Print
Email
Share
Facebook
Twitter
LinkedIn
CiteWe know why the global economy grew strongly in the first quarter. Nothing changed. Or rather, the basic pattern that has driven global growth for the past few years intensified.
The US continued to be the engine of global demand growth. We don't have US import data for March, but the port data suggests that imports will bounce back, big time, from their blip down in February. Non-oil import growth is likely to be almost as impressive as the US oil import bill … and that's saying something.
China continues to supply that demand. China exports are up close to 30% y/y. And China is now to investment what the US is to consumption. Fixed asset investment is up 30% y/y. China's investment boom also provides impetus for global demand – even if in aggregate, China still saves more than it invests.
It isn't hard to figure out why Chinese investment growth accelerated in q1. After several quarters of restraint, Chinese banks lent like mad in q1. With a guaranteed spread between deposits and loans, the banks have a strong incentive to grow their lending book. The equation is simpe: More lending = more current profits. Nore future risks too, but that doesn't seem to worry many bankers right now.
China's central bank had been holding back lending growth with administrative controls, leading deposits to pile up in the banking system. In the first quarter, the central bank either eased up or the banks stopped paying attention. Who knows. But if the PBoC did want to ease up to generate a bit more domestic demand, it now seems to worry that it may have unleashed a bit too much of a good thing.
Like Dr Roubini, I am not convinced a massive 27 bp increase in an economy growing — in nominal terms — at 15% will have any impact on lending growth. Even after their recent lending spree, the banks are very liquid, with lots more deposits than loans. That has put downward pressure on lending margins. I don't see that changing quickly. The central bank will need to continue to use administrative controls to limit lending growth.
UPDATE: Andrew Browne and Michael Phillips — or at least the WSJ's headline writers — play China's 27 bp rate increase as a signal of "movement toward market economy." They are drawing on quotes from Andrew Bernard of Dartmouth. I still have a rather different take. China's various baby steps (27bp here, a 2.1% revaluation there) strike me as too small to matter. And as a result, to me, they reflect continued resistance to letting key prices — the price of money, the price of energy, the price of foreign exchange — drive the allocation of economic activity. Some are struck me the fact that China has moved a bit, I remain far more struck by the fact that the moves are so small in the face of the economic forces now working through China that, in practical terms, they have next to no impact. And they force China to rely on other policy tools — notably administrative guidance on credit — to try to rein the economy in.
The Economist has noted that the IMF — despite its best efforts — will never be more than the "master of ceremonies" for the global economy. The Chinese will never let the IMF be the "master of currencies."
Maybe so.
But what I don't really understand is why China believes that it continues to be in China's interest to resist currency appreciation.
China's central bank is clearly worried that China is investing too much. Rightly so. Investment is now close to 50% of China's (revised) GDP. And investment is rising relative to GDP. One obvious response is higher lending rates. That means something like what the Fed has done – not a token 27 bp increase. Particularly not when the central bank flooded the banking system with liquidity to keep a range of rates – rates on central bank bills and government bonds among others – down during the previous year. So long as China pegs to the dollar, its central bank's hands are tied.
Some argue that China's peg allows it to import US monetary policy. That is false. Right now China's monetary policy is far looser than US monetary policy. Fast reserve growth – even with lots of sterilization – is leading to rapid growth in base money. The Fed has tightened more than the PBoC. That is a conscious policy choice: to limit hot money flows, China wants to keep its deposit rates (and a host of other rates) below US rates. That means interest rates remain quite low – in my view too low – for an economy in the midst of an investment boom.
Another obvious response to concerns about an overheated economy – and an overheated export sector – is a stronger currency. Yet China won't let the RMB breach 8 (i.e. be worth more than 12.5 cents). And with the dollar now depreciating against a range of other currencies – and with inflation in China lower than inflation in the US – China's exchange rate is probably depreciating in real terms in the midst of its boom.
That also doesn't make sense to me.
Some say the exchange rate spurs job growth. Yet Asian job growth hasn't been that impressive. Low interest rates encourage the substitution of capital for labor.
Some say that China can not let its nominal exchange rate appreciate without replicating Japan's experience with a "bubble" economy.
I think that misreads the causes of Japan's bubble, which didn't stem from yen appreciation as much as from loose monetary policy in the face of yen appreciation …
But it also seems to over generalize on the basis of one — admittedly important — example. Lots of countries have experienced currency appreciation without experiencing a bubble economy and then a decade of deflation. As Dr. Roubini notes, the yen appreciated from 73 on … not just from 85 on. Germany's real appreciation in the 70s and 80s came in part from a nominal appreciation of the mark. And so on. More recently, the US dollar appreciated big time during the late 1990s investment boom.
China, though, seems so paralyzed by fears of being the next Japan than in practical terms, it continues to do very little. And as a result, its unbalanced economy keeps growing in an unbalanced way. Or perhaps Chinese policy has simply been captured by interests that benefit from a weak RMB. I don't know.
What I do know is that China keeps missing opportunites to let prices adjust, and instead adopts 1/2 measures that don't seem to work that well (I think Andy Xie is right on this point). China risks over-investing now, building too much capacity now, and then going through an extended period of subpar investment (and finding that it has built a lot of things it doesn't need). What goes up can come down.
In the end, China may get its own version of the bubble economy without an appreciating currency. Like Japan, the bubble would be spurred by a loose monetary policy. But in China's case, the loose policy would stem from efforts to avoid apprecation, not from efforts to keep growth up in the face of an appreciation.
In a paper presented to Chatham House's conference at New York on Monday, Karen Johnson – the director of the Federal Reserve Board's international staff – argued that excessive reserve growth can distort a whole host of markets, and a whole host of economic decisions (No link yet to the paper).
