|
Pressure
on China to do something about its allegedly undervalued currency is mounting
by the day. Please consider the following articles.
World Bank Calls For Stronger Yuan
The World Bank Says China Must Pare
Stimulus to Counter Bubbles
The
World Bank indicated that China, the world’s third biggest economy,
should raise interest rates to help contain the risk of a property bubble and
allow a stronger yuan to help damp inflation expectations.
The nation’s “massive monetary stimulus” risks triggering
large asset-price increases, a housing bubble, and bad debts from the
financing of local-government projects, the Washington- based World Bank said
in a quarterly report on China released in Beijing today. The group raised
its economic growth forecast for this year to 9.5 percent from 9 percent in
January.
The World Bank’s call echoes the assessment of private economists --
analysts at Morgan Stanley this week said higher reserve requirements for
banks may be “imminent” and interest rates could start to climb
as early as next month. China’s economic rebound has also sparked
increasing calls for an end to its exchange-rate peg to the dollar, adopted
in mid-2008 to help shelter exporters amid the global recession.
Senate
Considers Currency Manipulator Regulation
Bloomberg is reporting Senate May Force
Obama to Take Tougher Yuan Stance
Five
senators including Charles Schumer of New York and Lindsey Graham of South
Carolina introduced legislation yesterday to make it easier for the U.S. to
declare currency misalignments and take corrective action. Even if the bill
stalls, it may have “ripple effects” that lead the Treasury Department
to declare China a currency manipulator, William Reinsch, president of the
National Foreign Trade Council, said.
Obama’s goal of doubling U.S. exports in five years depends on his
ability to get China to raise the value of its currency, said Sherrod Brown,
an Ohio Democrat and co-author of the legislation. China’s intervention
in currency markets to keep the value of the yuan, or renminbi, at a set
value acts as a subsidy to exports and tax on imports, Brown said at a news
conference yesterday.
Senator Debbie Stabenow, a Michigan Democrat, and Sam Brownback, a Kansas
Republican, are also supporting the legislation. Graham is a Republican and
Schumer is a Democrat.
The senators said the U.S. recession could boost the political prospects for
the legislation, which Schumer has proposed in various forms since 2003.
Schumer said the Senate proposal will be attached “very soon” as
an amendment to “must-pass legislation.”
“The only way we will change them is by forcing them to change,”
Schumer said.
The yuan is undervalued by as much as 40 percent, which is “blatant
protectionism,” Bergsten said. Brown and Schumer quoted the analysis of
Bergsten and Nobel Prize winning economist Paul Krugman in support of their
efforts.
Business
Sours On China
Please consider Business Sours on
China.
China's
relationship with foreign companies is starting to sour, as tougher government
policies and intensifying domestic competition combine to make one of the
world's most important markets less friendly to multinationals.
Patent rules imposed Feb. 1 threaten to increase costs in China for foreign
innovators in industries such as pharmaceuticals, and let authorities force
foreign drug companies to license production to local companies at state-set
prices.
A year ago, in a move foreign critics called protectionist, Chinese
regulators rejected a bid by Coca-Cola Co. for China Huiyuan Juice Group
Ltd., saying it could crowd out smaller companies and raise consumer prices.
The two combined held just a fifth of China's juice market.
In July, four executives of Anglo-Australian mining giant Rio Tinto were
detained, initially accused of stealing "state secrets," amid tense
negotiations between global miners and China's steel industry over iron ore
prices. Rio Tinto denies wrongdoing by the men, who await trial on reduced
charges of bribery and theft of commercial secrets.
Google Inc.'s woes highlight the angst. The search company, long troubled by
Chinese censorship rules, threatened Jan. 12 to depart China after it said a
Chinese hacking attack penetrated its computer network. Related attacks hit
dozens of other multinationals. Google is expected soon to close its Chinese
site, Google.cn., leaving local companies dominating an Internet market of
400 million users.
"The Google issue has had a crystallizing effect," says Lester
Ross, managing partner in Beijing for U.S. law firm Wilmer Cutler Pickering
Hale and Dorr. "It raised the consciousness of government and of the
boardrooms and other stakeholders" about the difficulties of doing
business in China, he says.
Krugman
Wants To Take On China
Inquiring minds are reading Taking On China by
Paul Krugman.
