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Sunday, November 22, 2015

Real Effective Exchange Rates vs Market Rates: the RMB (Chinese yuan)

Mike Smitka, Washington and Lee University

Here's a chart I created for my China's Modern Economy class showing the appreciation of the Chinese RMB / yuan [人民币·元] relative to the rest of the world. I put in the US$/yuan rate, inverted so that higher means stronger. But the core series is the monthly real effective exchange rate from the Bank for International Settlements. This the average value of the yuan with the exchange rates of the world's 61 largest countries, weighted by the amount of trade China conducts with each. In addition, the BIS corrects for inflation in each country, because if for example there's deflation in Japan, then at the same exchange rate US$1.00 buys more goods and services. Again, higher means stronger. At the bottom I append the most recently available (2013) trade data from the China Statistical Yearbook, to highlight the need to view China through lens with a wider perspective than the US bilateral relationship.

[I was in Japan this summer and benefited both from a weak dollar and Japanese deflation: it's really a good time for an American to be a tourist there. I have an additional advantage, because I speak and read Japanese, so can find cheaper lodging and so on.]

Oh, to politicians and businessmen everywhere: while the yuan may have fallen against the dollar, from China's perspective it's not depreciated because the dollar has gotten stronger, and they trade more with Europe and Asia than with the United States.

One tweak is that I use a log scale. This is second nature for those of us who grew up using slide rules, but what it means is that a 5% change, up or down, is always the same vertical increment. I adjusted the scale so that the horizontal lines represent (duh) a 5% increase. (I don't know why I never thought of doing that before...).

For those rusty on logs, log AxB = log A + log B, so if B = 1.05 (+5%) then we have a 5% increment equal to log A + log 1.05. The latter obviously doesn't change, whatever the magnitude of A. There is one minor issue: a 5% decrease (multiplying by .95) is not exactly the same as 1/1.05 (which is .952). So moving down one increment is a little less than a 5% fall.

To get even more technical, while correcting for inflation is important, the BIS uses the consumer price index, because it's readily available with the lag of only a month or so. Trade data come out with a greater lag, so the latest November release is only for August 2015. However, trade doesn't take place at retail prices, and consists of a different basket of goods than what households purchase. A country may import coal and wheat, while consumers buy electricity and bread. Those prices don't move independently, but the link isn't tight. This is of course a generic issue for economists: the data that are available seldom align exactly with the concept we're trying to measure.

11-6 Value of Imports and Exports by Country (Region) of Origin/Destination; Source China Statistical Yearbook 2014
Country (Region) 2013 2013 Share
  Total (US$ billion) Exports Imports % Total % Exports % Imports
Total $ 4,159 $ 2,209 $ 1,950 100.0% 100.0% 100.0%
  Asia $ 2,224 $ 1,134 $ 1,090 53.5% 51.3% 55.9%
      Hong Kong $ 401 $ 384 $ 16 9.6% 17.4% 0.8%
      India $ 65 $ 48 $ 17 1.6% 2.2% 0.9%
      Indonesia $ 68 $ 37 $ 31 1.6% 1.7% 1.6%
      Japan $ 312 $ 150 $ 162 7.5% 6.8% 8.3%
      Malaysia $ 106 $ 46 $ 60 2.6% 2.1% 3.1%
      Saudi Arabia $ 72 $ 19 $ 53 1.7% 0.8% 2.7%
      Singapore $ 76 $ 46 $ 30 1.8% 2.1% 1.5%
      South Korea $ 274 $ 91 $ 183 6.6% 4.1% 9.4%
      Thailand $ 71 $ 33 $ 39 1.7% 1.5% 2.0%
      Vietnam $ 65 $ 49 $ 17 1.6% 2.2% 0.9%
      Taiwan $ 197 $ 41 $ 156 4.7% 1.8% 8.0%
  Africa $ 210 $ 93 $ 117 5.1% 4.2% 6.0%
      South Africa $ 65 $ 17 $ 48 1.6% 0.8% 2.5%
  Europe $ 730 $ 406 $ 324 17.6% 18.4% 16.6%
      U.K. $ 70 $ 51 $ 19 1.7% 2.3% 1.0%
      Germany $ 161 $ 67 $ 94 3.9% 3.0% 4.8%
      Netherlands $ 70 $ 60 $ 10 1.7% 2.7% 0.5%
      Russia $ 89 $ 50 $ 40 2.1% 2.2% 2.0%
  Latin America $ 261 $ 134 $ 127 6.3% 6.1% 6.5%
      Brazil $ 90 $ 36 $ 54 2.2% 1.6% 2.8%
  North America $ 575 $ 398 $ 178 13.8% 18.0% 9.1%
      United States $ 521 $ 368 $ 152 12.5% 16.7% 7.8%
Australia/Pacific $ 153 $ 45 $ 109 3.7% 2.0% 5.6%
      Australia $ 137 $ 38 $ 99 3.3% 1.7% 5.1%