The government was actively buying stocks today and as a result, not surprisingly, the market surged on hopes that they are serious about putting an end to the bear market. After declining yesterday by 0.3%, the SSE Composite jumped 76 points today to close the day at its high of 1965, up 4.0%. Central Huijin, a subsidiary of the CIC, increased its stake in China Construction Bank, as it said it would do last September. If this is sustained, it may help relieve a little of the gloom, but it is not clear to me that the rally has stronger legs than previous government-inspired rallies.
More interestingly, the dollar market today was acting strangely. Since late yesterday there have been no bid-offers on dollars, until the PBoC came in late in the day to sell dollars (the PBoC is normally a buyer of dollars). This suggests that capital outflows, at least for this week, have outpaced current account inflows, although we don’t want to read too much into this as of yet. January’s 4th Quarter PBoC numbers should prove very interesting as we wade through the increasingly difficult-to-interpret numbers to estimate hot money behavior.
As far as I can piece together today’s currency-market activity from conversations with some of my former students, now trading, and my friend Logan Wright, at Stone & McCarthy, the market has been very short of dollars in recent days as corporations over the past three days have been net buyers from banks. Since banks are not allowed to be net short, there were rumors that they had reached their dollar limits yesterday and were refusing to post prices for fear of being lifted.
Why have corporations been buying dollars? Part of the reason seems to be the NDFs in Singapore are pricing in a depreciation of the RMB, and corporations who can get around the capital control rules are finding it profitable to buy dollars in China and sell them in the NDF market. This is a great arbitrage if you can do it. But part of it may simply reflect the fact that talk of currency depreciation has increased in recent weeks, and until today the RMB has been depreciating. Today the central parity appreciated by 0.0025 to 6.8501, although the RMB closed the day at the weak end of the 0.5% band.
It is not irrelevant that Secretary Paulson will be here tomorrow for two days as part of the Strategic Economic Dialogue. His call for a stronger RMB yesterday signals that the currency is still likely to be at the heart of the debate. There has been more and more talk over the past few days about the possibility of RMB depreciation, and of course President Hu’s comments on Sunday about China losing its competitive edge strengthened the talk, but until there has been no real reason to think that there has been a policy shift.
Still, the possibility that pro-depreciation constituencies in China may yet gain the upper hand in the debate is very worrying. At first depreciation might seem like an obvious policy move – if export growth is slowing, and if unemployment pressures are rising, why not engineer demand expansion by increasing foreign demand for Chinese goods? After all, the outlook is increasingly grim. A “Blue Paper” by the prestigious Chinese academy of Social Science forecast GDP growth for next year at 9.3% – insanely optimistic, I think – but they did list some of the problems facing China. According to today’s Xinhua:
The Blue Paper also notes that housing prices will fall dramatically in a short period of time, and subsequently enter a rather long adjustment period in 2009. Economists from CASS believe the real estate industry will be bogged down throughout 2009 as demand weakens under high prices and the global financial crisis. Homebuyers and investors will be more prudent in their activities. Suppliers will also experience a chilly season next year as some small and medium-sized enterprises with limited capital are forced to leave the market.
Risks will increase as some homebuyers become unable to pay their mortgages and some builders will not be able to pay workers to complete projects. On the country’s employment front, the Paper adds that one million college graduates will be unable to find jobs by the end of 2008, a problem that will be exacerbated when more people may lose their jobs in 2009 as more than five million new graduates begin seeking employment the same year.
But remember that Chinese overcapacity is part of the global problem, and as interesting as they may seem at first, capacity-boosting measures only make the global imbalance worse. Yesterday Vice Premier Wang Qing made a speech on the subject in which he both called for consumption enhancing moves as well as export-enhancing moves. An article in Xinhua reported:
Chinese Vice Premier Wang Qishan has called for more concrete measures to tap China’s domestic consumption potential to sustain economic growth. External demand for Chinese goods has fallen markedly amid the global financial crisis, while domestic consumption power also fell, Wang told recent meetings on foreign and domestic trade.
…The vice premier urged a reduction of burdens for businesses, help for them in getting finance and promotion of mergers and acquisitions. He also called for more measures to optimize the export structure and explore new markets to offset the negative impact on the export sector of the global economic slowdown
That last paragraph worries me if it indicates the direction of policy. I really do believe that we are on the brink of a very ugly period for trade relations, and anyone in China who thinks that trade conflicts will not be devastating for China does not understand China’s role within the global balance of payments. This is not the time to try to strengthen exports at the expense of trading partners without a significantly larger increase in imports.
