I will be in NY and Boston during the first week of February and plan to meet a number of investors there to discuss China. I believe it becomes official on February 1, but I recently joined the Hong Kong subsidiary of one of China’s top broker/dealers, Shenyin Wanguo. I will continue teaching at Peking University and doing research for the Carnegie Endowment – this new responsibility simply takes off from my existing work.
Unfortunately it will mean that my blog postings (in the future, and clearly not this one) will become shorter and perhaps more reacting to market events, but of course it also means that it will be much easier for me to travel to meet clients and friends in Asia, Europe, North America and elsewhere for more focused (and perhaps more open) discussions of China and the international economy.
For now I suspect everyone will want to discuss currencies. One of the more interesting pieces of news for me was yesterday’s Financial Times story on President Sarkozy’s finding “unacceptable” the disordered currency markets (“disorder” means a rising euro). According to the article:
Nicolas Sarkozy on Thursday stepped up his attack on global exchange rate imbalances saying “monetary disorder” had become “unacceptable”. The French president said he would make exchange rate policy an important theme of France’s presidency of the G8 and G20 forums of advanced and developing economies in 2011.
“There cannot be financial, economic and social order until we put an end to currency disorder,” he said at a conference in Paris. Mr Sarkozy has long railed against Chinese “monetary dumping” and the dominance of the dollar, but has sharpened his criticism in recent days reflecting concern in Paris that a balanced economic recovery in the eurozone could be choked off by an overvalued currency.
With a large trade deficit and with exports that are more price-sensitive than Germany’s, France feels more susceptible to exchange-rate movements than its neighbour across the Rhine. “We can’t increase the competitiveness of our businesses in Europe and have the dollar lose 50 per cent of its value against the euro,” Mr Sarkozy said. “When we produce in the eurozone and sell in the dollar zone, are we supposed to just give up selling?”
So we are sort of stuck, aren’t we? The dollar is overvalued, and it must rebalance downwards in order to force up US savings rates relative to US GDP, but since it cannot decline against Asian currencies, whose central banks intervene heavily, it must decline against the floating currencies like the euro.
But the euro is probably already overvalued against the dollar, so European manufacturers will be forced to accept the brunt of the adjustment. This will be painful for everyone in Europe, but I suspect it will be most painful for Germany, a country that is more dependent on manufacturing than the rest of the region and so who will suffer more if there is a sharp drop in demand for European manufactured goods. The fact that President Sarkozy is nonetheless making the most noise about the euro indicates that this is going to become a very popular political topic and has great demagogic appeal.
Later in the article Sarkozy was quoted as saying “You know how close I feel to the US. But this is not possible. The world has become multipolar. We must have a multi-monetary system.” As a half-French half-American I have to say I suspect that it is not likely to be easy to convince too many Americans of the truth of the first part of his statement. I think however, that although the US and the world (except perhaps export-dependent Asian countries) would be better off with a multi-monetary system, Sarkozy may be confusing issues.
The dominance of the dollar in reserve accumulation has little to do with a lack of an alternative currency and a lot to do with the inability of any country but the US to absorb the trade deficits created by export-dependent development strategies. Trade-surplus countries buy dollars because when they buy euros, they cause angry reactions from European businessmen and politicians who are uncomfortable with the impact of a rising euro on domestic manufacturing and employment. In fact, the rise of the euro against the dollar is precisely what Sarkozy claims to oppose in the first part of his statement and to support in the second part. If Asian central banks rely less on the dollar and more on the euro for their reserve accumulation, guess what will happen. Yes, the euro will rise against the dollar.
Japan is worried too
It always surprises me how readily people believe that the status of the dollar as a reserve currency has to do with same nefarious conspiracy. As long as the US is willing and able to run large trade deficits, the dollar will be the overwhelming currency of choice for reserve accumulation. Once the US ability or willingness stops, which I suspect is likely to be the case over the next few years, central banks will stop accumulating dollars. Like it did during the period of large US deficits in the 1960s and the 1980s, the talk about dollar hegemony will once again fade away as US trade deficits decline.
Sarkozy’s comments were reinforced, in a way, by comments the same day from Naoto Kan, Japan’s finance minister. Here is what the South China Morning Post said in an article today.
Japan’s new finance minister backed off his call for a weaker yen following an apparent rebuke from the prime minister yesterday, saying currency levels should be determined by markets.
Still, Naoto Kan said the government should pay heed to the views of the country’s business community, signalling that he was sticking to the view of favouring a weaker yen to boost the competitiveness of Japanese exports. ”Currencies undoubtedly should be determined by markets,” Kan said. “But I also believe that generally speaking, it’s the finance minister’s job to act against currency moves when needed.”
…He jolted markets in his first press briefing as finance minister on Thursday, saying he hoped the yen would weaken further and that he would work with the Bank of Japan to achieve an appropriate exchange rate level.
For those who remember the 1980s, when many policymakers in Japan insisted that Japan’s trade surplus had nothing to do with the value of the currency, and everything to do with domestic competitive advantages in manufacturing, it is a little weird seeing them now worry so much about the impact of a rising yen on their manufacturing sector and on the process of economic recovery. Currencies do matter, I guess.
Currency talk is likely to be the flavor of this year. The currency issue simply will not go away, and the fighting over it is likely to get worse, not better. On that topic, a research fellow at the Institute of World Economics and Politics at CASS had an interesting proposal earlier this week. According to an article in Bloomberg:
China should consider a one-time appreciation in the yuan of 10 percent against the dollar to reduce inflows of speculative capital into China, a researcher at the Chinese Academy of Social Sciences said. The revaluation could be followed by a cap of 3 percent in annual moves up or down for the currency against the greenback, Zhang Bin, a research fellow at the Institute of World Economics and Politics at CASS, which advises the cabinet, said in an interview from Beijing today. He said he couldn’t predict whether his proposal, outlined in an essay, would be adopted by the government.
