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October 18, 2006
China: The Good, And The Maybe Not So Good
The following comes from an essay appearing in the latest annual report from the Federal Reserve Bank of Cleveland:
A recent research project completed at the Federal Reserve Bank of Cleveland by [Paul] Bauer, [Mark] Schweitzer, and [Scott] Shane examines a variety of factors that could influence the evolution of state per capita incomes over time...
The authors conclude... that the largest factor underlying relative income differences in 2004 is patents, followed by education then industry specialization... Bauer, Schweitzer, and Shane interpret the strong patent result... as income accruing to places that are relatively innovative and produce more patented inventions than other places.
That conclusion is more guesswork than evidence, but it is at least plausible. And if you believe it, this story, from the Financial Times, ought to grab your attention:
China has overtaken Germany in the global ranking of patent applications to become the fifth largest source of filings, underscoring an increasing prominence of Asian industrial powers in intellectual property.
In its first comprehensive report on patent activity, published on Monday, the World Intellectual Property Organisation found China had a sevenfold increase in patent filings in 10 years.
That would be the aforementioned "good." In the other category? Although the big financial market news of the day is the CME/CBOT merger, there's a pretty big deal brewing in the Chinese financial sector as well. From The Wall Street Journal (page A20 in the print edition):
Fannie Mae and Freddie Mac, meet ICBC. China's largest bank joins the ranks of publicly listed companies next week when it unveils what may be the world's largest-ever IPO in Hong Kong and Shanghai. But as with America's mortgage behemoths, investors are betting as much on implicit government support as on ICBC itself.
Headquartered in Beijing, the Industrial Commercial Bank of China Ltd. is China's largest commercial bank by total assets, loans and deposits. With more than 18,000 branches and $21.7 billion in 2005 operating income, it holds 15.4% of total loans in all Chinese banking institutions, according to its offering prospectus. For foreign investors hoping to profit from China's rapid economic growth, ICBC shares may seem just the ticket.
Since 1998, Beijing has injected $95 billion into the "big four banks," and carved out $305 billion of bad loans, according to Fitch Ratings. ICBC itself received a $15 billion state capital injection last year, plus a government-financed nonperforming-loan carveout of $85 billion. Foreign banks added an additional $20 billion; Goldman Sachs, Allianz Capital and American Express own 10% of ICBC's equity.
With all this money floating around, why worry? Well, bailing out banks -- or the implicit guarantee of doing so -- implants perverse economic incentives. Investors will be betting that public-company standards will help transform ICBC's lending practices, but there's no guarantee that the companies it is lending to have been transformed. Communist Party officials also still populate Chinese banks' boards of directors.
Like other state-owned banks, ICBC is still swimming in nonperforming loans -- which are classified according to Chinese, not international, standards. Fitch estimates a nonperforming to total loan ratio of 4.7%. If you kick in so-called "special mention" loans -- debts that haven't gone bad yet, but might -- the ratio jumps to 9.2%. ICBC also has heavy exposure to manufacturing, transportation and energy industries that are highly cyclical.
So, though government guarantees make the investment safer for private shareholders, the growth-enhancing power of financial intermediation is hampered if there are significant distortions in the allocation of funds. Maybe not so good.
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September 11, 2006
More Fuel For The Yuan-Debate Fire...
... which, thanks to Tyler Cowen (here and here), Brad Setser (here and here), and others, was burning pretty hot last week, comes today in the form of the latest report on the Chinese trade surplus. From The Financial Times:
China’s trade surplus reached $95.7bn through the first eight months of the year, soaring to a monthly record of $18.8bn in August, according to customs statistics released on Monday.
The figures for August were the fourth consecutive monthly record this year, well exceeding the $14.6bn reported in July. China’s trade surplus this year is expected to exceed last year’s total of $102bn within weeks.
The soaring Chinese trade surplus though does imply that the scale of capital outflows needed to keep the RMB from rising, should Chine ever liberalize its capital account (which, as Drezner notes, isn’t about to happen), has grown.