Tensions
are rising over Chinese economic policy, and rightly so: China’s policy
of keeping its currency, the renminbi, undervalued has become a significant
drag on global economic recovery. Something must be done.
Today, China is adding more than $30 billion a month to its $2.4 trillion
hoard of reserves. The International Monetary Fund expects China to have a
2010 current surplus of more than $450 billion — 10 times the 2003
figure. This is the most distortionary exchange rate policy any major nation
has ever followed.
So how should we respond? First of all, the U.S. Treasury Department must
stop fudging and obfuscating.
If Treasury does find Chinese currency manipulation, then what? Here, we have
to get past a common misunderstanding: the view that the Chinese have us over
a barrel, because we don’t dare provoke China into dumping its dollar
assets.
It’s true that if China dumped its U.S. assets the value of the dollar
would fall against other major currencies, such as the euro. But that would
be a good thing for the United States, since it would make our goods more
competitive and reduce our trade deficit. On the other hand, it would be a bad
thing for China, which would suffer large losses on its dollar holdings. In
short, right now America has China over a barrel, not the other way around.
Looking
At Half The Equation
For starters, Krugman conveniently ignores one side of the equation.
A sinking dollar is good for exports, however, given China's regulatory
policies as noted in Business Sours on China, it's not at all clear
exports to China would rise by much. Indeed, I suspect that China's
regulatory restrictions are a far bigger impediment to trade than currency
fluctuations.
Furthermore, one cannot (or at least should not) ignore what would happen to
the price of imports. A falling currency is not a free lunch.
While I agree with Krugman that China would not dump US Treasuries, the idea
that the U.S. has China over a Barrel because is preposterous. Mutual deadly
embrace with unbalanced winners and losers is more like it.
What China Can and Cannot Do With Reserves
Please consider What the PBoC
cannot do with its reserves by Michael
Pettis.
It
is a real toss-up as to which generates more bizarre comment in the
international press: Beijing’s long-feared dumping of US Treasuries, or
the use and value of the PBoC’s central bank reserves. The revelation
last week that Chinese holdings of US Treasury obligations fell in December
by $34.2 billion, to $755.4 billion, generated a frisson of fear and
excitement, leading one prominent newspaper to worry that “If there is
one thing that gets investors twitchy, it is the fear that China is losing
its appetite for US government bonds.”
Remember that China has a large current account surplus which necessarily
must be recycled abroad, and the US has a large current account deficit which
necessarily must be funded abroad. It would be astonishing if, under these
circumstances, total Chinese holdings of USD assets declined, and of course
it is impossible that they declined faster than the willingness of other foreigners
to replace them.
If China runs a current account surplus, it must accumulate net foreign
claims by exactly that amount, and the entity against which it accumulates
those claims (adjusting for actions by other players within the balance of
payments) ultimately must run the corresponding current account deficit. And
as long as China ran the largest current account surplus ever recorded as a
share of global GDP, and the US the largest current account deficit ever
recorded, and especially since China also ran an additional capital account
surplus (i.e. other non-PBoC agents ran a net capital inflow), it was almost
impossible for the PBoC to do anything but buy US dollar assets. Given the
sheer amounts, a substantial portion of these assets had inevitably to be USG
bonds.
This was not a discretionary lending decision. It is the automatic
consequence of China’s currency regime, in which it pegs the RMB to a
foreign currency, in this case the dollar. Why? Because when the PBoC decides
on the level of the RMB against the dollar, it does not do so by passing a
law, and making it a capital crime for anyone to trade at a different price.
What it does is far simpler. It offers to buy or sell unlimited amounts of
RMB against the dollar at the desired price.
If it stops buying dollars, it must let the market decide by itself on the
new equilibrium price of the dollar. In that case the value of the dollar has
to plunge in RMB terms (or the RMB soar, which is the same thing) in order
for buyers and sellers to match up and for the market to clear. The moment
the PBoC stops buying, in other words, the RMB will rise in value – and
so it cannot stop buying in anticipation of the RMB rising in value, as the
FT article suggested.
