And shouldn’t they get twitchy?  After all this reduction in Chinese holdings of Treasury bonds comes from the USG’s TIC data, so it must be true that China is dumping dollars, right?

No need to twitch, it means no such thing.  First of all, the data from which this was derived indicates national ownership of USG bonds only to the extent that foreigners are directly registered holders.  It says nothing about what happened to the large amount of bonds held by the PBoC and other Chinese investors indirectly or in street names.Those could have easily gone up by more than the reduction in bonds directly held by Chinese investors in their own name. If the PBoC had let maturing Treasury bonds get repaid, for example, and reinvested the proceeds into the USG bond market through another account, or in a street name, its total holdings would have actually increased even though its registered holdings would have declined.

More importantly, the TIC numbers completely fail to disclose whether China’s reduced holding of USG bonds was matched by increased holding of other dollar assets, thereby increasing the pool of capital available to fund USG bonds by an amount equal to its reduced Treasury holdings.  If Chinese investors decide to take on more risk, for example, they might sell USG bonds and use the proceeds to buy corporate bonds.  Of course the seller of these corporate bonds will then have cash, which must be put to work, and ultimately this ends up back in the USG bond market.

China did not reduce its dollar holdings

So was China a net seller of dollar assets in December?  Almost certainly not.  Just look at the PBoC balance sheet.  PBoC reserves rose in December by $61.3 billion, of which $39.0 billion was the trade surplus – cialis buy online.

Remember that China has a large current account surplus which necessarily must be recycled abroad, and the US has a large current account deficit which necessarily must be funded abroad.It would be astonishing if, under these circumstances, total Chinese holdings of USD assets declined, and of course it is impossible that they declined faster than the willingness of other foreigners to replace them.

Of course if the US current account deficit declines, net new foreign purchases must by definition decline too.  If the US wants its current account deficit to decline so that the USG can reduce the fiscal spending needed to generate any fixed number of jobs, this cannot possibly happen without a concomitant decline in net foreign, including Chinese, purchases of dollar assets.  But it need not result in any difficulty in funding the new, lower amount of debt issuance.  Depending on why it happens, reduced purchases by foreigners should probably be seen as a good thing for the US Treasury market, not a bad thing.

Confused?  How can a reduction in foreign purchases help the USG fund its massive fiscal deficit?  Because the purpose of the fiscal deficit is to create jobs in the US by boosting US spending.  Since some of the jobs that higher USG spending creates will accrete outside the US, via demand that “leaks” abroad through the deficit and creates employment for foreign manufacturers, a smaller trade deficit can itself be expansionary for the economy.  That means the USG will need to borrow less to create the same number of jobs; cialis buy online.Fear of Chinese “dumping” of US treasury bonds cialis buy online, even if it were possible, should be a non-issue, but since it plays easily into various geopolitical conspiracies, we seem to love to worry about it needlessly.

Among other strange comments the TIC data generated last week were those by the Financial Times, arguing that “if the latest numbers mark the beginnings of a diversification by China away from US Treasuries and other dollar assets, a widely speculated rise in the value of the renminbi against the dollar is on the cards.”  Aside from the fact that it marks the beginnings of no such thing, it still wouldn’t be an indication of any future RMB strategy.  A rise in the value of the RMB may very well be in the cards, but this has absolutely nothing to do with what Beijing did with its USG bond holdings in December.

Why?  Because if China had intervened less in December, the RMB would have already shot up – in December, not at some time in the near future.  Of course if the PBoC believes that a rise in the RMB will cause the dollar to fall against the euro, it might have swapped out of dollars into euros as a clever trade based on its inside knowledge of the RMB strategy, but since the opposite is almost certain to be the case, it is hard to believe that any PBoC net sales of Treasury bonds would indicate its plan to raise the value of the RMB.

The TIC data in December tells us almost nothing about what will happen to the RMB. To see why cialis buy online, it makes sense to discuss a little how and why the PBoC has accumulated dollars, and what those dollars mean for China and the central bank.  Here, the first thing to recognize is that the PBoC does not “decide”, as a banker, to lend money to the US.  It basically has very little choice.

Beijing is not Washington’s banker

If China runs a current account surplus, it must accumulate net foreign claims by exactly that amount, and the entity against which it accumulates those claims (adjusting for actions by other players within the balance of payments) ultimately must run the corresponding current account deficit.  And as long as China ran the largest current account surplus ever recorded as a share of global GDP, and the US the largest current account deficit ever recorded, and especially since China also ran an additional capital account surplus (i.e.other non-PBoC agents ran a net capital inflow), it was almost impossible for the PBoC to do anything but buy US dollar assets.  Given the sheer amounts, a substantial portion of these assets had inevitably to be USG bonds.