On that note, the EU Observer had the following piece earlier this week:
EU-China relations usually revolve around trade, with the EU buying €231 billion worth of goods from China last year and exporting €72 billion in return. But human rights concerns came to the fore during the Beijing Olympics, when scores of EU leaders stayed away from the opening ceremony after Chinese troops shot Tibetan protestors.
China is also unhappy that the EU continues to uphold an arms export embargo dating back to the 1989 Tiananmen square massacre. The latest summit and death penalty row could play into the hands of European leaders keen to restrict the flow of Chinese imports during the EU’s economic downturn, experts warn.
“Protectionist sentiment toward China in Europe has been growing for a while,” Center for European Reform analyst Katinka Barysch wrote in the Wall Street Journal. “Anti-China sentiment is on the rise in Germany …Even in traditionally liberal Britain, people who see China as an economic threat outnumber those who see it as an opportunity by four to one.’
The meetings between the Dalai Lama and European leaders is once again inflaming passions both in China and in Europe, and this is not the kind of atmosphere in which trade disputes are easy to resolve. There is (yet again) a movement afoot in China to boycott French goods, but I am not sure countries running large current account surpluses should be talking about boycotting countries who are running deficits with them.
This kind of talk can easily backfire. An interruption of the trade relationship between the two countries is actually likely at the macro level to be good for France in the short term (or, in what amounts to the same thing, it is easy enough politically to make the argument), and bad for China in both the short and long term. Remember, for France any interruption of international trade means they need to increase production to meet domestic demand. That means hiring workers. For China it means reducing its ability to export overcapacity, and this usually means closing down factories. I know, I know, France is not necessarily likely to produce at home what China sells, but in this world, finding a new supplier is a lot easier than finding a new customer.
At any rate this evening rumors have been swirling through the markets that November’s exports have declined year on year by 7%. One of my former students, now a currency trader in Shanghai, just told me this. I have no idea if it is true, but it gives a sense of how nervous markets are.
If i am not mistaken, many chinese companies had been loading up on US dollar debt, in anticipation of a stronger CNY and thus lower debt costs. With the NDF’s now pointing the other way, these banks may be trying to unload their dollar debt in order to avoid getting hit by FX-related rises in interest or principal.
Any thoughts?
Whenever there’s a collapse of demand for exports, countries with pegged or managed float exchange rate regimes try to defend the local currency. Usually this does not work for long; finally you see that the currency collapses. Despite various commentators’ view that the defense of the local currency does not work, most countries continue with that policy.
Rather than assume this behavior to be either bureaucratic or shortsighted I would tend to think that the focus of the central bank is typically on maintaining a high level of foreign exchange rate reserves. While defending the currency in the face of reduced exports might reduce the competitiveness of exports, it does help to reduce the drain of Forex reserves towards import payments.
On the other hand China’s decision to further devalue the RMB against the USD in the face of decreasing exports might very well indicate that they are abandoning the policy to accumulate foreign exchange reserves denominated in dollars. My thinking is that while the devaluation will sustain current employment levels it will cause a drain of Forex reserves through increased dollar value of imports.
Even today the credit-default swap premium on US Treasury Notes has gone up, indicating increasing global market perceptions of a default risk on the US Treasury.
In the light of China’s bilateral free trade agreements with various countries in South America, Africa, etc and in the light of better ability to sustain petroleum supplies from Kazakhstan, Myanmar and Siberia, it would be interesting to know if China is in a situation to sustain imports and exports at reasonable levels if the dollar reserves are completely drained.
It would be extremely useful if you could analyze factors related to fall in import volumes, such as recent falls in hard wood log imports; and China’s overall import levels; to see if positive accretions to the current account balance will continue.
Either the devaluation leads to a better trade balance on account of decreased volume of imports; or it leads to a steady drain of USD reserves even as current employment levels are sustained.
The latter would indicate an imminent collapse of the US dollar according to me, followed by a default on Treasury Notes. This would also explain increased market perceptions of credit risk on the US Treasury.
I said before that RMB would gradually depreciate. For 2 reasons: China would just print more money to meet the fiscal demand; Hot money would flow out when economy goes down.
I am not sure that the boycott talk is serious. Thus, it is kind of wasting time to talk about it as if it is real.
