A tale of two Asias: China, and almost everyone else
Many emerging Asian economies — Korea, India, perhaps some others — are now intervening to keep their currencies up rather than trying to hold them down. Raphael Minder of the Financial Times reports:
South Korean authorities on Tuesday sold as much as $1bn to shore up the won, according to currency traders in Seoul, underlining concerns in several Asian countries about weakening currencies in the face of oil-fuelled inflation … South Korea’s predicament is shared by other Asian nations that have seen an abrupt currency reversal compound inflationary pressures as oil and food prices remain near record highs.
Other Asian central banks likely sold dollars as well. An Indian newspaper reports:
” Central banks across Asia region likely to have intervened in the foreign exchange markets. The Bank of Korea, Bank of Thailand, Banko Sentral ng Pilipinas and Reserve Bank of India are all suspected to have sold US dollar to boost domestic currencies in order to contain inflation,” Sherman Chan, Economist, Moody’s Economy.Com said.”
China, like many other emerging Asian economies, imports oil. but it otherwise is in a rather different position than many other Asian economies. The hike in oil prices has yet to put much of dent in its trade surplus. Its larger current account surplus is expected to remain constant in dollar terms this year. And its central bank is still buying dollars, not selling dollars.
If the latest leaked data is accurate, China reserves increased by $40 billion in May. I would estimate that China bought about $44 billion in the market, after adjusting the $40 billion total to reflect a slight fall in dollar value of China’s exiting holdings of euros in May. $44 billion (over $500 billion annualized) is a huge sum. But it likely leaves out another $22 billion that China’s banks accumulated, as China’s central bank continues to ask China’s state banks to meet their (rising) reserve requirement by holding dollars rather than renminbi. $66 billion — almost $800 billion annualized — is a very big number.
It is a smaller than the $75 billion increase in China’s reserves in April — a number that rises to $80 billion after adjusting for valuation gains and rises to above $100 billion if the April rise in China’s reserve requirement is factored in. Slowing down the pace of RMB appreciation in April (it has subsequently picked up somewhat) may have helped slow the pace of hot money inflows — or China’s efforts to tighten the enforcement of its capital controls may have had an impact.
But Michael Pettis is right. The overarching story is that China’s reserves and foreign assets continue to increase at a stunning pace. Throw in another $45 billion in June reserve growth, and the increase in China’s reserves — after adjusting roughly for valuation effects — in the first half of 2008 could approach $290 billion.
I would round that up to $300 billion. That is roughly as much as India, the emerging Asian economy with the second highest reserves, has in the bank. Michael Pettis — drawing on work by our mutual friend Logan Wright — has estimated that China’s adjusted reserve growth in the first five months of 2008 was about $435 billion. To get that total, he assumed China transfered $75 billion to the CIC in q1 and that the banks have added $90 billion to their dollar holdings to meet their reserve requirement. China hiked its reserve requirement again in June. My own projections would net out some valuation gains in a way that would reduce the increase over the first five months of 2007 to around $410 billion. But that is still an absolutely huge number.
It consequently isn’t unrealistic to project that China’s adjusted reserve growth for the first half of 2008 could be close to $500 billion. Then double that number. The 2008 increase in China’s reserves, bank reserves and CIC could match Japan’s total stock of foreign exchange reserves. And not so long ago most people thought Japan had a ton of reserves.
Brad,
I saw an interesting video interview on bloomberg today with Beutel where he argued that the price of oil will increase if the ECB continues their Hawkish rhetoric on inflation. My understanding is that your views differ in that the price of oil will drop with inflation control abroad. Won’t raising central bank interest rates abroad cause a decline in the value of the dollar, thereby driving commodity prices further?
Jeff — I am more inclined to think the casuality, such as it is, runs the other way: high oil prices push the dollar down. I am not convinced $ weakness explains oil’s rise — beyond the mechanical effect where oil’s euro price would fall if the dollar fell v the euro and the $ price of oil was constant. oil is up v. most currencies over the past year.
If other countries adopted more restrictive policies that reduced their demand for oil, i would expect oil to fall v a basket of the currencies of consuming countries. there might be some offsetting effects from additional $ weakness if the dollar also fell on the $ price of oil (implying a need for the $ price of oil to rise to keep oil constant v the basket), but I would look for the first effect to dominate.
but i am far from an expert on oil.
