Does the U.S. Want the Renminbi to Rise Now?

Daniel Drezner wrote:

danieldrezner.com :: Daniel W. Drezner :: The Bush administration gets says it's getting serious about the dollar: Looks like the Bush administration is shifting from passive-aggressive to aggressive in trying to get the Chinese to revalue their currency. Andrew Balls and Edward Alden have the story in the Financial Times:

The US administration is calling for China to move immediately to introduce a flexible currency, a marked shift in tactics after several years of patient diplomacy aimed at nudging China towards allowing the renminbi to float. A senior US administration official told the Financial Times on Friday: 'Action is needed now. This is a co-ordinated effort to get the message across.' The decision to demand prompt action by Beijing comes in the face of growing pressure from Congress over the burgeoning US trade deficit with China. Officials acknowledge they were shocked by a 67-33 Senate vote earlier this month to allow consideration of a bill championed by Democratic senator Charles Schumer that would impose a 27.5 per cent tariff on all Chinese imports if China does not revalue in the next six months.... The message is being delivered to China at all levels in advance of this weekend's Group of Seven meeting in Washington. China, which has been a guest at the past two G7 meetings, is not sending its finance minister and central bank governor to this weekend's gathering...

That last bit suggests to me that this pressure won't have an appreciable effect anytime soon. This will irritate the Bush administration but really irritate the European members of the G-7, who blame the United States and the Pacific Rim for the magnitude of current global imbalances.

---

Brad Setser wonders if the U.S. really wants the renminbi to go up by a lot, right now: a fall in China's (and other central banks') purchases of dollar-denominated assets reduces the value of the dollar and so boosts demand for U.S. firms in export and import-competing industries, and raises dollar interest rates, reducing investment. In our simplest finger-exercise models--teh ones I will teach next year in Econ 101b--the first effect dominates. But that is small comfort, for the score that the international monetary system appears to be playing off of these days bears little resemblance to finger exercises and much more resemblance to something like "Night on Bald Mountain."

Brad Setser's Web Log: First the President tells China that it is holding a bunch of worthless IOUs ...: And now he tells China it really should revalue, in far stronger language than the US (or the G-7) has used before. It seems like Tim Adams, the incoming Treasury Under Secretary for International Affairs, plans to get tough on China. Adams reportedly thinks that China has not rewarded Bush for keeping the rhetorical heat on China down during the campaign....

If I were part of the Bush Administration's economic high command, though, I would worry that China might take the hint. If China revalued (really revalued) and its reserve accumulation slowed, the US might find it a bit harder to find buyers for all the IOUs the Treasury is churning out, even as US 'soft patch' could widen the US deficit. And there might not be quite so much demand for Agency debt/ mortgage backed securities either....

[T]here seems to be pretty good evidence that the value of the renminbi does have an impact on China's export growth. Consider this: From 1996 to 2001, China's real exchange rate rose from 86 to 101, and its exports almost doubled, going from $174 billion to $301 billion. From 2001 to 2004, China's real exchange rate fell from 101 to around 90. China's export growth accelerated: China's export grew by 35% in 2003, 35% in 2004, and, according to the latest (March) data, are increasing by 33% y/y in 2005. China's exports are on track to more than triple between 2001 and 2006: rising from $310 billion to $1030 billion (China's end 2004 exports were around $740 billion). That's a much bigger increase than the increase in the five years that preceded 2001, when the renminbi generally was appreciating along with the dollar.... The fall in the dollar has not done wonders for US export growth, but it sure has had an impact on China.

A very large hedge fund (oops -- a well-respected investment bank) used more formal econometric techniques to arrive at the same conclusion. A recent Goldman study indicates that even a 10% rise in the renminbi's real value would cut the growth in China's exports by 15%. That has to happen at some stage: China is too big for its exports to keep growing at a 30% plus annual rate. And if a Chinese move made it a bit harder for the US to finance its deficits at current rates, that just might provide some of the impetus the US needs to start putting its own house in order...

---

Nouriel Roubini has a much stronger view that he expresses, um, frankly: for the U.S. to push for China to revalue the renminbi by 20% is for the U.S. government to shoot itself in the head:

Nouriel Roubini's Global Economics Blog: April 2005 Archives: [I]s the US really serious about demanding that China revalue its currency or is the US outright clueless and masochistic? The first rule of good manners - and finance as well - is that you should not bite the hand that feeds you. In the case of the US, for the last two years about three quarters of the US fiscal deficit has been financed by foreign central banks (mostly China and Asia), 100% of the US fiscal deficit has been financed from abroad (as US residents have not increased by a penny their net holdings of US Treasuries) and about 80% of the US current account deficit has been financed by foreign central banks (again mostly China and Asia). Last year China accumulated $200 billion of forex reserves, mostly in US dollar assets, and it is still accumulating them at the same rate this year.... [R]educed supply of financing of the US twin deficits from China/Asia would lead... to a sharp increase in the US long term interest rate, thus leading to a fall in housing prices, in equity values and in the price of a wide range of other risky assets such as high yield bonds, i.e. a hard landing.

How much would US long term rates increase...? [W]e argued at least 200 basis points... two anecdotes are more powerful.... Recently, when an obscure Korean government document sent to its congress had a line about diversification... the DJ index fell 1.6%, the US bond market tanked with the 10yr yield up 15bps and the dollar fell sharply.... [W]hen the Japanese PM Koizume spoke - or mispoke? - about diversifying the Japanese forex reserves a similar shock wave affected US stocks, bonds and the dollar....