China may see “huge” inflows of so-called hot money as foreign investors step up bets on yuan gains, Zhang Xiaoqiang, deputy head of the National Development and Reform Commission, said in a statement yesterday. The government has rebuffed calls from U.S. and European officials to allow the market to set the exchange rate and has pegged the yuan at about 6.83 per dollar since July 2008 to help exporters weather a global recession.
“It’s a good strategy to protect China from the impact of short-term capital inflows,” said Zhang. “Now is a very good time. Foreign pressure will intensify this year and China should take an active strategy.”
…A 10 percent revaluation would have limited impact on exports and slow growth in overseas sales by 3.3 percent, said Zhang. Exports dropped 1.2 percent in November from a year earlier, following a 13.8 percent decline the previous month. China’s customs bureau is scheduled to report trade figures for December sometime between Jan. 12 and 14.
Zhang, who has been interviewed by Xinhua news agency on global economics previously, said the revaluation should be adopted soon. “The earlier, the better,” said Zhang. “We shouldn’t wait until after foreign capital flows into China and expectations on yuan gains increase.”
Does the value of the RMB matter for trade?
What would the impact on trade be? Strangely enough many of the opponents of RMB revaluation insist that it would have no impact on trade balances. A new “International Finance Discussion Paper” (Board of Governors of the Federal Reserve System) by Shaghil Ahmed sees it differently (“Are Chinese Exports Sensitive to Changes in the Exchange Rate?”)
The main results of the paper can be summarized as follows: First, including the latest period of greater real exchange rate variability reinforces the conclusions of some earlier studies, such as Marquez and Schindler (2007), which found that Chinese exports respond quite strongly to movements in the real exchange rate, and go against studies which fond little effect of exchange rate changes or effects that go in the opposite direction to conventional wisdom.
Second, considering the components of the real exchange rate, consistent with the theoretical model, when the source of Chinese real exchange rate appreciation is movements of the RMB against other emerging Asian countries, this does not have a significant effect on Chinese processing exports, but it does have a significant negative effect on Chinese non-processing exports. On the other hand, when the source of the renminbi appreciation is movements against the currencies of non-emerging Asian Chinese trading partners, generally both types of exports go down. Moreover, even though processed exports remain very important for China, increases in non-processed exports have recently accounted for more of the overall increase in exports. Finally, model simulations indicate that the path of total Chinese real exports would have been quite a bit lower if the renminbi had appreciated more in recent years.
Overall, the results suggest that greater exchange rate flexibility could have significant impact on China’s trade balance by restraining growth of exports, particularly non-processed exports.
…The implications of the results for global imbalances depend on what is exactly meant by global imbalances, which is not always clear-cut. If China’s large current account surplus or its bilateral current account surplus with the United States by itself contributes to global imbalances, along with the U.S. bilateral current account deficit with China, then our results suggest that greater degree of appreciation of the Chinese currency would substantially help mitigate global imbalances. If, however, the big part of global imbalances is the U.S. overall current account deficit and the current account surplus of the emerging market world taken together, then it is less clear that greater appreciation of the Chinese currency would make a significant dent to global imbalances. For example, following an adjustment of the Chinese real exchange rate one scenario could well be that the fall in exports by China is largely matched by a rise in exports by other emerging market economies, including in emerging Asia, leaving aggregate current account balances of the United States and of emerging market economies more broadly unchanged.
But the results do seem to imply that greater flexibility of the exchange rate would help China toward its stated desired goal of shifting the sources of growth more toward domestic demand with less dependence on external demand.
Regular readers of my blog might remember that from late 2006 until the beginning of 2008 I had argued that the best way for China to address the domestic (and of course external) problems caused by the undervalued exchange rate would be for a 15-20% one-off revaluation. This would both force through a rebalancing and help revive consumption growth, all the while protecting the country from the problem of hot money inflows, which had become terrible by that time.
After the onset of the crisis I backed away from such a large revaluation (not because it wouldn’t be a good idea in the long run, but rather because it would be too painful in short run) while still arguing that a one-off 10% revaluation still made sense. Needless to say I enthusiastically agree with Zhang Bin although, like him, I am doubtful that policymakers will be willing to absorb the short term cost in exchange for domestic economic benefits that probably won’t accrue until well after 2012, when the current leadership will have retired.
Hot money
My guess is that we will see a much smaller appreciation, perhaps 2-3% during the first quarter. Apparently I am not the only one who believes that appreciation pressures are mounting. That terrible bugbear, which made China’s too-little-too-late appreciation strategy from 2005 to 2008 so difficult for the PBoC, hot money inflows, seems to be rapidly becoming a problem again. Earlier this week a senior policy advisor sounded, and not for the first time, the warning. According to an article in Bloomberg:
China may see “huge” speculative inflows as overseas investors step up bets on yuan gains, making it difficult to manage liquidity, said Zhang Xiaoqiang, deputy head of the nation’s top planning agency. Loose monetary polices in developed countries, a weakening U.S. dollar and China’s economic recovery will put renewed pressure on the yuan to appreciate, Zhang, from the National Development and Reform Commission, said in a statement on its Web site today. The country is becoming more reliant on foreign economies, he said.
Already some of my students whose parents own their own businesses have been telling me that Chinese speculative money held abroad is flowing back into the country. One of my students from rich coastal city Wenzhou, the most free-wheeling and business-savvy city in China, and perhaps the world, just rolled his eyes when I asked him if his family and friends were tying to bring money into the country. “Of course,” he said. I didn’t get the impression that he thought mine was an especially astute question.
Meanwhile all the big guns in the “monetary alarmist” camp in China have been pounding the table (in the discreet way preferred of policymakers here) about the risks of monetary expansion. As everyone now knows, the PBoC yesterday sold three-month bills at a higher interest rate for the first time in 19 weeks. Long Chen, one of the students in my PBoC Shadow Committee seminar, reported to the class via email as soon as it happened: “Hey guys, the primary yield of 3M PBOC bill increased this week. Significant sign.”
Yes, although the increase was tiny, it may indeed be a significant sign that the PBoC no longer wants to wait and is starting to tighten conditions, although I can only add that conditions are so alarmingly loose that it would take an awful lot of tightening to get back just to “loose”, and it would be hard to do this without seriously undermining current growth and employment in the short term. My guess is that this may be a beginning, but it will be a very slow and tentative beginning. The PBoC has already been lambasted (unfairly, in my opinion) for jumping the gun in 2007 and 2008 and they have little political capital against which they can afford another “mistake”.
In fact much of their action tends to be signaling – what in the US we would call “jawboning”. Four days ago, for example, Governor Zhou made another attempt to warn about risks to the banking system in an interview with China Finance very similar to a speech he gave late December. According to an article in Bloomberg:
Chinese central bank Governor Zhou Xiaochuan reiterated government warnings that investment in industries with excess capacity and in redundant infrastructure projects could threaten banks’ loan quality.
The People’s Bank of China will guide credit, seeking to avoid volatility in lending, Zhou said in an interview dated yesterday on the Web site of China Finance, a central bank publication. Investment in duplicated projects or industries with overcapacity could “pose a risk to the quality of banks’ loans,” Zhou said.
China’s policy makers are seeking to contain risks from an unprecedented credit boom, in which banks extended 9.21 trillion yuan ($1.3 trillion) of new loans in the first 11 months of 2009. Liu Mingkang, chairman of the China Banking Regulatory Commission, said yesterday that lenders have “more than” enough capital, while also cautioning that asset bubbles may emerge in the world’s third-biggest economy.
It is hard to be both soothing and at the same time to raise the alarm.
To move away from currencies and monetary policy, I saw an interesting article about the US in Xinhua.
A recent New York Times/CBS News poll has found that more than half of Americans said they are spending less money in stores and online. A New York Times report available on its website Saturday quotes the poll as saying that nearly half of Americans said they were spending less time buying nonessentials.
“Some are working longer hours, but a larger proportion are spending additional time with family and friends, gardening, cooking, reading, watching television and engaging in other hobbies,” says the report. The report also quotes the U.S. Department of Labor’s time-use survey as showing that compared with 2005, Americans spent less time in 2008 buying goods and services and more time cooking or taking part in “organizational, civic and religious activities.”
Net demand from abroad
This is almost certainly good news for the US in the medium term, but if true, needless to say, it seriously undermines hopes that US net demand will revive enough to justify the overcapacity issues exacerbated by China’s fiscal and credit expansion. There has been some hope that boosting trade with developing countries, and especially with developing Asia, will result in a new source of net demand. James Kynge said something like this in the Financial Times earlier this week:
Popular narratives sometimes overshoot. One of the latest to outlast its veracity is the conventional wisdom that China’s export engines have been spiked by subsiding consumer demand in the US. This, so the argument goes, leaves Beijing with no option but to spur domestic demand to compensate for lost export revenues.
This became an über-narrative last year. Its snowballing popular appeal was powered by two unassailable charms: it made sense and seemed largely true – but not any longer. Its potency appears set to wane in coming months not so much because of a challenge to its central plot, but by other things happening off stage.
The telling off-stage action is the recent upsurge in trade with south-east Asia and the “newly-rising economies” of Brazil, Africa and India. Although Chinese trade with these places has historically been limited, it has grown so fast in the past five years that a robust performance in 2010 may be enough to offset any moderate weakness in China’s trade with the US.
A friend wrote to me to ask what I thought of this possibility, citing Kynge’s article, and my response (with some editing) was:
The idea that net demand from developing countries can replace net demand form the US is alarmingly widespread, both in China and abroad, and mainly indicates to me a lack of familiarity with the history of developing countries. The developing world excluding China is roughly the same size as the US, so if you want them to replace the US you need the developing world to run trade deficits of roughly equal to 7% of their GDPs.
Leave aside the huge problem that most developing countries also want trade surpluses and have a stubbornly tough time understanding why they should run deficits in order to help Chinese employment, the historical evidence suggests that just a few years of trade deficits of 2% of GDP will lead to external debt crisis. For example it took the Asian Tigers just a few years of deficits after 1993-94 to run into the Asian crisis. Do Malaysia, Indonesia, Vietnam and so on really want to go through that again? Developing country demand cannot replace the US. Even Europe cannot replace the US. This is an unrealistic hope.
No, I think the rapid growth of US consumption relative to (very healthy) US GDP over the past 30 years or longer may have been a special historical circumstance whose life, if not over, is coming to a close. Except for small countries whose trade surplus can easily be accommodated, I think the days of rapid growth driven by trade-surplus policies may be over.
This is getting to be another of my very long pieces (as my friend Kaiser Kuo reminded me last night at my club), so I will stop, but not before referring to one last interesting article about another controversy in Chinese academic circles. China is trying very hard to boost the quality of its scientific and technological research, which is, with a few exceptions, of very low quality. I am skeptical about how successful they will be, in part because the educational system here, as a history teacher in the top high school in Shanxi province once told me, is a machine for stamping out critical and creative thinking, and in part because the process is not being driven by scientists but by bureaucrats. Here is what the South China Morning Post says:
The exposure of two researchers who published fake data in an international journal is the subject of heated debate in mainland scientific circles, with opinion divided on whether the blame should rest on unscrupulous individual behaviour or deep flaws in the academic system.
Zhong Hua and Liu Tao from Jinggangshan University in Jiangxi published faked datasets in specialist journal Acta Crystallographica Section E in 2007. The fraud would have gone undetected without new computer analysis, the journal said on its website.
Leading British medical journal The Lancet urged China to tighten measures against scientific fraud, otherwise it would not become the research superpower President Hu Jintao has pledged by 2020.
These kinds of problems are so commonplace that normally I wouldn’t bring it up except for two reasons. The first is that it is a measure of how complex the problem is that there is even a debate about this episode. Normally, faking research brings universal condemnation, but the researchers have earned some sympathy because they are desperately responding to a very difficult system. The second reason I cite this article, which follows the first, is because of a very perceptive quote from Professor Jiang Gaoming of the Institute of Botany under the Chinese Academy of Sciences:
“All living creatures have an instinct to survive. When a bad system determines the survival of researchers, they have to do all kinds of corrupt and unethical things to live. The outcome is inevitable,” Jiang wrote.
This is something I often tell my students, especially about the banking system. It is not because they are especially stupid or dishonest that bankers have made bad loans, but rather because they are responding intelligently to bad incentives. Any system with distorted incentives creates distorted results.
Please don’t listen to your friend, we love the long pieces!!
I hope you are able to continue posting in future despite the new professional engagement. Good luck!!
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Wonderful piece, professor. I don’t often comment but this entry compels me to note that you have an amazing ability to wade through the same mess of news as the rest of us and to pick out the underlying narrative.
My impression is that opinion in the US is currently much more mixed on the desirability of having sole reserve currency status than is was previously. There is still a contingent that views reserve status as a badge of honor, but their attachment is more political than economic.
A Chinese revaluation probably would have less of an effect on the US than most in the US calling for one think, as it would partly just redistribute the US CAD. On the other hand I think it would clearly make the nearly inevitable process of closing that gap much easier, more efficient, and more fair to our other trading partners.
I don’t suppose you’ll be doing any public lectures in Boston?
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Hi Michael,Good for you to join Shenyin Wanguo HKG as Chief Strategist. It will be tons of money to be made there, and the return of Wall Street trading good old days.
I will miss your cogent discussions of issues. I hope you can at least post some shorter entries. Can you suggest links to other blogs or news websites that readers might follow?
(you don’t have to post this in your website)
Michael
Congratulation on your new position ! As a Boston resident I hope that you will find time to enjoy one or more of the fine new restaurants in the area during your visit to the Hub.
I look forward to your future “more open” posts.
Finally, as a confirmed skeptic regarding Sino-statistics especially on the local level, I heartily concur with your assessment that “any system with distorted incentives creates distorted results’.
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This post was mentioned on Twitter by offwitz: “Days of rapid growth driven by trade-surplus policies may be over. ” Michael Pettis on currencies http://bit.ly/5qk538 #china…
Punative trade practices continue in the US directed at China as the US uses sticks to force China to revalue. Why did the US senate majority leader write a letter to China ( http://mobile.reuters.com/mobile/m/FullArticle/CPOL/npoliticsNews_uUSTRE5BA3TN20091211?src=RSS-POL)regarding revalue if further protectionism is not in the works? How is the Fed printing of dollars in an attempt to devalue dollar any different from China’s inactions? If the Fed would revalue their zero rates the dollar would appreciate along with the RMB.
This is a problem created and aggravated by the greed and incompetency of the captured US govt. I hope soon China will cut their losses on their US holdings and move to create a new non-aligned
Professor, glad to hear about your new role as chief strategist at Shenyin Wanguo in Hongkong. While looking forward to more market-event based short entries, I think many regular followers of your blog (me included) hope that you could keep those long and illuminating entries on relatively more general topics as usual if you have time for that. Thank you very much in advance!
Well, about 10% one-off appreciation, I checked the bloomberg article and was a bit shocked by the public endorsement by deputy head of NDRC. Given that Zhang is such a high level official in the powerful NDRC who in the past seldom talked about currency issues, is it a very clear sign that Chinese government has finally determined (or been forced) to open the appreciation path of RMB? Even though this one-off evaluation has long been widely discussed by policy makers, this is till now the first (but already strong) endorsement by an official in such a high level if I remember correctly. ““The earlier, the better”as he said about the strategy, I do feel this is a very strong signal. NDRC used to be neutral on currency appreciation, and even the alarmist PBoC used to state their preference for “stable and gradually apprciation” over “one-off appreciation” for many times. So Professor, accoding to your knowledge and instinction, do you think the likelihood of one-off option is really increasing, or is it still far from maturity? If 2010 is a “currency year”, I guess the way China is going to adopt would be heart of the whole story.
Ditto on the long pieces….. highly value your posts.
M. Pettis: “This will be painful for everyone in Europe, but I suspect it will be most painful for Germany, a country that is more dependent on manufacturing than the rest of the region and so who will suffer more if there is a sharp drop in demand for European manufactured goods.”
But isn’t Germany mainly exporting manufactured goods to other European countries (countries using the Euro)?
A short Examination of Germany’s exports published on “stratfor”:
“Germany: An Examination of Exports
December 30, 2009 | 1327 GMT
JENS SCHLUETER/AFP
According to several Dec. 28 media reports, China is set to eclipse Germany in 2009 as the world’s largest exporter by volume. The news is no surprise, as China and Germany have been jostling for the top exporter spot since 2007. In 2008, Germany’s exports just barely topped China’s, with Berlin’s total exports valued at $1.46 trillion, or 45 percent of gross domestic product (GDP), compared to Beijing’s $1.42 trillion, or 40 percent of GDP.
But the announcement gives STRATFOR the opportunity to explore the definition of Germany’s exports. The most obvious point is that Germany is part of the EU’s single market — an economic union of 27 member states in which restrictions on the movement of capital, labor, goods and services have been almost completely eliminated.
Furthermore, Berlin is a eurozone member and dominates the bloc’s monetary policy because it is the eurozone’s largest economy and because it essentially controls the European Central Bank’s policy making. Germany’s exports to the eurozone can therefore hardly be compared to the Chinese exports to the United States or Japan, for example. They are part of an intra-eurozone trade that cannot be compared to global exports of other countries.
Of Germany’s total exports in 2008, 43 percent went to the eurozone, 63 percent to the European Union (which includes the eurozone), and 37 percent to the rest of the world. When viewed this way, non-EU exports only account for 16.5 percent of Germany’s GDP, though that number grows to 25.7 percent of GDP if Germany’s exports to EU member states outside the eurozone are considered.
Ultimately, Germany still depends on exports. However, its exports to the EU and eurozone cannot be considered global since those markets are practically indistinguishable from its domestic market. This actually gives Germany an advantage over global exporters like Japan and China, since a sizable portion of its exports is destined for markets with which Germany has much in common or outright controls through its leadership in the EU and eurozone. But though it has a degree of control over its export markets in the EU, as a major exporter of high-end, capital-intensive goods, Germany is also vulnerable to the vagaries of global investment demand and the availability of capital.”
Professor Pettis,
I agree wholeheartedly with JJs comments. You have a remarkable gift.
I wish you could post longer pieces more often.
Fantastic stuff!
Professor Pettis, I have noticed that you often use Asia as an example of the mercantile countries who insist on devaluing currencies to achieve export supremacy at the expense of other nations, but where does the oil-exporting middle east fit into your equation? Saudi Arabia, Kuwait, etc. often do the same thing.
From a political perspective, it’s bizarre. To me it seems as though Asian governments exploit cultural factors such as Confucianism which allows them to in turn exploit their people to work as slaves of the state (for want of a better phrase). In other words good government is about creating jobs, period. But what about government provision of social and political freedoms? For example open and transparent governance, social safety net, free education systems, etc.
This manifests itself in the emergence of sovereign wealth funds, while many of the people are still living in poverty.
In contrast, Middle Eastern governments (with few exceptions) provide even less. They use religion instead, while the Mullahs and Sheiks rip off, not slave labour, but natural resources such as oil, to enrich themselves while leaving their populaces in perpetual poverty and religious indoctrination. This has manifested itself not only in Sovereign Wealth Funds, but also terrorism.
From a long-term perspective (the next 20 years), to what extent do you think the US, Australian, European and Japanese debt crises could be solved by co-operation in the field of science and innovation surrounding a green revolution?
With companies like Better Place and many others seeking to solve environmental, economic and geo-political goals simultaneously, could we expect to see deficit reductions occurring less at the expense of Asia and more at the expense of the Middle East (by ending dependence on oil)?
Do you think that in the interests of furthering global peace, “the West” (I hate that term) should consider only allowing students of countries who have academic freedoms (you mentioned your blog is blocked in China) to study in our schools and universities?
I am interrelating economics and politics a little here, but I am curious as to how you believe the West could speed up the process of good governance in these countries. At the moment, I can’t decide which time bomb will explode in China first – the economy or the environment.
Seeing as though economics emerged as a discipline in order to ‘achieve the efficient allocation of scarce resources’ the two are obviously inextricably intertwined. The inefficiencies in China’s economy may cause a banking crisis, an inflation crisis, or an employment crisis. But equally they may cause an environmental crisis (water).
This is often overlooked as we have still failed to account for what we still crudely refer to as “externalities” in economics. Given your links to the Carnegie Institute for Global Peace, I await any comments from you in response to this post with much enthusiasm. Also, I hope that in future you could use your privileged position and stature, not only as a means to make money (congrats in your new job), but also as a means of explaining in Chinese education institutions the correlation between economics and the environment.
Chinese are very worried about water scarcity and global warming and they don’t often see the link between government policy (command capitalism) and the consequential misallocation of finite resources.
Those such as yourself are incredibly important in information exchange as education achievement is revered in Asia and will achieve far more than a meeting at Copenhagen.
Thanks and Regards,
Tony
Fantastic piece. Your influence continues to grow and for good reason.
I wonder what you take is on Simon Johnson’s view that the American banks are taking huge risks in emerging markets, especially China.
http://www.youtube.com/watch?v=RLKuXwisOrc&feature=player_embedded
Are US banks in any way protected by Chinese restrictions on western investment?
“Any system with distorted incentives creates distorted results.”
The world’s financial system described in eight words.
The per capita Chinese export is nothing compared to the real export powerhouses such as Germany and Japan. I think both Chinese export and exchange rate have received way too much attention than they deserve.