In June the World Bank published two reports; one on China another on Vietnam. To readers of this blog this description of China will sound very familiar:
(page 1) “Confronted with massive capital inflows . . .the government still chose to give priority to rapid growth. The monetary authority purchased large amounts of foreign currency to prevent appreciation . . .and eventually failed to mop up the additional liquidity through the sale of bills. The growth in base money led to a rapid expansion in credit. As a result, inflation accelerated and a real estate bubble developed.”
(page 9) “World inflation and an informally pegged exchange rate can explain a large portion of the acceleration in inflation.”
Oops, sorry; that’s the World Bank’s description of Vietnam; here’s what happened in China: (page 4): “ High food price increases pushed up overall consumer inflation, but the worst of the food price hikes may be over.” (page 7) “. . .inflation is unlikely caused by excessively loose monetary policy.”
I would be very sceptical about reports on the Vietnamese economy. Of course the guys from Washington have to fill pages with recognizable and plausible prose. Chinese statistics are iffy (see the Winter issue of the Journal of Economic Perspectives (admitted. a layman’s read) that compares long term growth in China and India. Between the lines of course.
Brad,
Hmmmm…. These are very interesting times, and you are just about the only one covering the story.
As you noted, the Asian countries, other than China, are letting go of their currency manipulations in order to fight inflation. But, as the World Bank report cited by Rien Huizer indicates, China is continuing to print yuan to buy dollars, which is causing inflation in China.
I see these events in the context of my Comment #9 in response to your June 6 posting, “Does Chinese inflation now constrain the Fed?” I wrote:
“The Federal Reserve is not responsible for the inflation in the mercantilist countries. The mercantilist countries are responsible for that inflation. That inflation is occurring because their central banks are increasing money supply much faster than their economies are growing. For example, the Chinese inflation is likely being caused by the Chinese government printing yuan in order to use them to buy dollars so that they can keep their currency from rising against the dollar.”
Howard
Brad,
You may have missed part of the story. China is not alone in buying dollars. Did you notice how fast the dollar has been rising compared to the yen dollar since the second half of March when the U.S. Treasury apparently abandoned its weak dollar policy. Check out:
http://www.x-rates.com/d/JPY/USD/graph120.html
Apparently, it’s not just the Chinese who are buying dollars like mad, either the Japanese government or speculators in the Japan Carry Trade, or both, are apparently borrowing yen like mad in Japan right now to lend them to the United States in order to profit from the rising dollar versus the yen.
Howard
Whoops, I was unclear about motives in my posting above. I meant to say, that the speculators in the Japan Carry Trade are buying dollars in order to profit from the rising dollar versus the yen.
The Japanese government is likely buying dollars in order to weaken the yen so that their industry can gain market share in its competion with foreign industry.
“Flush with dollars from a huge trade surplus, the Chinese sovereign wealth fund is beginning to test the waters in New York real estate, said Scott Latham, executive vice-president of capital markets group for real estate services company Cushman & Wakefield.”
http://chinadaily.com.cn/china/2008-06/26/content_6797165.htm
Asia needs to have a coordinated currency policy, so that no Asian country gains a competitive advantage from currency appraciation. Revaluation is necessary to help moderate growth and inflation, not to mention raise living standards throughout Asia. It seems like a classic prisoner’s dilemma, where rather than hang together, the Asian nations are hanging separately.
Charles, that is n excellent idea, and one that has been dicussed often and never gone any further than that. One of the things that helpd the EUR is an enormous amount ot intra-EU trade ( with gigantic trade imbalances). The ASEAN countries looked at these things for a while but (a) there is not a lot of intra regional trade (except food and energy of course) and much of that is intracompany business. But due to the fundamental changes in China’s structure and role, over time there might be something. Of course there is now an informal currency cartel, but that is based on high individual reserves. Also (but that may be changing now China is becoming so rich) there are arrangements between governments (often involving Japan) to prevent a return of 1996/7 and subsequent embarrassing IMF meddling. It is worth paying attention to signs that something is emerging. But do not hold your breath, as long as Koreans riot over beef (of course US beef is at least as safe as Koreans and probably the Koreans know that too) and Indonesians become more devout, you can bet your boots that any elite dependent on popular consent (which rules out only Myanmar, N Korea and Brunei) will have to hide attempts at cooperation and if the public finds out and someone can show that any gains are compensated by losses, only the losses will get attention and the politicians in question will have a hard time.The public wants competition. Look at Singapore’s purchases of ailing banks in Indonesia, or Shin Corp in Thailand. East Asia is not only the realm of various kinds of naked mercantilism, it is also ethnic. Nationalism is in fact a fairly weak force, compared with ethnicity.