[W]hat would happen on the day when China - followed on cue by the rest of Asia as what prevents Asians from moving their effective dollar pegs is the Chinese peg - were to announce that it will... reduce its accumulation of dollar reserves? The answer is simple... financial Armageddon.... Thus... [do] the US authorities really... really mean what they say or are they clueless?... There are at least three interpretations....

1. Talk is cheap and the posturing is aimed at containing protectionist pressures in the US....
2. The US authorities are really clueless or masochistic....
3. Wishful thinking that a Chinese revaluation alone would solve the US current account problems....

There is a view out there... folks at the Fed... fall of the US dollar... would have little effect on US interest rates and that the beneficial effects by themselves of such a dollar fall on US demand and net exports would have a positive effect on US economic growth (see the Greenspan February speech and the more recent one by Bernanke).... A variant of this... is that... a reduction of the US fiscal deficit is... likely... moderate Republican senators will not vote for making the US tax cuts permanent... the AMT... [is] a stealth tax increase and... Social Security privatization is already bust....

But such wishful optimism... has little basis in the data or... Washington. The US current account has worsened rather than improved since it started to fall in 2002 ; and this is not due just to J-curve effects (that last 6-12 months, not 28 months) and is not just due to high oil prices (as non-oil imports are still growing at a very fast rate).... [T]he moderate Republicans in Congress voted for a 2006 budget that was even more loaded with new budget busting tax breaks.... Reducing the deficit by half by 2009 by freezing non-defense discretionary spending to 2005 levels for 5 years is something that not even a single Republican congressman - 'conservative' in theory but more piggish in practice when it comes to pork barrel spending - would vote for....

So, which interpretation is the correct one?... a combination... the Administration knows that its talk is cheap and it is trying to stop Congress from slapping tariffs on China... the administration... must also be really clueless and playing with fire by pushing so hard China to revalue early... there is also plenty of delusional wishful thinking that a Chinese move alone, together with miracoulous deficit reduction - falling like manna from the sky with no policy action on taxes - would reduce the US twin deficit....

Maybe unconsciously - and this may be the fourth freudian interpretation - the administration really wishes to be woken up from its own delusional dreams and rejoin the 'reality-based community' where most the world resides...

Now a fall in the dollar could have little effect on U.S. interest rates if a dollar fall was accompanied by a Federal Reserve declaration that it was focusing on internal balance, and the Federal Reserve adopted a definition of "internal balance" that was to peg the nominal yield on the Ten-Year Treasury at five percent per year.

The life of a central bank governor would then become very exciting indeed.

It would become especially interesting if it is indeed the case, as Brad Setser reports, that this is taking place because "Tim Adams reportedly thinks that China has not rewarded Bush for keeping the rhetorical heat on China down during the campaign." In order for the U.S. to attain a soft landing U.S. national savings needs to rise relatively swiftly and the dollar has to decline slowly and gradually--so that nobody ever thinks it is about to collapse--a half-step behind the change in the exchange rate. The U.S. doesn't need anything that decreases the chances of a soft landing. Yet the word is that Treasury Undersecretary for International Affairs to be Tim Adams doesn't get this: that he is treating pressure for the revaluation of the renminbi as a move in the political game--as a way of punishing China's government for not being grateful enough to George W. Bush--rather than as the economic equivalent of pouring gasoline on a powder keg.

Comments

[P O'Neill]

The mention of agency debt is also a reminder that now is maybe not the best time to be making overseas investors unsure as to exactly what the future role of Fannie Mae and Freddie Mac will be.

[tea]

The last time I checked, the U.S. liability was in dollars and the Fed, not the Chinese, government, prints dollars. The chinese accumulate dollars because they sell goods here. And they sell because they have no other markets. So, if they decided not to accept dollars, they also have to decide not to produce. If they dont maintain 9% growth, they will have a revolution in quick time. As someone said, the Chinese need to maintain a NARRG--nonaccelerating revolution rate of growth! Who is dependent on who?

[trevelyan]

QUOTE -- The US administration is calling for China to move immediately to introduce a flexible currency, -- ENDQUOTE

What do they want? An adjusted peg or a truly floating currency? The first is likely to happen, the second much less so. Does the press even appreciate that these are two different things?

China may appreciate the RMB, but the hopes for them actually floating the currency are remote since that would require an end to the legal monopoly the BOC currently enjoys over currency exchange. The USD-RMB peg has been a central plank of China's developmental strategy since 1994 and isn't likely to change given China's current reliance on USD inflows for liquidity, not to mention the reliance of the Chinese banking system on constant bailouts from the center.

Onwards to public offerings!

[anne]

With all the raucous city or village scenes that we may find in China now and again, make no mistake how dramatic growth has been for 20 years, how much cohesion this has created in a country in which there is always division merely because of the vastness in area and population, and how capable China's leaders and advisers are. Economic diplomacy may be tough, but we would be sadly mistaken were we to set aside the understanding that we are increasingly partners in development with China.

[anne]

Remember, we have little household saving and a serious budget deficit and growth tht has not been strong enough to generate a strong labor market. A sharp decline in demand for America debt as the dollar fell in value against Asian currencies would tend to raise interest rates and slow growth further. What does the Federal Reserve then do? Lower short term rates against possible further dollar weakening and more inflation pressures or allow growth to slow and the labor market to further weaken? Not a pleasing choice.

[Alex]

"The first rule of good manners - and finance as well - is that you should not bite the hand that feeds you."

Tell that to Nestor Kirchner. It is unlikely that the debtor here is in as weak a position as Roubini thinks merely by virtue of being a debtor.

[lise]

Alex

What happened in Argentina was a tragedy. We do not wish to even think of being Argentina.

