from Follow the Money

China linkfest

August 1, 2009

Blog Post
Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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Qing Wang of Morgan Stanley: "Given China’s high national savings rate, from the perspective of the economy as a whole, there are only three forms in which China can deploy its savings: 1) onshore physical assets; 2) offshore physical assets; and 3) offshore financial assets. .... We therefore think that from the perspective of the economy as a whole, the opportunity cost of domestic fixed asset investment, or formation of physical assets onshore, should be the total returns on US government bonds. Put in simple terms, in the debate about over-investment at the current juncture, it actually boils down to an investment decision on building railways in China versus buying US government bonds, given China’s high national savings.

David Pilling: "Far from a sign of strength, Beijing’s accumulation of vast foreign reserves is the side-effect of an economic model too reliant on exports. The enormous trade surplus is the product of an undervalued renminbi that has allowed others to consume Chinese goods at the expense of Chinese people themselves. Beijing cannot dream of selling down its Treasury holdings without triggering the very dollar collapse it purports to dread. Nor are its shrill calls for the US to close its twin deficits – which would inevitably involve buying fewer Chinese goods – entirely convincing. Rather than exposing the superiority of China’s state-led model, the global financial crisis has laid bare the compromising embrace in which the US and China find themselves. "

Peter Garnham touches on similar themes for the FT.

Philip Bowring on the obstacles (mostly self-created) to internationalizing the renminbi: "China’s expressions of desire to reduce the role of the dollar are anyway contradicted by its actual policy of maintaining a de facto peg to the U.S. currency, meanwhile continuing to accumulate dollars in reserves now totaling $2 trillion. The modest yuan appreciation after 2005 came to a halt more than a year ago as China has sought to sustain exports in the face of the global slump. There is conflict between macro-economic stabilization goals and pressures from industries and employment creation not to put more pressure on exporters. ... Nor has there been any significant move towards full convertibility as the financial crisis has, with good reason, made the authorities nervous of liberalization .... any significant use of yuan requires and significant offshore stock of the currency. That is incompatible with China’s expressed desire to reduce its dollar reserve dependence."

Robert Pozen on the limits of the SDR.

Michael Pettis on his blog and in the Financial Times: " If the Chinese economy was the biggest beneficiary of excess US consumption growth, it is likely also to be the biggest victim of a rising US savings rate. ... Eventually, and maybe this is already happening, the decline in the US trade deficit must result in a decline in China’s ability to export the difference between its growth in production and consumption. When this happens, China’s economy will grow more slowly than Chinese consumption, just as the opposite is happening in the US. Put another way, rather than act as the lower constraint for GDP growth as it has for the past two decades growth in Chinese consumption will become the upper constraint, as for the next several years Chinese consumption necessarily rises as a share of GDP, just as US consumption must decline as a share of US GDP.

And Paul Cavey on China’s credit boom -- which clearly jump-started China’s economy in the second quarter.

The Economist on China’s low level of consumption.

Additional recommendations welcome.

Update, based on the suggestions in the comments:

Lardy and Goldstein on China’s exchange rate regime.

And John Makin’s evaluation of the risks associated with China’s stimulus program. Makin and Pettis don’t seem all that far apart: Both worry about efforts to support production in anticipation of future demand, and worry about the impact of rapid money and credit growth of China’s long-run economic health.

Free exchange claims that many things you know about China are wrong, specifically arguing against the notion "China depresses domestic demand to boost its exports" as Paul Cavey forecasts that "China’s current-account surplus will fall to under 6% of GDP this year and 4% in 2010, down from a peak of 11% in 2007. Exports amounted to 35% of GDP in 2007; this year ... that ratio will drop to 24.5%." There are other forecasts that suggest a smaller fall in China’s surplus (it is down in q2 09 v q2 08, but is still running at roughly the same level as in 2008 in nominal dollar terms), but projecting some fall in China’s surplus isn’t unreasonable in a "rebalancing world."

Let’s be clear here though. No one is arguing that China is currently limits domestic demand to support its exports; China is currently stimulating domestic demand. The question is whether or not Chinese policy makers took steps to depress domestic demand back when net exports were contributing 2 percentage points or more to growth, bring China’s surplus up to that 2007 peak. And on that point, I don’t think there is much room for debate. Fiscal policy was tight -- look at the data on the central government’s fiscal balance from 2004 to 2007, and the large deposits that the government built up over this time. More importantly, after 2003, the government reigned in bank lending with administrative limits on loan growth and high reserve requirements. As a result -- according to the IMF data -- China entered into this crisis with one of the lowest loan to deposit ratios in the emerging world. That, in turn, gave China greater capacity to stimulate than most, as it could simple take its foot off the brakes it was applying to the banking system.

China is not currently suppressing domestic demand. But back when exports were booming China opted to limit inflationary pressures with a range of policies to limit domestic demand growth rather than allowing currency appreciation (yes, the RMB appreciated v the dollar after 2005, but that appreciation came when the dollar was generally depreciating v many currencies). Look back at China’s policy choices back in 2003/04, when a lending boom threatened to produce a sustained rise in inflation. There is a reason why China’s import growth didn’t keep pace with China’s export growth from the end of 2003 to the end of 2006. See the data in this post; there is a clear dip in import growth in 2004, one that coincides with China’s decision to limit bank lending.

I agree though with other argument that Free exchange (drawing on the Economists’ coverage of China) makes, namely that China’s export boom was capital rather than labor intensive, and didn’t generate all that many jobs. That is one reason why labor income slid relative to GDP during China’s boom.

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