Chinese Premier Wen Jiabao recently hinted teasingly that China might buy more risky-country European debt; a “helping hand,” he called it.  Yet even if China follows through, it is unlikely to increase its intended purchases of European debt but rather just change the composition.  China’s euro purchases have increased dramatically over the past two years (we estimate these to be ¾ of reserves purchased in excess of the change in China’s U.S. asset holdings).  Most of this can be presumed to have been invested in German bunds, Europe’s closest thing to U.S. Treasurys.  Chinese euro purchases over the coming twelve months equivalent to those of the previous twelve months could cover the entire 2012 net financing needs of Portugal, Ireland, Italy, Greece, and Spain (PIIGS), as the figure above shows.  Every euro China invests in new PIIGS debt, however, can be expected to come at the expense of bunds.  Such a diversion would push up German interest rates—precisely what Germany wants to avoid by resisting eurobond issuance—without giving Germany any greater say over eurozone fiscal policies.  Chancellor Merkel therefore gains little, if anything, in making political concessions to secure Wen’s “helping hand.”

Read more »

All countries with central banks exercise monetary sovereignty, right?  Nobel economist Paul Krugman certainly thinks so.  “Wow,” he wrote, after reading Benn Steil and Manuel Hinds say otherwise in the Financial Times on May 24, “Have these guys ever talked to anyone in Sweden, which doesn’t need euros to create more kronor?” Fortunately, we have the data, which is better than talk.  Since Mr. Krugman throws Australia into the mix, we will too.  As the figures above illustrate, when the Swedish and Australian central banks expanded credit dramatically during the recent financial crisis their net foreign assets plummeted.  And this is not merely a crisis effect, as the three decades of Australian data show. So it turns out that you do indeed need euros and (American) dollars to create kronor and Australian dollars.  A country that plows on creating credit without them eventually becomes a ward of the IMF.

Read more »

China will hit a “growth wall” within the next three years, according to NYU economist Nouriel Roubini. The country’s reliance on fueling GDP growth through exports is unsustainable. He argues that China needs to revalue its currency so as to allow a transition from export-led to domestic demand-led growth. “The real income of households is going to increase, and they’re going to consume more. You export less and you consume more.” Is he right? Though there are more ways than one to skin this cat – domestic reforms that would facilitate faster rising Chinese wages, as advocated by Stanford economist Ronald McKinnon, are one way to fuel greater household spending – the data do indicate that Roubini is correct. As this week’s Geo-Graphic shows, when the renminbi appreciated significantly between 2005 and 2008 Chinese export growth slowed and household spending growth rose. This trend reversed after the pace of appreciation subsequently fell dramatically. This suggests that the Chinese government’s most recent five year development plan, which states that the government “must persist in the strategy of expanding domestic demand and maintaining steady and relatively fast development,” should include currency revaluation as a component policy element. Read more »

In the run-up to the June G20 summit in Toronto, China came under significant U.S. pressure to loosen its currency peg to the dollar. “The administration constructively set the G20 meeting as an important juncture for China to change its inflexible currency practices,” said Sander Levin, chairman of the House Ways and Means Committee on June 16^th. “If China does not act and the administration does not respond thereafter, the Congress will act.” Then one week before the summit, China announced that it would relax the peg, and indeed the renminbi (RMB) began to rise. The political tension dissipated. Yet since July 2^nd, five days after the summit, the RMB has ceased rising. It would appear that the much lauded Chinese currency pledge was a pre-summit head fake. Read more »

Chinese trade officials are reluctant to change China’s dollar-peg currency policy, citing concerns over the fate of exporters. Vice Commerce Minister Zhong Shan has argued that exporters will fail if the currency appreciates because profit margins are often less than 2%. However, when China International Capital Corporation (CICC) performed an analysis evaluating the effect of a hypothetical 5% increase in the value of the RMB against the dollar, by comparing decreases in revenue with the cost savings from cheaper imports, they found that most manufacturing sectors’ profitability actually increased. But as Chen Deming, the Minister of Commerce, has said, ‘we also have our own employment and stability to think about.’ Decreases in revenue suggest reduced employment, which Chinese officials appear unwilling to accept. Maintaining the peg can also, at least temporarily, prop up facilities that would not be profitable at a higher exchange rate. Supporting ventures that are unprofitable at equilibrium exchange rates will not, however, foster economic growth over the long run. Read more »