Gao Haihong of the Chinese Academy of Social Sciences has a paper advocating exchange rate cooperation in East Asia.
Howard Richman,
Unless I have missed it, the Japanese authorities have not intervened against the yen for about four years now. Anyway, if the US was unhappy about the exchange value of the dollar versus the yen, unlike in the case of the renminbi it can respond in kind by buying yen. Arguably, the US should have been doing this anyway; as I have pointed out here and elsewhere ad nauseum for readers, the US foreign exchange reserves are as under-adequate as China’s are over-adequate.
RebelEconomist:
The Japanese Central Bank never stopped accumulating currency reserves, though the pace has slowed in recent years. Here is foreign exchange reserve data in millions of dollars as it appeared in the Japan Statistical Yearbook, see table 15-16 at:
http://www.stat.go.jp/english/data/nenkan/1431-15.htm
1985 21,916
1190 69,488
1995 172,444
2000 347,212
2005 828,813
2006 874,569
Howard
Mitchell, thanks for Gao’s paper. Monetary union in EAsia long way away and only combinations that make real economic sense would include Japan and China. ASEAN by itself (as shown earlier), not viable. Of course if they all shadow USD and have lots of reserves (plus mutual support agreement and limited convertibility) we have something looking a bit like the early versions of Europe (everyone trying to shadow DM). Except that the real sector in Europe tends much more to integration.Hence complementary deficits and surpluses. In Asia, why would China or Japan assist the Philippines. What can they do if it refuses to adjust. Then a fortiori, why support India or Bangl Desh. There may be ad hoc reasons, but basically very limited structural motive and “infrastructure” for cooperation.
Whoops I misread what Qingdao posted. The World Bank actually doesn’t think that Chinese inflation is due to monetary growth. They wrote:
“Inflation in China has so far been driven by surging food and other raw commodity prices instead of excessively loose monetary policy.”
Here’s a link to the report:
http://web.worldbank.org/WBSITE/EXTERNAL/COUNTRIES/EASTASIAPACIFICEXT/CHINAEXTN/0,,contentMDK:21809859~pagePK:1497618~piPK:217854~theSitePK:318950,00.html
Howard
Howard — the increase in japan’s reserves since 04 has been entirely due to:
a) currency valuation effects
b) bond valuation effects (Japan markets to market, so the value of its portfolio of long-term bonds rises when us rates fall and vice versa)
c) accumulated interest income. japan doesn’t sell the interest it gets paid for yen but rather adds it to the stock.
The question of asian currency integration is an interesting one. right now Asia basically manages its currencies (to varying degrees) v the $ (an external currency). so long as the rmb tracks the $, this means smaller coutries also manage their currencies against the rmb. Overtime, I think it makes sense for asia to have one or two or three or more big currencies that float against the currencies of other major economic regions.
Linking to the $ at an undervalued rate (at least for China) isn’t an optimal long-run solution for ASia or the US. But the natural anchor of Asia is china (i.e. countries that wanted fixed rates manage their currencies v china’s currency), and china cannot act as an anchor of a floating asian block so long as it itself pegs to the $ and its capital account isn’t convertible (i.e. other central banks cannot hold RMB reserves).
I could also envision a world where an ASEAN currency floats v China — but the huge differences in levels of development within ASEAN hint at the difficulties of that.
Thanks for making those points Brad.
A similar history of US currency reserves would show them essentially unchanged, despite growing financial markets, imports and US foreign debt. What is the policy which explains that? Ain’t got one!
America’s trade complaints today remind me of Britain in the 1970s. We restricted imports and devalued sterling, but it did not help save, for example, the British motorcycle industry from Japanese competition, because fundamentally its problem was not currency-related but that its products were outdated, of poor quality, and produced inefficiently.
Brad,
Thanks.
Howard
There was a report that Iran moved 70-80 billion from EU banks to Asian banks ahead of the EU sanctions.
Could this be the source of the increase?