This was not a discretionary lending decision.  It is the automatic consequence of China’s currency regime, in which it pegs the RMB to a foreign currency, in this case the dollar.  Why?  Because when the PBoC decides on the level of the RMB against the dollar, it does not do so by passing a law, and making it a capital crime for anyone to trade at a different price.  What it does is far simpler.  It offers to buy or sell unlimited amounts of RMB against the dollar at the desired price.

No one will sell dollars for less than what they can get from the PBoC, nor will anyone buy dollars for more than what they can pay the PBoC, so all transactions get done at that price.  That is how the PBoC (or any other central bank that intervenes in the currency market) sets the foreign exchange value of its own currency.

This means that as long as it wants to set the exchange rate, then, it must take the opposite position of the market.  Since the rest of the market is a net seller of dollars (China runs a current and capital account surplus), the PBoC has no choice but to be a net buyer of dollars, which of course it must then invest.

If it stops buying dollars, it must let the market decide by itself on the new equilibrium price of the dollar.  In that case the value of the dollar has to plunge in RMB terms (or the RMB soar, which is the same thing) in order for buyers and sellers to match up and for the market to clear.  The moment the PBoC stops buying, in other words, the RMB will rise in value – and so it cannot stop buying in anticipation of the RMB rising in value, as the FT article suggested.

Of course the PBoC must fund the purchase of these dollars.  It does so primarily by borrowing in the domestic money markets, selling PBoC bills or entering into short term repos (although it also issues some longer-term bonds), or by “creating” money by crediting the accounts of the commercial banks who sell it the dollars.

This means, to simplify, that the PBoC has a balance sheet consisting on one side of dollar assets (and here “dollar” is short-hand for all foreign assets).   Against this and on the other side it has a roughly equivalent amount of RMB liabilities (I say “roughly” because when you run a mismatched balance sheet, changes in the relative value of assets and liabilities will create losses or profits).

Here is where things get interesting.  China’s reserves are often thought of as if they were a treasure trove available for spending.  They are not.  They are simply the asset side of the mismatched balance sheet.  If the PBoC wanted to “spend” $100, say for example to recapitalize a bank, it could do so, but this would automatically create a $100 dollar hole in its balance sheet; cialis buy online.– it would still owe the RMB that it borrowed originally to purchase the $100.  To put it another way, the reserves are not a savings account, free for the PBoC to spend as it likes.  Reserves are effectively borrowed money.

Can PBoC reserves protect China?

So the PBoC cannot give away the reserves without causing an increase in its net indebtedness.  This is why I have often said, to the confusion of some of my readers, that Beijing cannot just recapitalize the banks with reserves.  A substantial amount of NPLs will one way or another increase government debt.  The only way Beijing can recapitalize the banks is by borrowing, or by raising direct (or hidden) taxes.  Having the PBoC recapitalize the banks is just another way for the government to borrow, and since almost everyone would agree that losses in the banking system should be paid directly out of fiscal revenues, and not indirectly by the central bank, it would be a very inefficient way of doing so.

So what are reserves good for?  As long as China maintains its own currency and denominates all domestic transactions in RMB, the PBoC reserves cannot be used in China; cialis buy online. They cannot go to pay doctors’ salaries, to build bridges, to lower taxes or to subsidize consumption.  They can only be used to purchase or pay for things from outside China.  This means that reserves ensure that China can import foreign commodities and other goods as long as it can pay for them domestically.  It also means that the PBoC can ensure the availability of dollars to repay foreign debt and foreign investment.

Here is where a great deal of confusion arises.  The US crisis of 2007-08 notwithstanding, we seem implicitly to believe that a financial crisis is always caused by an inability to repay foreign debt and investment, in which case having huge amounts of reserves certainly should protect a country from financial crises.

But this is only partly true.  Reserves are useless in preventing domestic debt crises (not totally, because they affect the credibility of the currency, but the RMB today doesn’t seem to suffer from a lack of credibility).  As I pointed out two weeks ago, there are many cases of countries with huge amounts of reserves that nonetheless suffered from all kinds of financial crises.  It is just that they never suffered from external debt crises.

When it comes to domestic debt crises, large levels of reserves actually can make things worse.  Why?  Because financial crises are always caused by mismatched and highly inverted balance sheets, and the central bank’s accumulation of reserves is exactly that kind of balance sheet.

