La cigale et la fourmi: CNY/USD revisited

Time to revisit the "Yin and yang of the greenback" theory.  The theory, regarding the relative value of Chinese and US currencies, is basically "La cigale et la fourmi", not as a moral story but as basic economics. China, the ant  in our parable, has spent the last 25 years working hard and, thanks to government policies that amount to forced savings, not consuming that much.  Meanwhile, the US, the cricket, has spent the last 25 years living off  its charm and beauty as the most advanced economy in the world. Its currency's status as world reserve currency gives it a free lunch in terms of being able to borrow.

At some point, the ant will be tempted  to start "cashing in", converting all that past hard work into a higher standard of living.  How? Well there are several ways the government can convert those savings it has accumulated in USD into benefits for consumers. It could subsidize imported goods like fuel for example. Or more generally, it could let the exchange rate of CNY/USD rise, which would make all foreign goods cheaper in China.  So that's the fundamental thesis, which is not at all an original point of view.  The question was (and still is) when will this play out?

The financial crisis of 2008 looked to me like it was going to be the perfect opportunity for them.  Because it added a couple of other factors (increased US deficit, and the rich world's reduced ability to import from China due to a recession) that added more pressure for the Chinese currency to rise. As it turned out,  rather than shift gears into the next phase of development, one with less reliance on exports and  increased domestic consumption, they decided to stay in the same gear and press on the accelerator instead: they maintained the exchange rate quasi-frozen and stimulated exports even more.  So the big jump in CNY/USD has been postponed.

But will it occur? I still think so. The reserves are still accumulating. Here's the picture I cited last time, Foreign Holdings of U.S. Securities

	Country or category	Total	Equities	Long-term debt		Short-term
				ABS	Other	debt
1	Japan	1,197	220	133	768	76
2	China (Mainland)1	922	29	217	653	23
3	United Kingdom	921	421	160	316	24
4	Cayman Islands	740	279	236	186	38
5	Luxembourg	703	235	104	320	44

And here is what we have two years later, in the latest report just released last month:

	Country or category	Total	Equities	Long-term debt		Short-term
				ABS	Other	debt
1	China (Mainland)1	1,464	78	360	866	160
2	Japan	1,269	182	136	883	69
3	United Kingdom	788	279	64	422	23
4	Cayman Islands	650	227	140	210	73
5	Luxembourg	578	137	49	312	80

Even more of the same! The pressure keeps building....

Moreover, the rumours are that China might have stimulated itself into a bubble of it's own. How does that affect our theory? You face a bubble, and you had a pile of foreign reserves.... Well that's like being in the kitchen with toast almost burning and a huge reserve of nutella. Pop the toaster and enjoy the sandwich, China!

Update: Note that in the above tables, the amount of Chinese holdings of US securities increased a lot both in absolute and relative terms. Also, I should point out one more argument in the same direction: that western policy makers are increasingly calling on China to strengthen CNY.