As for scientific research in China, all kinds of problems are inevitable, just like in the U.S. For example, in the U.S., “political” (in contrast to academic) in-fight in the departments of graduate school is common. Quite a few dubious research papers are submitted every year for the sole purpose of grabbing research grants. The mother of all fake research actually occurred in South Korean (regarding stem cell), where western, especially U.S., influence is supposed to be heavy.
I would think any judgment on the future of Chinese scientific research is rather premature at this juncture. For one reason, the potential of Chinese market has just started to appear. For example, all of a sudden, China is the largest market in the world for both light and heavy vehicles now. And China is also one of the largest market for aircrafts. To grab a share of the domestic market, Chinese researches in these industries are destined to take off now, instead of earlier.
Amazing that Western pundits criticize the Chinese for maintaining monetary stability with stable exchange rates. But the United States gets a “free pass” with its intentional currency devaluation policy. The US Treasury is issuing debt like there is no tommorrow, and the Federal Reserve is printing non-stop trillions of dollars. Doesn’t the Federal Reserve mandate include a “sound money” policy?
Would it be possible to link some of the reports you author?
Your entries will be missed.
Congrats on your new appointment! Much luck and good remuneration . . . ,
I’m disturbed that locals are pulling money back into the hot money pileup. This has the legs and potential for a “hot” financial pileup on a worldwide basis.
I love the long pieces too, and I learned a lot here. Best wishes in your expanded endeavors.
Wishing you every success in your new undertakings for 2010. I enjoy reading your thoughtful comments on current topics.
The US/China perpetual argument – whose really manipulating things is a non issue…it was/has been an ingenious way to provide growth capital to China and supposed ownership rights to western corporations.
China had the need for capital during economic expansion…and the US provided that ..now that world economies are contracting the pendulum is shifting and Chinese and US are rethinking the relationship..or actually debt and markets are forcing that rethink ..like any marriage of necessity ..a time comes when both parties start thinking..screw this.. I can do better ..or actually…wait ..Can I do better?
What does the US do to replace China..Mexico..possible,…Brazil..nope ..not happening…Africa..lol..not in this century..
So the US has Mexico ..possible alternative..
Who does China have that can replace the American consumer? And more so is the American consumer injured ..or permanently handicapped..
Most importantly..how wealthy is China really ..if the wealth is denominated in a bankrupt countries currency..?
Politics aside..because many times politics does not make economic sense ..both countries have more to lose ..from any type of trade war and more so both are very aware that the their “beloved other” isn’t the same person they married 10 years ago. Where does the marriage go from here?
Michael,
Good to hear that the real private sector has finally caught you. Sincere best wishes in your new job and, hopefully, you will be more parsimonious there than in this extremely long piece with its excessive display of expertise. Clients may not have the appetite for such intelligent commentary. They just want to make money.
Incidentally, you did not say what the impact would be of:
“No, I think the rapid growth of US consumption relative to (very healthy) US GDP over the past 30 years or longer may have been a special historical circumstance whose life, if not over, is coming to a close. Except for small countries whose trade surplus can easily be accommodated, I think the days of rapid growth driven by trade-surplus policies may be over.”
But it is not too hard to imagine. Pity that from now on you will become (part time?) a one-armed economist..
Cheers
I don’t understand the need for a one-off currency appreciation. The currency is pegged, but that doesn’t stop the adjustment from occurring as it already has through inflation.
The notion of U.S. demand does not at all adequately describe what is going on in the U.S. What is really happening here is liquidation–government is withdrawing from the society.
It’s too bad economists don’t study this phenomenon very closely, and they don’t do it because unemployment never reached 30% during the Depression.
However, it is a complex phenomenon with its own pathology. One good way to chart it is in the deterioration of the supply chain. You can even Google New “supply chain” and add “risk” or “finance” or related terms, in order to give you all the relevant stories.
We have supply chain deterioration well under way in transportation, and now it has moved on the agriculture (this also happened during the Depression).
The problem with not studying liquidation is that you attribute some development to something else besides liquidation. For example, government financial moves are called “stimulus” or “stabilization,” and that looks like MORE, not LESS, government interaction with the society.
But it is really liqudiation–powerful forces removing government from the society. When American suburbia was expanding, and that looked like a money making opportunity, government was happy to align with it. But now suburbia is here, the question is how do we maintain it, there is no consensus on that, and so American society is a sick person. Do you want to be in bed with a sick person? No, and so government is getting out of that bed we call America.
You will see it this year particularly in state and local government spending and employment. State budgets will be dramatically cut, state employment will be slashed.
The danger is that government participation in the economy is always strategic: when it removes itself, the strategy has changed. Something else is pulling the levers.
As for currencies, the long and short of it is that we are in currency race to the bottom. And that is where liquidation is taking us: to the bottom. Rubin is our new Mellon.
Michael, excellent as usual.
This really must be one of the most useful financial blogs of all. China insight such is this is rare.
Please keep them as long as possible!
“the developing world excluding China is roughly the same size as the US, so if you want them to replace the US you need the developing world to run trade deficits of roughly equal to 7% of their GDPs.”
Actually, they could continue their current trade surpluses and replace the US as a consumer of Chinese goods by changing their spending patterns. What is the most likely case is that US CA deficit stabilizes closer to 4%, developing Asia buys more of China’s cheap goods and less of whatever substitutes they are currently buying (i.e. from each other).
Also, I was wondering if you knew the factors that the Chinese government used in deciding at what value to fix the exchange rate. Or is it more of an ad hoc political decision?
[...] Everyone wants to talk about currencies, Michael Pettis, 9 January 2010 [...]