Of course when the rest of the country has an equally mismatched balance sheet in the other direction – like when South Korean companies in 1997 had huge amounts of won assets financed by dollar debt – the central bank mismatch enhances financial stability.  It acts against the mismatch carried by the rest of the economy, and the net impact is that the economy is less vulnerable to financial crisis.  In that sense reserves are a kind of insurance to protect against excessive foreign borrowing.  Because South Korea, unlike China today, had too few central bank reserves against the rest of the country’s too-large dollar obligations, its overall balance sheet was mismatched and it was susceptible to a collapse of the won.

But China has very little external debt – certainly very small compared to its reserves – and so this clearly isn’t an issue for China.  But then could the huge mismatch on the PBoC’s balance sheet create the opposite risk for China?

Balance sheet mismatches

Yes and no.  And this is where another great misperception occurs.  Many people in China and abroad have argued that China cannot afford to raise the value of the RMB against the dollar because it would mean that China will take huge losses because of its massive reserves.  After all, if the RMB rises by 10% against the dollar, the value of its reserves will have necessarily declined by $250 billion in RMB terms.

This is almost completely wrong – China will not take losses anywhere close to that amount and may probably even take a gain if it revalues the currency.  Unfortunately this kind of confused thinking is nonetheless the source of some strange claims.  One foreign economist even published a rather loony piece three months ago, which excoriated the Obama administration’s “bogus” trade argument for revaluation as done purely for nefarious and no doubt imperialistic reasons – and to strengthen the conspiratorial air it somehow ignored the fact that nearly every country in Europe and Asia has made the same argument.

Ironically enough, it replaced the very reasonable trade argument with one that is truly bogus, and indicates how foolish and even hysterical the discussion can become.  The argument is that the US wants China to revalue the RMB not because of trade rebalancing (wrong, and this makes a common but still annoying mistake about the relationship between the currency and the trade balance) but rather because of a secret American scheme to reduce the amount that the US government has to pay China on its PBoC holdings.  Appreciation of the RMB, according to this theory, represents a transfer of wealth from China to the US because it effectively reduces cost to the US of servicing the debt:

If the arguments presented for RMB revaluation by the US administration have no factual basis, why are they being put forward? The real answer lies not in trade but in debt – as other writers, such as Daryl Guppy, have rightly pointed out.In asking for RMB revaluation cialis buy online, President Obama’s advisers were, in effect, asking China to donate $150-$300 billion in RMB to the US via debt reduction.

The arithmetic of this is simple. Cialis buy online: china’s holdings of US dollar assets, chiefly Treasury Bonds, are around $1.5 trillion, or 10.2 trillion RMB.A 10 percent devaluation of the dollar vis-à-vis the RMB would reduce the value of these holdings to 9.3 trillion RMB cialis buy online, and a 20 percent dollar devaluation would reduce their value to 8.5 trillion RMB.In either case the U.S.is asking for its debt to China to be reduced by 10-20 percent in RMB terms.  It may now be seen why President Obama’s advisers have a vested interest in not examining the factual situation of China’s trade – cialis buy online. Cialis buy online: they are seeking a large debt relief package.

Cialis buy online: sigh.  The arithmetic is apparently not as simple as it seems.  When one of my central-bank seminar undergraduates showed me this article in December, he was chortling with glee at its bad economics and suggested I used the article to teach the freshman class – the assumption being that no PKU finance student above the level of freshman could have ever made this kind of conceptual mistake.  Perhaps not, but certainly anyone writing about currency policy should have at least done the math first.

Although this article is more confused than most about the impact of an appreciation on central bank reserves, it is worth explaining why it is wrong so as to address the less excitingly conspiratorial mistakes made by the merely confused.  First, can an appreciation of the RMB reduce the cost to the US government of its debt obligations?  Of course not.

The US government transacts almost exclusively in dollars, raises dollars in the form of taxes and borrowing, and owns dollar assets.  Since it will pay exactly the same number of dollars to Chinese investors after the change in the RMB value as it did before the change, simple arithmetic should indicate that there will be no impact at all on the cost to the US of repaying the debt.  After all, if a revaluation of the RMB causes the euro to drop against the dollar (a highly plausible outcome), could it possibly be true that the USG would reduce its payments on $100 of obligations owed to Chinese investors while increasing its payments on $100 of obligations owed to European investors?  Exactly how would this work?

Are there no winners and losers?

It wouldn’t.  The claim is nonsensical and violates simple arithmetic.  But if the RMB is revalued are there no losses and gains anywhere?  Yes, of course there are, but the distribution of these gains and losses is completely different from what this article claims, and depends wholly on the structure of various balance sheets. In a nutshell cialis buy online, anyone who is net long dollars against RMB loses, and anyone who is net short dollars against RMB gains.