I reckon that's right, but I couldn't help notice this story, also from the Financial Times:
Xinhua, Beijing’s official news agency, on Sunday issued rules demanding international counterparts censor news and information distributed in China and barring them from dealing directly with local clients.
The rules, which take effect immediately, mark a dramatic resumption of Xinhua’s efforts to regulate the Chinese operations of rival foreign news agencies tightly...
Sunday’s ban on the distribution of any agency content that “harms China’s national security or honour” or “disturbs the Chinese economy or social order” matches other recent moves by Beijing to tighten media censorship.
Where this will lead is still anyone's guess...
However, it is unclear how forcefully Xinhua will be able to implement its new regime, which is likely to be opposed by domestic banks and other financial institutions as well as by the foreign news agencies themselves.
... but I'm moved to emphasize this passage, from Tyler's original New York Times article:
The yuan should not, as matters stand, float freely with free capital movements. Large quantities of Chinese savings, currently restricted to the domestic currency, would probably flee the country, worsening the serious solvency problems at Chinese banks. The Chinese must first clean up their banking system before they can have free capital markets. Contrary to the conventional wisdom, a market-determined value for the yuan might well be lower than today’s exchange rate, not higher.
Here's a question: What would normally happen to a free-floating currency, unrestrained by pervasive capital controls, in the wake of, to borrow the characterization in the FT headline, moves to "tighten the leash on foreign media"?
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August 10, 2006
Will Nouriel Be Proven Right?
No, not about his contrarian view that the U.S. economy is about to go in the tank, but about his prediction that a major revaluation in the Chinese RMB is in the offing. As Brad Setser reported yesterday. "China's monthly trade surplus is still rising", and according to the Financial Times the People's Bank of China may have had about enough:
China’s central bank stoked expectations of further renminbi appreciation on Wednesday by saying the exchange rate could play a role in addressing international payments imbalances.
The statement, in the People’s Bank of China’s second quarter monetary report, came a day before China announced a record trade surplus for the third straight month in July, data that would add to the pressure on Beijing to adjust its currency...
The renminbi has risen just 1.66 per cent since Beijing’s 2.1 per cent revaluation last July, in spite of soaring trade surpluses and complaints from the US that the currency is undervalued.
However, the PBoC has recently permitted slightly greater daily volatility in the renminbi-dollar rate and allowed a series of record highs for the currency. This has fuelled predictions it will widen the current 0.3 per cent daily trading band and allow a more rapid appreciation..
It gave no details and the statement falls far short of a commitment to either appreciation or even significantly greater flexibility in the renminbi exchange rate – which the bank repeated should be kept “basically stable at a reasonable balanced level”.
But some analysts said the report supported the view that a consensus was forming among Beijing policymakers behind a stronger, more flexible currency.
How reliant the Bank will be on revaluation versus other policy options remains to be seen. From China Daily:
China will boost imports, loosen controls on outflows of capital and make the yuan more flexible to help curb a record trade surplus and slow the fastest economic growth in a decade, the central bank said...
But the bank said that China cannot rely solely on currency appreciation to balance its external payments.
"As part of a policy package, the exchange rate can play a certain role in adjusting the imbalance in international payments. But the fundamental way to resolve the international payment imbalance should come from expanding domestic demand and lowering the savings rate"...
We will use various monetary tools to reasonably control lending growth and prevent the economy from overheating," the central bank said. "We will speed up the implementation of the policy of boosting domestic spending and adjusting the economic structure to promote the balance of international payments."
The central bank said it will "adjust the bias in the management of foreign exchange which currently encourages foreign-exchange inflows and restricts outflows"...
The government will adjust preferential policies toward foreign companies, speed up the unification of domestic and foreign company corporate income tax rates and regulate policies by local government to attract foreign investment, the central bank said in Wednesday's report.
And from Xinhua Online:
China's central bank reiterated on Thursday the country's currency, the yuan, will remain "basically stable at a rational and balanced level".
The early move, according to the China Daily article, went in the "wrong" direction...
