China’s Economy: Action vs Rhetoric

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International concern remains high that China hasn’t done enough to rebalance its economy and help reduce global trade and currency imbalances. While Beijing continues to send reassuring messages about making its currency more flexible and relying less on exports, the reality over the past year suggests there are some less comforting nuances.

With Chinese President Hu Jintao preparing to head to Washington next week, there are four issues that are worth revisiting to better understand the situation.

The first is what has been the headline-grabbing issue of currency revaluation. China claims that it’s moving to a more flexible system and gradually appreciating the currency. Flexibility is clearly desired, but a major appreciation isn’t. Beijing tends to adjust its currency in light of international political considerations, and significant upward movement has been seen shortly before three high-profile events—Premier Wen Jiabao’s meetings with Barack Obama and European leaders in the early autumn, the G-20 meeting in November, and now Hu’s upcoming US visit—since the renminbi (yuan) was allowed to fluctuate in June 2010 following the collapse of the euro.

The net change so far has been an appreciation of only 2.5 percent—a far cry from the 20 percent suggested by mainstream observers. Political events clearly matter in the 135 daily adjustments taken by China’s central bank since June 21. In September, during the build up to Wen’s meetings, the renminbi appreciated 1.5 percent; in November prior to the G-20 meeting it appreciated another 1 percent; and after confirmation of Hu’s visit in late December, it went up another 0.6 percent. During these three episodes, the renminbi moved up 34 times and down just 8 times. Aside from these three periods, the renminbi moved up roughly the same number of times it moved down (48 to 45) and on balance actually depreciated by 0.6 percent.

Looking at this, it’s no wonder critics continue to be agitated by the perceived pace of revaluation of the currency. Speculation is now focused on whether the recent adjustments are real or just another politically driven half step. The most likely scenario appears to be continued event driven small appreciations with a net rise of no more than 5 or 6 percent over the coming year. 

The second issue to consider is China’s trade surplus—it’s lower than before the financial crisis, but it continues to be larger than expected. Despite significant wage increases and cost pressures, China’s labour productivity remains high relative to competitors. And, even though global trade is down, China is still capturing a larger share. Any reduction in exports due to diminished demand in the United States and Europe appears to be moderated by gains in emerging markets, meaning that China’s competitors in the developing world may become as vociferous on currency issues as the West.

The third concern is China’s ability to increase consumption and reduce investment to moderate global imbalances. The fact here is that any hopes for change need to be tempered. Although Chinese consumption is exceptionally low as a share of GDP, consumption has been increasing at an impressive 8-9 percent annually for years. While it makes sense to expect a rebound in consumption after a recession in the United States and Europe, this argument is less convincing in China.

Comments
8
Liang1a
April 23, 2011 at 15:45

It is foolish for the Americans to force China to raise the value of the yuan. The unemployment rate of America had been falling since 1994 when China lowered the value of the yuan from 5 yuan per dollar to 8 yuan per dollar. But since 2005 when China raised the value of the yuan some 20% the American unemployment rate had gone up to more than 10% before falling down to 9%. Americans are foolish to think that if China increased the value of the yuan then it will help America to export more. It will not. At least not significantly more so. This is because China earns its foreign exchange by exporting to America. If China did not export more then it cannot import more. Therefore, it is unrealistic to expect China to import more by making American goods cheaper. Imagine the exchange rate is 6 yuan per dollar (to keep things simple). Let’s say a shirt costs 60 yuan or $10. If China raised the value of the yuan to 5 yuan per dollar, then the same shirt will still cost 60 yuan but inflated to $12. So Americans will still pay $60 for 5 shirts instead of 6 shirts as before. Americans are getting fewer shirts but the Chinese are getting the same amount of dollars. Therefore, China cannot import more American goods no matter how much the value of the yuan is raised. The only consequence is the deterioration of the American standard of living. This is why it is foolish for the Americans to force China to raise the value of the yuan.

On the other hand it is good for China to raise the value of the yuan. It will have the salutary effect of phasing out the labor intensive exports and rechannel resources and energy to domestic development. Of course, China must get out of the WTO so that it can ban FDI and keep China’s domestic market for China’s own investors and businesses. Ultimately, China’s domestic development and foreign trades are mutually exclusive because they compete for the same scarce resources. Therefore, domestic development cannot grow because exports sector will take most of the resources by outcompeting against the domestic consumer market. Furthermore, exports depending on cheap labor will keep the Chinese people poor and therefore cannot support an extensive domestic consumer market.

Ultimately, China can achieve a GNP of $100 trillion on 300 trillion yuan based on exchange rate of 3 yuan per dollar. China can reach that goal by growing at 7.5% per year in 30 years. But China can never develop $100 trillion economy by depending on foreign trade. Therefore, it is a simple matter of logic and arithmatic that China must rely on domestic development to give its 1.5 billion people the highest standard of living in the world by making the Chinese people produce all the goods and servies they consume. And to allow the Chinese people to be the most productive in the world, China must advance cutting edge technologies indigenously developed and owned and urbanize the farmers or rural residence to make them maximally productive working in the service and manufacturing sectors in the urban areas.

Johnny
March 13, 2011 at 02:45

@Nathan If you have some counter claim to debunk Matt’s claim then post that and we all will decide who to believe. But your posting of rage comments is not helpful to anyone and it actually reflects very poorly on you.
And he is not saying that Chinese will go extinct because of economic crisis. He is simply saying that economic downturn will result in collapse of dictator. Chinese dictator and China are two entirely different things.

John Chan
January 17, 2011 at 10:33

@Matt, you must be pretty rich, it seems you know the future price of Gold; future sight is a trait no human being possesses right now. Did you short any gold? If you didn’t you would miss the chance to become next John Paulson. Goldman Sachs, JP Morgan, UBS, and many others all said that gold would see $1800 by the end of this year. So what are you going to do, short or long?

Do you actually understand what is a hedge? Hedge is a risk management tool to safe guard the future uncertainty. Only the reckless westerners abuse the hedge as a betting tool instead of risk management tool, that’s why the financial system of the West collapsed in 2008. All those banks and similar institutions gambled and lost.

Despite being a developing country, China took a huge risk for the sake of world peace and prosperity. It took an unproportional risk and pitched in to help those affected by the financial crisis in Europe. The Germans, French, and Brits have abandoned their obligation to help their European partners, yet China practiced being a good world citizen by unselfishly contributing to help bail out the world, and you cursed them for it! The US is not helping to solve the world crisis it created, the US is pulling China’s leg to help the world by massive QEs and underhanded trade war traps, yet you praised the US’ destructive behaviour. So Matt, what are you? How can you see the selfish, treacherous, destructive nature of the US as something positive?

Do you know that China uses a two-tier currency system? That means the exchange rate hardly matters in China? Also do you know that China does not need to borrow for stimulus packages like the US?

You spit out a lot of financial mumbo jumbo, and then used it in bad faith against China. It seems something very disturbing has happened to you. Why do you have such burning hate of China, what has happened to you personally Matt?

John Chan
January 17, 2011 at 08:23

@Matthew Hall, if you cannot counter Michael’s argument with reasons, please do not recast the argument as cultural warfare between good and evil, and lash out at readers with different opinions with little or no regard for facts. Your petulance and demagoguery are a danger to the world peace and prosperity, and do no good for open and honest dialogue between people with different point of views regarding difficult issues are now encountered by the world.

Nathan
January 16, 2011 at 12:41

Matt….you have a wild and pessimistic imagination! The West is certainly messed up and have no one to blame but themselves! China on the other hand has kept their powder keg dry and has more fire power ready at their disposal! China has been around for 5000 yrs and has overcoming foreign invasions, opium wars, civil war, cultural revolution, great leap forward, famine and even communism and yet will crumble because of an economic downturn??? LOL You should try your hand at comedy or science fiction, you’ve definitely got an imagination for it!

Matthew Hall
January 16, 2011 at 10:59

“Michael” ;), chinese restrictions on inward investment and imports are countless and very effective. The chinese government is doing what is in its interests not the interests of the people of china. “Michael’s” shameless propaganda is yet another sign of the great danger china posses to the world and lengths they will go to in order to pursue it. Whether “Michael” is paid for his efforts or, even worse, a true believer in authoritarian government we will have the fight of our life on our hands with china; get ready “Michael” and everyone else.

Michael
January 16, 2011 at 07:37

China is not a vassal state of the West who will commit economic suicide to please their masters like Japan did! China’s currency has appreciated 25% since 2005 and yet America’s trade deficit has been climbing higher just as it did with Japan. The West wants to export more to China yet restricts high end technology exports which China wants and then has the audacity to complain about trade deficits! China is restricted from investing in Western markets yet is demanded to open up her market to the West. The Chinese are not fools and will do what is in their best interest, not the interest of Global corporations and bankers!

Matt
January 16, 2011 at 02:45

China is heavily invested in gold as it is the taxation base, gold is a bubble, when the hedge was removed, the Chinese had to increase their exposure to act as a hedge to prevent the bubble from bursting. Or millions of Chinese will wake up one morning to find that all their life savings are worth a quarter of it original worth, the taxation base.

Now as they are heavily invested in the euro, they have to increase their exposure and prop up the PIIG’s, they need the EU as an export market otherwise it will have implication at home, in relation employment. Germany is close to breaking, the French are seeking UK help for the EU but the UK does not want to know about it. That places the PRC in the position of having to increase exposure and act as a hedge.

The question is when will uncle Hu run out of fingers to plug the dikes. They have a property and credit bubble, inflation is out of control. The US keeps quantitative easing lowering the value of Chinese held debt. Obama sneaks in protectionism clauses into US imports and exports every chance he gets. The quantitative easing lowering the US dollar makes the US exports more competitive, and promotes buy American domestically.

The way the PRC stimulus package was formed has led to 1.5 trillion in debts that will not be paid back. Which is part of the credit bubble, by limiting their short term exposure via the stimulus package from private sector finance has lead to long term exposure to the state. So they may not only need to have a second stimulus package directly from the state, but will have to absorb losses to the worth of 1.5 trillion. They are relying on domestic and export growth projections to avoid this outcome. Or they will have to act as hedge for their own private sector.

They are acting as a gold hedge, now for the Euro. There is a food crisis which is another bubble. It is wrong to look at commodities a a single bubble, there are multiple bubbles, wheat, soybeans etc. You have oil on the rise placing increased pressure on the taxation base. If the gold bubble bursts, the EU hedge fails to stabilize the EU, leading to high unemployment in the PRC (of the taxation base which has lost their life savings in gold), high crude prices. China could fall apart. Certainly it will be the end of the Politburo.

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