Letting Their Money Rise To Where Their Mouths Are
Renminbi Rising Against The Dollar
By blackhedd Posted in Economy — Comments (21) / Email this page » / Leave a comment »
Important news from the foreign-exchange markets: China's renminbi ("the people's money") is being allowed to appreciate against the US dollar. This morning, the yuan is trading at about 7.47 to the dollar, with some analysts expecting it to strengthen to 7.4 by the end of this year.
Although driven primarily by inflation pressure inside China, the moves have critically important implications for the global trade balance, and also for politics in the US.
Read on...
The People's Bank of China manages the yuan by setting a value for it against a basket of foreign currencies every day. It then allows market fluctuations within a very tight spread around the daily value. (This is roughly how FDR managed the value of the dollar against gold throughout the first year of his Presidency, a point that has some resonance with China's situation.)
This system of managing the yuan has been in place since 2005, and it replaced a strict peg to the US dollar. That move was intended to blunt criticism from American politicians that China was deliberately undervaluing their currency in order to steal our jobs. (No one stopped to ask why the US was and is at full employment if all our jobs were floating overseas and to illegal immigrants.)
But the yuan has appreciated only about 10% against the dollar since 2005. It turns out that China's "market-driven" currency closely tracks the dollar anyway. And the calls for protectionism by US Democrats continue.
Over the last several months, however, China's monetary authority has quietly allowed the yuan to appreciate against the dollar at an accelerating rate. At the same time, the yuan has fallen sharply against the euro and moderately against the Japanese yen.
This quote from the article linked above makes it about as official as it ever gets with the Chinese:
Deputy Governor Liu Shiyu on Oct. 26 said foreign exchange markets have ``a role to play in correcting'' trade imbalances, reacting to calls for more rapid gains by the Group of Seven nations.
You may recall from my previous post on the subject that the Washington meeting of the G7 finance ministers and central bankers two weeks ago was expected to be a bash-the-weak-dollar fest. Instead, Treasury Secretary Paulson appears to have intimidated enough of his peers to turn the thing into a pile-onto-the-strong-yuan party.
Why does China persist in undervaluing their currency? The most reasonable theory I've heard is so that they can prevent lower-cost producers in East Asia (like South Korea, Taiwan, Indonesia, Malaysia, Thailand, Singapore, and Vietnam) from stealing any of their market share for exported manufactured goods. But there's a funny thing about reality: you can't deny it for long. If you do something unnatural like undervalue your money, the stress will show up somewhere else.
And China is running out of alternatives. They face raging domestic inflation caused by their enormous trade surplus with most of the world. Since they artificially undervalue the yuan against the dollar, the influx of dollars from American importers translates into far too many yuan back in China. (Chinese exporters are not allowed to hold dollars, and are required to exchange their foreign revenues into yuan.)
They've tried increasing benchmark interest rates and bank-reserve ratios, each several times this year. Recently they also tried increasing the passbook savings rate, which has been below the inflation rate all year. Chinese individuals, who are notorious savers, are smart enough to know when their deposits are losing real value, and they have responded in the logical way: by plowing their money into the Shanghai and Shenzen stock markets, which are now at astronomically high bubble-like valuations.
None of this does anything to slow down Chinas's rampant overinvestment in manufacturing capacity, because obviously it doesn't attack the real problem, which is too much money. Allowing the renminbi to appreciate will help, but it's an open question whether China will let it happen fast enough. There is a case to be made that the yuan should be at 5 to the dollar rather than 7.4.
China also faces extreme danger from the United States, on two fronts. First, we may drop into recession, which will dampen consumer spending and maul the Chinese export economy. And second, the Chinese expect that the most likely next President (Hillary Clinton) will work together with a strengthened Democrat majority in Congress to enact protectionist legislation against them. Both of these are reasons to proactively abandon their currency undervaluation.
With all this, it's still an extraordinarily important step for China to expose themselves to the discipline of free markets. Both by character and by history, they're extremely fearful of what happens when foreigners have anything to say about their internal affairs. They're every bit as fearful of allowing their own citizens to interact with the rest of the world, free of government control.
They have a very long way to go. But remember the ancient Chinese proverb about the journey of a thousand miles.
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Letting Their Money Rise To Where Their Mouths Are 21 Comments (0 topical, 21 editorial, 0 hidden) Post a comment »
tells you as well...
“The path of the righteous man is beset on all sides by the inequities of the selfish and the tyranny of evil men."
...but I'll try it a different way. Remember that the Chinese government picks winners and losers. You can't really declare failure, go bankrupt and go do something else under such conditions because too many important people lose face. What China (and Japan and Korea) have traditionally done is to keep failed enterprises afloat and just the carry their bank loans without marking them to market. That's why Asian banking systems have such a bad name.
China has gotten much better at this in recent years, though. They are starting to let people fail when they should fail. But if there is a US recession and a lot of Chinese businesses fail, then I suspect they'll revert to tradition and keep most of them on life support.
Now there's an entirely different kind of failure that sometimes happens to Chinese businesses. That's when they fail in ways that make headlines. Examples include the pet-food deaths and the Mattel lead-painted toys this past year.
China usually deals with these situations by persuading the managers of the affected businesses to commit "suicide" by shooting them in the back of the head.
Not to be macabre, but Asians, particularly Japanese and Chinese, love to commit suicide when they screw up. Stoicism never really took hold over there.
rp
like the rest of the world, which could act as a break on the asset bubble.
Oh, that Communist thing. Never mind.