China's peg results not just in too much investment, but too much investment in China's traded goods sector. I don't take much comfort in the fact that HSBC thinks China's new rural development policy is, drumroll please …. , more exports.
China's peg also leads to too little investment in traded goods production elsewhere, including in the US. And too much investment in sectors that are insulated from Chinese competition – and that benefit from the financial flows associated with China's peg. Yes, I am talking about real estate.
But that is only one set of distortions.
Johnson also noted that the peg ended up distorting China's financial system, as the banks were forced to hold sterilization bills rather than learn how to lend at market rates.
Lots of bad loans have been moved off the books of China's state banks and to the books of the central bank and the asset management companies (AMCs), so it is a bit unfair to say that China's banks are as rotten as they have ever been. The AMCs are the really rotten ones now.
But that doesn't mean China's financial system is functioning well. So long the central bank relies on a host of non-market measures to try to keep everything from getting out of control when all the market incentives – lots of deposits, lots of loan demand, low interest rates – say "go," China's financial system will not learn how to allocate capital efficiently. Administrative controls are slapped on, loosened and then tightened again.
Johnson didn't argue that China's peg also distorts the US financial system.
But others have made that argument. I for one suspect financial flows from China – and from the Gulf – have contributed to low spreads and high valuations in certain US markets as well.
And the large profits of the financial sector no doubt pulls in talent that otherwise might be devoted to other professions. That too is a potential distortion. Physcis or high finance ..
The risk is that so many decisions have been taken in the expectation that these distortions will remain, and that betting on the continuation of the status quo will be continue to be rather profitable. Which makes any change not just difficult, but rather risky.
I am drifting away from my core point though. China shouldn't change its peg because the US says so, or because the IMF says so. It should do so because it is in China's interest to have a tighter monetary policy than the US has, not a looser monetary policy.
A country in the midst of a once in a generation investment boom shouldn't be holding its policy interest rates essentially still as the rest of the world tightens.
Its currency shouldn't be tied to a depreciating currency either. The RMB has moved by less than 1% against the dollar this year. The Euro is up almost 6% this year (using yesterday's euro/dollar close) … So the RMB is falling once again against the euro and a whole of other currencies, despite China's balooning trade surplus and overheated economy.
“in an economy growing — in nominal terms — at 15%”
and later:
“with inflation in China lower than inflation in the US”
Do I spy a contradiction? How do you square the two, when the real GDP growth is at 10%?
There are more reports coming out confirming the sustained fast wage growth and labor shortage in the Pearl River Delta.
The problem with appreciation is that you really shouldn’t appreciate a pegged currency. That will cause either more inflow (if appreciation is judged insufficient) which worsens the problem you described or a rapid outflow (if no further appreciation is expected). You really need to reform the forex market and go to a real float. Appreciating a pegged currency is like what you said, the 1/2 way measure that makes things worse. PBoC is now fighting to establish control of expectations, like any sane central bank would try to do. The pegger’s curse is that once you hitched your horse, there isn’t much good option around to unhitch it.
I see your focus on a truely important problem, but I don’t see a real good solution. The real problem is the wage gap. The best solution to me is to grow the export sector wage, with administrative measures if necessary, and remove all export subsidies. The best time to switch to the float is when you have some semblence of equilibrium.
Brad, I wish that I agreed with you on this, that achieving balance is in China’s interest. But I’m just not persuaded. Arguments like this don’t wash:
“China’s financial system will not learn how to allocate capital efficiently. Administrative controls are slapped on, loosened and then tightened again.”
Who says China cares about learning how to be a good, Western-style market economy? China has adopted certain market-like tactics and reforms because it has decided those reforms are in its interest. But it has no ideological attachment to a neoliberal economist’s vision of a “healthy economy”. China hasn’t conceded the point that the Party as a general matter should absent itself from control of the economy, just that at certain times and places, it’s useful to outsource decisionmaking to semi-free markets. What if they don’t mind the continued necessity for administrative interventions, ad infinitum?
China runs a very loose monetary policy, sees little inflationary pressure, and despite coastal labor shortage anecdotes, still has lots of people to employ. Labor shortage is better than unemployed masses from a stability perspective. And even the US fed would stay loose under these circumstances, so why not China? (You note that Asian job growth is unimpressive. But surely you don’t think a tight monetary policy would help? Sure some labor would substitute for more expensive capital. But the overall effect would be contractionary, no?)
I agree that China is distorting the US and world economy. Anyone who believes in the neoliberal dream — I really want to myself — sees harm to the future welfare of the entire globe from distortions made in China (and Washingtion, and Riyad). But US nuclear engineers turning financiers is hardly a distortion that troubles China.
From the perspective of a self-interested Chinese Communist Party, skeptical of neoliberal economics, fearful above all of social unrest, and willing to do whatever works irrespective of theory or ideology, what incentives are there to make a change?
In face of its massive trade surplus with Europe, China has devalued its currency by 6% against the euro in a month or so. But don’t say a word. They are capable of intervening massively in favour of the dollar to escape the blame. In turn this intervention would probably cause a sharp fall in the us t-bond yield, and prop the worldwide stock markets to new “internet era” highs. Who said that central planning was easy?
2006 GDP 1Q was 4.8, down from the expected 4.9. We came down from 6.5% that we all expected 3 months ago.
The GDP prioce index was much higher at 3.3, compared to 2.7 that was expected.
Pesonal consumption was higher at 5.5 compared to 5% that we all expected.
Employment cost index was lower at 0.6, compared to 0.9% that we all expected. One reason why our unemployment rate has been low.