There are a million different theories for what is going on right now. The basic facts are that the PBOC fixed USD/CNY a little higher on Monday (6.8507 vs a tight range around 6.82 ish in the past month, though a large range that goes a bit higher than 6.85 since the change in policy over the summer), and this the market took as a signal of depreciation, which caused spot to be bid up big-time (and the NDFs to surge as well). Tuesday and Wednesday the spot market spent large periods of time bid limit up, at the top end of the daily +/- .5% band from the fix, and, a bit strangely, the PBOC did not come in to sell at all. Prior to this everyone assumed if the currency got to the top the PBOC would be there on the offer for $2 Trillion, but this caught the market by surprise. I heard a trader called up the PBOC and asked them if they would be selling, to which they said “no”…one theory being that they wanted to prevent the arbs from buying onshore USD/CNY forwards versus selling the NDFs. However this just creates more panic. At the end of the day the PBOC ended up coming in and selling in small size.
Frankly, no one really knows what the hell is going on and the execution by the authorities of whatever it is that has been going on has been amateur. Some think it is simply China gaining flexibility and sending a signal to prevent pressure from the US at the SED starting tomorrow. You know, the often made statement “China’s currency policy is a sovereign issue”…which obviously is a ridiculous assertion given that the USD/CNY fx rate is the relationship between two currencies and by that logic at least as much of a US “sovereign issue” as it is for China. Along these lines, another theory is that China is sending the US a message that they like the SED as a forum to address trade issues, a signal to Obama that they want it to continue, as he hasn’t committed yet to it.
More people though are calling for a period of gradual fx depreciation. It may simply be too much for the rebalancing faction. On the other hand, there have been unattributed statements on news wires (in particular Market News International, which seems to always have an “in” in China) from such agencies as the NDRC resisting currency depreciation and saying internally there is widespread opposition to it. Another theory is that China wants to get in a little currency depreciation before Obama comes in, who is expected to take a harder line on the issue.
Another theory which has been supported by some statments from officials is that USD/CNY is now going up a little since EUR has gone down so much and China needs to adjust to that due to the rising NEER etc. Nevermind that USD/CNY was hardly adjusted directly in line with EUR on the way up since early in the decade.
One other interesting theory is that China is about to widen the trading band from +/- .5% to something like +/- 1.5%.
A week or two ago I had heard that the PBOC called a meeting for onshore spot traders asking them what they thought the evolution of USD/CNY would and should look like over the next six months to a year. Apparently the consensus was actually that USD/CNY should be stable for awhile and they eventually go lower mildly. To me this is actually one of the better outcomes for the world if it were to happen, but it looks like the market may be ignored.
Needless to say, this could all end up evolving in a messy fashion. Given we’ve seen three consecutive record trade surpluses, and despite all the complaining China actually seems to be seeing a positive terms-of-trade “shock”, the US and EU can hardly be expected to support FX depreciation. It’s probably safe to say that whatever is going on in China is not the product of any sort of grand strategy but rather a hodge-podge of factions fighting it out.
I agree with you- a messy trade war full of misunderstandings and conflicting signals is becoming more and more likely.
Also, let’s not forget that steady, non-random currency depreciation has it’s own pitfalls, such as encouraging capital outflows as you’ve mentioned above. I think it’s a big mistake even from China’s perspective to depreciate the currency. It’s just a stupid risk to take. From the internal point of view I would argue they should just put in place more export tax rebates. However, old habits die very hard especially when the stakes for keeping your job (or, from the Communist Party’s perspective, “social stability”) are high and the pressure is on.
Pettis: Why have corporations been buying dollars?
I suspect that a lot of corporations have over the last few years been speculating on a RMB appreciation in various clever ways borrowing short-term liquid US dollars and lending long-term illiquid RMB. Now that those bets are going bad in a big way, there is probably a frantic effort to get dollars to cover their loans.
As far as trade goes, one thing that keeps things from going into a total trade war is that WTO rules limit everyone can do, and thus far no one has suggested doing anything that violates those rules.
Lcccheh and Twofish, there was an explosion of USD borrowing in China in the last year, but I believe a lot of it was done to get around bank loan caps. Since the loan caps applied only to RMB loans, banks made USD loans and swapped them back into RMB. For the corporation these were really RMB loans, but for banks they could be treated as USD loans and so held outside the loan caps. Certainly anyone who could be short dollars was short dollars, so with rising uncertainty about RMB depreciation, they are probably now trying to close out dollar positions.
Global chessboard, I don’t think depreciating the RMB will cause imports to surge. It is the opposite. Imports would probably decline because foreign goods will become more expensive. Generally speaking currency devaluations lead to increase, not decrease, in the trade surplus. As far as “an imminent collapse of the US dollar according to me, followed by a default on Treasury Notes,” I think both are so unlikely as to leave me completely puzzled why so this is so widely discussed on the blogosphere. The dollar cannot decline without something else rising. Since Japan and Europe are more indebted and growing more slowly than the US, I assume you don’t think it is the euro or the yen that will surge. And since you are arguing that this will be precipitated by RMB depreciation, then obviously the dollar cannot collapse against the RMB. So against what will the dollar collapse? The Mexican peso? The Russian ruble? As for a default on US Treasury bills, I mean no disrespect but this is total nonsense. In spite of all the overexcited talk about default (an inevitable partner of every crisis, it seems) the US government has no external debt, less domestic debt than many other rich countries (less than half as a share of GDP than Japan, for example), and only a small portion of its domestic debt is owned by foreigners – most is owned by Americans. Interest rates are low and it has no trouble borrowing. Why would it default, when in a pinch it can monetize if it needs to? Especially why would it default following a collapse of the dollar? That would boost production and tax revenues and reduce the need for fiscal spending.
Fatbrick, I think that unless the rational can regain control of policy China will depreciate for a different reason. It believes it should do so to regain export competitiveness. This is a huge policy mistake.
SharpeMinde, we are all watching with bated breath. This has the feel of a slow-motion train-wreck. Next year we run the risk of a real mess as the crisis migrates from the current account deficit countries to the current account surplus countries. We saw this after the 1873 crisis and the 1929-31 crisis. I suspect we will see it again.
If the Chinese want to exchange real capital goods (not for consumption anymore, but for the purpose of rebuilding US’s aging infrastructure), against green paper that will strongly depreciate in real terms, the US should be fine with that.
What the US would not like, is that the Chinese, instead of being invested in overvalued US bonds, want to get REAL assets in the US (such as the newly built bridges, motorways, power grids,etc… or the companies that own them). Expect the modern version of Smooth-Hawley not to be about trade (which is made difficult by WTO rules) but about investments : if the US becomes the only borrower in town, it can decide who it will allocate the assets to, it won’t be a market any more.
What is amazing is that each side seems to think it is going to trick the other one. At some point, it is going to end in tears.
Very good post that clarify the situation.
WHEN A GOVERNMENT WANTS AN EFFECTIVE DEVALUATION, IT DOES NOT ANNOUNCE IT BEFOREHAND… And this is clearly what happened here.
Why? Because once you – government – start talking down the currency, it it of course mechanically down.
Did they wanted to prove why the currency depreciation was needed? Only fools would call this kind of outflow market-driven ones anyway…
can the US just start accepting yuan when china imports US goods? Does payment have to be converted into dollars?
Charles Monneron, there already is a kind of Smoot-Hawley out there, and it’s been in effect for many years. It’s called USD/CNY. The WTO has even come out against the PBOC’s undervaluation of the yuan.
Why is all talk about protectionism always worrying about what the US government will do? China has been one of the most protectionist countries in the world, what with its endless export tax rebates, its closed capital account (at least to foreign institutions), its disallowing of foreigners to take stakes in Chinese banks, its policy of often forcing foreign companies to create JVs with locals instead of just starting a local subsidiary, numerous hoops foreign corporations need to jump through when doing business, and, above all, its massive currency manipulation and reserve accumulation, one of the ultimate causes of this global crisis in the first place.
If we want to talk about hypocrisy, I would again point to the often made statement in China that “China’s currency is a sovereign issue and the US should respect this.”
Michael,
Did you get a chance to look at today’s FT editorial by Martin Wolf? Also, look at the comments today by Tim Duy over at Economit’s View. Seems like there is a consensus forming along the lines you have been arguing.
OT: I would really appreciate your thoughts on Duy’s statement that the Asian CBs started accumulating surpluses in response to their poor treatment by IMF during the 1998 currency crisis. Did Geithner and/or Summers had a role in it?
I think that people want China to do things that it just can’t do simultaneously. People want China to boost domestic demand and then reduce the trade deficit with the United States, and you just can’t do both without coordination with the United States.
To boost domestic consumption you need to expand the money supply. However if you expand the money supply this causes the value of the currency to go down. Conversely if you keep the RMB value high, this shrinks the money supply and this decreases domestic demand.
To think it about it another way. Anything that encourages Chinese to spend more money on Chinese goods will also cause Americans to spend more money on Chinese goods.
The reason that the RMB has started to tank is that the government has announced a massive stimulus package and that will cause the RMB to drop. If you want to keep the RMB high, then you have to sell dollars, but if you sell dollars you have to buy RMB, and this shrinks the RMB money supply which defeats the purpose of stimulus.
I’d be interested if anyone sees a hole in this logic, and comes up with a way that China can simultaneously encourage spending through monetary and fiscal means while at the same time reducing the trade gap with the US. The only why I can see this working is that if you have coordinated stimulus by both China and the US in which China expands the money supply, but the US expands the money supply even more.
Michael: SharpeMinde, we are all watching with bated breath. This has the feel of a slow-motion train-wreck.
From my point of view, this is a great improvement. A month and a half ago, it had the feel of a fast motion train wreck.
Michael: Could you offer some further comments about the Panic of 1873? Those of us who study Ulysses Grant are dismayed to find him being cast as the villain. Measured against current events, his policies seem remarkably sane. He insisted that the banks determine among themselves who was credit worthy and that they look to their own resources rather than the Treasury’s for the solution to counter-party risk. Through the use of clearing house certificates the panic on the exchanges was ended within 2 months of the default of Jay Cooke & Company. Grant vetoed the 1874 greenback bill, and he had the U.S. resume convertibility by 1875; by year-end the dollar was trading at par relative to specie. These may not have been boosts for immediate consumption, but weren’t they the sensible steps that a country with a continuing need for foreign capital should take in order to revive investment and enterprise?
Twofish- I might agree with you if USD/CNY was at a value determined by private investors and independent of government manipulation. However, it’s so far from that level that it seems like arguing for a weakening of the FX relative to a value that is much stronger than now.
Mike, I dont think the loan caps applied only to RMB loans. There were specific limits for both FX and RMB loans, which were reviewed every 3 months. Of course, that is no longer a concern as recently the caps were lifted completely (although it is meaningless as almost all the banks haven’t really used up their original loan quotas anyway).
MXQ, there is no “US”. There are US importers, and they cannot use RMB to pay their costs. Since the RMB is not a convertible currency, the only thing they could do with it is keep it in deposits in a branch on the mainland, which would not do them any good unless they subsrquently needed to purchase or invest in China.
Tyaresujm, yes I saw the Wolf column and, perhaps not surprisingly, I liked it very much. I think more and more analysts are starting to recognize the balance of payments constraints, and I think this is key to avoiding a messy trade environment. I didn’t see the Duy’s piece, but to me there is no question that something important happened in 1997-98 that caused the explosion in Asian reserve accumulation that has been such a fundamental part of the global imbalance.
Twofish, I am not sure I agree with your statement that China cannot “boost domestic demand and then reduce the trade deficit with the United States” without US help. On the contrary, boosting domestic demand would increase Chinese imports as well as divert some Chinese production previously exported towards domestic consumption. That would cause an reduction in the trade balance. Actually boosting domestic demand is probably the only good way of reducing the trade surplus (the other ways would be: trade restrictions, a collapse in US demand or, what would amount to the same thing from China’s point of view, closing down Chinese factories). I am also not sure that boosting demand can only be accomplished by increasing the money supply. I would have though that there are a lot of other ways to do it – including fiscal, interest rate and wage policies. I also don’t agree with your reasoning about why the RMB has declined (it hasn’t “tanked” by any stretch of the imagination). It declined on rumors of an intense debate within policy-making circles over depreciation as a policy to boost exports. The value of the RMB is driven largely by PBoC policy.
LetUsHavePeace, I am glad you bring up that period because it is very relevant for the discussion, but Grant’s very orthodox monetary moves may have aggravated the contraction. They were good for money center bankers (dollar trading up, for example) but they caused fury within the agricultural, mining and labor sectors and were seen by many Americans as a gift to Wall Street at their expense.
Megatone, I have to check that, but dollar loans surged in the first half of the year, so if there were caps either they were very high or they were not taken seriously.
Finally got back on your site, was wondering if the net police got to it?!
My guess on this topic – probably yes, hard to justify money sitting in a foreign investment when your parent organization is facing a credit crisis in the parent country. Besides, China is not immune to the crisis, not to mention that some things are overplayed and the unwinding is not quite done; the quiet trickle hasn’t quite gone to torrent yet. Chances are, some people are discovering that it isn’t that easy getting out of China.