Friday, July 22, 2005

China has unpegged its currency from the US dollar, and has revalued the renmimbi by 2%. This will make its exports less competitive, and will make it easier for other countries to export their goods to China. The Chinese currency will now float against other currencies, but the float will be managed by reference to a basket of currencies of its major trading partners. This lessens the influence of the (relatively weak) dollar in determining China's trade.

Inflation in China remains low, at below 2%, and growth has eased somewhat from the supercharged 13% figures of a few months back. Domestic pressure for the change in policy is unlikely to have been the driver, therefore. But the Chinese government has come under increasing pressure from other countries to free its currency. Notably, the US, with which China has a huge trade surplus, has been especially keen to gain leverage from the extra degree of freedom that independent exchange rates for the two giant countries can afford. For Americans (as for Brits, and as for China's other trading partners) the move may make flashdrives slightly more expensive, but will it will stimulate their economies. This is welcome news.
Chancellor of the Exchequer, Gordon Brown, has a reputation for prudence, won largely as the result of his careful management of the economy during the Labour government's first period in power. Since then he has been more relaxed about spending, and the government budget surpluses earned in the early years have turned into deficit. Key to his prudent image has been his self-imposed 'golden rule' that, over the course of the business cycle, government should not borrow other than to pay for capital investments.

During the current cycle that golden rule looks like being breached. Or at least it did until the Chancellor employed a sleight of hand to give himself more wiggle room. That sleight of hand entailed redefining the time when the current cycle started from 1999 to 1997. Since the government made a surplus in 1998, this gives him more to play with.

Certainly the case for stating that the cycle began in 1999 always looked weak. Growth was much higher then than in 1997. So far so good for the Chancellor. But if we roll the years forward to 2000, things don't look so compelling. In that year, growth dipped once more, and indeed on some measures growth was slower in 2000 than in 1997. The Chancellor was right to change the date that the cycle began. But he still hasn't got the right date.

Since the years after 2000 have been characterised by government budget deficits, the truth of the matter is that the golden rule is being broken in style. Fortunately this has not yet led to inflationary pressure, but it does build up problems for the future. Taxes will need to rise to pay for the excess government spending, and if people anticipate those tax rises they will be cautious about their own spending now. Consumer pessimism dampens demand and stifles growth, making it all the harder for the Chancellor to meet his targets. Unless he starts to pull rabbits out of hats (without a sleight of hand this time), the Chancellor's reputation for prudence is set to wane.