For reference:
In 2005 Q4, GDP growth was 1.7%, GDP price index was 3.5%, personal consumption was 0.9%, employment cost index at 0.8%.
Just reporting to fuel meaningful discussion among you intelligent people.
I agree with Brad. If China continues the peg, as is, they’re going to run into a lot of problems. I find it hard to believe that inflation is under control in China. Maybe for labor intensive goods, but some sectors must have very high inflation like real estate. One of the problems with assessing the situation is I don’t trust any of the info coming out of China. The chinese gov’t doesn’t want bad publicity so you won’t see any originating in China. They want to paint a picture of a country that is barely able to survive with the peg. Without the peg, the whole country would collapse. To get real information you have to look at reliable data from other countries and fill in the blanks.
China can’t win. If they keep their peg, inflation will drive up the cost of exported goods in Yuan (and USD since they’ll essentially be the same currency). If they appeciate their currency, then the cost of goods in USD goes up, but remains relatively stable in Yuan. I don’t really buy the argument that the peg keeps things stable. I think it makes things in China very unstable since it causes rapidly depreciating yuan within China. At least if china changed their peg, they could control the value of a yuan within China. I wouldn’t be surprised if at some point in the near future, the chinese gov’t puts price controls on exported good to try and fight inflation. What a disaster that would create.
Another problem is with NPL’s. At some point, money flows into banks will slow and the bad loans will be exposed. No matter how bad things get, you’ll never hear info from within China that there’s a loan crisis.
5.5% growth in personal consumption is what jumps out at me …
Steve W. How exactly are China’s growing inequalities (and local land seizures) consistent with less social unrest …
But I concede that a lot of my argument rests on the notion that by encouraging the substitution of capital for labor, China’s peg (and the associated distortions) hasn’t done nearly as much to create jobs as is often claimed …
brad writes :
maybe
“Chinese policy has simply been captured by interests
that benefit from a weak Rmb”
yes
but
brad also writes
“China, though, seems so paralyzed
by fears of being the next Japan”
not to my notice
if you mean the potential
bigger and worser “lot bubble ”
that can be handled with a george/ramsey taxso
long as the public interest prevails
no the reval you and i both urge
still looks like shooting themselves in the foot
seems uncle sam will have to stand up top its own trans nats
and threaten to shoot china in the gut
unless they reval
ie
make em a reval offer they can’t refuse
brad writes
“.. China risks over-investing now,
building too much capacity now,
and then going through
an extended period of subpar investment ”
second part first
” an extended period of subpar investment ”
effective demand management should preclude this
first part second
“China risks over-investing now,
building too much capacity now,
this is not an economy
that can easily over weight any sector
as an export platform
given the huge potential internal market
so they don’t really fear
” finding that it has built a lot of things it doesn’t need ”
cause a switch to domestic demand
remains a bottomless option
if they can get their households to spend more
and they know how thats done…..
errr more or less
a quick look at JAPAN AND GERMANY
shows or at least we’re told it shows
a sense of uncertainty
can send household savings to nasty
macro foolish highs
Chinese Employment crisis with capital-intensive production, massive oversupply of labor
http://news.ft.com/cms/s/33b345be-d617-11da-8b3a-0000779e2340.html
” A “huge global oversupply of labour” resulting from the growing integration of China with the world economy had led to a “race to the bottom” as companies pursued competitiveness with “often ideological zeal”.
In China, it is getting harder to create jobs. In the 1980s, the ADB study calculates, it took a 3 per cent growth rate in China to induce a 1 per cent increase in employment, compared to the 8 per cent growth rate that was required to achieve the same result the following decade.
Employment growth rates have been especially disappointing in the formal sector, where production is more capital-intensive and workers have defined employment contracts that provide for decent working conditions and greater job security. ”
- London Financial Times
Charlie: High inflation is something that you can’t hide very easily. The reason that there isn’t much inflation in China is that you have huge sectors of the economy that are underproductive.
Also, there isn’t a “good news” bias in the Chinese government as far as economic issues goes. If anything the current government has tended to highlight economic and social problems and understate the good parts.
Statistics from China can’t be trusted, but this is because good statistics are hard. This makes it more difficult to figure out what is going on because without a deliberate “good news” filter, it is possible that the real situation is better than the statistics indicate.
The Party has no particular interest in surpressing economic debate (and for the most part doesn’t). If you state the problems, you can debate solutions and then *fix them* which is what happened with the state bank NPL issue. Also, people very quickly figure out when you are in touch or out of touch with reality, and a attitude of “there are problems but we are trying to fix them” gets you a lot more credibility than “there are no problems.”
In the case of the peg and a lot of other things, different people just have different opinions, and trying to work to a consensus is why there aren’t any sudden moves.
The other thing to keep in mind is that as far as economic decision making goes there isn’t a “party line.”
In PRC economic decision making circles you have everything from Neo-Marxists to laissez faire capitalists, and when you have a situation like that, you aren’t going to have fast decision making nor are you going to get very far appealing to theoretical economic principles. You are going to end up with slow, muddled, painful compromises, and endless, heated debate, and (one hopes) far better decisions than if everyone agreed on what to do.
That’s democracy, and it’s a good thing.
Joseph — price controls on gasoline help hold CPI down as well.
USD is down to 113.69 Yen and Euro is at 1.2628 now. This is taking into account that the market is 95% expecting the next Fed rate announcement on May 10 to be “up” leading to 5%. It really shows how the Fed rate hike has lost its effect in terms of appreciating the USD.
