More variations on 7.99. The world changes, Chinese policy doesn’t.
The latest Chinese macro news summary from Market News International pretty much says it all – nothing much has changed. The RMB floats between 7.990 and 7.999. Exports grow faster than imports. And investment growth continues to be stupendous.
**The yuan ended at 7.9926 to the dollar on the exchange-traded market, against yesterday's close of 7.9910, traders said. The central bank set a central parity rate of 7.9948 to the dollar before the start of trading today, compared with yesterday's 7.9916.
**China's GDP climbed 10.9 pct year-on-year in the second quarter, the official Securities Times reported. China's CPI rose 1.5 pct year-on-year in June, while PPI was up 3.4 pct year-on-year in the same month. Fixed asset investment in the first half rose 31.3 pct year-on-year, and it rose about 35 pct for June alone. The industrial value-added output in June gained 19.5 pct year-on-year.
It sure seems like China is unwilling to even try to make use of standard macroeconomic tools to help cool the economy. The maximum policy measures under consideration under Beijing – whether higher interest rates or a bit more appreciation in the RMB – are far too small to make a difference. Say China lets the RMB appreciate by 2% rather than the 1% of the first half of the. The total move would perhaps make up for inflation differentials between China and the US. And the RMB would still depreciate in real terms.
With oil at $75 plus again and concerns that events are spiraling out of control in the Middle East, the world seems to be changing far faster than Chinese policy.
Should China’s investment bubble burst (30% y/y growth in fixed asset investment has to be discounted to get the number in the national accounts, but it is still very fast growth), China won’t have anyone to blame but itself. It sure won’t burst because the exchange rate has been allowed to appreciate too fast.
And it may end up bursting because China continues to miss opportunities to make use of standard instruments of macroeconomic control – higher interest rates, a stronger exchange rate – too cool an economy that sure looks to have grown an extraordinarily fast clip in the first half of 2006. Perhaps even faster than the official estimate.
Investment was darn close to 50% of Chinese GDP by some measures even before the most recent surge …
Stephen Roach: “Macro China has reached a critical sustainability impasse — the economy is far too reliant on investments and exports. And yet Micro China continues to power ahead — driven by autonomous development imperatives at the local level. The all-important social-stability constraint bridges the gap between the macro and the micro… In the end, an accelerated pace of reforms to a market-based economy is the only means to relieve these mounting tensions. Only then can traditional macro policies achieve the traction they need in order to be effective.”
China established more Communist Party “cells” within businesses in order to expand the party’s presence in the growing private sector.
Japan’s surplus on the current account widened to $13.98 billion in May, helped by an 18.8% rise in exports.
Brad,
Let’s say that your concerns and badgering become reality.
How will such a situation impact China’s current exports?
What’s the bottom line?
Which concerns?
An investment slump?
In the short-run, that won’t have much of an impact on Chinese exports. Lots of capacity will come on line no matter what. Chinese exports will continue to grow for a bit. Might even grow more, as Chinese firms try to make up for a lack of domestic demand.
Imports would fall.
Volumes would fall. Prices would fall.
The current accout surplus would rise.
The impact on Chinese reserves is ambiguous — capital inflows might fall, and reserve growth is a function of both the current account and capital inflows.
I would expect tho that the central bank woudl still have to intervene to keep the RMB from rising. Capital inflows might slow, but even if they slowed, i don’t tihnk you would see massive capital outflows on a scale sufficient to offset the rising current account surplus.
Is that what you are asking?
Brad,
Yes. And everything you shared makes sense. So, what’s the upside of China taking the actions that you would like to see them take? Why shouldn’t China just ride the same horse as long as possible and deal with the corrections when the negative blip hits?
Is there are reason why China would benefit by going ahead and cutting its internal infrastructure investments as well as really floating its currency on the global markets? I not sure that I see the incentives for China to make the major adjustments until the global markets cool, abruptly or slowly.
What is happening right now may not be pretty, but it’s obvious what the game is.
Is the current strategy a real problem for this business cycle (before the next global recession)?
I would like to see you (plural) speculate on what happens when the real estate/investment/over-producing sectors/banking sector (?) all simultaneously get into trouble; clearly unemployment and “unrest” will increase; but what advise would you THEN give the authorities in Beijing? What would be the global repurcussions?
Brad,
“standard macroeconomic tools?”
“standard instruments of macroeconomic control” ?
This isn’t Japan or Germany!
I can’t find a time in the last 30 years when China EVER successfully used macroeconomic tools to influence the economy in a subtle way. Not once.
