In particular, one of the the more important developments in 2013 that did attract too much attention was the rapid rise in China's real exchange rate. Against the USD, appreciation was fairly modest, rising ~2.5%. But given big moves in the Yen and relatively high inflation, China's real exchange rate was up ~7%.
This exchange rate appreciation was in spite of weak growth in the rest of the world for the balance of 2013. And so far it looks like the stronger exchange rate has been a restraint on an improvement in the Chinese export sector.
The latest PMI data are perhaps a useful example. The chart on the left shows new export orders in China vs. an equally-weighted index of the EU and US indices.
Its not so clear from history whether Chinese exports should be stronger at this stage of the recovery in the developed world. The previous downturn was much sharper and more inventory-driven, so the bounce was apparent in Chinese exports well before manufacturing elsewhere.
Lags are perhaps playing somewhat of a role in the continued weakness in sentiment in the Chinese external sector and it seems likely that exports will be stronger in 2014 than 2013.
However, the big move in exchange rates means that other key exporters are likely to increase their share of the gains. Manufacturing in Japan, for example, has strengthened much more than elsewhere.
Why is this important? It would be tempting to believe that at an aggregate level, exchange rate movements just redistribute the share of activity. But this ignores the spill-over effects in different economies.
In particular, exchange rate weakness in a depressed economy can have a much bigger impact on driving a recovery in activity than it does in an economy which is already strong.
This is also important when thinking about the growth trajectory for China and how well policy makers can manage risks. Rebalancing domestic activity and reducing credit risks is easier when the external sector is strong, as it provides a growth buffer if policy is too aggressive. But given the sector sector is not particularly vibrant, the margin for error is smaller and the risks of slowing growth too sharply more high.
This risk currently appears relatively high for China in 2014, just as it played a major role in the middle of 2013.
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