I am still not sure if BoJ will reverse its ZIRP by Fall. Economically I don’t think they should. But for political reasons, Koizumi administration might want to declare victory over deflation before the regime change. On the other hand, the market is expecting the ZIRP to end soon. The market is expecting ECB to raise next time despite their pause in the last one. Hence, I get the feeling that even if BoJ and ECB don’t raise rates, betraying the market’s expectation, that only increases the market pressure for their rate hikes on the subsequent opportunities, leading to the appreciation of these currencies; hence depreciation of the USD. I think the USD will fall hard (although I’m not sure if the US GDP growth will fall below 3% in 2006, maybe 2007). I read DB report early this year talking about 130Yen/1USD. How wrong were they?!
Another interesting link is how China raised its rate; market thought this is a sign of slowdown in China, a country that has increased its import of oil tremendously over the years; hence, oil price down. Oil price down from 75 to 71 yesterday, and the USD also down.
“…interesting tidbit came from a CNBC Steve Liesman bit on global gasoline prices. He had the flip charts going and was showing viewers how prices here in the US are still way below that of the rest of the industrialized world. He flips through and you generally see numbers between 4 and 5 bucks a gallon. Then he flips past China, where motorists (apparently) pay $1.67 a gallon for gasoline. Steve quickly adds the qualifier that gasoline is subsidized in China, he then moves on to the next chart. The $1.67 gas price in China was not his point. Meanwhile… I’m thinking….what would happen if China (and Japan) recycled their FX reserves back into domestic fuel subsidies?…” http://www.fxa.com/plant.asp?urlID=434
jw slips this in
” The reason that there isn’t much inflation in China is that you have huge sectors of the economy that are underproductive”
might be a bit too easy to confuse
rural population sumps where
chronic marginal productivity
of labor remains near zero
and sectors
with over capacity
because of excess
plant and equipment of certain sorts
the existence of the second type of overage
even in the mid term
is flat out none sense
the key to flat price levels
huge labor pools and
marked productivity gains
as the production system
moves toward the technical fronteer
without yet reaching it
the rest of jw’s comment
has
the usual acute insight
though democracy and open debate
are not the same thing by any means
and
sw has the party far more clearly in his cross hairs
jw
even if u view all this from a distance
you are often closer to the inside reality
then many other pundit commenters
u remind me of sherlock homes
good at deep accurate deductions
from a trace of clues
Not quite sure i get what it means to recycle fx reserves back into fuel subsidies. China already pays the international price for its imported crude. I don’t the Saudis give a discount to ex-Communists. Its reserve increase comes in the face of paying the full international price. I guess the central bank could give some of its reserves to the State oil cos (help them invest abroad) rather than giving them an RMB check … But that gift creates a bit of a mismatch on their balance sheet (similar to the mismatch on the balance sheet of the state banks).
Right now, the state oilers (gcs lingo) pay the international market price of imported crude (that takes $, which they get at the central bank for rMB, I assume, given that there is still a de facto peg), and sell it domestically for RMB. They make an RMB loss on that transaction. They also sell their domestic oil at the domestic price, and make profits on that. in addition one of the oilers gets an RMB check — a subsidy — to make up for the fact that it has lots of refining but little domestic oil production, so it cannot cross subdisize its imports out of its profits from domestic production.
Fundamentally, tho, the oilers have an RMB revenue stream (which they convert into dollars) and a mix of dollar (external imports) and RMB (domestic production) costs.
they already get the dollars they need from the PBoC at the current exchange rate to buy foreign oil — that is one of the drains on the BOP. and reserves are still going up. If the PBoC makes up for the losses created by the gap between the RMB cost of imported oil and the rMB revenues from selling that oil with a dollar check, well, the oil cos have more dollars. Which means that they would have to buy fewer dollars otherwise from the central bank if they used those dollars to pay for their imported oil. but it all seems a wash.
To “use” reserves, you have to spend them domestically on a new project that brings in new imports and starting running a current account deficit (or a smaller surplus).
i don’t quite see how this all works — external assets have to be used externally. they cannot be spent domestically, at least not directly. unless the state oil cos want to hold dollars for some reason, i don’t see what giving them reserves accomplishes.
in a sense by holding domestic oil prices down and thus encouraging consumption, the chinese are already encouraging imports and thus hurting the BOP and holding reserve growth below what it otherwise would be.
1.26 — hmmm.
i guess i missed the most recent market move, as usual. tho i never turned bullish on the dollar, so I just I can say that the market finally proved me right. But like most policy makers, i think the market is misinterpretting the G-7 statement — I didn’t call for any action. And everyone has known for some time that the Treasury wanted Asia to appreciate v. the $.
But there is no doubt that I downplayed the impact of all the talk this weekend, and the market has used it as a reason to push the dollar down. The mood of the market definately seems to have swung. Funny.
WHile I agree with you, Dr. Setser, as always, I think I would take into account the following:
1. China’s interest rate rise came immediately after President Jitao’s meeting with Bush. A lot of economists including your partner Dr. Roubini said this will not happen, because it would look like China bowed down to the demand of the US.
2. China’s interest rate rise came immediately after G-7 and IMF statements which pointed their fingers at China specifically for the first time.
3. China’s interest rate rise came immediately after oil hit unprecedented $75/barrel, indicating to the market its plan of slowdown, leading to the decline of the oil price, reducing the danger of the global economy.
Again, I agree with you that China’s moves are not enough. But this rate hike, to me, was a good news.