[brad]

"China has no other markets"

Really? Last I checked, they were doing quite well in Europe, and in several other places too. Moreover, there is that little thing called the Chinese domestic market -- which, going forward, has more potential for rapid expansion than the US consumer market. If China truly depends on the US market to deliver a accelerating, nonrevolutionary rate of growth (small change to the title)), they are in for trouble. It is really hard to sustain 35% y/y export growth to a country that already has a trade deficit of close to 6% of GDP.

[brad setser]

Incidentally, when the administration decided it wanted a "change in the peg NOW" I think they effectively shifted from calling from a move toward a full float, which cannot happen "Now" to calling for a simple revaluation of the existing peg.

John Taylor generally wanted a move toward both greater exchange rate flexibility and a more open capital account, and was tempmentally inclined to be patient. He seemed less inclined to accept a simple repeg than a general increase in flexibility. I suspect Tim Adams wants a "win" -- and the easiest "win" is a simple revaluation, perhaps with a bit bigger band. And to be honest, I think a simple revaluation is what makes the most sense at this stage in any case, provided it is big enough.

[KeithK]

OK. Let's have a compromise. Let the Yuan float, but keep the Renminbi pegged to the dollar.

[knut wicksell]

Short version of Roubini's point about the US Treasury.

'Clueless in Gaza'.

Should make a great novel.

[DOR]

Good posts by tea and trevelyan above.

brad: “‘China has no other markets’ Really? Last I checked, they were doing quite well in Europe, and in several other places too.”
---Last time I checked, China exports to Asia were larger than exports the US and Europe combined.

_ _ _

If China revalued (really revalued), the prices US consumers pay for daily goods would rise by at least an equal amount. There would be no new jobs created in America. Indeed, the tax – that’s what it is – on Chinese imports would more likely reduce the number of jobs in America.

_ _ _

“From 1996 to 2001, China's real exchange rate rose from 86 to 101, and its exports almost doubled, going from $174 billion to $301 billion.”
---From 1996 to 2001, China’s real gross fixed capita formation rose by 44.7%, whereas that of the US rose by just 28.9%.

“From 2001 to 2004, China's real exchange rate fell from 101 to around 90. China's export growth accelerated:…”
---From 2001 to 2004, China’s real gross fixed capita formation rose by 41.8%, whereas that of the US rose by just 15.9%.

See the pattern? Invest, and your products become more attractive to buyers. Moreover, in 2000, the share of Chinese exports produced by foreign invested enterprises was 48%. In 2004, it was 55%. (The ratio for imports was higher in both years: 52% and 56%.) And, let’s not forget that the 1996-2001 period included the Asian Financial Crisis.

_ _ _

Homework assignment: Review the trend in US imports from North-east Asia (China, Japan, Korea, Taiwan, Hong Kong) since 1986. What might explain the apparent contradiction between the downward slope in the share of imports coming from that region and the upward trend in imports from China (hint: substitution)?

Extra credit assignment: consider the results of the 1985 Plaza Accord on Japan’s economy in 1990-2000 with the likely outcome of a similar exchange rate adjustment on China’s economy today. Do not neglect to compare the levels of sophistication of the economic, political and financial systems in the respective countries.
.

[randal]

As an investor, why should I not take some large % of my
american dollar derived investemnts and buy chinese
currency with them?
Scenario 1: Status quo: chinese to not either float or
revalue their exchange rate, and I lose
my risk free rate of return on those assets
( i lose tbill rate or whatever)
Scenario 2: Chinese revalue to +10 or +20% next week,
Quite a nice pop for a week

Scenario 3: Chinese 'float' their currency, and i get
a 10 to 40+% return- quite an amazing
return, all my friends think i am a
brilliant!

Scenario 4: They float it and it goes down! bummer.

Scenario 1, 2 or 3 seem likely, so there is very
little down side risk, and quite a nice upside.

Scenario 4: dont think that is likely.

Why isnt the investment world all a twitter with this
idea? Am i missing something?

[chris]

While all the multi-nationals and the smaller scale entrepreneurs invest in China for their next production facility; the skilled technicians die off, apprencetices don't get hired and learn the skills, factory locations get sold off for lofts or flattened to build housing and shopping malls. If you say, okay I'm going to open a casting factory after the chinese yuan appreciates by 20%, equipment will probably have to come from Germany or ironically China so you're paying a higher price, skilled labor won't be available, those skills are lost, you might have to hire temporary foreign technicians who get to laugh at stupid locals, and you have to locate raw materials at escalating prices while the U. S. dollar depreciates. After all that Chinese labor is still going to be a fraction of that in the U. S. There has to be a time lag of years now in the U. S. before we start replacing imports with American made.

On the other hand the skills in China are improving. Their currency might appreciate and increase their purchasing power. At some point as someone else pointed out there will be enough people in China with a high enough standard of living that domestic demand kicks in and the economy grows off of itself. The productive power and skills will be overthere.

China's trade has swung into surplus with Europe to the tune of $9 bil for the first quarter of this year. The flip side of another detail is when demand slows in the U. S., it's U.S. export platforms in China that will be hurt. Look at everyone's favorite pet rock the iPod. The parts have to come from Japan, the U.S. but maybe from overseas factories, and China with the entire thing assembled by Taiwan owned factories in China. Apple provides the design and integration.

Plus we've all been enjoying, haven't we, the Bush boom of easy money. Lot's of people have bought more home and more SUV than they can afford. All they have to do now is pay for it either in a high inflation rate environment or a higher interest rate environment or a combination of both.

