Pass-Through and the Renminbi’s Appreciation
Since mid-2010, the Chinese renminbi has steadily appreciated against the dollar. Many here in the United States hope that a more expensive renminbi will induce a proportional rise in the prices of Chinese goods and take some of the sting out of China’s competitive bite. They may, however, be disappointed. The relationship between exchange-rate changes and import prices is often loose—more like a swing dance than a tango.
Between 1995 and 2005, China pegged the renminbi at roughly 8.28 per dollar—a rate that undervalued the renminbi and allowed China to accumulate a substantial portfolio of dollar-denominated assets. In July 2005, as complaints about China’s exchange-rate practices mounted, China undertook a controlled appreciation of the renminbi. Over the next three years, the renminbi appreciated 19.1 percent against the dollar, but the dollar price of U.S. imports from China rose only 4.7 percent. Only one-quarter of the renminbi appreciation seemed to pass through to higher import prices.
In mid-2008, as the global financial meltdown chilled its economic activity, China once again pegged the renminbi at roughly 6.83 per dollar. Again, complaints about China’s exchange-rate practices proliferated, and in mid-2010, when its economic outlook brightened a little and inflationary pressures began to build, China once more allowed the renminbi to appreciate. Since then, the renminbi has appreciated 7.1 percent against the dollar, a slightly slower pace than earlier. This time around, import prices have risen 4.5 percent; roughly 64 percent of the renminbi’s appreciation has passed through to import prices.
This variation in the rate of pass-through results because renminbi appreciations can induce secondary adjustments that offset their main price impacts. In China’s case, the distinction between the “domestic content” and the “foreign content” of exports to the United States is important. The former refers to the value of Chinese goods that directly emanates from Chinese economic activity. This would include such things as the wages of Chinese labor, the cost of Chinese resources, and the depreciation of Chinese capital used in the production process. China, however, produces many of the goods that it exports to the United States with hefty amounts of foreign content, that is, with goods imported from other countries, even from the United States. While very difficult to estimate, the domestic content of Chinese exports to the United States is probably no more than 60 percent.
A renminbi appreciation against the dollar would raise the dollar cost of the domestic content of China’s exports to the United States. This appreciation, however, could simultaneously lower the renminbi price of the foreign content of those same goods, if the appropriate foreign exchange rates remained unchanged vis-à-vis the dollar. This seems unlikely.
In the end, the net effect of a renminbi appreciation on the price of Chinese exports to the United States depends largely on how those other foreign currencies might change against the renminbi. Between June 2005 and July 2008, the currencies of those countries that supply the lion’s share of China’s imports depreciated by 10.3 percent against the renminbi overall, or about 0.3 percent per month. This lowered the renminbi price of China’s foreign content and helped China maintain its competitive edge. Since June 2010, those key foreign currencies depreciated 0.4 percent, or about 0.02 percent per month. So the offset effect of the current renminbi appreciation has been smaller than the previous renminbi appreciation, and more of the renminbi’s strength has now passed through to higher import prices.
Besides exchange-rate changes, the U.S. price of imports from China reflects underlying inflation trends in that country and the pricing strategies of Chinese exporters. Since June 2005, China’s inflation rate has generally outpaced inflation in the United States. While productivity in the trade goods sector is undoubtedly higher than in other sectors of the Chinese economy, the higher overall rate of inflation is still corrosive to China’s competitiveness. China’s exporters also might respond by cutting profit margins as the renminbi appreciates, but the scope for this type of adjustment is probably narrow.
Even if all of the renminbi appreciation passed through to Chinese export prices, the development might only reshuffle competitive pressures instead of damping them. The Congressional Budget Office conservatively estimates that one-third of the Chinese import penetration into the United States between 1998 and 2005 came at the expense of imports from other—mostly Asian—countries and not at the expense of U.S. manufacturers. In many cases, firms moved final assembly operations into China from their home countries. If China’s competitive position should deteriorate because of higher domestic price pressures or from a renminbi revaluation, these firms might shift operations out of China, say, to Viet Nam or Mexico or to other low-wage countries. A renminbi appreciation might then only change the source of U.S. imports, not the level.
So to those relying on appreciation, here’s a tip: Many’s the slip twixt cup and lip.