Sure, there have been major, whack-up-side-of-the-head moves, but not once has there been a subtle move that made a bit of difference.
That’s why they don’t try it now.
Take raising interest rates, for example. Who would have to pay more interest, and therefore be likely to invest / consume less? Certainly not struggling SOEs, as they don’t pay on their loans. Certainly not your typical household, as it doesn’t use credit.
The ones that would be affected would be well-run companies and those specifically funded by the state to undertake large projects such as infrastructure construction. Is that the target?
.
As I see it, Movie Guy has made a point: Why should China worry if the U.S. doesn’t?
Traditionally, it was the country with current account deficit who had to adjust - not the country with c.a.surplus.
The same could be said for the oil-exporters. After all, oil someday will run out. It makes more sense to keep some reserves than to spend them all now.
If the CPI for China is actually 1.5%, why would the Chinese be buying gold?
Chinese GDP growing 10% & Chinese money supply growing almost 20% implies 10% inflation eventually. That would end the peg of the Yuan.
“The RMB floats between 7.990 and 7.999.”
So buy at 7.990 and sell at 7.999.
Brad–Sure, it is in the interest of China to appreciate its currency. If left as it is, China will experience a high inflation and/or a huge asset price bubble, which will result in great difficulty in the future.
However, since there will be a major reshuffle of senior officials at the central and local governments next year, policymakers are now extremely defensive and will not make any big decisions unless encouraged by the political leaders.
DOR is right. China has never used standard macroeconomic tools because standard macroeconomic tools have never worked with the Chinese economy.
Basically instead of using interest rates to stop investment (which has ***never*** worked), the Chinese government just issues orders to SOE’s to stop investment. The trick is doing that without causing the economy to grind to a halt, and the Chinese government is getting better at this. They did pretty well in early 2005.
algernon: M2 growth has always been above GDP growth since 1978.
HK: There isn’t a major reshuffle next year. The major reshuffles happen in years ending in two’s. There are usually some minor changes in years ending with seven’s.
This all stems from easy bank credit I think. They are trying to slow down growth while banks are lending away easy money with lax terms from the reserve accumulation. Its pointless to try and slow this unless they stop accumulating reserves.
If the Fed engineers a US slowdown to halt inflation, and Chinese imports decline, There will be in China many mothballed empty factories (with expensively purchased land, copper wiring, cement Etc.) and angry destitute peasants. Would have been wiser to invest today in healthcare and rural education or whatever the farmers need. ANd not so many damned export factories. The RMB appreciation would have fit the bill nicely I think
PBoC FX reserves hit $66 bio in Q2′06!
Who is likely to answer for over-capacity and falling prices as well as increased unemployment in China when it comes? The local government who built those factories on borrowed credit from the state banks? Or the policy makers in Beijing? Change the few or change the many? What would the manager of a football team do? Sack the coach or change the team on the field? Clearly to me, local officials will keep the pedal to the metal and the risks are real, but asymmetrical if and when the slowdown arrives, and factories are not worried about it because they are making products today and they may or may not ever pay back those state loans.
re: “standard macroeconomic tools have never worked with the Chinese economy”
- along with many others? Is there not some concern that, going forward, standard macroeconomic tools may not work so well, or yield standard results in the United States?
re: “what happens when the real estate/ investment/ over-producing sectors/banking sector (?) all simultaneously get into trouble”
Whether an energy price and supply shock may be the catalyst in an economy that is increasingly petroleum dependent. Still thinking about all the intangibles built into the price of oil.
“…In oil markets, the causes of the price increase were virtually all political and psychological as traders fretted that Israel’s conflict with Lebanon could provoke wider fighting or unrest in the Middle East, where 31 percent of the world’s oil is produced and where 62 percent of proved reserves lie.
Adam E. Sieminski, chief energy economist at Deutsche Bank AG, explained that one way to calculate the political premium would be to multiply the odds of a supply cutoff by an estimate of its effect. So if the chances of military action against Iran or of a supply cut there are even modest, given the huge impact such events would have on oil prices, then worries about Iran alone could account for $10 to $15 a barrel in the current world price of crude. Sieminski said oil traders could also add $5 for possible hurricanes, $5 for risks in Nigeria (where militant groups have attacked pipelines and cut oil output by more than half a million barrels a day), and $5 for other risks. “Supply and demand are not the only things people look at,” Sieminski said.