[brad setser]

DOR -- take a look at overall US imports from the asia pacific since the end of 2003, not just imports from China. They are growing quite rapidly. China is growing the most rapidly, but overall, imports from the rest of the region are still growing. Yes, there has been some substitution, but that is not the entire story. In relation to GDP, US imports are growing quite strongly right now (and have been since the recovery started), both overall and from the asian pacific region. That per se is no problem, but given the size of the us trade deficit, the fact that overall non-oil imports are growing much faster than overall exports is problem, in my view.

I am familiar with the impact of Plaza on Japan, and the argument that by responding to a more appreciated yen with loose money, the Japanese fueled the bubble economy that then burst. But I don't quite get your argument. the investment surge you laud in china looks like a bubble to me. Shanghai 04 feels like Tokyo in bubble days, with reports of apartments going for NYC prices. in this case, though, the easy money/ rapid credit growth is coming from keeping the renminbi pegged to the $/ resisting appreciation -- not from trying to offset the impact of a strengthening currency. bubbles come in many forms.

Do you honestly think the current situation is sustainable, politically and economically? And if not, what is your preferred adjustment mechanism, since I take it is not nominal renminbi appreciation? Are you in the McKinnon camp (i.e. believe that inflation is the best way to bring about the real exchange rate appreciation)?

[tante aime]

The answer is behind door #1. Talk is cheap and the posturing is aimed at containing protectionist pressures in the US. Tariff wars would be global suicide for US, the same as a landlord evicting all their tenants in a highly-incentivized renter's market. The only stability the US has been able to attain is precisely because the OPEC countries and China peg their currency to ours.

If China floats off the dollar, it would be crushed,
as it was before it pegged itself to the greenback. There is no "flexibility", you can't be a little bit pregnant. Either you hard peg, or die a dog's death.

So Lord Snow continues to posture that US equity is still a great investment at over twice the price valuations, and China continues relentlessly it's monkey-on-the-back strangle hold on the US economy.

Indeed, as long as China has a path to redeem dollars through global commodity purchases or currency swaps, and as long as the US government remains a noisy but still faithful lapdog, and the US markets remain eager traders and currency manipulators, then the US trade deficit curve will smoothly and sweetly go geometric.

But you shouldn't fret. As a recent summation of the Chinese success story points out, China led the world GDP for 3,000 of the last 4,000 years. Now that they're off the opium with a martial economy, and the US is on crack in our economy, China will inevitably re-triumph.

Darwin's Law, misappropriated once again in economics.
We are now at "1998" in terms of a Dot.bomb comparison, and the latest oil spike was just a hiccup prelude to another record deficit and rent party like it's 1999.

[DOR]

chris,

“There has to be a time lag of years now in the U. S. before we start replacing imports with American made.”
---Don’t you mean “before we start replacing imports from China with imports from Brazil, Vietnam or India” ?

Brad Setser,

Thanks for your useful comments. If China today looks like Japan in the late 1980s, and if the US succeeds in imposing a Plaza II type appreciation on China, my view is that the results will be a total disaster.

Japan was politically, economically and financially stable enough to ride out a decade-plus of depression. With China, the more likely scenario is war, domestic or otherwise. Very scary, and very avoidable.

I don’t believe the China bubble (if any) is exchange rate based. I believe the strong growth and rapidly rising prices for real estate (not equities!) is primarily investment and productivity based.

Sustaining the current situation requires, first and foremost, fixing the US fiscal deficit. In 2004, the US federal debt increased three times more than that year’s trade deficit with China. We shouldn't even be discussing China!

As for the renminbi, the best change (if any) would be to re-peg to a basket of currencies. It isn’t perfect (China’s main trading partners import and export via dollar-based transactions), but if there has to be a change, that is the least damaging.

Inflating is a way of getting out of debt, so that would not be appropriate for China. It is also a way of reducing unsustainable standards of living, which is not China’s problem. For the US, these may be appropriate solutions, but that's not my area of expertise.

Yes, the dollar value of imports from Asia has been rising, but not the share of imports.

US imports:
From Asia + Japan
1994: 43.8% 2004: 42.3%

From Asia ex-Japan
1994: 38.0% 2004: 28.9%

From Asia ex-Japan and ex-China
1994: 20.1% 2004: 20.1%

_ _ _

Here's another one for consideration:

Average annual percent change in employment, 1995-2004

Japan -0.19%
Taiwan +0.91%
China +1.20%
Korea +1.29%
USA +1.40%
.

[chris]

DOR:

Brazil is going to have to struggle to keep some export markets for itself; it has the same problems as American manufacturers. Hasn't it been struggling for decades to hit a steady export dependent development path like China or the other East Asian countries? All things staying the same isn't China's or the many factories/companies in China competitiveness, skills, education, equipment, access to raw materials, access to transportation, improving at a faster rate than Brazil's? There was a report in the NY Times that partially touched on a JV between a Brazilian small commuter aircraft maker and some Chinese factory. I think it mentioned that the Brazilians were worried that some day the Chinese might decide to do it all by themselves.

Vietnam is getting some investment, but a lot of it is spillover from China. Vietnam will have to struggle to find its place, too. Ho Chih Minh City is hopping with investment in light manufacturing, but supposedly Hanoi is still moving at a slower pace.

There's probably over-investment in export oriented factories in China now. There might be a bubble in Shanghai property. A lot of that is fueled by overseas hot money. People from East Asia, even a few Americans, buying apartments that will sit empty while the owners wait for them to appreciate. And, I am guessing, these real estate speculators have savings so they can sit through a downtown better than our leveridged domestic home punters.

