Xiao calls on the troubled experience of Japan in prematurely appreciating its currency during the Plaza Accord of 1985, and indicates that currency appreciation as a means of adjusting trade imbalances— a common stance among US policy-makers— is a misguided notion. The huge potential for cross-border investment and debt financing between the US and China, and the potentially larger size of cross-border capital flows as compared to trade flows between the two countries over time, encourage a stable exchange rate as being in both countries’ longer-term interests. Moreover, structural inflation will ultimately lead to a real revaluation of the RMB, which will then facilitate the shift to a flexible exchange regime along the way.
Of course, tolerating structural inflation will necessitate policymaking that will mitigate distortions and shocks that will occur during the adjustment process. Chinese policymakers must deal with property and stock-market bubbles currently being formed. As Professor Xiao makes clear, this will require raising Chinese interest rates (which currently lie at dangerously low, and even negative rates in real terms), and improving capital-control mechanisms as greater capital inflows ensue.
Read more on this discussion at: