from Follow the Money

A strange way to go about rebalancing China’s economy…

March 19, 2007

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China now exports more than it imports – a lot more.   Even most American economist are starting to recognize that the “China runs a surplus with the US but its overall trade is balanced” argument is now a bit dated.

China does import a lot planes.   Aviation is one area where the Chinese concede the US might have a competitive advantage even at current exchange rates. So importing more American and European planes is one way China might chip into its surplus. 

Or maybe not.   The government of China has decided to create a Chinese airbus – a state company to make big planes to compete with Boeing and Europe’s own Airbus.

China's long-term ambitions to produce large planes won’t immediately affect  Boeing's sales, let alone the trade balance.  It will likely take China 15 to 20 years to learn how to make large planes.   

Indeeed, that it what makes the politics of this interesting.   Neither Boeing nor Airbus (or their workers) really wants a third participant in the market, and certainly not one with access to the deep pockets of China's government.  Airbus gets some state aid, but it is currently handicapped by the strong euro. China state firms … well ... aren't exactly handicapped by a strong currency. 

At the same time, China is expected to spend a lot of money buying planes over the next 15-20 years.  Richard McGregor

The European group's latest forecast places China second behind only the US in both the number and value of jets needed between 2006 and 2025, with a market for 2929 large aircraft worth $US349 billion ($439 billion).

I think most Chinese airlines are state-owned and the airlines need the government’s permission to import planes.    Complaining about China’s long-term plans, consequently, risks losing short-term sales … 

And in a way, responding to concerns about China's trade surplus by taking a policy decision to increase Chinese production of something China now imports is a potential metaphor for China's broader macroeconomic policy choices.

China has taken a set of macroeconomic policy measures that seem – at least to me – unlikely to help rebalance China’s growth and slow the expansion of Chinese exports.   Remember, China export growth surged in January and February.   The surge was so large that I half thought that it represented disguised capital inflows. And it may well be.   But Jon Anderson of UBS reports that the most likely explanation for the surge in industrial production is the surge in China’s exports -- and also has data showing that the growth in overall exports tracks with an increase in outbound container traffic.   Both suggests that maybe the rise was real.

What has China done in response?  

Well, the pace of RMB appreciation seems to have slowed a bit over the past couple of month.   China presumably doesn’t want to make the RMB even more of a one way bet.    And China has taken new steps to curb domestic demand growth by curbing investment, including the recent interest rate hike.   If that works, it should increase the trade surplus, not reduce it …   Huang Yiping of Citi

``It's difficult to reduce both investment and the trade surplus … You can do one but you'll see a rebound in the other.''

And with lending growth running well ahead of the government’s targets --  Bloomberg reports that yuan loans grew 17.2 percent y/y in February, and that January February new lending of 981 billion yuan ($127 billion) was almost a third of the government’s target for all of 2006 – additional administrative curbs on lending are likely.   The banks are flush with cash … so their ability to lend even more isn’t in question.

This is a script that we have seen before.    China tried to cool the economy in 2004 and again in early 2006 by raising rates (a bit – they still remain well below the growth in nominal GDP) and tightening lending while opting not to allow the RMB to move much.

The result, as Martin Wolf has noted, was a rise in the trade surplus and an economy that ended up relying more, not less, on exports for growth.   The weak RMB stimulated the export sector, and China kept the overall economy from overheating by using government policy to restrain the rest of the economy.    Menzie Chinn asks -- quite rightly -- which the Chinese governments prefers more exports to more domestic investment.

That may be happening again.

It isn’t clear that holding the line on the RMB will be enough to keep capital from flowing into China (or to encourage Chinese savers to move their funds out) either.   With Chinese deposit rates now close to 3% (2.79%) and US rates –judging from market expectations – more likely to fall than rise, the pace of RMB appreciation would have to be really slow indeed to make holding dollars more attractive than holding RMB. 

And most analysts are still expecting a 4 to 6% apprecation of the RMB -- if not more – move in the RMB for the year.  3% + 4% = 7%.   That tops 5.25%.  3% + 6% really tops 5.25%.

Bottom line: I am not sure that China’s current policy mix will allow the Chinese government to achieve its stated objectives.

Update: Check out Dr. Roach's take on recent developments in China.   He argues that China's leadership recognizes that its current policy mix hasn't worked -- growth is strong, but the composition of growth isn't what the leadership wants.  And he suggests that China's leadership is now really is intent on changing its growth model.  Among other things, he hints -- based on his most recent conversation with Chinese officials -- that q1 reserve growth has been very, very strong.   Hat tip, Gamma.

Update 2: Menzie Chinn is also worth reading.  He puts Chinese policy decisions in theoretical context -- and asks why the Chinese government thinks a yuan of export demand generates more jobs than a yuan of domestic investment.  With Chinese policy restraining domestic investment to keep export demand from generating too much growth ("overheating") that is a very fair question.   Menzie Chinn also found a link to a press report highlighting Jon Anderson's argument that the RMB's recent stall might be setting the stage for a big one-off jump later in the year.   Interesting.   That is the first I have heard anyone other than Dr. Roubini hint that a big one-off revaluation is under serious consideration.   And I suspect Jon Anderson talks to more folks close to the Chinese government than Dr. Roubini!

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