[Michael Robinson]

"I believe the strong growth and rapidly rising prices for real estate (not equities!) is primarily investment and productivity based."

The real froth of late in the Chinese real estate market has been in overseas investment in "international quality" residential units in Shanghai, and to a lesser extent Beijing. This is universally attributed to speculative hedging against RMB appreciation, as this is one of the very few RMB-denominated investments open to individuals that can generate returns in dollars.

A repeg would deflate that market to equilibrium.

Elsewhere in China, the real-estate market is speculative, but not unrealistically so in a rapidly urbanizing economy with sustained ~8% real GDP growth.

[anne]

A decidedly interesting thread. I have long considered the Plaza Accord of 1985, from which the dollar declined in value more than 40% against prime European currencies and 50% against the Yen, a significant long term problem for Japan and Europe. China has to increase the value of the Yuan for its stability, but the change must be controlled carefully and must be accompanied by increased Chinese domestic spending and American saving to be properly effective.

[Michael Robinson]

Also, as a follow up to the previous China exchange-rate thread, the question was raised as to what mechanism there was to ensure that the PBoC was not simply a revolving door for converting dollar-denominated FDI into U.S. Treasury purchases.

Here's the overview:
http://www.tdctrade.com/chinaguide/eng/05/5-1.pdf

I think it would be helpful for further discussion to have everybody on the same page.

[anne]

The reason we have a current account deficit is simple, because American household saving is low and there is a large and growing government deficit we spend in total more than we save. The difference must be made up by imports of products and savings. So, we have a current account deficit. The problem is not monetary policy, but fiscal policy. We had a large and growing government budget surplus in 2000, but that is reversed. The current account deficit was easily sustainable in 2000 but not so now.

We can blame Mexico and Brazil and India and China, but we control our fiscal policy and not other countries. We can blame the Federal Reserve, but low interest rates are a reflection of little inflation and a Fed that generally wishes high growth. Were the Fed like the European Central Bank, American growth would be far less and we would be in far poorer employment condition.

The problem is fiscal policy and the cure can be fiscal policy. Other countries are not the problem.

[anne]

The reason we have a current account deficit is simple, because American household saving is low and there is a large and growing government deficit we spend in total more than we save. The difference must be made up by imports of products and savings. So, we have a current account deficit. The problem is not monetary policy, but fiscal policy. We had a large and growing government budget suplus in 2000, but that is reversed. The current account deficit was easily sustainable in 2000 but not so now.

We can blame Mexico and Brazil and India and China, but we control our fiscal policy and not other countries. We can blame the Federal Reserve, but low interest rates are a reflection of little inflation and a Fed that generally wishes high growth. Were the Fed like the European Central Bank, American growth would be far less and we would be in far poorer employment condition.

The problem is fiscal policy and the cure can be fiscal policy. Other countries are not the problem.

[trevelyan]

Randal,

Your problem isn't in converting dollars into RMB, it is getting your RMB back into USD after appreciation. Most foreigners working for Chinese companies have contracts which stipulate legal support for converting a percentage of earnings into foreign currency -- these clauses exist because you can't just walk into a bank with RMB and out with foreign currency. You still need papers and stamps.

Michael Robinson has a nice post above on the real estate market and how it is a way some investors are trying to get around this.

Also worth noting that these restrictions imply that shifting to currency convertability might actually result in short-term depreciation, as Chinese citizens start selling RMB for dollars and domestic capital owners find it easier to diversify RMB-denominated portfolios.

[p.lukasiak]

If you were China, and you had hundreds of billions of US dollars on hand, and the US was pressuring you to make those dollars worth a whole lot less -- and thus significantly reduce your wealth, what would you do?

Personally, I'd be spending/dumping those dollars as fast (and as surreptiously) as I could without creating a panic. Then, I'd create a panic by publicly dumping dollars as fast as I could, watch the US economy go into freefall, and revalue my currency once the damage had been done, and the US was no longer the premier economic power of the planet.

The bottom line is that if the current global economic system fails, China is in the best position to pick up the pieces and emerge as the leader of a new economic order----and China knows this.

[chris]

For guys, our President likes this talk, who know how to read body English the administration is really misreading the Chinese.

BUSINESS/FINANCIAL DESK | March 7, 2005, Monday

China Says It Won't Sell Dollars

By KEITH BRADSHER (NYT) 489 words
Late Edition - Final , Section C , Page 4 , Column 5

ABSTRACT - Guo Shuqing, official in charge of China's huge foreign currency reserves, says China has no plans to sell dollars; rules out any 'large scale' appreciation of China's yuan against dollar; seems to be addressing undercurrent of popular dismay in China over rapid accumulation of dollar-denominated assets even as dollar has weakened

And the Chinese premier said back off. They'll do that, revalue, in their own time.

Let's see who wins this negotiation. The Chinese win while stalling the game, there is no deadline so one of our President's favorite tactics stalling but with a deadline won't work.

[p.lukasiak]

ABSTRACT - Guo Shuqing, official in charge of China's huge foreign currency reserves, says China has no plans to sell dollars;

I wonder if China has "no plans to sell the dollar" in the same way that the Bush regime had "no plans to invade Iraq" in the spring of 2002.....

[Michael Robinson]

"I wonder if China has 'no plans to sell the dollar' in the same way that the Bush regime had 'no plans to invade Iraq' in the spring of 2002....."

Not quite the same thing. In this case "no plans to sell the dollar" may be perfectly true, but completely meaningless. The point at issue is whether China has plans to continue buying dollar-denominated instruments from U.S. financial markets fast enough to maintain the peg at the current rate indefinitely.

Or not.