The yuan fell 0.08 percent to 7.9772 per dollar as of 3:30 p.m. in Shanghai.
... but it's early yet.
CORRECTION: I think I misread that last China Daily passage. The word "fell" here, I believe, applies to yuan needed to obtain one dollar -- so a decline in the exchange rate means that the dollar is depreciating against the Chinese currency. It has definitely depreciated since -- from Bloomberg:
The People's Bank of China fixed the reference rate for yuan trading at 7.9688 against the U.S. dollar today, compared with a close of 7.9772 yesterday on the interbank market, the strongest fixing since the currency was revalued in July 2005.
Now that makes more sense.
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July 25, 2006
What The Dollar Bears Have Been Waiting For
China should increasingly diversify its foreign-exchange reserves to reduce the risk of losses from declines in the dollar, the country's National Bureau of Statistics said...
"The U.S. dollar may continue to weaken, increasing the risks of foreign-exchange losses in our currency reserves,'' the statement said. Speculation that the dollar will fall "also boosts expectations that the yuan will strengthen.'' The bureau didn't provide reasons why it expects the dollar to fall.
Well, beyond the obvious fact that the U.S. current account deficit is pretty large, there are the reasons included in the update in this post. And, of course, there are the simple facts on the ground. From Brad Setser:
Floyd Norris of the New York Times highlights something that was also on my radar screen: a sharp fall off in foreign demand for US treasury bonds. For the first time in years, the US budget deficit is being financed by domestic investors.
Foreign inflows to the US haven’t fallen off, to be sure. But the composition of these inflows has changed. Foreigners are buying more agencies and US corporate debt and fewer Treasuries. First quarter data is here; the TIC data from April and May do not indicate that the story has changed.
And (again from the Bloomberg article):
"Diversification is a continuation of China's reserves management,'' Standard Chartered's Hui said. "There's evidence or suggestions China has been moving gradually away from U.S. dollars into other major currencies, such as the yen or euro.''
There are, of course, the not atypical mixed messages:
[China] should also encourage Chinese companies to invest abroad to curb expectations of a stronger yuan, the bureau today said in a statement on its Web site...
Today's statement came a day after China said it may allow its brokerages to raise hard-currency assets and invest them overseas for the first time As part of the central bank's efforts to encourage capital outflows and reduce pressure on the yuan to rise.
That should give you pause, but if you are looking for a fearless prediction, here it is:
Fund outflows "will be gradually increasing, but they probably won't have an immediate effect in reducing the upside pressure of the yuan,'' [Tai Hui, an economist at Standard Chartered Bank in Hong Kong] said. The Chinese currency may strengthen 3.8 percent to 7.80 to the dollar by the end of this year, he said.
Even at the lower end of that range, I'd declare Nouriel Roubini's 5-percent prediction a winner.
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July 24, 2006
More On China And The Yuan
... both [Roubini and Altig] talk about China's overheating as a fact and they both cite Chinese growth statistics as though they are wholly accurate.
More importantly, however, is that both economists ignore the political and social imperative for continued growth in China. I am of the view that the Chinese government wants growth. I am of the view that the Chinese government needs growth. I am of the view that the Chinese government's comments about wanting to slow down the economy are mainly for foreign consumption...
And is China's economy really "overheating," anyway? I have certainly seen a lot of talk about inflation fears, but I have yet to see any numbers indicating much of it already...
I am not going to predict whether China will or will not allow the Yuan to appreciate further, but I will say that in analyzing this question, one must do more than just look at the economics; domestic politics must be considered and domestic politics say there will be no appreciation.
Good observations all, though I would point out that if it is difficult to trust Chinese growth statistics, it must be equally difficult to trust the inflation numbers. And the Chinese government does seem to take the overheating issue seriously. As Claus points out on his blog today, China has, for example, just announced plans to trim export subsidies "as part of measures aimed at rebalancing and restraining economic growth and its swelling trade and current account surpluses. "
However, the point that the exact truth regarding economic circumstances in China remains murky is well taken, and it is one of the reasons I believe that estimating the future of the yuan is even trickier than the usual shadow-chasing business that is exchange rate forecasting.
