Thursday, August 14, 2008

A New Estimate of China's Real Exchange Rate

The Economist has its "Big Mac" Index of inflation and purchasing power parity across nations. I'd like to introduce my "Green Cities" index. Let's see if I can do this arithmetic right. I'll make one assumption that the english version (mine) of "Green Cities: Urban Growth and the Environment" and the chinese version of the same book are of equal quality (perfect substitutes).

Let's go to Amazon for the pricing of each:

English version prices at $17

Chinese version price 20 Yuan

Exchange rate 1 $ = 7 Yuan (source Economist Magazine)

Does Purchasing Power Parity Hold? If the only good you buy is my book?

I sell one english version and have $17.
I exchange this for 17*7 Yuan = 119

I can buy 6 copies of my book there: 119/6. This looks like a violation of PPP.

It looks to me that the true exchange rate is almost 1 to 1.

So I agree with this quote from Wikipedia

"For example, the World Bank's World Development Indicators 2005 estimated that in 2003, one United States dollar was equivalent to about 1.8 Chinese yuan by purchasing power parity [2] — much different than the nominal exchange rate that put one dollar equal to 7.6 yuan."

so for you currency arbitrage dudes, I'm telling you to buy the Yuan over the medium term.


Anonymous said...

English versions and Chinese versions are differentiated goods. A bad translation in will reduce the value of the book. If your book is published as an international edition, its price will be much higher. Chinese readers tend to buy an English version instead of a Chinese version.

Kelly Hsu said...

I am college student majoring in international economics, I've been reading your blog for a long time. What I want to say here is that maybe English verstion and Chinese verstion are differentiated products, but we still can view them as the same goods here in this comparison. But the problem is if we select different products to calculate the true exchange rate, let's say, like computer, the result would be completely different. If a HP laptop costs 700 dollars in the States, and then the same laptop costs 5000 Yuan in China(it does exist, because I just did some price research on the Internet).The true exchange rate here should be 1:7. The result is understandable, because the laptop sold in China is just made in China. Here raises a question, selecting different products leads to different results in true currency exchange rate. Maybe this is the disadvtange of PPP that the rate would vary dependin on the choice of goods selected.

Aaron said...

Kelly, the Balassa-Samuelson model might help you there. It assumes that non-tradable goods and tradable goods have different PPP characteristics. The computer should cost the same in both places, because it can and does cross borders easily. PPP is more likely to hold for these tradable goods. But a Chinese language translation of an American book isn't very useful for cross-border trading. The classic example is a haircut. It costs much less to get a haircut in real terms in a nation where productivity and wages are not as high. The Balassa-Samuelson model gives a theory why this happens.