My Blog

April 10, 2008

The RMB broke through 7 today.  This is pretty much a non-event, in my opinion, but it was treated as a symbolic milestone and some accounts claimed it had psychological importance.  Since the rapid increase in the RMB is a pretty well-established trend by now, I think the only thing that will make me sit up and notice is if it suddenly gaps upward overnight.

Much more interesting was the news about the trade surplus and FDI.  The trade surplus for the first three months of the year was $41.6 billion ($19.5, $8.6 and $13.6 billion for January, February and March, respectively), versus $46.3 billion in the first quarter of 2007.  This is the first time the quarterly trade surplus has declined in three years.  

Some commentators are suggesting that this decline in the trade surplus is evidence that the credit-related measures to slow the economy and the rising RMB, combined with the global slowdown, are finally having an impact on the trade account.  I am not sure I agree.  First of all it is still not clear whether the full impact of the January storms has worked itself out of the numbers. 

Second, and more importantly, for all the worry about how a rising RMB would cripple exporters (and it hasn’t really risen except against the dollar), Chinese exports in fact grew by a very healthy 21.4%.  It is only because export growth has been so phenomenal recently that 21.4% seems like a small number, but it is in fact a very big increase for such a major exporter, and as Chinese exports increasingly dominate their markets it becomes statistically more and more difficult to maintain earlier growth rates.  This “reduction” in the growth rate of exports has nothing to do with the rising RMB or slowing world growth. 

Imports grew by 28.6%, and high oil and commodity prices may have accounted for a big chunk of this growth.  According to Mark Williams at Capital Economics, the higher oil bill took out $10 billion in the first quarter of 2008 relative to the same period last year.  Strip this out and we may well see that domestic consumption growth is still not keeping up with production growth – i.e. the trade surplus, which is the gap between the two, would have increased.

What was particularly interesting was what happened in the FDI account.  According to the numbers released today, FDI for the first quarter was $27.4 billion – nearly 73% more than the $15.9 billion recorded last year over the same period.  So although the trade surplus declined by $4.7 billion, it was more than matched by the $11.5 billion increase in FDI. 

This means that without even counting other net inflows – most especially hot money inflows not accounted for in the trade and FDI numbers – the increase in central bank reserves continues to grow beyond even last year’s unbelievably high numbers.  Remember that January and February reserve growth were (even with the possible $22 billion underreporting caused by the redenomination of bank minimum reserves) the two highest monthly numbers on record, and I suspect that the total increase in reserves for the first quarter of 2008 will be a whopper.

We are now caught in the most mechanical and frustrating part of the monetary trap in which China has been caught during the past five years.  The trade surplus was the original driver of China’s out-of-control money growth, but by now the growth seems to have taken a life of its own as money piles into the country seeking to take advantage of the nearly-inevitable run-up in the value of the currency.  Hu Xiaolan, the head of SAFE, said that SAFE and the Ministry of Commerce are going to investigate whether FDI has become a channel for hot money inflows.  Hmmm, I wonder.

On perhaps a related note, Xinhua reports today that China’s external debt increased over 2007 by 15.7%.

China's foreign debt reached $373.62 billion at the end of 2007, up 15.68 percent over the previous year, the State Administration of Foreign Exchange (SAFE) announced on Wednesday.  China's medium and long-term borrowing totaled $153.53 billion at the end of last year, an increase of $14.17 billion, or 10.17 percent, according to the SAFE.

Meanwhile, the country's short-term borrowing increased $36.46 billion to $220.08 billion, up 19.85 percent.  Of the total external debt, $34.89 billion was the sovereign debt; foreign invested enterprises accounted for $74 billion; and the amount for foreign financial institutions in China was $46.31 billion.

Preliminary statistics showed all of China's foreign debt indices were under the international standard safety line in 2007, the SAFE said.

I don’t really have much information about the reason for the $50.6 billion increase over the year, and of course there is no way to discern the impact of this borrowing on the country’s reserve position without knowing to what use the funds were put (i.e. were they spent in China or abroad?), but the practical trader in me assumes that even with the easy domestic-currency borrowing conditions it still makes a lot of sense for Chinese companies to fund as much as possible from abroad.  China’s external debt levels are miniscule given the country’s size and, more importantly, reserves, but foreign borrowings are one more source of domestic money growth.