First of all, will China as an economic entity lose?  Leaving aside the vigorous discussion about whether an RMB revaluation will increase or reduce China’s long term growth prospects (I think it will), the net balance-sheet impact of a revaluation depends on whether China is net long or net short dollars.  There is no precise way of answering this question, because every single economic entity in China implicitly has some complex exposure to the dollar (by which I mean foreign currencies generally) through current and future transactions, but generally speaking China is likely to gain from a revaluation because after the revaluation it will be exchanging the stuff it makes for stuff it buys from abroad at a better ratio.  The value of what it sells abroad will rise relative to the value of what it buys from abroad, and if we could correctly capitalize those values on the balance sheet, it would probably show that the Chinese balance sheet would improve with a revaluation of the RMB.

Some people might make a more sophisticated argument that since China is a net creditor – i.e.it is net long dollars – it will lose by a revaluation of the RMB.  This argument also turns out to be wrong, but for more complex reasons, and to explain why I have to put on my former-trader’s hat and explain the difference between a real loss and a realized loss.

If you believe that the RMB is undervalued then you must accept that China takes a “real” loss every single time it exchanges a locally produced good or asset for a foreign one.  It does not “realize” the loss, however, until it revalues the RMB to its “correct” value – cialis buy online.

Cialis buy online: in other words, the PBoC, as the representative of China’s net creditor status, will immediately realize a loss when the RMB revalues, but this loss did not occur because of the revaluation.  It occurred the very day the trade took place.  When a Chinese producer sold goods to the US and took payment in US dollars, there was an unrealized economic loss equal to the undervaluation of the RMB.  This unrealized loss was passed onto the PBoC when it bought the dollars from the exporter and paid RMB.

This loss, however, will not actually show up until the RMB is revalued, which forces the real loss to be realized (i.e.recognized as an accounting matter). Postponing the revaluation, then, is not the way to avoid the loss – it is too late for that.  The only way to avoid future additional loss is to stop making the exchange, which means, ironically, that the longer the PBoC postpones the revaluation of the RMB, the greater the real loss it will take.

So a revaluation of the RMB will not cause any real loss to any Chinese entity today.  The loss already occurred but hasn’t been realized.

But wait, if the RMB is revalued by 10%, the value of the PBoC’s assets will immediately decline by $250 billion in RMB terms.  Since the Chinese measure their wealth in RMB, isn’t this a real additional loss for China?

No, because remember that the only thing you can do with reserves is pay for foreign imports or repay foreign obligations.  And just as the value of the reserves drops 10% in RMB terms, so does the value of all those foreign payments – by definition they must go down by exactly the same amount in RMB terms.

This means that China takes no loss.  It can buy and pay for just as much “stuff” after the revaluation, and with less implied PBoC borrowing, as it could before the revaluation – and the real value of money is what you can buy with it.  So the real value of the reserves hasn’t changed at all – just the accounting value in RMB, but this simply recognizes losses that were already taken long ago when the trade was first made, and should be a largely irrelevant number (except perhaps for conspiracy theorists).

Wealth is transferred within China

But that doesn’t mean nothing at all happened.  Although the Chinese overall balance sheet is probably a little better off with the revaluation, within China there are a whole set of winners and losers – cialis buy online.Which is which depends on the structure of individual balance sheets.  Basically everyone who is net long dollars against the RMB loses in an appreciation cialis buy online, and everyone who is net short dollars against the RMB wins.

Who loses?  Of course the PBoC is a big loser.  It has a hugely mismatched balance sheet in which it is long nearly $3 trillion (if everything were correctly counted), funded by an equivalent amount of RMB obligations.

Exporters and their employees, too, are naturally long dollars and so they would lose.  Cialis buy online: they are long dollars because more of the net value of their current and future production less current and future costs is denominated in dollars (they are “sticky” to dollar prices) – for example labor costs, land, and almost all other inputs except imported components are valued in RMB, whereas most revenues are valued in dollars.

Chinese companies with more assets abroad then foreign debt might also lose.  Who wins?  Nearly everyone else in China, since everyone in the country is short dollars to the extent that there are imported goods in his life.  The local tea seller is short dollars if his tea is delivered to him in gas-guzzling trucks, as is the family planning to visit Egypt next year, as is the local provider of French perfumes, as is a teenager who wants to buy Nike shoes, and so pay for the corporate sponsorship of a Brazilian soccer star playing for a Spanish team; cialis buy online. Every household and nearly every business in China is, in one way or another, an importer (and this is true in every country), so unless they own a lot of assets abroad they are effectively short dollars and will benefit from an appreciation in the RMB.