Brad — Total agreement on inequality and land seizures. My impression is that China’s gov’t is terrified of the unrest seizures provoke, and is genuinely working to spread the benefits of economic success into the countryside and to rein in local gov’t on seizures to prevent disturbances. China’s not a monolith, the central gov’t can’t afford to enforce policies disruptive to and unpopular with local gov’t by fiat, so progress is slow. If you were to base your arguments for macro policy change on calming rural unrest, I think they’d get a fairer hearing. You’d have to change your prescriptions though. In a broad theoretical way, the peg may have a lot to do with Chinese inequality. But urban and urban-migrant Chinese (following the US model) don’t seem to mind great inequality in a context of upward mobility and personal opportunity. Rural Chinese would gain wealth through RMB appreciation, but rural unrest results from specific expropriations by local gov’t. A diffuse increase in earning power wouldn’t much change that, I think. Regardless, framing arguments in terms of helping China deal with its internal tensions is, I think, a very productive way forward, rather talking about macro distortions more salient elsewhere.
I love Joseph Wang’s description of economic decision-making in China. I think he’s right: “…you have everything from Neo-Marxists to laissez faire capitalists… You are going to end up with slow, muddled, painful compromises, and endless, heated debate… That’s democracy, and it’s a good thing.” China really is experimenting openly, without a set pattern or ideology. But it’ll act in its own plain interest, not according to any theory of some abstract greater good. And very disruptive changes, like private rural land ownership, face a commensurately high burden of proof, no matter how obvious and comfortable they may seem to The Economist.
The only argument that I think has salience re the peg is the likelihood of a US and global hard landing before China is ready, and the harm and unrest that could provoke inside China. I think China is working under the misguided impression that by extending credit and coopting US business, it can put off global rebalancing until it’s begun a transition to domestic demand-based economy. Your “modified foreign flight” scenario, in which US demand gives out before China has put a domestic leg under its economy, ought to terrify China’s leaders.
Brad–I think the PBoC governor, like any central bank governor, wishes to have the freedom of monetary control; that means either a flexible exchange rate or, at least, an exchange rate which is neither undervalued nor overvalued. But, China’s political leaders fearing negative implications of currency appreciation do not allow him to move the exchange rate. So, what he can do is to resort to some administrative controls (capital controls, lending caps on commercial banks, and so on), or raise interest rates nominally. Of course, minor interest rate increase cannot control inflation or asset bubble. But administrative controls may be able to suppress inflation or asset bubble, though with considerable distortions.
One reason why political leaders in China are so fearful of currency appreciation is, I think, many American economists and business people are advising them not to do so. (Look at Mudell, McKinnon, Stigritz, Roach, GM, Ford, GE, Boeing, Microsoft, etc.)
hk — we agree.
kz — G-7 wants China to let the RMB appreciate. China responds by raising interest rates. it isn’t quite the same thing. I think the RMB has been flat against the dollar this week, when the $/ euro and $/ yen haven’t been flat.
sw
lets not get too carried away here
dengite black cat white cat pragmatism
is not
let a thousand schools contend
democracy it ain’t nor wants to be
this is a debate among cadre
mandarins and euinchs
every one below
must use corruption or disruption
Exciting times.
Just love it when markets move like this – similar to marvelling at the awesome power of nature. It’s the speed that gets you. At first you’re not aware of it, then a few days later you realise that 2-3% has gone, just like that.
CND at highest level against USD since June 1978. Any takers for parity?
Methinks if this continues, steam will be coming out of Dr Setser’s keyboard. Then again maybe I’m reading too much into it. After all, the equity and bond markets seem relatively sanguine and hey, the US economy is booming.
Whenever markets move fast though – especially currency markets – risks increase. And we’re in world where risk doesn’t seemed to be priced into much any more.
FTX — setting Canada aside, what gets me is that the $ is moving v. currencies/ regions that don’t have current account surpluses faster than it is moving against currencies/ regions that do have surpluses. Admittedly, the yen is rising, but not as fast as the euro …
and the renminbi and gulf currencies are following the $ down.
that balances the world economy — it helps China export more so it can lend more to the US, and it leads the gulfies to consume less (Europe costs more, only the rich can afford a mercedes) so they too can lend more to the US. I suspect the bond market will only start to crack when the dollar zone starts to crack (my next post, I suspect).
gcs — yeah, “democracy” is a bit too strong a word for anything in china, a bit too loaded a word for nearly anything anywhere. but joseph wang really captured something that struck me, in describing china’s approach to economics. china, meaning its ruling junta, is remarkably open-minded on economic matters. democracy is the wrong word. but mao’s party today represents the least dogmatic, least ideologically stuck group of economic policymakers in the world today. they are kicking butt, economically and geopolitically, by being open-minded and smart. i wish i could say the same for US policymakers.
in america we are blinded by religion, we are like feuding sects in the church of neoliberalism. the bible is already writ, and interest groups fight to have it interpreted their way. we all believe in “free trade”, but sometime have to “level the playing field”. markets are always right, even when they’re clearly broken and openly manipulated. we preach economics, but we’ve stopped challenging our orthodoxies and innovating where things’re broken. we smugly presume the “developing world” eagerly awaits our good, scientific, Western advice, and smugly expect those who deviate from our orthodoxies will be punished in the afterlife.
i dislike that china’s development strategy is harmful to my country and its economy. i dislike more that US policy wonks are too boxed in, ideologically and politically, to come up with creative countermeasures. i dislike that china’s development strategy involves a lot of silent theft from its own people, but i have to concede they may be better off for it anyway. i dislike that maintaining ccp hegemony is as important a state goal as alleviating poverty in china. but in pursuing its goals, china’s leadership has shown a level of intellectual seriousness, an openness to diverse policy choices and a willingness to evaluate each on its merits, that i think we’ve really lost. we are the gospel of adam smith as retold by business tycoon thieves, huckster politicians, and academics engaged in intercollegiate sport. (Present company excepted — Brad S has his allegiances, but he’s the fairest, most open-minded and data-driven of the bunch.) we are losing fair and square.
