In discussing whether or not China can change its policy of accumulating dollars, he says "China would be better off financially if it let the RMB appreciate substantially, stopped financing the US and took large losses now rather than continuing to finance the US, adding to its stock of dollars and adding to the scale of its future losses.A bank that is lending to a failing company reduces its ultimate loss by cutting the company off and taking its lumps now, not by covering ever bigger losses with new loans to avoid “turmoil.” China is in a similar position.The US isn’t a failing company, but China is lending to the US on terms that imply very large financial losses for China."
Well said, and spoken like a trader. One of the arguments often made, by those arguing that China should not revalue, is that any appreciation in the RMB would imply a loss on the value of its dollar holdings. Aside from the fact that the local currency value of foreign reserves doesn't matter except to the extent that the central bank may become insolvent, which is not the case in China (this is because reserves can only be used to purchase foreign assets, so what matters is not the value of dollars in RMB terms but rather the value of the dollar in terms of China's basket of external debt and foreign imports), it doesn't make sense to protect a losing position by adding on more losing assets.
If the dollar is undervalued relative to the RMB, rather than try to protect it from adjusting by accumulating more dollars at the current RMB price, the PBoC should raise the price at which it buys them (i.e. revalue the RMB). Otherwise it is simply adding to its underwater position, which doesn't make sense if you are concerned about the value of your holdings.
This leads to a whole discussion about whether the existing trade relationship between the US and China is harmful for the US and/or China. I would argue that it benefits the US moderately and in some ways it actually hurts China, but because of concerns about the impact of export growth on reducing unemployment, China is stuck with the system, at least for the near future.
Michael Pettis is a professor at Peking University's Guanghua School of Management, where he specializes in Chinese financial markets. He has also taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business. He is a member of the board of directors of ABC-CA Fund Management Co., a Sino-French joint venture based in Shanghai.
Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups. He has also worked as a partner in a merchant banking boutique that specialized in securitizing Latin American assets and at Credit Suisse First Boston, where he headed the emerging markets trading team. Besides trading and capital markets, Pettis has been involved in sovereign advisory work, including for the Mexican government on the privatization of its banking system, the Republic of Macedonia on the restructuring of its international bank debt, and the South Korean Ministry of Finance on the restructuring of the country’s commercial bank debt.
Pettis is a member of the Institute of Latin American Studies Advisory Board at Columbia University as well as the Dean’s Advisory Board at the School of Public and International Affairs. He is the author of several books, including The Volatility Machine: Emerging Economies and the Threat of Financial Collapse (Oxford University Press, 2001). He received an MBA in Finance in 1984 and an MIA in Development Economics in 1981, both from Columbia University.
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October, 2007