Revaluing the RMB, in other words, is important and significant because it represents a shift of wealth largely from the PBoC, exporters, and Chinese residents who have stashed away a lot of wealth in a foreign bank, in favor of the rest of the country.  Since much of this shift of wealth benefits households at the expense of the state and manufacturers, one of the automatic consequence of a revaluation will be an increase in household wealth and, with it, household consumption.  This is why revaluation is part of the rebalancing strategy – it shifts income to households and so increases household consumption.

So a revaluation has important balance sheet impacts on entities within China, and to a much lesser extent, on some entities outside China.  But since it merely represents a distribution of wealth within China should we care about the PBoC losses or can we ignore them?  Unfortunately we cannot ignore them and might have to worry about the PBoC losses because, once again, of balance sheet impacts.

The PBoC runs a mismatched balance sheet, and as a consequence every 10% revaluation in the RMB will cause the PBoC’s net indebtedness to rise by about 7-8% of GDP.  This ultimately becomes an increase in total government debt, and of course the more dollars the PBoC accumulates, the greater this loss.  (Some readers will note that if government debt levels are already too high, an increase in government debt will sharply increase future government claims on household income, thus reducing the future rebalancing impact of a revaluation, and they are right, which indicates how complex and difficult rebalancing might be).  In that sense it is not whether or not China as a whole loses or gains from a revaluation that can be measured by looking at the reserves cialis buy online, and I would argue that it gains, but how the losses are distributed and what further balance sheet impacts that might have.

I apologize for such a long post, but I promised several people that I would try to address some of these issues, and it is hard to do so briefly.  In short, what the PBoC does to the value of the RMB and how it invests its reserves matter a lot to China and the world, but not always in the way China and the world think.  To get it right, we need to keep in mind the functioning of the balance of payments, the PBoC and other balance sheets, and the way the two are interrelated.

Note: In response to many complaints by people who were confused by the headline — I was being sarcastic; buy cialis generic. Puerile humor, perhaps, but the point is that over the last year it seems that we hit absolute bottom roughly every fifth week.

Have we reached a bottom? A lot of analysts are pointing to the improvement in both measures of Chinese PMI to suggest that Chinese manufacturing may finally have reached a bottom, even though both PMI measures are still well below 50 and so indicate a contraction in manufacturing; buy cialis generic. More impressively the stock market has rebounded, with the SSE Composite bouncing off its January 13 close of 1863 to reach, as of yesterday 2108 (up 13.1%). Today it traded up another 2.0% in the morning before giving it all back, and more, during the afternoon to close down 0.5% for the day. Before the market turned Bloomberg today reported a very optimistic fund manager:

“Stocks continue to be lifted by speculation more stimulus measures are on the way,” said Michiya Tomita, a Hong Kong-based fund manager of Chinese stocks at Mitsubishi UFJ Asset Management Co., which oversees $61 billion.“There’s a growing perception that China’s economy will recover surprisingly fast.”

Surprisingly fast? I’ll take that bet; buy cialis generic. Aside from the normal excitement we all get from the right kinds of stimuli, part of the recent optimism seems to reflect the huge upsurge in bank lending I reported last week – with loans in January rising by RMB 1.3 trillion. Nearly one-quarter of that was provided just by ICBC. According to an article in today’s Bloomberg:

Industrial & Commercial Bank of China Ltd., the nation’s largest, said it offered 252.1 billion yuan ($36.9 billion) of new loans in January in response to the government’s stimulus plan to avert an economic slowdown. The bank lent 69.3 billion yuan to power grid, railway, roads, and hydroelectric power projects, and 135 billion yuan in discounted bills to small and medium-sized companies, the Beijing-based firm said in an e-mailed statement, without giving comparisons – buy cialis generic.New loans to individuals buy cialis generic, including mortgages, amounted to 16 billion yuan.

China dropped lending quotas and unveiled a 4 trillion yuan stimulus package in November to maintain economic growth and counter the global financial crisis – buy cialis generic. Buy cialis generic: banks have responded by raising lending targets and focusing on railways, roads, power grids and other infrastructure projects with stable returns. Domestic banks offered a record 1.2 trillion yuan of new loans last month buy cialis generic, representing almost a 50 percent gain from a year earlier, the China Securities Journal said yesterday.

ICBC aims to advance 530 billion yuan of new loans in 2009 buy cialis generic, about the same as last year, the 21st Century Business Herald reported today.The bank plans to complete 45 percent of the loan target in the first quarter – buy cialis generic. ICBC attracted 271.2 billion yuan of deposits in January, equivalent to a quarter of the total increase in 2008, according to today’s statement.