Rebel — the US export response to $ weakness has been fairly strong. and if takes a weak $ to get Germany and Japan (and who knows who else — tho I am not a fan of Chinese state firms ’cause I would expect them to be looking to invest in china so as to create jobs in China) to invest in efficient small car production in the uS, I am all for it.
Organic George — China’s closed capital account makes it an unlikely destination for Iranian funds looking to avoid sanctions. Some SE asian countries strike me as more likely destinations. Malaysia for example.
Brad-
countries with current account deficit have to protect their currencies to maintain inflation targets in the absence of money inflows.
Can you bring an article between south korea, thailand and phillipines vs south asia as forex reserves in the former is due to trade surplus in the past for most part while for the latter it due to hot money inflows.
satish — a fair amount of thai and phillipine fx reserve growth reflects capital flows as well. I would though need to dig a bit to get the data. the big current account surpluses outside of China are in Signapore and Malaysia.
I think one thing that keeps the yen undervalued is that people believe Japanese authorities will not let the yen appreciate above a certain point. This greatly emboldens the yen carry trade by putting a floor on potential currency losses. A strong message that the U.S. will no longer countenance mercantilist currency manipulations would probably go a long way to correcting the current imbalances, before the euro area collapses under the weight of tasking the whole brunt of u.S. currency adjustments.
Brad,
You wrote: “the increase in japan’s reserves since 04 has been entirely due to: (a) currency valuation effects, (b) bond valuation effects …, and (c) accumulated interest income.”
You are clearly correct as far as the period from March 2004 to March 2007 is concerned. But with the falling yen of the past year, I believe that Japan has resumed its currency interventions.
I just looked more closely at the Japanese foreign exchange data which can be found month by month since April 2000. I refer to data that can be found if you go to the following IMF website and then click on “CSV” to download the spreadsheet:
http://internationalmonetaryfund.com/external/np/sta/ir/jpn/eng/curjpn.htm#I
If I am reading this data correctly (i.e. looking at the third row), in March 2007 they had foreign exchange reserves worth $889 million but in March 2008, the month that turned around the strengthening yen, they had foreign exchange reserves worth $988 million. That’s an 11% rise in just one year, a year in which many of those lending to America took huge losses due to the crash of the subprime market.
Howard
(I meant because of the “rising” yen of the past year, not because of the “falling” yen of the past year.)
Howard — Japan’s reserves rose during that period for all 3 reasons I mentioned: interest income (not small on $900b), fx valuation gains (japan has some euros) and bond valuation gains (us rates fell, and japan has some long-term bonds which rise in value when rates go down). Basically, they had a fairly conservative portfolio that paid off in a crisis environment. No outright intervention. I’ll grant that expectations matter and there is an expectation in the market that at some point japan would intervene to cap yen strength, and i’ll grant that not selling the interest income is a choice that has some intervention like aspects. but in terms of outright purchases in the fx market, japan hasn’t been active.
Don,
What I am saying in #24 is that you are likely correct. The Japanese government has been intervening to support the Japan Carry Trade.
Howard
Oh, I forgot about the euros! My impression, based upon no evidence whatsoever, was that their forex was almost entirely dollars. What’s your guestimate of the proportion that’s euros?
Howard
between 10 and 15% — and i would bet on a number closer to 15% than 10%. see ted truman’s various papers with anna wong.
Brad
To the nation accumulating reserves, the only problem usually lies in a decline in reserves or lack of. To Asians, after the horror of the 90s, the more the better, after all, reserves are reserves, not exactly anything that needs to be paid back.
Rebel
Wonder what you thought of the British car industry?
As for Japanese and German investment in the USA to produce fuel efficient cars, why? Is it beyond American automotive industry to do so on their own?
Judy,
The same as our motorcycle industry. Some iconic models (eg mini, jaguar e-type etc) but let down by quality and efficiency. Endless strikes and pleas for protection and bailouts until Mrs Thatcher let it go. My first car was a mini; had a VW ever since!
For me the telling fact is, how do your goods sell in non-competitor export markets. There used to be lots of British cars in India, Middle East etc; now you hardly see any. You can’t blame protectionism for that. You do see Mercedes everywhere!
The dollar is cheap vs the sterling and the euro, but you see very few American-made cars here. What I find interesting though is that Ford in Europe have made some good cars (eg the Focus) that did not transfer to the US. I think that it is partly a question of American preferences and partly the complacency of an industry used to making good margins on heavy, inefficient vehicles.
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