Altogether, the political premium could make up a third of the price of crude oil. And it’s a source of political controversy, because even though the reasons for the high price may be psychological, real money is still transferred into the hands of oil-producing countries and companies… In the physical world of oil, experts said that if anything, the supply balance was better than it was a couple of years ago, when prices were much lower… But with excess oil production capacity much lower than it was a few years ago, markets remained sensitive to any future risks. Sieminski said that would explain why companies were keeping higher inventories than they did a year ago.”
http://www.washingtonpost.com/wp-dyn/content/article/2006/07/13/AR2006071301686.html
“…Hong Kong suffered its biggest one-day percentage drop for a month as investors grew nervous about the posibility of a Chinese rate rise…” http://www.ft.com/cms/s/2cd549b6-1228-11db-b1ff-0000779e2340.html
Though US govt/FED doesn’t have a clue on what to do… I am pretty sure the Global Investment Banks (Big 5) will do their part which will ensure China becoming next Japan and US staying as an economic super power.
the FT article quoted in the prev post is a good example of what I am taking about
Enrique - You ask, “Why should China worry if the U.S. doesn’t?”
I think China should be more worried than US as its the Lender ?
This is 8:19AM on Friday.
I’m seeing $77.51 for oil. NYMEX Crude for OCT is $79.60.
BoJ ended its ZIRP; nonetheless, JPY is down to 115.9.
Not much to say at this point, but the appreciation of the USD despite all these news is “race to the safety zone” after what’s happening in Middle East.
DOR makes an excellent point. This is, arguably, the most dangerous time in the Chinese transition process. Growing market forces have weakened the effectiveness of the “Plan”, but are not yet strong enough to promote the efficient allocation of resources. The result is that that nobody is minding the store–central planning does not work, but it does (at least in theory) try to ensure that resource constraints are met. While reforms to date have freed people to take risks and invest, nascent (heavily-regulated) capital markets and the absence of an effective market for corporate control are ineffective in allocating capital efficiently. The Chinese undoubtedly know the risks they confront in the transition process; that explains their fundamental (Burkian) conservatism: “don’t change institutions (i.e., your nominal anchor) until you have identified a better alternative”. The current policy is unsustainable. The authorities know it is unsustainable, and are looking to change it (have announced they will change it). But until the costs of not changing exceed the potential risks associated with changing policy, they will retain the status quo. We do indeed live in interesting times
Hi Brad,
Regardless of what the Washington Consensus demands, the Chinese government will make economic policy decisions based on solely domestic considerations. While the yuan is trading close to 8 to the dollar, China is permitting the yuan to appreciate two to three percent per year. Before bashing the Chinese for the US trade deficit with the world, the US should reconsider its use of trade sanctions as a foreign policy weapon against other sovereign nations. Trade sanctions have proven to be ineffective with even the small island nation of Cuba off the coast of Florida.
High-tech US export sanctions have not prevented Chinese access to European nuclear, aerospace, and semiconductor technologies. By forcing the Chinese to import French nuclear reactors, German semiconductor machine tools, or British jet engines, the US government is de facto imposing economic sanctions against its own national industrial base. European satellite and aerospace manufacturers are designing out, US electronic components from their high-tech products due to US export restrictions targeting China. What is there for the Chinese to import from the US when most high-tech US exports to China are prohibited by law enforcement. American manufacturers have lost hundreds of billions of dollars in export sales due to a misguided foreign policy.
Regards,
re: “Who is likely to answer for over-capacity and falling prices as well as increased unemployment in China when it comes?”
Any chance Chinese authorities may be waiting for the most appropriate externality, or mix of externalities to take full effect, and therefore remove most of the blame from themselves, same as any other government would do?
Anonymous (who follows kz) — I like your assessment. One example: a recent article on over-capacity says the problem comes in “mixed” sectors where there are both SOEs and private firms. New private capacity comes on line, but inefficient SOE capacity never goes offline … Steel is the obvious example.
And I think you have nailed the authorities assessment of the risks. HK’s point about a forthcoming transition reinforces it.
Personally, I see far higher risks of inaction — right now, the risks of correlated slump in the US and China seem to me to be uncomfortably high, and with China trying to export its way out of the slump and US growth slowing, the politics could easily become unmanageable. And I think that China may pay a high price for over-investment. Very rapid growth now. But then a big overhang of spare capacity and a lengthy period of subdued growth. One other cost of inaction: the status quo actually has pushed back efforts to use more market mechanisms to allocate capital. Read Eswar Prasad. Or just consider how hard the PBoC has to struggle to keep the banks from lending out their excess liquidity when the deposit int. rate cap and loan int. rate floor make lending flow profitable …
A final point: even if macro tools have never been used in China, China’s economy is not what it once was either. Domestically. And internationally. We are looking at a country that will export more than the US by the end of the year. It is very hard to have such a large economy operate by rules that are very different than the rules of the rest of the global economy.