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July 22, 2006
Odds And Ends -- July 22 Edition
A rainy morning in Cleveland, and an opportunity to do some quality blog-surfing.
The confluence of Chairman Bernanke's Congressional testimony and the release of the June FOMC meeting minutes got lots of people thinking about what is next for U.S. monetary policy. Brad Delong is "surprised that there hasn't been a pause yet" and thinks that we haven't seen one because "the Fed is scared of the 'soft on inflation' headlines that a pause would generate." The Capital Spectator offers a terrific round-up of the week's economic news, and claims that "In theory, a slowing economy makes it easier for the Federal Reserve to cease and desist with its current round of interest rate hikes. In practice, life's more difficult, thanks to the worrisome rise in core CPI in June..." Tim Duy also thinks that "although the Bernanke sounded soothing relative to expectations, the incoming data argue for another rate hike in August." Toni Straka believes the "rate trend will stay the same and probably accelerate." At Hypothetical Bias, the opinion is "Once more and done (for a bit, at least)". William Polley is leaning that way too. Barry Ritholtz reiterates: The Bernanke bounce in the stock market is a "sucker bet".
Speaking of the Chairman -- more specifically his ideas about the global savings and investment and their relationship with interest rates -- Mark Thoma has a legitimate beef with the use of the word "glut."
Other summaries of, and commentary on, the week's economic news: From Dr. John John Rutledge (here and here). Calculated Risk provides a nice graphical look at where housing inventories are building, replicated from the Wall Street Journal. The Nattering Naybob Chronicles has its usual rundown of the week in bond and equity markets. MacroMouse contemplates the end of quantitative easing in Japan, and sees lessons for U.S. policymakers. Tim Iacono has plenty of this and that, as does The Skeptical Speculator.
On my exchange with Nouriel Roubini on Chinese currency reform, Kash agrees "it does not feel like we're getting closer to some sort of crisis" but wonders "what should we expect it to feel like?" Paul at Truck and Barter gets right to the substance of our exchange, while Brad Setser adds his own, ever insightful, thoughts at RGE Monitor. The Skeptical Speculator notes that "China has taken additional steps to cool its economy." Though not about the Chinese case specifically, Daniel Gross addresses a related and really important question: Is the end of American dominance in capital markets done?
Russell Roberts echoes an argument made this week by Ben Bernanke: In dealing with low-wage workers, an earned-income credit is preferable to a minimum wage. He also takes on Paul Krugman's position on both the minimum wage and the inequality statistics that Krugman argues support a minimum wage policy.
Brad DeLong highlights an interesting column by Hal Varian on luck and taxation. (Bottom line: If luck -- as opposed to hard work and risk-taking -- is a big part of being rich progressive taxation makes good economic sense. The intuition would be that luck is not sensitive to prices, and so won't be diminished by relatively high taxes.)
Mark Thoma noticed the Varian piece too, and has several links to others opining on the inequality debate more generally. I'd also check out Greg Mankiw's ruminations, Tom McGuire's recent "Stalking Points", and, if you have the time, everything in the Cafe Hayek archive on inequality.
Taking a more global perspective on poverty and inequality, J.S. at Environmental Economics shares some thoughts on "Rethinking Development Aid For The 21st Century" (thoughts which sound pretty darn sensible to me). Also, NEI Nuclear Notes asks "Should Developing Nations Embrace Nuclear Energy?" In the category of excellent advice, The New Economist quite rightly commends your attention to the Private Sector Development Blog. (So do I.)
A colorful picture of who gets what from oil revenues across the G7 is available at Contango.
Hat tip to Captain Capitalism for the link to this article about a county in Oregon that is running its own monetary system. Mark Thoma comments intelligently on a proposal to implement a commodity-based monetary system backed by "local renewable energy" (whatever that might mean).
Daniel Drezner links to an interesting article in the Economist on the value (or lack thereof?) of large quantitative trade models.