“that balances the world economy.”
Yes, but how do the appreciating countries react? Many of them are relying on export demand to give a boost to GDP at a time when government can’t spend any more and consumers are up to their eyeballs in debt. Do we get competitive currency deval, with the hope that imported Chinese deflation will offset other inflationary pressures so interest rates don’t have to rise vs US rates? Is any country happy to see its currency rise against the dollar at the moment?
Not surprising that gold is heading to the moon.
sw writes:
” china, meaning its ruling junta,
is remarkably open-minded
on economic matters”
indeed like all godless rascals
they are
indeed nimble
facing off against them
however are
the trans nats
and like all good profiteers
at least as “pragmatic ”
so despite their market godly exteriors
happy enough
to cut these infidels in
as partners
pandeamonium
To Steve Waldman,
Why is it that Americans always hire lawyers to blame others? Frankly, it is totally preposterous to claim that Chinese are responsible for American overconsumption habits. It is unbelievable that Federal Reserve Chief Ben Bernanke blames US Economic imbalances on the rest of the world for what he calls a “savings glut”. Why isn’t he, instead, urging Americans to save and to invest? Are the Fed governors really as stupid as they appear?
Regards,
Dave Chiang
“….preposterous to claim
that Chinese are responsible
for American overconsumption habits”
right you are
the strategy of corporate amerika works like this
keep wages low but by looser credit standards
let the jobbery borrow the diff
that sez to me
higher wages on trend with productivity gains
would look like improved household savings
even if homer simpson still spends
the same amount “too much ”
but as to the poor toiling chinese
if the global forex system
was functioning better
from an american wage earners
point of view
the usury capital might come
out of dipping into
domestic trans nat profits
not the ccb dollar surplus
generated largely by over seas trans nat profits
sw
as usual i agree with you
and how about that lurid imagery
great stuff
Dave C — you’re misreading me entirely. i certainly don’t blame china for US overconsumption. i do blame american institutions and policy makers for permitting the US to put itself in hock just because china’s development strategy made that possible and comfortable. i admire china’s leadership, for pulling off the most astonishing development arc in the history of the planet, and for doing so in a way that put a formidable rival at a disadvantage, even if that wasn’t especially their intention or plan. i am very frightened about how all this will work out, very bad outcomes are possible, but perhaps we’ll all muddle through. obeisance to “free markets” is so deeply engrained in the US that american policy makers countenanced major distortions in the nation’s real economy in response to capital markets that are openly rigged. it so happens that china is one of the riggers, but, well, we all play hardball out there, and china’s currency and reserve policies were no secret. bernanke was absolutely right, descriptively, about the “savings glut”. he is not a stupid man. what matters now is not his intelligence, but his courage.
Andy Xie: Tightening, Property Bubble and Systemic Financial Risk – “China is in a macro trap. The excesses in the economy are still expanding. The risk to the financial system is also rising. I believe that it will take considerable policy adjustments – and soon – to avoid a hard landing.”
Martin Feldstein: The Dollar at Home — and Abroad – “We need a strong dollar at home and a competitive dollar abroad: i.e., an exchange rate that will make American goods more attractive to foreign buyers and that will cause American consumers and firms to choose American-made goods and services.”
Ben Bernanke: To date, the United States has had little difficulty in financing its current account deficit, as foreign savers have found U.S. investments attractive and foreign official institutions have added to their stocks of dollar-denominated international reserves. However, the cumulative effect of years of current account deficits have caused the United States to switch from being an international creditor to an international debtor, with a net foreign debt position of more than $3 trillion, roughly 25 percent of a year’s GDP. This trend cannot continue forever, as it would imply an ever-growing interest burden owed to foreign creditors. Moreover, as foreign holdings of U.S. assets increase, at some point foreigners may become less willing to add these assets to their portfolios. While it is likely that current account imbalances will be resolved gradually over time, there is a small risk of a sudden shift in sentiment that could lead to disruptive changes in the value of the dollar and in other asset prices.
David Wessel: The U.S. government has made benefit promises it can’t afford to keep and the U.S. economy can’t expect to borrow ever-greater sums from abroad. So why isn’t the bond market upset by the dire fiscal outlook? Former Treasury Secretary Robert Rubin, now at Citigroup Inc., is still convinced that the day of reckoning is coming and shares a colleague’s intriguing hypothesis to explain the market’s apparent lack of concern: “A lot of investors believe in ‘just-in-time politics’ — that the political system isn’t going to be unwise enough to allow all these untoward things to happen, so it will respond just in time.”
Andy Mukherjee: China’s Capitalist State Needs Its Just Reward – “China’s state-owned enterprises had a combined profit of 628 billion yuan ($78 billion) last year, slightly more than General Electric Co. has earned in all of the past five years combined. While GE shareholders received about $40 billion, or 52 percent of the company’s total earnings, as dividends, the Chinese government got a big zero.”
Jeremy Siegel: Will stock and bond markets collapse as retiring baby boomers start liquidating assets? – “If we rely just on ourselves, people will have to work 12 years longer. But if we embed in global economy, we can sell assets to the developing world, and they can ship us goods. That is our best hope, and if we do that our retirement age will stabilize at 68.”