I have long argued that credit is a much better gauge of money supply in China than any of the monetary aggregates buy cialis generic, so this explosion in bank lending should suggest at least that China is making the right moves from a monetary point of view – pumping liquidity into the system to avert a contraction in money supply that would exacerbate the contraction in demand. But I have three very serious problems with the optimism associated with the latest numbers on credit expansion.

First, this credit expansion is not all that it may seem – buy cialis generic. Aside from the fact that a lot of this new credit has consisted of an increase in bill discounting buy cialis generic, in order to understand what is really happening to total credit in the Chinese economy we need much better data. There are persistent rumors that part of the increase in bank lending consisted of putting back on balance sheet loans that were taken off balance sheets in 2007 and 2008 when the PBoC was trying to constrain bank lending. Buy cialis generic: it isn’t really new credit. We also don’t have a very good feel for what is happening in the informal banking sector, and in the past there was evidence that contraction and expansion in the informal banks counteracted what occurred in the formal banking sector.

What is more, there is clearly an increase in lending games aimed at making policymakers happy by showing fat loan books. One of my students just visited me today with an example that involved his father. I don’t want to get into too much detail, for obvious reasons, but the net effect of the transaction involving his father was that an entity was created to borrow money from a bank, the proceeds of which were deposited in a CD, which was then assigned in ownership to the real borrowing entity, which then used the CD as collateral for the “real” loan; buy cialis generic. Buy cialis generic: aside from the complications used probably to get around credit restrictions, one single loan was recorded as two loans plus a CD deposit. Apparently the lending bank knew about all the intermediate steps. Surprise, surprise! It turns out that if your career prospects depend on increasing the total amount of loans outstanding, with less focus on the quality or structure of the loans, in fact it isn’t hard to show very nice, fat loan book.

One of the readers of this blog, yesterday gave another very interesting example of what might be included in this new lending. He says:

As for the sudden surge in lending, this looks to me to be an accounting exercise, clearing or otherwise funding non-bank debts piled up by SOEs.Many large SOEs (not central ones, regional/local ones, though the central ones win no prize themselves) are behind on paying wages, suppliers etc, and the stimulus provided by this lending surge is really just to ease the log-jam of triangular debts – buy cialis generic. Buy cialis generic: this implies that there will not be much “bang” for all of this lending

Second, exploding credit may provide a fillip to growth in the short term, but if it leads to a future increase in bad loans, it will have exactly the opposite effect in the near future. As I discuss in my previous blog entry, this represents a big bet on the duration of the slowdown.

Third, the biggest problem has to do with how much credit expansion will make a difference. Andrew Batson at the Wall Street Journal (sorry, I don’t have the link) makes this point when he discusses the “string of dire profit warnings has signaled a rapid deterioration in the financial health of Chinese companies.” His relevant paragraphs:

Corporate investment is hugely important to China’s economy, where capital spending accounts for more than 40% of annual output, one of the highest ratios in the world – buy cialis generic.The profit decline will have major effects across the economy as companies have less money to buy new equipment or expand their businesses.

…Economists have long warned that Chinese companies’ heavy reliance on retained profits would tend to exaggerate swings in the nation’s investment cycle.Official statistics show that 63% of investment in China last year was financed by what are called “internally generated” funds buy cialis generic, which include retained profits.That’s up from just below 50% a decade ago.

Basically Chinese corporate profitability in China is dropping sharply, and nearly everyone expects the trend to continue over the rest of 2009 – buy cialis generic. Buy cialis generic: if nearly two-thirds of investment in China was funded by retained earnings, a sharp drop in profitability should result in an equally sharp drop in investment funded by retained earnings. I don’t know the magnitude, but I would guess that a very large increase in real bank lending aimed at real investment, far more than has been reported, would be needed just to make up for the decline in investment out of retained earnings. This, by the way, is an argument that has also been made by my friend Sam Baker at TNR.

For these three reasons (and a few others), I am not as impressed as many others are by the recent expansion in credit. I acknowledge, of course, that I may be hemming myself in intellectually because of my very strong belief that China will be forced one way or the other to make a necessary but difficult adjustment from export orientation to growth based on domestic consumption, and so I am blind to the good news, but for now I am sticking with my belief.

Aside from doubting the beneficial impact of credit expansion a larger part of the reason for my continued skepticism is that I am much more impressed by the expectations of hordes of workers returning to work after the Spring Festival and not finding jobs. Today’s South China Morning Post starts off an article today

One of the world’s leading luxury furniture makers has folded in Shenzhen amid the economic crisis, leaving more than 2,000 unpaid workers blocking traffic in protest until the local government paid more than 10 million yuan (HK$11.3 million) in back wages. DeCoro, the Shenzhen-based Italian sofa manufacturer employing nearly 3,000 people, had gone into liquidation with all assets seized by a local court in Longgang district, the National Business Daily reported.