As you know, China has two distinct sets of stock markets. The one based in Hong Kong is only for foreigners. This is where you get companies like PetroChina, which is now the second largest company in the world by marcap, even though only a tiny sliver of its stock is publicly traded. (About 88% of PetroChina is owned indirectly by the Chinese government.)
And then there are the Shanghai/Shenzen stock markets, which are off-limits to foreigners. These are the markets that are absorbing the hit from China's inflation-shocked savers, and they're now at extraordinary levels. Proportionally far higher than the Nasdaq bubble that popped in early 2000.
The biggest recent news in China's stock markets was the IPO of PetroChina, which will sell maybe $9 billion worth of shares in Shanghai, at a deliberate undervaluation. This caused Shanghai to dump nearly 10% last week (think of the S&P 500 dropping 150 points), because Chinese money managers wanted to free up cash to buy into PetroChina.
The bizarre thing is this: because of China's strict controls on what flavor of people may own assets on which exchange, it's unclear that there will be any opportunity to arbitrage between the different markets. We will probably see cross-listed stock like PetroChina trade at considerably lower levels in Hong Kong than in Shanghai.
And that's just plain unreal. The government of India tried a similar tactic a few months back, putting in a rule to restrict arbitrage trading with equity derivatives. Sure enough, their stock market dumped 10% in a day, and the government had to back off.
the wrath of a compitent and well-informed arbitrager is instant karma.
“The path of the righteous man is beset on all sides by the inequities of the selfish and the tyranny of evil men."
to invest in Hong Kong listed shares. Hong Kong's market has had a boost since the announcement in late summer. The impact on China's frothy market is uncertain (to me). I know folks who have done will with BAIDU and others earlier this year but it seems closer to pulling a slot machine handle than investing.
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"Enlightened statesmen will not always be at the helm." -- James Madison
but they're moving very slowly. Yes, they'll develop a real money market, but it'll take them time to get there.
Even without the communist thing, the common Chinese reaction is to change slowly. With the communist thing, it makes them a little less anxious to release control.
Give them time. Don't push, just nudge. They'll get there unless we try to force it on them. I have great hope for the future of China.
Socialism doesn't work. It looks nice on paper, but it's been tried and it's failed miserably every time (usually accompanied by widespread death and suffering).
Proud member of the V.R.W.C.
a Hillary presidency and enacting protectionist trade policies against China--where does all the campaign cash that she is getting from the Chinese figure into this? Is it to influence her against doing this or for some other reason? Financially illiterate minds want to know.
...I'd have to say that campaign cash to Hillary Clinton is one of the most leveraged investments China could possibly make. As for their motives, you'd have to ask them. As for her motives, I'll have to bite my tongue.
Is there any chance that China will let the yuan float in the near future?
...a long habit of not thinking a thing wrong, gives it a superficial appearance of being right...
---Thomas Paine---
They'll let it go higher at their own speed, in their own time, for their own reasons.
One critical character issue for them is that they don't want to be seen as bowing to pressure from Hank Paulson, the G7, Chuck Schumer, or anyone else.
That's why the recent moves to allow the yuan to rise are so important. My interpretation is that they're doing it because they'll have an explosion at home otherwise. I would bet large that their inflation situation is even more serious than it looks from the outside, which is really saying something.
...a long habit of not thinking a thing wrong, gives it a superficial appearance of being right...
---Thomas Paine---
but you managed to keep and pique my interest and curiosity. Just call me finance-averse. (The last person who could hold my interest re: finance and markets was Louis Rukeyser.)
It does seem, from your comment about China's reasonable fear of a Democrat president and return to protectionish policies, that the free market policies of Bush have been a huge boon to China, abeit allowing them their sleights of hand much longer than would otherwise have been possible. I suspect Bush has actually been great for economies all over and the global anti-Bush brigade will never admit it...or more likely, is truly led by Soros-like billionaires who get theirs regardless and in fact profit when businesses fail. China and the rest of the world should FEAR a Democrat president.
Incidentally, I do understand that true, conservative economic policies would have been an even bigger boon to all of us.
You may not be interested in war, but war is interested in you.
...business conditions for China or anyone else. I think the President's emphasis on global security has definitely paid dividends by making the world safer for capitalism, but I have no clue how you could measure this effect. Undoubtedly the world will be a more dangerous place under President Clinton, and this will have equally real (and equally unmeasurable) effects on asset values.
We've been in the midst of a very unusual period in financial history, in which long-term interest rates are far below where several lines of logical analysis say they should be. The most reasonable explanation for this is that globalization is exerting a strong dis-inflationary effect on the entire world, but most particularly the United States.
One assumes that President Clinton, abetted by increased Democrat majorities in Congress, will take actions to reduce the returns on investments in the US (Clinton, Obama and Edwards have all promised to do so, as if it were a good thing). This is benign for China in the near-term, slightly negative in the medium and long-term.
One also assumes that the ascendant Democrats will enact protectionist legislation against imports. If they do this, it'll explode in their faces, as the disinflationary effects of globalization abate. The Federal budget deficit will suddenly go from the minor annoyance it is now, to a very major crisis.
Global business and finance people of my acquaintance are already assuming Clinton will be elected next year. And they're already planning for lower US growth as a result. This is only rational, since business planning has to be done in advance.
I assume some of China's marginal manufacturing firms will get plowed under if their selling costs increase due to currency risk. How does their system accomodate failure?
“The path of the righteous man is beset on all sides by the inequities of the selfish and the tyranny of evil men."