China keeps the peg down because it needs to maintain velocity of cash. Another reason is so there will be some money with little transparency. China’s politics are predominantly like machine politics to me. Means alot of payoffs, kickbacks, etc, etc…So while gov’t officially has little cash to pay people properly, it allows the workers to get cash under the table via loose subsidy requirements, reciept fraud, etc, etc…
This is a thinking out loud post. In other words, I’m thinking China’s leadership prefers the peg system for all the unsanitized cash it generates, which allows it to fund the government and leading industry with the lowest transparency possible…
Some of you may question BCA’s analysis:
Strong Growth Does Not Equal Monetary Tightening: Potential for further interest rates hike in China is limited and will not trigger a broad-based, significant growth slowdown in the domestic economy “….First, the government is committed to boosting private consumption as well as infrastructure spending. Second, inflation remains under control and tighter policy is not necessary. Third, a substantial slowdown in investment would escalate China’s trade surplus, which in turn would increase political pressure on Beijing to revalue the RMB. The authorities will try to avoid such a scenario.”
The Root Of Global Disinflation Is Intact: China should continue to be a source of global disinflation. “The recent reports of rising wages in China have… raised the question of whether China’s inflation is about to rise. This concern is premature. Investors should not confuse wage increases with inflation. Chinese wages have been growing rapidly as a result of double-digit economic expansion, but broad measures of inflation have been falling. The reason is that wage growth has been far offset by labor productivity growth….” http://www.bcaresearch.com/public/index.asp
About how the Chinese government works…
One thing that you do get when you talk to people that see economic decision making in China up close is that the process for making economic policy feels more or less like the process for making policy in developed nations, and just isn’t the stereotypically Stalinist/totalitarian.
There are two reasons for this:
1) There is a deal that the Party has made which is that as long as one doesn’t question the goal of the government (to make China rich and powerful) and as long as one doesn’t question the one-party system, everything else is open for debate.
One of the consequences is that the Party now has adopt a “big tent” policy to accomodate different internal voices. You have party members that are neo-Marxists and those that are basically laissez-faire capitalists, and the Party has to accomodate both in order to prevent an internal split. If you ask fifty government officials whether the peg is a good thing or not, you will get fifty different answers.
The main way that the Party has done this is to do a lot of experimentation. Since most of these matters are unresolvable by ideology, you just run an experiment and see what happens. You devalue the currency by 2% and see if good things happen or if bad things happen.
2) The big difference between the United States and Chinese leaders is that Chinese leaders are terrified of destroying the country whereas American leaders are not. The Chinese leadership knows that if they don’t make the right decisions the Party will collapse and there will be massive chaos and destruction, and this may mean the end of China. So they are willing to listen to anyone that gives them ideas on how to keep the Party in power and to make China rich and powerful.
By contrast, I really don’t think that Bush (or most American leaders) that it is even possible the United States would cease to exist and collapse like the Soviet Union if they make the wrong economic decisions.
The euro is rising again. This raises chances of a stronger US-Europe alliance to pressure China and Japan to reevaluate.
BWII is entering into danger zone.
Rates are already high in the USA.
If china reevalues AND raises rates both action will cool its economy a lot and bring deflation.
Many commentators seem to think that the euro will appreciate because of smaller interest rate differentials versus the USD.
I think they will be proven wrong. The eurozone recovery is not strong enough to withstand both a substantial appreciation and higher interest rates, or at least interest rates rising faster than in the USA.
“Why does China have a looser monetary policy than the United States?”
—Wild guess: the need for 20+ million new jobs each and every year?
“China’s various baby steps (27bp here, a 2.1% revaluation there) strike me as too small to matter.”
—Second wild guess: When macroeconomic practitioners try something that’s never been done before – in China – small steps are a way of reducing the risk that something goes drastically wrong. Given China’s history of Very Large Mistakes pre-1977, this make sense.
Over-investment: Given that 500+ million Chinese haven’t got the kinds of things China exports (laptops, designer clothes, fancy toys), it seems strange to think that all that export-oriented capacity will sit idle some day soon. Sure, there are problems with distribution, pricing and power supply, but these are surmountable.
“Johnson also noted that the peg ended up distorting China’s financial system, as the banks were forced to hold sterilization bills rather than learn how to lend at market rates.”
—Umm, which rates were those? Market interest rates? No such thing in China, and that long pre-dates the current peg.
* * *
First question: why is China’s current exchange rate quandary being compared to Japan, Germany and the US? Why not to India, Russia or some other economy with at least a basic level similarity?
“China shouldn’t change its peg because the US says so, or because the IMF says so. It should do so because it is in China’s interest to have a tighter monetary policy than the US has, not a looser monetary policy.”
—Isn’t that what they’re doing? Changing policy one small step at a time is what Chinese policymakers have decided is in China’s best interests.
* * *
Second question: How does 10.2% real GDP growth + under 2% CPI increase yield 15% nominal growth, unless there is a whole lot of inflation in the export side of the GDP deflator?
Third question: What is the impact of tightening the money supply and / or sharp appreciation when inflation is running 2%, down from 5% two years earlier? Isn’t there any consideration at all for the domestic consequences?
.
DOR — GDP deflator has been higher than CPI recently, and with the recent runup in commodities, i expect that to continue. Nominal GDP growth was above 17% in 04 and close to 13% in 05 (per the world bank quarterly, using the revised data) — GDP deflator was close to 4%. With stronger growth and more pressure from inputs, i don’t think 15% is unreasonable. Stronger growth and the same deflator alone gets you to 14% or so.
In an economy that consumes as little as China, CPI doesn’t seem to be a great guide to overall nominal price growth in the GDP data. I actually thought this was one of your points.
As for inflation, well, China I suspect if China liberalized petrol prices, inflation would be a bit more than 2%. And I certainly think that China has plenty of tools to avoid deflation in the face of modest appreciation — less sterilization = strong money growth (tho that feels a bit like Japan in late 80s … ), taking breaks off bank lending, massive fiscal stimulus etc.