Less anecdotal is another article, also in today’s edition:

Guangdong authorities are expecting millions of unemployed migrant workers to pour into the province in search of work, despite official warnings that the prospects are slim; buy cialis generic. Provincial labour authorities say 10.25 million migrant workers left for the Lunar New Year holiday, and of the 9.7 million expected to return soon, about 20 per cent would find it extremely difficult to find work; buy cialis generic.

But the biggest problem I have is that anyone taking a global view, and not just a very local view, cannot fail to be impressed by how bad the numbers out there are – buy cialis generic. For one thing buy cialis generic, US GDP contracted by 3.8% in the fourth quarter of 2008. Normally that would be a horrible piece of news, but most analysts were pleasantly surprised because they expected something closer to 5.5%. Does that suggest that the US, too, is bottoming out? No, because apparently what saved the US from a much larger contraction was heavy orders from factories, including foreign factories, based on a surge of optimism during the summer – buy cialis generic. According to an article in Monday’s Wall Street Journal (I don’t have the link because I read it in the plane, but for those interested the article is titled “US Economy Dives as Goods Pile Up”):

While the fall wasn’t as steep as expected – most forecasts had GDP falling by 5% to 6% — output was boosted somewhat by a rise in inventories of goods that were produced but not sold in the fourth quarter; buy cialis generic. Excluding the inventory adjustment buy cialis generic, GDP fell at a 5.1% rate, which economists say more accurately reflects the nation’s weakness.

Rising inventories, in other words, accounted for the better-than-expected US economy in the fourth quarter of 2008. But now those inventories have to be sold. That means however bad we expect US demand to be in the next few months, US companies will buy even less because they have excess inventory that needs to be run down. The unexpectedly good results for the last quarter will cause an unexpectedly bad result this quarter (not unexpected, of course, but you know what I mean).

And there is more. The US savings rate dropped to below zero in 2005 and 2006 but since then has been rising as Americans are forced to pay down debt and save more. Savings rose to nearly 3% of disposable income in the fourth quarter, from 1.2% in the previous quarter, according to the same article. But 3% is not enough. My guess is that this represents less than a third of the total adjustment that needs to be made. Remember that every dollar the US saves is a dollar that doesn’t go towards consumption; buy cialis generic.

Here is another way of looking at the same data; buy cialis generic. David Pilling has a very sober piece in yesterday’s Financial Times in which he argues that “China should raise wages to stimulate demand.” Of course he is right and of course they should (at least this is what I have been arguing for a while), even though it seems completely counterintuitive; buy cialis generic. Most analysts both in and out of China are arguing that China should try to increase the competitiveness of its manufacturers and the profitability of its businesses buy cialis generic, and in this light raising workers’ wages seems stupid, but in fact I would argue that this is the best medium-term strategy to minimize the cost of the downturn to China. I will argue this more fully another day, but I do want to extract two paragraphs from Pilling’s article:

To see why, look at US personal consumption, which hovered around 67 per cent of gross domestic product in the last quarter of the 20th century.That was already high by the standards of the previous 25 years; buy cialis generic.But from 2000 to 2008, it shot up again to an unprecedented 72 per cent; buy cialis generic.That trend has now gone into painful reverse; buy cialis generic.As Stephen Roach, chairman of Morgan Stanley Asia, notes wryly: “We are already all the way down to 71 per cent.” In other words, it will be a very long time before Americans are again filling up their shopping carts – buy cialis generic.

…In 1980, 65 per cent of output of developing Asia was accounted for by consumption – buy cialis generic. Buy cialis generic: today it is about 47 per cent. Buy cialis generic: the main reaction to the Asia crisis of 1997-98, when economies’ vulnerability to financial flows was exposed, was to build up exports.In doing so buy cialis generic, Asia has swapped one kind of dependence for another.

US consumption dropped from 72% “all the way down” to 71%. Of course Stephen Roach is joking. US consumption has to decline by a lot more than that buy cialis generic, and it will. Any attempt to understand China’s economy without situating it firmly within the global context, and especially within the contraction in global demand (remember as a major trade-surplus country China needs foreign demand to absorb its huge overcapacity) will not get the picture right.

By the way, on a related note, the US “Buy America” plan, which has been both widely criticized and widely replicated – explicitly or implicitly – by a lot of countries including China, is an example of how things are likely to turn when it comes to trade prospects. The good news buy cialis generic, I think, is that those of us who worry about an explosion of protectionism are getting so alarmed that there may be a concerted fight to ward it off.