[theCoach]

Echoing p.Lukasiak's comments about what the smart play for China is, and given the strange flexibility a state controlled economy like China has, aren't there some angles that fall outside of traditional macro scenarios?
I do not have the knowledge to figure them out, but if you were China what would you be doing?

[p.lukasiak]

" but if you were China what would you be doing?"

well, I would certainly be stoking nationalistic fervor in order to make the imposition of greater levels of authoritarian rule acceptable to the Chinese people -- kind of like what we see occurring with the protests against Japan that are being encouraged by the Chinese government....

[lise]

http://www.nytimes.com/2005/03/07/business/worldbusiness/07yuan.html?ex=1114056000&en=ae89ae8bc62987a9&ei=5070

This is the link to the New York Times article on China's wish to retain the currency peg.

[anne]

We must detach ourselves from an American vantage to an extent, especially so with regard to China and likely Asia in general. We have always had difficulty understanding China. There are 1.4 billion people in China. For most of the last century, economic development was terribly slow and there were repeated setbacks. By adopting increasingly broad market structures, and careful macro economic control, China is now on what appears to be a sustained rapid economic growth path that might continue for decades as she closes with well developed countries. However, market development has produced significant economic imbalances from rural to urban, in infrastructure, in social services, in income and wealth. China's leaders and advisers to leadership are aware of the imbalances, and the leadership is aware of instability that imbalance can bring in its wake. There is development, there is concern about stability. Which is the prime concern? Stability. Much of what the leadership is about is assuring a stable development process. We must look at the adoption of economic and political policy from this vantage. The currency peg of Yuan to dollar has helped foster astonishing growth but also stability. The Chinese central bank will always opt for stability, and consider the price of holding American debt small when this is achieved. Growth is so much the better, and growth there surely has been.

The peg will be changed, though likely when we least expect. I would guess a basket of currencies may replace the single currency peg. I would guess a stepwise increase in value of the Yuan. Remember, for a century as Brad DeLong writes economists did not find convergence in development and finally began to doubt it would happen. Certainly development models proved faulty again and again. Then, there is China and with China there is India and South Africa and Brazil. Speak with an African, and there is intense optimism about China as a model; if only.

China will have a currency reserve loss when the Yuan increases in value against the dollar. But, China will have a more valuable Yuan and China will have developed apace having weathered a currency crisis in 1998 and slowing international growth periods before and after 1998.

[anne]

http://www.nytimes.com/2005/04/18/business/worldbusiness/18shanghai.html?pagewanted=all&position=

Pushing (and Toeing) the Line in China
By DAVID BARBOZA

BEIJING - Hu Shuli, the most powerful business editor in China, used to write propaganda for Workers' Daily, the Communist Party's publication. Now Ms. Hu pushes an aggressive staff of 50 young journalists to investigate government corruption and lift the veil on corporate fraud in China.

Since 1998, Ms. Hu, 52, has been the driving force behind Caijing magazine, a thriving business journal published twice a month that is now a must-read in the capital. At a time when the state still holds tight control over the media, regularly censoring articles and closing down errant publications, Caijing (which means 'finance and economy') has artfully pushed the envelope on what is journalistically permissible, writing exposés on the government's reaction to severe acute respiratory syndrome, or SARS; stock market manipulation; and corruption at some of the nation's biggest state-owned banks.

'I know how to measure the boundary lines,' Ms. Hu said over lunch. 'We go up to the line - and we might even push it. But we never cross it.'

Caijing's aggressiveness, which has earned Ms. Hu the title of 'most dangerous woman in China' in several press articles and magazine profiles, is a result, in part, of its status as a business publication in China. While press freedoms are severely restricted here, the government - perhaps hoping to develop an open and robust capital market system - has given the business news outlets here greater latitude and broader press freedoms. And while Ms. Hu's glossy journal has carefully steered away from some political issues, like the Falun Gong movement, that the government has deemed largely off limits to the press, media specialists say that Caijing has become one of China's first noteworthy magazines built on Western journalism practices....

[Michael Robinson]

"...is a result, in part, of its status as a business publication in China."

Of course, it doesn't hurt that Caijing is owned by the Stock Exchange Executive Council. In China, moreso than almost anywhere else, it helps to have friends in high places.

[anne]

Michael Robinson.

Agreed. Relationship has been and is especially important among the Chinese, extending from the family and out as though ripples in a pond.

[anne]

http://www.nytimes.com/2005/04/19/business/worldbusiness/19energy.html?pagewanted=all&position=

The Great Engine of China Is Low on Fuel
By KEITH BRADSHER

GUANGZHOU, China - Service stations across China are starting to run short on diesel this spring, while electricity blackouts here in southeastern China are growing worse as power stations cut back on purchases of fuel oil.

For truckers and factory owners, the diesel and electricity shortages are a nuisance, sometimes a costly one. The Guangzhou Boaosi Appliance Company, which makes refrigerators here, is without electricity from the municipal grid four days a week, and just bought a costly generator last month to continue operating on diesel.

The diesel and power shortages have one thing in common: they are largely the result of the clash between China's Communist past and its increasingly capitalist present. The government has set retail prices too low for diesel and electricity. So businesses, facing high world oil prices, are supplying less of both.

Disruptions in Chinese markets for fuel oil, diesel and other oil products are causing ripples in global markets in turn, as traders and investors around the world struggle to interpret the effects on international oil supply and demand.

The puzzle for oil analysts is how Chinese households, factory owners and refinery managers will react when the government eventually liberalizes prices, which is expected in the next few weeks. Government officials have already announced that they will raise retail electricity prices for industrial users, although probably not homes, on May 1. An increase in diesel prices is also widely expected.