July 22, 2006 in Asia, Economic Growth and Development, Energy, Exchange Rates and the Dollar, Federal Reserve and Monetary Policy, Housing, Inequality, Saving, Capital, and Investment, This, That, and the Other | Permalink
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July 21, 2006
The Yuan Float, One Year Later
Nouriel Roubini and I debate the issue, in the latest edition of the Wall Street Journal Online's Econoblog feature. I'm a bit distressed, though not really surprised, that so few questions have been resolved since Nouriel and I last met on the Econoblog battlefield.
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» Yuan float - questions unresolved from New Economist
Dave Altig and Nouriel Roubini debate The Yuan Float, One Year Later over at the Wall Street Journal Econoblog column. Dave comments on his weblog that:...I'm a bit distressed, though not really surprised, that so few questions have been resolved since... [Read More]
Tracked on Jul 21, 2006 3:22:15 AM
» Chinese Yuan Rising? -- But What About China? from China Law Blog
Today's Wall Street Journal has an interesting article on the Chinese Yuan. Will it appreciate? When, by how much, and what will its impact be? The article is in the form of a back and forth exchange between two leading economists, Nouriel Roubini and ... [Read More]
Tracked on Feb 2, 2010 1:16:39 PM
July 10, 2006
UPDATE: The original posting of this item was, for some reason, scrambled. All fixed now. (Thanks Shadya!)
The Chinese surplus machine is showing no signs of slowing down. From Forbes.com:
China's trade surplus is bigger than expected and the government hopes to see more balanced trade, Liao Xiaoqi, the vice minister of China's Ministry of Commerce said...
China recorded a trade surplus of 33.75 bln usd from January to April, up 61.4 pct in the same period last year, according to Ministry of Commerce data.
No surprise, however, that the global policy village is less enthralled. From Bloomberg:
U.S. lawmakers say an artificially weak yuan is partly to blame for a record trade deficit and the Group of Eight nations said on June 10 ``widening global imbalances'' are a risk to the world economy. China's surplus has also flooded the world's fastest-growing economy with cash, undermining the central bank's efforts to control investment and inflation.
"There's a considerable inflow of money into the economy and it's a challenge for the central bank stop it adding to the money supply,'' said Tai Hui, an economist with Standard Chartered Bank in Hong Kong. "The government will want to keep a lid on money supply and lending growth to prevent it from stoking inflation and asset price bubbles down the road.''
I have noted before that, abstracting from capital controls, theory would predict an undervalued currency is a problem that should eventually take care of itself. The reason is that pegging the nominal exchange rate -- the only currency price a central bank can hope to influence in the long run -- requires flooding the world with your domestic currency. Given enough time, the inflationary consequences of those policies will cause the fundamental value of the nominal exchange rate to fall on its own. These dynamics are, apparently, of more than academic concern in China today:
Higher food and fuel prices pushed China's inflation rate higher in May. Food prices rose 1.9 percent from a year earlier and costs of fuel and vehicle spare parts fore 13.2 percent, the most since August.
The government, which controls fuel prices to limit their impact on inflation, is authorizing higher charges to help refiners such as China Petroleum & Chemical Corp. cut losses and to allow prices to more accurately reflect global oil markets. The oil refining industry lost $9.8 billion yuan in the first quarter, the government said in April.
There are signs that companies are beginning to pass on higher energy and raw material costs to consumers. Prices of consumer durables rose in May for the first time in at least 17 months, today's report showed.
"Upward pressure on inflation is greater than downward pressure,'' the People's Bank of China said in its quarterly monetary policy report, published last week...
M2, the broadest measure of money supply, rose 19.5 percent from a year earlier in May, the biggest gain since December 2003, the official Shanghai Securities News said June 9. Outstanding loans rose 16 percent, the most in more than two years.
The central bank has said it will step up measures to slow money supply growth, which has led to a surge in bank lending for investment projects. The bank says unbridled investment in factories is creating overcapacity in some industries and driving up raw materials prices, hurting corporate profits.
