Thursday, April 14, 2005
What about the Yuan?
Call it idle speculation but maybe it will be the Yuan and not the Euro that replaces the Dollar.
Jax
First, they said it must be devalued. Now they want it to be "revalued".
It was the eve of the 1997 Asian financial crisis when the world first raised the chorus for yuan's devaluation. The logic of the markets then: the economy is in a shambles and the banks have run up unmanageable debts; if the yuan is not devalued, Chinese exports would soon become too expensive to hold their position and foreign capital would stop flowing into the country.
The Chinese government then thought there was little to gain from devaluation. It would trigger another round of competitive devaluation from other Asian currencies, which would eat into the newfound advantage of the yuan. So Beijing decided to hold on to its fixed peg to the dollar and boost exports by cutting taxes on exporting companies so that commodity prices went down in dollar terms. The strategy won. Asian currencies stabilized, the dollar went slowly down vis-a-vis other Asian currencies and the new kid on the block, the euro.
The lesson that China learned was that with currencies, one should not lose one's head, even if everyone else in the market is losing theirs. This is a lesson worth keeping in mind amid today's chorus for revaluation. Pundits point at China's long-lasting trade surplus, the gains in its labor productivity, the bulging foreign reserves, the low inflation rate and the country's contribution to global growth to draw the conclusion that yuan is going too cheap. Among their many arguments: a can of Coke or a Big Mac in China costs half of that in the United States, hence the yuan must go up 20-40%.
Reams have been written on how billions of dollars of hot money are waiting in the wings for the revaluation before entering China. The pressure of this hot money is even more compelling than the threat of high costs for exports that a revalued yuan would entail. The central bank has to intervene to sterilize this money, and this puts further pressure on the banking system, already creaking under piles of bad debt.
One more bandied about suggestion is to broaden the exchange band and let the yuan shoot up by some 10%. But if that were to occur, it could well trigger bigger problems. Hot money would have one more reason to come in. Japan's economy is improving but it is still weak after over a decade of crisis. The US is doing well but question marks over its huge deficit and the weak dollar persist. The euro, trading now at about $1.3-1, doesn't represent a vibrant economy. The European economy in fact can't get moving past a lackluster 1% growth. The task of successfully digesting former East European economies into the main frame of a new Franco-German economic coalition will take years. All these destinations for international capital thus look gray if compared with China's 9.5% growth rate for the past quarter of a century. Given the country's steady growth, any revaluation of the yuan would only open the floodgates to hot money.
Moreover, China might not be ready for a huge flow of investment into or out of the country. Its stock exchange is, basically, a waste bin. It's the legacy of a time when the state used the share market to rip off small investors to finance non-performing state-owned enterprises (SOEs). But there was a moral angle to this rip-off: the SOEs were supporting workers and the social fabric of urban China. The state and the market needed reform and reform needed money, but there was none available. At the same time, there were lots of people making money, often walking in a gray line between legal and illegal in the shifting paradigm of China's economy in the 1990s. But this money was hard to invest because of the lack of investment tools and also because the aspiring investors were not too keen on explaining how they made that money.
So the stock exchange worked for both the investors and the state: it gave the state the cash for reform and investors an avenue to distil their ill-gotten money. Even if they were to be ripped off, they couldn't complain too much - the money was easy come, easy go. Thanks to the stock exchange, the state would reap the taxes these investors had evaded in the first place. Hundreds of SOEs were thrown into the market, to be treated more like gambling chips than long-term investment tools. The present stock exchange still retains many such companies that shouldn't have been listed in the first place or de-listed a long time ago.
Banks are in no better health either. Deposits vastly exceed investment, which means banks are failing to invest properly. The bank spread between interest on deposit (about 1%) and that on credit (over 5%) is huge. This problem of inefficiency of the banking system is much graver than the bad debt problem. Bad debt is the legacy of a time when banks served as the state's financial arm to deliver aid to the SOEs. These debts should simply be written off and included in state accounts instead. But if this is done without improving the efficiency of the banks, it would be of little help.
More serious than the problem of bank management is that of the quality of credit. Nobody in China will reveal to his bank how much money or property he owns. Banks are not known to keep such secrets, and squeal to the tax bureau and police. Whoever has any money in China didn't get it clean - "primitive accumulation" in Marxist terms. The Americans had slave trade, the Chinese a murky economy in which some made fortunes while others had their heads chopped off. China has had a muddled legal framework, where the line between the legal and the illegal has been a very fuzzy one. Almost everybody in China has done something not perfectly legal with his or her money. In the past, even subletting one's apartment could make one liable for persecution. Thus no one wants to volunteer information on their wealth to the banks and risk a police inquiry into past history. So banks are mainly left with SOEs as their main clients, no surprise then that half the Chinese money is cash circulating outside the banking system.
But money must go back to banks as cash transactions are clumsy and open to deception.. However, for banks to be trusted and not seen as conniving with tax and police officials, there needs to be some kind of an amnesty for past economic "crimes" - something that would pardon, say, tax evasion, but help isolate cases of drug trafficking. Free flow of foreign money in China before all this is done could destabilize the Chinese economy.
Moreover, there is the US. According to Chinese scholars, over 50% of America's daily consumer goods come from China. An appreciation of the yuan by 5-10% would push up prices by about 1%. Again, the dollar would go further down and the euro further up. One isn't sure if that would save any jobs in the US, but hot money rushing in and out of China could well disrupt the Chinese economy, and by extension global finances. China is not sure if it - or anybody else for that matter - would gain anything from this, apart from some currency punters. But it certainly would be in the interest of everybody, including China, to broaden the currency band by some 5% and slowly create a basket of currency to peg the yuan, a basket that also includes the yen and the euro. Anything short of this would undermine the stability of the yuan and threaten the world economy. (Link)
Jax
First, they said it must be devalued. Now they want it to be "revalued".
It was the eve of the 1997 Asian financial crisis when the world first raised the chorus for yuan's devaluation. The logic of the markets then: the economy is in a shambles and the banks have run up unmanageable debts; if the yuan is not devalued, Chinese exports would soon become too expensive to hold their position and foreign capital would stop flowing into the country.
The Chinese government then thought there was little to gain from devaluation. It would trigger another round of competitive devaluation from other Asian currencies, which would eat into the newfound advantage of the yuan. So Beijing decided to hold on to its fixed peg to the dollar and boost exports by cutting taxes on exporting companies so that commodity prices went down in dollar terms. The strategy won. Asian currencies stabilized, the dollar went slowly down vis-a-vis other Asian currencies and the new kid on the block, the euro.
The lesson that China learned was that with currencies, one should not lose one's head, even if everyone else in the market is losing theirs. This is a lesson worth keeping in mind amid today's chorus for revaluation. Pundits point at China's long-lasting trade surplus, the gains in its labor productivity, the bulging foreign reserves, the low inflation rate and the country's contribution to global growth to draw the conclusion that yuan is going too cheap. Among their many arguments: a can of Coke or a Big Mac in China costs half of that in the United States, hence the yuan must go up 20-40%.
Reams have been written on how billions of dollars of hot money are waiting in the wings for the revaluation before entering China. The pressure of this hot money is even more compelling than the threat of high costs for exports that a revalued yuan would entail. The central bank has to intervene to sterilize this money, and this puts further pressure on the banking system, already creaking under piles of bad debt.
One more bandied about suggestion is to broaden the exchange band and let the yuan shoot up by some 10%. But if that were to occur, it could well trigger bigger problems. Hot money would have one more reason to come in. Japan's economy is improving but it is still weak after over a decade of crisis. The US is doing well but question marks over its huge deficit and the weak dollar persist. The euro, trading now at about $1.3-1, doesn't represent a vibrant economy. The European economy in fact can't get moving past a lackluster 1% growth. The task of successfully digesting former East European economies into the main frame of a new Franco-German economic coalition will take years. All these destinations for international capital thus look gray if compared with China's 9.5% growth rate for the past quarter of a century. Given the country's steady growth, any revaluation of the yuan would only open the floodgates to hot money.
Moreover, China might not be ready for a huge flow of investment into or out of the country. Its stock exchange is, basically, a waste bin. It's the legacy of a time when the state used the share market to rip off small investors to finance non-performing state-owned enterprises (SOEs). But there was a moral angle to this rip-off: the SOEs were supporting workers and the social fabric of urban China. The state and the market needed reform and reform needed money, but there was none available. At the same time, there were lots of people making money, often walking in a gray line between legal and illegal in the shifting paradigm of China's economy in the 1990s. But this money was hard to invest because of the lack of investment tools and also because the aspiring investors were not too keen on explaining how they made that money.
So the stock exchange worked for both the investors and the state: it gave the state the cash for reform and investors an avenue to distil their ill-gotten money. Even if they were to be ripped off, they couldn't complain too much - the money was easy come, easy go. Thanks to the stock exchange, the state would reap the taxes these investors had evaded in the first place. Hundreds of SOEs were thrown into the market, to be treated more like gambling chips than long-term investment tools. The present stock exchange still retains many such companies that shouldn't have been listed in the first place or de-listed a long time ago.
Banks are in no better health either. Deposits vastly exceed investment, which means banks are failing to invest properly. The bank spread between interest on deposit (about 1%) and that on credit (over 5%) is huge. This problem of inefficiency of the banking system is much graver than the bad debt problem. Bad debt is the legacy of a time when banks served as the state's financial arm to deliver aid to the SOEs. These debts should simply be written off and included in state accounts instead. But if this is done without improving the efficiency of the banks, it would be of little help.
More serious than the problem of bank management is that of the quality of credit. Nobody in China will reveal to his bank how much money or property he owns. Banks are not known to keep such secrets, and squeal to the tax bureau and police. Whoever has any money in China didn't get it clean - "primitive accumulation" in Marxist terms. The Americans had slave trade, the Chinese a murky economy in which some made fortunes while others had their heads chopped off. China has had a muddled legal framework, where the line between the legal and the illegal has been a very fuzzy one. Almost everybody in China has done something not perfectly legal with his or her money. In the past, even subletting one's apartment could make one liable for persecution. Thus no one wants to volunteer information on their wealth to the banks and risk a police inquiry into past history. So banks are mainly left with SOEs as their main clients, no surprise then that half the Chinese money is cash circulating outside the banking system.
But money must go back to banks as cash transactions are clumsy and open to deception.. However, for banks to be trusted and not seen as conniving with tax and police officials, there needs to be some kind of an amnesty for past economic "crimes" - something that would pardon, say, tax evasion, but help isolate cases of drug trafficking. Free flow of foreign money in China before all this is done could destabilize the Chinese economy.
Moreover, there is the US. According to Chinese scholars, over 50% of America's daily consumer goods come from China. An appreciation of the yuan by 5-10% would push up prices by about 1%. Again, the dollar would go further down and the euro further up. One isn't sure if that would save any jobs in the US, but hot money rushing in and out of China could well disrupt the Chinese economy, and by extension global finances. China is not sure if it - or anybody else for that matter - would gain anything from this, apart from some currency punters. But it certainly would be in the interest of everybody, including China, to broaden the currency band by some 5% and slowly create a basket of currency to peg the yuan, a basket that also includes the yen and the euro. Anything short of this would undermine the stability of the yuan and threaten the world economy. (Link)