One other piece of mild good news, China yesterday increased the tax rebate for textiles. Buy cialis generic: according to an article in today’s People’s Daily:

China will increase the tax rebate rate for textile and garment exports from 14 percent to 15 percent, an executive meeting of the State Council (Cabinet) announced Wednesday. The move would reduce exporters’ costs and support the textile industry, the Council said.

Increasing the tax rebate is actually a bad thing, in my opinion, since it seeks to improve the trade “competitiveness” of Chinese textiles and so increase China’s ability to export overcapacity, but the increase was much less than the industry expected. Thank god for small favors.

P.S.The day after I posted this the South China Morning Post provided a bit more clarity on the composition of ICBC’s loan expansion. According to an article in today’s edition:

Routine “bill financing” accounted for more than half of the loans the mainland’s largest bank by assets granted last month buy cialis generic, underscoring concerns that the lending upsurge Beijing recently hailed as a sign of economic recovery may be inflated. Industrial and Commercial Bank of China extended 135 billion yuan (HK$153.12 billion) in “bill discount loans” and 117.1 billion yuan of other loans last month, the lender said yesterday – buy cialis generic. Buy cialis generic: in discounting a bill, the bank takes on a company’s bill to a buyer before it is due and credits the value of the bill, after a discount charge, to the customer’s account.

Analysts said that of the 1.2 trillion yuan in loans made in January buy cialis generic, about 65 per cent or 780 billion yuan were estimated to be “real” loans.That was slightly lower than last year, meaning the loan surge was largely illusory. “Banks are snapping up quality clients and projects,” a credit officer at a large bank said.” Buy cialis generic: the more an enterprise does not need money, the more willing banks are to lend to it.”

…Banks generally only lend to quality small enterprises with loan yields of 6 per cent to 7 per cent, or 10 to 30 per cent above benchmark loan rates, according to Goldman Sachs. With the share of discounted bill financing in monthly incremental loans rising sharply from 5 per cent to 33 per cent over the past five months buy cialis generic, the proportion of medium to long-term loans has shrunk from 50 per cent to 32 per cent.

Thus, the strong lending growth’s boost to fixed-asset investment was limited, China International Capital Corp said in a report; buy cialis generic. The truth may be a blow to mainland officials who are eager to see the economy on track to a recovery buy cialis generic, but it could offer relief to bank shareholders in the short term.

P.S.S. Buy cialis generic: on Friday afternoon I had an email discussion with Standard Chartered’s Stephen Green, one of my favorite research analysts, in which I asked if numbers provided by the PBoC branch in Wenzhou (Wenzhou is widely known as the capital of the informal bank sector in China) suggested that the informal banking sector was contracting loans. His answer: “Yep, that seems to be the thrust of it. In Wenzhou informal pool around CNY 600bn in recent years but new report by Wenzhou’s PBoC reports that between Jan and Dec ’08, total deposit in Wenzhou’s banks rose 27.9% to CNY 208.5bn, indication they say that unofficial lending has slowed down – buy cialis generic.Certainly that was what seemed to be going on when we visited in September, large number of financiers had shut down for various reasons.”

– buy cialis generic

Both remained more or less stable for the next three years, but then beginning in 1999 and over the next eight years wages declined from 52% to 40% of GDP; online cialis. Online cialis: during that time private consumption declined from 47% to 37% of GDP. In almost every year except two both figures move in the same direction.

Over the last fifteen year, in other words, private consumption as a share of GDP has been very highly correlated with the level of wages – online cialis. China has very weak labor unions and worker representation, so in the fight between workers and capitalists for a share of the economic pie, workers have been on the losing end, and it is hard to see how they will do much better in the future, but it is probably in China’s best long-term interest that they do – online cialis. As wages have risen and fallen as a share of GDP, so has private consumption. This isn’t a surprise, but the relationship is pretty dramatic.

Unfortunately the World Bank report also says:

Direct government spending, in the form of government direct consumption or investment, typically creates more economic activity than an increase in transfers or tax cuts; online cialis. Online cialis: this is because higher transfers or tax cuts that increase income may not necessarily induce spending, especially by higher income people or when times are especially uncertain. Stimulus targeted at increasing demand for products of sectors with excess capacity will have a larger activity and employment effect – online cialis. In the short term, however, there is no difference in the growth impact between government investment and government consumption.

That means, as I see it, that in the long run it is very important for China to raise wages as it tries to develop an internal market, but it will be hard to exploit the crisis to force through wage increases since in the short term they are less effective than government spending; online cialis. There have been rumors about wage increases that have then been denied online cialis, so I have no idea where this idea stands in the hierarchy of policies, but I suspect that companies will use the crisis as a way of arguing that the last thing China needs is wage increases.