from Follow the Money

Variations on 7.99

July 6, 2006

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

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7.992

7.9955

7.996

Anyone detect a pattern?    China’s de facto dollar peg seems to be around 7.99.

At least for now. 

I haven’t written much about China recently because nothing much seems to change.

The exchange rate for one.   Or Chinese interest rates.  Or the pace of Chinese export growth.  Or the possibility that China is investing too much.  Or the certainty that China’s banks are sitting on pile of cash that the central bank would rather they not lend out – at least not all once. 

Or for that matter, the intellectual debate.

Steven Roach still doesn’t think China’s policy of resisting pressure for RMB appreciation from both China’s rising current account surplus and from large ongoing capital inflows has anything to do with the United States current account deficit.   

I – and I suspect some others -- still don’t quite see how the US would be able to save so little if China (and the oil exporters – Russia and Saudi Arabia probably added $140b to their reserves in the first half of the year) weren’t willing to lend the US so much. 

Particularly since they lend to the US on relatively favorable terms.  Ever checked out what Turkey and Iceland now have to pay to convince folks to finance their current account deficits? 

The Economist – perhaps listening to Roach, perhaps to Stiglitz, or perhaps to McKinnon -- thinks that the RMB isn’t really undervalued, and the US should just stop complaining.   

Unlike the much more illustrious set of economists defending the RMB’s peg, I still don’t quite see what caused the enormous acceleration in the pace of Chinese export growth (and industrial production growth) in 2002 if not the RMB’s depreciation against a range of currencies (Need a visual: look at the chart comparing Chinese and US goods exports at the end of this article).   If you haven’t noticed, the RMB is a lot weaker v. euro now than it was then.    Our friends over at the Economist just seem to think that the RMB’s deprecation against the euro and pound didn’t have any thing to do with the surge in China’s bilateral trade surplus with Europe.  It went from 32b euros in 2002 to 79b euros in the last twelve months – largely because Europe’s imports from China doubled (the data is here).    I am not convinced. 

There does seem to be one point of growing consensus:  China isn’t just exporting low-tech goods anymore.   I hope this soon leads to a recognition that Chinese value-added is growing.   China must be generating enough domestic value-added out of its export sector to pay for its rapidly rising commodity bill – and still run a big current account surplus.  And a lot of the studies showing that China does little more than assemble imported components without adding much value used data through 2002.  And China’s exports have tripled since 2002.  Things change fast with 30% y/y growth.

Incidentally, the Economist might not want to continue to use the RMB’s broad appreciation in 2005 as an example of why the RMB isn’t undervalued.  The trend kind of changed this year.   And 2005 came after 2002, 2003 and 2004 … 

These debates though don’t matter half as much as the internal debate in China.  But I am not sure much is changing there either.

Yu Yongding – an academic on China’s monetary policy committee -- continues to argue that the primary goal of Chinese monetary policy shouldn’t be keeping domestic interest rates below US interest rates in order to try to deter hot money inflows into China and thus limit the pace of reserve growth.  Given the difficulties with sterilization, rapid reserve growth often translates into rapid deposit and rapid lending growth.  Reuters:

Yu also said the government needed to tighten monetary policy to rein in excess liquidity and runaway fixed-asset investment growth, which accounted for 48.6 percent of GDP.

"Fixed-asset investment is growing well above that of GDP and this is not sustainable," he said. "Therefore, we must tighten monetary policy."

But Yu said China might have to tread cautiously in raising interest rates due to concerns about the impact on the yuan.

Yu is also worried about the enormous stock of short-term sterilization bonds the PBoC now has to roll over every few months.   He certainly understands interest rate risk.

Yet judging from the multiple variants of 7.99 that the PBoC has tested of late (note the irony), Yu doesn’t seem to be winning the internal debate in the PBoC.  Or perhaps the PBoC isn’t driving the debate in the State Council.        

Consequently, neither the interest rate – at least not the deposit rate -- or exchange rate are available tools for Chinese macroeconomic stabilization.   

Leaving China’s authorities dependent on a host of non-market tools – lending limits and the like. 

Roach nailed this.   China isn’t a market economy.  Not really.   At least not yet.   And it isn’t necessarily moving in the direction of relying more on market methods of macroeconomic management.   At least not yet.  

True market economies do more than supply global firms with cheap labor (and cheap land). 

And, as Roach notes, the growing power of the old planning commission is a bit at odds with the China bastion of market reforms story. 

In a market-based system, these problems could be tackled through a combination of monetary tightening and currency appreciation.  Considering the unprecedented excesses of investment and exports -- two sectors that collectively account for more than 75% of Chinese GDP and are still growing at a 30% y-o-y rate -- China has taken only baby steps in this direction.  Since 2004, there have been two modest 27 bp increases in short-term lending rates and a tightly controlled 3% revaluation of the RMB versus the dollar.  Instead, the heavy lifting on the policy front has been done by the modern-day counterpart of the old Chinese central planning administration -- the National Development and Reform Commission (NDRC).  Under the leadership of Chairman Ma Kai, the NDRC has emerged as China’s most powerful policy authority -- taking a series of targeted administrative actions aimed at restricting investments in a number of overheated sectors. 

If only Roach would reconsider his position on the RMB …

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