Particularly if it is systematically intervening to maintain an undervalued currency, and thereby artificially supporting a lot of industrial capacity … China’s impact on the global economy has grown to the point where it has some int. responsibilities. I realize that the US is not in a good position to lecture anyone about international responsibility. But China has been acting a bit like the US — we will do what we judge to be in our domestic interest, and the rest of the world can adapt. That didn’t matter when China was small. But it does now.
Hi Brad,
We are all becoming increasingly aware of China escalating growing interest in securing commodity access and influence. Most discussed in the US newsmedia are Chinese oil and gas ventures in Africa and Latin America. Metals, minerals and bilateral trade deals are announced almost weekly in Beijing. However of equal importance, are the diplomatic visits and signing of agreements across the world to secure demand for Chinese export products. This represents a urgent race against today’s imbalances and an inevitable eventual rebalancing. In light of a 14% increase in the size of America’s negative net international investment position (NIIP) to negative $2.7 trillions, this seems particularly true. China needs export contacts, agreements and trade relations to facilitate a reduction in her dependence on US consumer demand.
Chinese foreign policy is also attempting to establish an economic sphere of influence or economic bloc in the Greater China region to the exclusion of US global hegemony. A common culture is clearly facilitating the rapid expansion of the economic relations between the People’s Republic of China and Hong Kong, Taiwan, Singapore and the overseas Chinese communities in other Asian countries. With the Cold War over, cultural commonalities increasingly overcome ideological differences, and mainland China and Taiwan move closer together. If cultural commonality is a prerequisite for economic integration, the principal East Asian economic bloc of the future is likely to be centered on China. This economic bloc is, in fact, already coming into existence to the distain of the US government which has attempted to block any Asian regional integration.
Regards,
Dave Chiang — I agree with you that any future east asian economic block will be centered on China. i don’t think we are there yet, but i can see how such a block could develop — and it would no doubt develop in part as a response to concerns about the US (all of East asia is a net financier of the US) and a desire to develop alternatives to the US market and the US $ as a store of value. I don’t think we are there yet tho — given strong US demand for East Asian imports and China and Japan’s growing current account surplus in the face of a big oil price hike, I think both still rely to an extent on the US consumer. but they should be thinking of alternatives.
http://images.thetimes.co.uk/TGD/picture/0,,315912,00.jpg
http://business.timesonline.co.uk/article/0,,13132-2251243,00.html
Brad,
I think you might have underestimated the demand side inside China. The potential demand is real unlike Japan. China is still very under-developed. For the forseeable future the risk is commodity driven inflation.
True — China is underdeveloped.
But investment is part of demand, and i am not sure the other components could rise fast enought to offset a sharp slowdown in investment. nick Lardy consistently has noted that in the past (and things could change), that slowdowns in investment have generally been combined with a slowdown in consumption growth.
MrBill: I don’t see any chance of overcapacity happening for decades. There are huge sectors of the country that are underdeveloped.
Anonymous: Over the last decade, the Chinese government has figured out a system for market allocations of resources within a context of central macroeconomic control. It’s important not to think of the Chinese economic as “transitional” or assume that the end state should or will look anything like the US economy.
The thing that makes me optimistic is that the lag time for macroeconomic control is much shorter. In 1996, the cycle time was something like 12 months. Right now, it is something like two or three.
Also China isn’t raising interest rates, but a whole flood of orders have come down from on high to stop investment. The one reason for the flood of investment is that the surviving SOE’s have become lean, mean money-making machines, and no one has any real clue about what to do with the money they are generating now they are profitable, so it gets reinvested. I don’t see how raising interest rates is going to change the dynamic.
One commonality between the US situation in Iraq, and SOE reform in China was that no one ever really asked the question “so what do we do if we succeed?”
bsetser: Does Lardy (or anyone else) have a reason why consumption and investment are linked? The reason I’m wondering is that the last major slowdown in the Chinese economy was around 1998, and the economy is very different today than it was in 1998.
Also, I disagree that this has retarded movements toward a market mechanism for allocating capital. The trend has always been to go toward more general instructions. In 1985, the instruction would have been for this factory produce X units of product Y. In 2006, the instruction would be to an SOE investment group to spend less money with the decision on where to make the cuts happening at lower levels and determined by market pricing.
What you have is a “socialist market economy with Chinese characteristics” which oddly enough is what the Chinese government calls it.