Here is where things get interesting. China’s reserves are often
thought of as if they were a treasure trove available for spending. They are
not. They are simply the asset side of the mismatched balance sheet. If the
PBoC wanted to “spend” $100, say for example to recapitalize a
bank, it could do so, but this would automatically create a $100 dollar hole
in its balance sheet. – it would still owe the RMB that it borrowed
originally to purchase the $100. To put it another way, the reserves are not
a savings account, free for the PBoC to spend as it likes. Reserves are
effectively borrowed money.
So what are reserves good for? As long as China maintains its own currency
and denominates all domestic transactions in RMB, the PBoC reserves cannot be
used in China. They cannot go to pay doctors’ salaries, to build
bridges, to lower taxes or to subsidize consumption. They can only be used to
purchase or pay for things from outside China. This means that reserves
ensure that China can import foreign commodities and other goods as long as
it can pay for them domestically. It also means that the PBoC can ensure the
availability of dollars to repay foreign debt and foreign investment. .....
... if the RMB is revalued by 10%, the value of the PBoC’s assets will
immediately decline by $250 billion in RMB terms. Since the Chinese measure
their wealth in RMB, isn’t this a real additional loss for China?
No, because remember that the only thing you can do with reserves is pay for
foreign imports or repay foreign obligations. And just as the value of the
reserves drops 10% in RMB terms, so does the value of all those foreign
payments – by definition they must go down by exactly the same amount
in RMB terms.
This means that China takes no loss. It can buy and pay for just as much
“stuff” after the revaluation, and with less implied PBoC
borrowing, as it could before the revaluation – and the real value of
money is what you can buy with it. So the real value of the reserves
hasn’t changed at all – just the accounting value in RMB, but
this simply recognizes losses that were already taken long ago when the trade
was first made, and should be a largely irrelevant number (except perhaps for
conspiracy theorists).
Yuan is
Undervalued by as Much as 40 percent?!
For the sake of argument, let's assume The RMB is undervalued by 40%. Who is
the winner?
To answer the question let's return to a snip from Pettis:
"generally speaking China is likely to gain from a revaluation
because after the revaluation it will be exchanging the stuff it makes for
stuff it buys from abroad at a better ratio. The value of what it sells
abroad will rise relative to the value of what it buys from abroad, and if we
could correctly capitalize those values on the balance sheet, it would
probably show that the Chinese balance sheet would improve with a revaluation
of the RMB."
If that is true generally speaking, then the US is a beneficiary now,
generally speaking. This implies we should be careful of what we ask.
However, the situation is more complex because as Pettis explains there are
individual winners and losers:
"..it is not whether or not China as a whole loses or gains from a
revaluation that can be measured by looking at the reserves, and I would
argue that it gains, but how the losses are distributed and what further
balance sheet impacts that might have."
Shock Effect
Let's consider the global shock effect of a sudden large revaluation of the
Renmimbi. The key is the RMB does not float. To get a 40% rise in valuation,
China must buy or sell unlimited amounts of RMB against the dollar to maintain
the desired price. That might mean a huge hike in Chinese interest rates to
make holding the RMB attractive.
In turn, sharp interest rate hikes would likely cause a huge slowdown in
China, decreasing China's demand for imports. This is yet another factor that
Krugman and those crying "currency manipulator" miss.
And should the US impose a revaluation via tariffs, I would like to point out
a little thing called Smoot-Hawley.
By the way, I am all in favor of a huge slowdown in China. I think China is
on an unsustainable course, and the sooner and harder China slows the better
for everyone in the long run.
However, the consequences of such a slowdown would be huge on the commodity
exporters like Canada and Australia. Moreover, a slowdown in trade would slow
global consumption.
I happen to think those are necessary adjustments along with more debt
writeoffs, but believers in free lunches and Keynesian claptrap sure won't
see it that way.
Hopefully this gives you a bit more of an idea as to just what might go wrong
with all these simplistic "the Yuan is 40% undervalued - so label China
a currency manipulator" ideas floating around.
Mish
GlobalEconomicAnalysis.blogspot.com
To
sign up for a free copy of Sitka’s Monthly Client Newsletter,
please register your email address at the bottom of the Sitka Pacific Commentary Page.
Mish's Global Economic Trend Analysis
Thoughts
on the great inflation/deflation/stagflation debate as well as discussions on
gold, silver, currencies, interest rates, and policy decisions that affect
the global markets.
|
|