As buyers of everything from cotton pajamas to construction equipment gathered here from around the world Friday for the opening of the two-week Canton Trade Fair, the nearest Sinopec service station had signs on all its diesel pumps saying they were sold out of fuel, though the gasoline pumps were still flowing. A couple of trucks loitered nearby. In contrast, lines of trucks waiting for diesel have been reported at scattered service stations elsewhere in China over the last few days.

The Chinese government raised the regulated retail price of gasoline by 7 percent on March 23, to $1.66 a gallon. But it left diesel unchanged at $1.57 a gallon to avoid antagonizing farmers, who need a lot of diesel in their tractors for spring planting.

Speculators across China have responded by hoarding diesel in the expectation of a price increase after the planting, said Evan Jia, a spokesman for Sinopec, China's main refiner....

[anne]

http://economist.com/business/displayStory.cfm?story_id=3868539

April 14, 2005

China's people problem
From The Economist

CAN China—population 1.3 billion—really be running short of people? In many of the most important parts of its booming economy, the answer, increasingly, is yes. Though China has a vast pool of unskilled labour, firms in the south now complain that they cannot recruit enough cheap factory and manual workers. The market is even tighter for skilled labour. As the economy grows and moves into higher value-added work, the challenge of attracting and retaining staff is rising with the skill level, as demand outstrips supply. The result is escalating costs for firms operating in China. “If you think that China is a cheap place for labour, think again,” says Vincent Gauthier of Hewitt Associates, a human-resources consultancy....

Pay and benefits are soaring. A Chinese middle manager at a foreign company in Beijing or Shanghai can now command total annual cash compensation (salary plus bonus) of $27,000-$32,000, says Hewitt. Senior managers receive between $46,000 and $54,000 and top executives can expect $80,000 to $90,000 or more. While underlying inflation in China is around 2%, average annual salary increases for mid-level and senior managers are now 6-10%. Lai Kam-tong at the Hong Kong Institute of Human Resource Management says that accountants' salaries are rising by 14% a year. Jürgen Viethen, general manager for F&G China Electric, a small Spanish-owned electrical switchgear-maker, is offering key employees raises of up to 50%—and still losing them.

Bonuses, longer-term incentives, free housing and meals, a mobile phone and a set of wheels are becoming standard perks. More than one-third of 1,600 multinational firms surveyed by Hewitt now offer a company car. More holidays, maternity and paternity leave, more frequent job rotation and share options also now feature. Add in the big contributions that employers must make to China's national security fund system and the total cost of an employee can be double his basic pay....

[ChrisN]

We are all sadly misunderstanding the policy target. It's not about the economy. As we should all realise, the Bush administration is principally concerned with promoting democracy internationally, whatever the domestic cost.

If a drastic revaluation of the RMB doesn't by itself pull China's export growth rate down enough to get overall growth below the Non-accelerating Revolution Rate of Growth, then maybe causing the US economy to tank will push it over the edge. The Bush administration is on the side of the poor oppressed Chinese.

[DOR]

chris,
My point wasn’t that Brazil (et al) is an economic powerhouse. Rather, it was that US manufacturers aren’t going to reap the “benefits” of a Chinese revaluation.

Michael Robinson,
There may well be a foreign (albeit, illegal) element in the volume of investment going into Shanghai property, but I have serious questions about whether that would be sufficient in and of itself to explain the rapid run-up in prices.

trevelyan,
Changing Rmb into dollars is much easier than you think. It may involve a trip to Hong Kong, but it is very straight forward (unless, you’re thinking of millions rather than salary-based thousands).

p. lukasiak,
What to do with billions of dollars? Build domestic infrastructure. Of course, foreign exchange reserves are not the same as budget surpluses, so this really isn’t a straight “T-bills or highways” question.

As for your dump-dollars ploy, that would cause major disruptions to employment, lead to social unrest and likely result in you and all your closest friends doing a Romania-style retirement from power.
.

[chris]

Help. I need help understanding what these fabled foreign exchange reserves are. In the case of China these are U.S. dollar remittances used to pay for exports. So the dollars are earned by private enterprises then exchanged at the banks for RMB. Who controls the U. S. dollars at that point? Who actually owns them? What is this?

[chris]

DOR:

I understand that a depreciating U.S. currency isn't going to automatically convert into benefits for U. S. industry. I tried to make a related point here or elsewhere. When a factory shuts down the skills start to be lost. The older guys would be at the job site daily passing on experience to the newer workers. You can't take a 35 yr old mortgage broker and the next day make him the foreman at a sand casting factory.

Another example, if the U.S. wins some of the races to commercialize nanotechnology the production process for this will be fairly automated, I guess. Chances for employment will be limited beyond researchers and management. One of thse to be wonder materials will be a plastic like material. That stuff is going to be shipped in bulk to China to be turned into all sorts of consumer stuff. That's looking like limited higher profit/employment opportunities for a small set of Americans while the daily grind of producing stuff still will get done in China. In the meantime the Chinese are also working on developing nanotech but with the wild card that once succeessful foreign made materials are on the market, the Chinese will also be working overtime to re-engineer it.

Elsewhere one Indian has already proposed a plan to use their foreign reserves for bond collateral and use that money raised to build infrastructure. That man also raised the point of why invest that hardearned money in low yielding U.S. bonds when it would be much better used in poor India for roads and such.

[DOR]

chris,

Forex reserves are foreign currency funds (cash, bonds, etc) held by the central bank. They are no more “the central bank’s money” than my savings deposit is “the local bank’s money”.