Lardy’s argument is more or less less investment = slower growth = less consumer confidence and less consumption. His evidence comes from the early 90s, not post 98. and i think it is pretty clear what the post-98 slowdown had a bit to do with the broader regional slump and a bit too do with the de fact revaluation of the RMB v. all of the rest of asia (called a devaluation of the rest of asia v. $, but it was also a deval v. the RMB) and the associated impact on Chinese exports. Hot money outflows in anticipation of trouble in China didn’t help.
Plus, I think some of the SOE reforms (to increase efficiency/ reduce the iron ricebowl) were starting to hit then (but am not sure about this) so the timing of the RMB’s big appreciation v. the rest of asia wasn’t great from that point of view.
Brad,
In a surplus country there is more elbow room to stimulate demand. Witness Japan post bubble collapse. Yes it was mired in deflation for years, but the societal stress was surprisingly mild. On the other extreme you have Argentine where the stress from the loss of confidence of foreign creditors was severely punishing on the general populace. China is in the Japan camp on the surplus side, but it has the added “advantage” of being underdeveloped — so when the need arises the roads built will actually be driven on. (I am using roads as a metaphor. There are innumerable other things that can be further developed.)
My point is, if you fear a collapse, then by all means having a surplus is a good thing. It may mean the populace is not consuming at its full potential, but it does save for the rainy day.
I agree that there is a lot to be desired on the efficiency side with such a development model. But the macro picture is not dire — fx reserve acts as a buffer against loss of confidence.
I also agree that excessive surplus is undesirable — unncessary sacrifice for illusory security. But as you pointed out, the Chinese hasn’t learnt to use the macro lever to fine tune its economy.
enrique
“Traditionally, it was the country with current account deficit who had to adjust - not the country with c.a.surplus.”
and its precisely ass backwardslots of the time….
like east asia now
in a better system very often
the surplus states
would be the ones
forced to use ” policy tools”
to adjust and restore balance
“A final point: even if macro tools have never been used in China, China’s economy is not what it once was either. Domestically. And internationally. We are looking at a country that will export more than the US by the end of the year. It is very hard to have such a large economy operate by rules that are very different than the rules of the rest of the global economy.”
“Particularly if it is systematically intervening to maintain an undervalued currency, and thereby artificially supporting a lot of industrial capacity … China’s impact on the global economy has grown to the point where it has some int. responsibilities. I realize that the US is not in a good position to lecture anyone about international responsibility. But China has been acting a bit like the US — we will do what we judge to be in our domestic interest, and the rest of the world can adapt. That didn’t matter when China was small. But it does now.”
In October 2004, China raised interest rates by 27bps. The economy promptly grew faster. In fact, the largest impact - and the first in history such an impact was felt in China - was on stock markets half way around the world.
In 1997-98, the rest of the world warned China not to devalue. She didn’t.
In 1994, the uninvited external economic advisers (UEEA) lectured China about the problems of duel exchange rates. She pegged to one.
In 1978, an earlier version of the UEEA demanded that China abandon core principles and adopt Western economic models. She did.
Result?
Greatest increase in standards of living for more people than at any time in the history of the world.
By way of . . .
More than half of exports by foreign-invested enterprises; imports, too.
No macroeconomic tools to speak of.
No track record in moving the economy gently.
Massive pressure from abroad to make huge moves.
China’s economy: better than an “E” ticket at Disneyland!
.
In fact, the largest impact - and the first TIME in history such an impact was felt FROM China - was on stock markets half way around the world.
“”As well as raising wages, the government has increased administered prices of oil products and electricity.
Other measures to increase the cost of producing tradable goods could be in the works. Scrapping export tax rebates would be the equivalent to a 3.5 percent revaluation of the yuan, the official China Securities Journal said last Wednesday.
Andrew Smithers of London consultancy Smithers and Co. said he suspected China’s imbalances, reflected in a record trade surplus and record reserves, would be addressed through higher inflation without much of a change in the nominal exchange rate.
But whichever route is taken will produce problems for the world economy, he said: if prices of Chinese exports rise, the inflation rates of domestic services in rich countries will have to fall for central banks to keep overall inflation in check.”"
REF: To inflate or appreciate, that’s China’s question
Source: Reuters, July 17th, http://www.reuters.com
Link: [quote]http://today.reuters.com/news/newsArticle.aspx?type=reutersEdge&storyID=2006-07-17T064857Z_01_PEK59098_RTRUKOC_0_US-ECONOMY-CHINA-INFLATION.xml&pageNumber=2&imageid=&cap=&sz=13&WTModLoc=NewsArt-C1-ArticlePage2[/quote]
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