As that passage makes clear, ignoring capital controls is just too big an abstraction in the case of China. But, at least rhetorically, the Chinese government seems fully aware of the fragility of economic growth built on a platform of such controls. From Forbes:
China needs to address its mounting dependence on offshore stock markets as many quality large-cap firms list overseas, an official with the Ministry of Commerce said in remarks published in the official People's Daily.
'Large numbers of domestic firms listing on offshore stock markets increases the savings surplus, makes the country subject to extra foreign exchange risk and increases pressure for the yuan's further appreciation,' said Chen Lin, an official with the MoC.
'Finally, it weakens the independence of the country's monetary policy.'...
Chen noted that China should speed up the establishment of Miltie-tier fund-raising markets and further open up to foreign capital as a way to improve its stock market.
If you ask Moody's, this is more good news. From China Daily:
Moody's Investors Service rewarded China on Friday for a surging balance-of-payments surplus by upgrading its outlook for the country's foreign bonds.
Moody's said the change in outlook for China's A2 foreign currency bond rating to positive from stable also reflected China's success in holding down its overseas debt.
"Prospects are that China's external payments position will remain resilient to domestic and external pressures," Tom Byrne, a vice president at the ratings agency, said in a statement.
China has built up foreign currency reserves of US$925 billion, the largest stockpile in the world, as a result of intervention by the central bank to buy most of the dollars that flow into the country from its trade surplus and foreign direct investment.
The reform road is never straight, however, and some folks think that bringing monetary policy under control will, paradoxically, serve to increase Chinese surpluses, at least in the short run. From The Times Online:
Since the end of April, China’s central bank has moved to cool bank lending and investment activity by hiking interest rates, increasing commercial bank reserve requirements and mopping up excess liquidity in the financial system.
However, Qu Hongbin, an economist with HSBC in Hong Kong, said the trade surplus figures were not a surprise given external demand and China’s monetary policy tightening.
"If anything the monetary tightening will slow investment [and] will slow imports, so we should expect a big surplus," he said.
It just goes to show: It's always something.
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June 26, 2006
The Chinese Saving Glut
Stephen Roach... certainly believes that the big US external deficit is a problem. He just doesn’t think the RMB/ $ has much to do with the US external deficit, or with China’s surplus.
Roach’s argument is that the US would save too little (and China too much) no matter what the RMB/ $.
Perhaps. But it sure seems to me that the availability of easy financing from the Chinese central bank (and a host of oil investment funds) is one reason why the US saves so little. Roach views the US savings deficit as a product of US policies alone, I don’t...
All in all, I see far stronger links between China’s currency policy and low US savings than Roach does. I don’t think the US would be saving as little without a credit line from the PBoC. And it sure seems that China’s savings boom is correlated with its export boom, even if the channels linking a rise in China's trade surplus to a rise in Chinese savings are a bit more murky than the channels linking Chinese reserve growth to low US savings.
... A stronger RMB is not all that is needed to bring about a more balanced world. China does need to do more to stimulate internal consumption, and the US does need to do more slow the pace of demand growth (i.e. raise savings).
Not going to happen just yet. From Reuters, via China Daily:
China's Ministry of Finance said on Monday it would issue the country's first ever savings bonds, worth up to 15 billion yuan (US$1.9 billion), offering Chinese citizens a new investment option.
The tax-free three-year bonds, to be sold from July 1 to 15, would bear an annual coupon of 3.14 percent, the ministry said in a statement published on its Web site (www.mof.gov.cn).
The coupon compares with 3.24 percent for three-year fixed yuan deposits, but interest from the savings bonds is not subject to the 20 percent income tax for bank savings.
The non-tradable bonds would be sold through a pilot computer system linking big commercial banks to allow individuals to purchase, manage and redeem the forthcoming savings bonds electronically, the ministry said.
That will help in the long-run, as the web of existing capital controls is dismantled...
But they are largely forbidden from investing outside China, and their domestic options are limited to savings accounts and stock, bond and real estate purchases.