[...] spent a bit of time this morning catching up with a couple of unread Michael Pettis posts ( here and here are the links). Lots of good stuff and some particularly fascinating thoughts on trade [...]
For me the interesting point about the increased clattering on currencies is not the clatter but whom is clattering. The chorus is growing wider with more and more countries adding their voice.
Hi Michael,
Congratulations! You estimated renminbi will appreciate 2-3% during the first quarter of 2010, which is much higher than renminbi forward exchange rate in the market, so what’s the basis of your estimate?Thanks.
Congratulations on the new position Professor! I am glad to hear you will be staying up in BJ, and i presume this means that D-22 will be safe for the time being??
I note that your blog, and other sites including Youtube, Facebook, (i presume twitter but i never go in for that nonsense) are still blocked in the PRC. A shame for those of us thinking that these were temporary measures brought in for 2009 and all its anniversaries and ethnic tensions…
The export figures out this week have AGAIN sent Yuan NDFs up. I imagine that hot money flows for the 4Q 2009 and 1Q 2010 are going to show a continuation of the trend that began last summer.
Well done for coming out with a prediction for 1Q RMB move (albeit a small one!?Many Analysts say this in private, but because of Wen’s statements very few dare to make the prediction official.
Look forward to your next post!
The export model is dead and I have a (potentially) nonintuitive rationale for explaining this. Governor Terminator of California is asking the US government to fill California’s budget gap. Some commentators have stated he is going “cap in hand” to the feds for handouts. I listened to his interview on the American TV show Meet the Press. Not remotely is he cap in hand. He was totally angry about Sen. Ben Nelson’s health reform vote saving Nebraska from paying rising Medicaid costs. Arnold will not have California pay Nebraska’s Medicaid bills. In point of fact, he is tired of having California receive 78 cents for every $1 it sends to the federal government. He is telling the federal government to pay what it mandates and to share the burden equally. When you consider that 36 of the 50 American states are running significant fiscal deficits, this will resonate.
Expect this to become a political theme among other governors.
What does this have to do with Chinese exports? In abundant times, people accept what might seem to be a problem because of improving circumstances. In lean times, such acceptance disappears. The political dynamic driving California is very similar to that which drives trade dialogue. America is about to become very trade phobic. Selling the benefits of trade becomes problematic. America will demand more of its’ trade partners. You can dismiss America as a declining power, but you cannot dismiss it as the key to the current recovery. As Michael notes, other nations cannot pick up the slack in the near term.
China adjusts policies, or America will to the probable detriment of both.
I’m looking forward to future posts, short or long. Short is much better than nothing. Thanks in advance.
In addition, when you have a moment, I wonder if you wouldn’t mind recommending six or eight books on finance and/or economics for people like me with a background in social sciences. Imagine you’re creating a reading list for a room full of smart but clueless first-year graduate students in a history department at a U.S. university. Again, thanks in advance. (You’re book is on the list already, so don’t include it.)
Good luck with the new gig.
A question and comment: my question is about to what extent the RMB is undervalued in real and nominal terms relative to other East Asian currencies. My comment is that in terms of growth, the US monetary expansion has been smaller than China’s. The reason, I would suspect, is that in addition to domestic policy goals, China has been trying to use monetary expansion to keep the RMB from rising. It is also odd to hear people argue that China doesn’t depend on external demand to help propel growth, and can get along without it, while at the same time proposing that China cannot move on its exchange rate without irreperable damage to the export sector. Anyway, the RMB/USD rate is not the issue, and this adjustment will not change savings and investment balances (read the trade deficit) in the short-term. The real issue is the RMB relative to everything else in Asia.
OGT, it depends on whether the US CAD was wholly caused by mechanisms that induced overconsumption in the US, or whether at least part of the cause of overconsumption was reserve accumulation abroad, mainly in Asia. If the latter, then a relaxing of reserve accumulation should directly lead to a lower CAD in the US (and by the way I may be speaking at one of the schools in Boston, and if I do I will mention in on the blog).
Mark G, the fact that other countries (e.g. the US) may want to devalue doesn’t imply that all devaluation strategies are justified. If a Country A’s currency is undervalued relative to Country B’s, then by definition Country B’s is overvalued. For Country B to seek devaluation relative to Country A does not imply that Country A’s eagerness to devalue is equally justified.
Alonso, I think the economic arguments in favor of a one-off are very strong, and the political arguments against are equally strong. In other words, a sharp revaluation will almost certainly cause problems within the export sector, anger the powerful export-oriented constituencies, and force a short-term rise in unemployment. The justification for creating that kind of pain is, of course, that not doing so would only make it even more painful in the future, but that is not an argument that is easy to sell – in China or in any other country. Whoever went out on a limb to force through such a policy would probably sharply reduce his political life, so I would guess that what we need is a real consensus to develop.
Michael O, thanks for the color. Yes, much of Germany’s exports are to Europe, but a significantly portion still goes outside the eurozone (between 37% and 57% according to your article, depending on the flexibility of the non-euro European currencies). Furthermore these numbers are understated by whatever share of German exports to European countries are then processed and sold outside Europe. They are understated even more to the extent that some German sales to European buyers compete with products that can be purchased from US or other manufacturers (which suddenly become cheaper). Finally, while it is true that eurozone countries that run the counter deficits with Germany can’t undermine German pricing by devaluing their way back to health, it also means that it will take them much longer to regain balance, and as a consequence their demand for German goods will suffer. A rising euro will hurt Germany no matter what.