I would turn the question back around. Last time the domestic Chinese economy looked to be overheating — in part because of inflows generated by expectations of appreciation — China put the brakes on domestic demand, and imports tanked and exports didn’t. Growth didn’t slow much as the basis of growth shifted toward NX (see first 1/2 of 05 … but the trends started earlier). And for that matter, the cooling measures seem to have had a bigger impact on bank lending and imports than on investment, which didn’t actually fall much even as bank lending fell. I still don’t feel like I fully understand why. No matter, the policy was no external adjustment and domestic restraints and the result was a surge in China’s trade surplus.
Basically, at the current exchange rate, china needs a domestic credit bubble to keep the trade deficit from widening, best I can tell.
china now faces a similar choice. Restraining domestic demand alone would likely generate a similar outcome. Hello, 10% of GDP current account … the exchange rate offers another policy tool for helping to manage the pressures generated by the boom. Let more of the pressure dissipate into external demand, etc. And it has the added bonus of potentially (tho only after the XR moves quite a bit I suspect) creating more room to use interest rates as a tool of macro management.
So my question for you is why rule out the use of an obvious policy tool, and instead constantly swing between a credit boom (and import growth = export growth) and demand restraint (and a growing trade surplus) …
Agree that there aren’t market interest rates in China, but the goal of lifting the interest rate cap was to allow the banks to price their lending at the margin. But right now, the banks are all liquid, and the dispersion of lending rates doesn’t seem to be increasing and indeed some signs suggest lending spreads (over the base rate) are compressing (see the latest IMF paper on the banking sector).
bsetser: So my question for you is why rule out the use of an obvious policy tool, and instead constantly swing between a credit boom (and import growth = export growth) and demand restraint (and a growing trade surplus) .
Because no one knows what really will happen if the RMB appreciates suddenly. It is quite likely that someone really bizzarre and unexpected will happen.
The policy tools that the Chinese government are using right now have been used before, and we know more or less what their properties are.
It’s perfectly possible that appreciating the RMB will cause an unforsee trigger of events that will make the situation worse. That’s why the government is taking this one step at a time. Raise the value 1-2%, see if anything bad happens, and if it doesn’t, raise it some more.
bsetser: Agree that there aren’t market interest rates in China, but the goal of lifting the interest rate cap was to allow the banks to price their lending at the margin.
The main goal of lifting the cap was to allow banks to use the credit spread and lend to riskier customers (i.e. anyone that isn’t an SOE). The trouble right now is that there are very few ways of evaluating and protecting against credit risk in China.
Last year the Yuan appreciated by more than 10% against many currencies, including the euro. Seems like there wasn’t much of a negative impact. I don’t think this is the best time to test what happens when the RMB depreciates against the euro once again.
Brad,
I’m surprised the World Bank got their hands on revised quarterly nominal GDP rates going back any period at all, as I’ve not heard of them being made available and – this is important – the current “latest data” on the IMF’s Beijing office website for fixed asset investment is only August last year. Source?
On gasoline and CPI, this is a very minor part of Chinese households’ consumption and even considering impact on the entire distribution chain, should not show up as anything significant, price controls or not. Domestic China is still a local economy. As for CPI as an economy-wide measure, I do use it to double-check things like bubbles, the GDP deflator and retail sales growth rates, not much more.
As for China overheating, there were only 6 months in mid-2004 when CPI rose above 4% year-on-year, and those were the only 6 months for 9 solid years (back to Q-2 1997).
Sure, there were other signs such as nominal monthly investment figures with land prices, equipment inventories and the kitchen sink thrown in that pointed to over-heating. But, that one isn’t what I would call a reliable indicator.
On the other hand, if you consider under 2% inflation to be risking a fall back into deflation, then the risk has been present in each of the 12 months to end-March 2006, and absent in only 16 months over the past 100.
I’m not trying to argue that China isn’t growing too fast, or in the wrong ways. But, I do believe that the deflation risk is worth considering more thoroughly during discussions of exchange rate changes.
“Basically, at the current exchange rate, china needs a domestic credit bubble to keep the trade deficit from widening, best I can tell.”
Bubbles burst. Bursting bubbles hurt, a lot. So, the obvious choice is not to worry. After all, if [US fiscal] deficits don’t matter, neither do [Chinese trade] surpluses!
.
DOR — World Bank quarterly had an annual GDP/ GDP deflator/ real GDP series.
I think we differ in two respects:
a) I do think China risks exporting deflation at its current exchange rate — the US offsets those domestic deflationary pressures with loose money that drives up the price of non-tradables, but that also risks bubbles that burst (US Real estate). If China can only solve its deflation problem by exporting deflation, that is a problem …
b) Rather than relying on an undervalued exchange rate/ expensive imports and a booming export sector to manage dometsic deflationary pressures, I would like to see China make greater use of domestic tools.
I don’t find the Japan comparison all that persuasive. China is much, much poorer than Japan in the 80s, which was already fully urbanized. And I think China’s is making Japan’s bubble era mistakes (loose monetary policy) in the opposite context. japan minted yen to offset the contractionary impact of a revaluation (and probably an unnoticed at the time slowdown in trend growth); cHina is printing yen to offset massive inflows, and locking them up in the banking system. I suspect there already is a real risk of Japan like overhang of investment that will cause problems now or later. But I don’t think China can keep that problem from getting worse w/o a revaluation.
Chinese outbound investment is growing rapidly and the United States is going to need to decide whether to try to profit from it or miss out on it. It’s that simple.
http://www.chinalawblog.com