... but it doesn't exactly sound like a pro-consumption policy. And here is an sometimes under-appreciated reason Chinese saving rates are so high:
Chinese citizens hold $1.8 trillion yuan in bank deposits, due in part to an underdeveloped social welfare system that pushes many to save for medical care and old age.
That one is not going to be fixed by capital-market and currency reform alone. As for RMB revaluation, feel free to take a breath. From Bloomberg:
China's yuan fell after central bank Governor Zhou Xiaochuan said the nation will move "gradually'' to make the currency more flexible, disappointing some investors expecting greater gains to help slow the economy...
"We can be reasonably safe to assume that the pace of appreciation is going to be very, very gradual and it's probably going to be the scenario for next year,'' said Jan Lambregts, head of research at Rabobank Groep in Singapore. "China may feel like it's gotten away with it so far, so it's going to keep a very gradual track.'
All of which explains why Chinese trade surpluses aren't going away any time soon.
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May 29, 2006
Why I'm Not Convinced The Yuan Is Undervalued
From the May 30 edition of the Wall Street Journal
(on the opinion page in the print version):
Though it's hard to believe, China's sickly mainland bourses are the best-performing in Asia this year to date...
In normal economies, stock prices are based on expectations of a company's future earnings. China, however, isn't a normal market. Sure, mainland company profits are up slightly. But Chinese corporate profit forecasts -- when they're available -- are often linked closely to expectations of how the government will regulate a sector or company. Not to mention the poor corporate governance, lax financial disclosure and haphazard regulatory environment that lace the mainland's markets...
Foreigners aren't behind the recent euphoria. China's qualified foreign institutional investor program, which lets the waiguoren punt alongside the locals, is worth only about $6 billion. That's doesn't count for much in a market of around $450 billion. And not all of that foreign money is invested in stocks, either.
That leaves China's famed domestic punters, who may feel emboldened by other Asian stock market gains over the past few years. Or perhaps, given their limited investment options, China's investors simply can't think of anywhere better to park their cash...
The interesting question is, where would that domestic saving go in the absence of the extensive capital controls that support the PBoC's ability to so tightly control the value of the yuan? Anyone want to bet it won't be in China?
Bread Setser raises a related issue in a very interesting post on the Chinese government's attempts to recapitalize its (presumably) ailing banking system with its very nice collection of dollar-denominated assets. Says Brad:
That is the problem with giving the banks the country’s foreign exchange reserves. It creates a currency mismatch on the banks’ balance sheet. Potentially a big one. RMB deposits need to be matched with RMB bonds and RMB loans. Not dollars or Euros. If the banks get dollars or euros, and the dollar or euro depreciates against the RMB, good banks will become bad banks quickly. Depreciating assets are not a good thing for a bank...
There is one set of circumstances where China’s bad banks could require China to use its dollar reserves. It goes like this.
Chinese bank depositors lose confidence in China’s banks, and start to withdraw deposits from the banking system in mass. That would be a big change from the very strong deposit growth we are observing right now. But it could happen...
As depositors pulled their funds out of the banks, they would end up holding a huge stash of RMB cash. And they might want to convert that to dollars or euros.
China has capital controls, so this isn’t easy. But let’s suppose for the sake of argument that the controls are lifted. The central bank maintains a de facto peg – so the depositors could sell their RMB to the central bank for its dollars...
Two key points:
First, the dollars are useful if Chinese citizens want to pull their funds out of China. ..
Second, with a current account surplus of $150b (and growing) and net FDI inflows of $50b, Chinese deposits could send up to $200b a year without requiring the central bank to dip into its existing reserves at all. Rather than financing reserve buildup, China’s enormous surplus in its basic balance of payments would just finance capital flight.
Of course, Brad thinks -- and he is surely right -- that there are a lot of other fairly good candidates to which that capital could eventually fly. But I'd say you'd want to at least imagine that these arguments bound the downside.
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- Social Security
- This, That, and the Other
- Trade Deficit
- Wage Growth