TonyS, the OPEC Middle East countries are certainly a different issue altogether but I am not sure I understand them well enough to offer any useful comments. I do, however, disagree with your characterization of working conditions here as slavery. China is a very poor country, and like all poor countries workers here definitely do things that the rest of us would hate to do, but that is a function of poverty more than politics. In my experience the Chinese have quite a lot of economic freedom and my “middle class” friends in Beijing are no more likely to do things they don’t want to do then my friends in New York. I also don’t see why we should limit our universities to students from countries who don’t enjoy the academic freedoms we do. Aside from the fact that I am uncomfortable with any government policy aimed at restricting who US universities accept as students, I am not sure why punishing students who want to go abroad because they have been punished at home will help anyone. As for your comments about the role of environmental issues, again it is not an area where I can offer much. You are right that we face some pretty serious scarcities in China in the next decades, with water perhaps being the most alarming problem, and I know that there is a lot of thinking, worrying, and planning on these topics.
Lark, Youtube is blocked here so I didn’t have time to see the piece. I am not sure what you mean by your question.
Seatrus, I agree that academia is politicized everywhere, and famously so. The problems here are, however, a little different. I worry that universities and high schools systematically undermine the kind of learning that will be necessary for China to evolve to the next stage. Obviously I am not the only one to think so and not even the most worried. There are a huge number of educational experiments taking place in China in order to get around just this problem, but we should not underestimate how difficult it is to transform an educational system – not impossible, of course, but certainly difficult.
Dave Chiang, sorry, but whenever anyone begins discussing China by excoriating “Western pundits” my eyes glaze over and my instinct is to assume that he knows little about China. In fact the toughest and most intelligent criticisms of Chinese monetary policies do not come from “Western pundits” but from Chinese academics and policy advisors. And I am not sure what you mean by a “free pass”, but if you mean that unlike Chinese monetary policy, no one criticizes US monetary policy, then I can only wonder how carefully you read the news.
Brazil6, unlike many others I am not sure that the US only buys from China things it cannot make. If you look at US import and deficit numbers, they soared in the past decade, so unless the US only imports things that have only been invented in the past decade, I would guess that much of what it currently imports it used to produce domestically. I agree that trade war leaves the world worse off overall, which is why it is important for us to address the issues realistically and quickly, before they spin out of control. Once the process really kicks off it is very hard for any one country to lead a reverse without taking a lot of pain.
Mark, inflation differentials over the past decade or two have been much too low to accomplish the necessary revaluation. In fact I think they have been less than productivity growth differentials, so in fact the currency is getting more undervalued, not less.
Brandon, if developing countries buy more from China and less from each other, that will have the same impact on their current accounts. It will still force them into large deficits since their imports are the same but by definition their exports are contracting.
Glenn M, I agree. This is as much about politics as it is about economics.
Ma Bole, a post on my favorite books in finance and economic history is something I have wanted to do for a while. I will get there.
“having a lot to do with the inability to absorb…” – bull’s eye.
Long posts or not, your blog is fantastic. Really good information… In general, a good mindset for a writer is to think “No one wants to read your s**t,” but your s**t is good, so it is an exception to the rule…
QUESTION:
Regarding “Hot Money,” is almost all of this from Chinese nationals?
@ michael & DC
re: trade war
http://www.ft.com/cms/s/0/f65a4ba6-ffd7-11de-ad8c-00144feabdc0.html
[...] think this particular post of Michael Pettis is well worth a read. 13 Jan 2010 | By V Anantha Nageswaran | [...]
[...] Pettis: Everyone wants to talk about currencies – China Financial Markets [...]
I think it’s more important for China to consolidate the Hong Kong and Macau currencies into RMB. It’s weird for a country to have three different currencies in use.
After the consolidation, then it can decide on the appreciation of Yuan.
Dear Prof. Pettis, Chinese policy is to invest heavily in export capacity at a time when the US cannot resume its former high level of imports. You have so clearly pointed out the long term problems with this misguided investment. Is China’s policy complete folly? Oddly, the answer may be ‘No’. There is another outcome that makes perfect sense.
China will undercut all others exporters. It will increase its trade with other partners by offering very low prices. Its supply of cheap labor will continue. Internal supply chains and expertise are already in place. As China becomes the largest manufacturer in a particular kind of product, the “learning effect” will allow it to keep costs lower than other producers.
China will grow its exports by taking business away from other exporters. It will become the largest trading partner of almost every country. Exports to the US do not need to grow for this policy to work. As you have mentioned, other exporters will be angry. They will not be able to do much about it, however.
As long as export has some growth capacity left, China will exploit it. China’s trade history with US is just the first chapter, and it is going to be repeated with other countries across a wide spectrum of products.
China seems to think its ASEAN trade pact will help reduce export reliance away from the EU/USA. It will probably decimate entire industries in the ASEAN countries , but I gather ASEAN raw materials sectors think they will benefit.
“so unless the US only imports things that have only been invented in the past decade, I would guess that much of what it currently imports it used to produce domestically..”
Prof. Pettis ..My point.. I’d believe the odds of the US taking back a high percentage of what it used to produce domestically in the past decade are small..that is without a trade war which also risk more costly real wars and like it or not both sides are stuck with one another. I also believe that the entire arrangement was done to the detriment of the US in the long term and benificial in the short term …for China it is and has been long and short term HUGE win.
PS love the blog and as so many others stated ..the long posts are GREAT! thanks for your work..
[...] his post on currencies. Already some of my students whose parents own their own businesses have been telling me that [...]
[...] today I want to respond to one comment I don’t entirely agree with, which he made in a post in early January: For those who remember the 1980s, when many policymakers in Japan insisted that Japan’s trade [...]