For countries without a hard currency, forex reserves are needed for imports and other payments abroad. However, changing the foreign dollars earned (goods, services, income, transfers and investment) into local currency will boost the money supply and may well lead to unwanted inflation (a risk in my suggestion that China build infrastructure with the money). Moreover, if the regulations commit the financial authorities to allowing local currency to be changed into hard currency (either with conditions or freely), then the central bank will need to keep a reasonable amount of foreign currency on hand for such demand.

_ _ _

I tend to view different national economic activities by the amount of value added. Very broadly,
--dragging things out of the ground (agriculture, mining) is low on the list, followed by
--bashing the stuff into things people want (breakfast cereal, cars);
--moving the stuff around (transport, distribution, retailing);
--convincing people they really need the stuff (media, advertising, branding);
--financing the above activities (bank lending, leasing, stock markets);
--dreaming up new things to make (R&D);
--working some esoteric mathematical magic such that seeming to own something for a few seconds that is already promised to someone else has real value(derivatives); and finally
--explaining it all (economics and other religions) :-)

Not a perfect list, and I’m open to suggestions on how to make it better.

_ _ _

If an economy remains stuck in a lower level of adding value -– say, African agriculture and mining countries -– it runs a risk of being bypassed by economies that move up the scale. The risk isn’t that they can’t continue to do what they’re doing (although mining is finite), but that the price they get for what they sell will deteriorate in comparison to what they buy (terms of trade). In management-speak, “up or out”.

America made garments in the 19th century, and we’re still making garments (OK, better ones). That segment of our economy hasn’t moved on sufficiently such that what the companies / workers do earns the money they need for what they want to buy (or, pays a decent ROI).

Solution: stop doing that and do something more value adding (this adjustment is necessary, but can be painful).

One result is that the economy loses the skills that used to be valuable enough to want to have. That is a price of progress (Tom Peters said, “All economic progression is a matter of moving up the ‘value-added chain’.”) Move it (your skills) or lose it (your standard of living).

More: The further down the value-adding chain an economy, the more likely it is to be damaging the environment and its citizens’ health. Getting someone else to do the “dirty, dangerous and disgusting” work adds value to the entire nation’s society. NIMBY.
.

[chris]

DOR:

thanks your reply. Good list. I might change explain to teach. All the gerunds are pretty active till you come to the derivatives. Maybe that belongs to the financing/banking group or maybe that area is suspect. We can watch the next couple of years to see whether Morgan/Chase blows up when their derivative book juggles when they expected it to jiggle.

I'm stuck thinking we need an active bashing segment. In the U.S. we're in the stage of of convincing and higher, but the number of Americans that can fit into these areas and earn from overseas is limited. While I understand the economic progression, I'm stuck with believing that we still have to have an active bashing segment of the economy. It helps to earn foreign exchange. One side bar topic of our difficulty is the stuff that we can export is all easily copyable, software, movies, music. What else, airplanes-tough sell, military equipment-well, leave that one alone.

[Michael Robinson]

"There may well be a foreign (albeit, illegal) element in the volume of investment going into Shanghai property, but I have serious questions about whether that would be sufficient in and of itself to explain the rapid run-up in prices."

Illegal? Not in the least.

There are nearly 1 million Taiwanese living in the vicinity of Shanghai, and hundreds of thousands of other foreign nationals. Almost the entirety of the "rapid run-up" is in those (relatively few) developments that cater to foreigners and wealthy Chinese.

[chris]

I'm not sure about 1 mil Taiwanese in the Shanghai area alone, 200,000 and higher, yes. That, overseas Chinese, would be where a lot of the hot money gambling on apartment appreication would be coming from. My brother-in-law works for a construction company that put up a few buildings there. He never mentioned buying one as a risk investment. Now his company is back building in Taiwan in a sign of common sense.

This is getting anecdotal. There was an American in Taiwan 14 years ago that through his father's connections got an agreement from Snapple and Gatorade to import their drinks into Taiwan. Snapple was pop then. Gatorade seemed to be the better opportunity. Neither drink did well, lots of local drinks almost the same available for like a dime less a bottle in the 7-11 fridge. Gatorade wanted to control its own distribution so after some legal trussles the American got $900,000. This all worked out through the 90s. He took that money and recently bought an apartment in Shanghai as an investment but he also gets the bragging rights of talking in front of other Yanks about the investment, and a nest to bring women home to. I think that guy is going to enjoy the Shanghai price decline. There's about a decade lag between the built apartments sale prices and what a great number of local Shanghainese can afford.

[DOR]

chris,

Metal bashing can indeed help earn foreign exchange, which is useful if you are not the single economy with the default currency. There are other ways to earn from exports, too, such as licensing. Decent global intellectual property protection would go a long ways toward rebalancing the current-account.

Michael Robinson,

Correct me if I’m wrong, but foreigners are not allowed to own residential property in China. The deals are being done through local middle-men (sometimes family members, in the case of overseas Chinese), to skirt the law.
.

[chris]

DOR:

Licensing will be good for individual corporate profitability. It isn't good for broadening employment. It's also the first step in the re-engineering process as it teaches potential competitors what you can do, they retrace your footsteps through the snow or prod themselves to develop the next thing before the company holding the license so they don't have to pay no stinking royalties.

Saw your note on foreign Asian bank buying of treasuries suppressing rates on the other thread. Yes, that is the question.

[TraderBrian]

The relationship between the US and China is far reaching and complex. To assume that Bush, Congress or any other entity is going to "Get Tough" on a particular matter, especially one such as this with all its far-reaching effects is an over-simplification. That's not taking into account all the behind the scenes issues between the two countries.