Meanwhile the NBSC has revised upward GDP growth for 2007.  It turns out that because of underreporting of growth in the services industry, including telecommunications and retailing, China’s GDP growth for 2007 was actually 11.9%, not 11.4%.  We would like to see services comprise a bigger part of the economy, and this revision is welcome for many reasons.

Comments (6) for "Money keeps pouring in"

Hi Prof Pettis, Re: China's increasing external debt. At first this made no sense to me - why would China be borrowing money when it's brimming with money? I'm no economist, so please forgive my ignorance, but could it be that Chinese companies want to borrow in declining USD, so that when the debt is repaid in future RMB the amount will be reduced by the appreciation of the RMB as opposed to the dollar? If so that's interesting & clever - it reminds me of the yen carry trade where money borrowed from the BOJ was pumped into US mortgage backed securities. If so this seems like yet another unintended consequence of globalization. To me it seems that a golbal financial system, without any sort of global system of governance will always lead to these sorts of loopholes and money managers who find and exploit them. Thanks for writing such an excellent blog - you have helped me understand many of the rather unclear aspects of what's going on in today's economy. By David Geise - 4/10/2008 12:57 AM

There is an arguement that the reserve growth is due to the declining US treasury yields in the first 3 months this year. The portfolio held by SAFE is making money in $ terms. Considering inflated oil and commodity as a reason of growing import, how big impact does inflation have on export? Maybe this time exporters can pass on some costs to the retailers in U.S. By fatbrick - 4/10/2008 2:00 AM

I wonder where else the abundance of money in the West would go as (i) US financial companies, hedge funds are going thru massive de-levering; (ii) Feds keeps on cutting short-term rates & flood the market with liquidity; (iii) US/EU term markets are practically stand-still as pension funds, insurance companies and the alike sitting on the sideline. Is US Trsy attractive? Not sure. Proceeds of US Trsy might just round trip with no where to go but to the East. With these much cheap $$$, why not buying up properties and natural resources/raw materials around the world? Significant stakes in energy/mining companies are good options too. As you have pointed out b/f, securing steady supplies of natural resources/raw material is a salient trait of mercantilism... By zh - 4/10/2008 3:17 AM

Let's assume a Chinese textiles/toys/electronics producer. Since last year his salary costs in renminbi have increased by 15-20%, raw-materials are generally strongly up, and on top of that the renminbi has strengthened to the dollar. If he exports the SAME REAL VOLUME of textiles/toys/electronics, his export income should be 20-30% up. Thus I have difficulty in being impressed by 21,4% increasing exports (I assume this is the nominal growth in dollars). By Stefan, Tallinn - 4/10/2008 5:07 AM

David, thanks for your kind words. I am not sure that I see the exploiting of loopholes as necessarily a bad thing. It complicates PBoC policy, but I think the original mistake was the policy itself. The sooner they fix it the better. Fatbrick, as Stefan notes below, inflation works both ways -- it inflates the import numbers as well as the export numbers. I think you are right that a very accomodative US monetary policy in response to US domestic problems is making things much worse for the PBoC, since it increases the ability and incentive for hot money to come to China. This is one of the obvious risks of currency pegging -- you are forced to imprt the domestic monetary policies of the currency to which you are pegged whether or not you want them. By Michael Pettis - 4/10/2008 1:46 PM

ZH, I think the option of buying hard assets is certainly being considered by the Chinese authorities -- see the Rio Tinto and Total purchases. Still, I wonder if this is the best time to go on a buying spree. A lot of assets are at all-time high prices. It may be better to hoard cash (i.e. buy US Treasuries) and see what happens to prices if there is a slowdown. In times of trouble, they say, cash is king. Stefan, your reasoning may be right, but I think your numbers are high. Salary costs have gone up by around 10-15%, the rising RMB has had only half the nominal impact on export costs (since half the value of China's exports are imported), so the total cost of production may have risen by 10% or less. If this full cost was passed on to China's export markets, which I don't think has happened, and Chinese exports still grew by 21% (and it is now the largest player in many, if not most, of its market, which makes the feat all the more impressive), I would argue that this is good evidence that the rising RMB will have no seriously adverse impact on the Chinese economy via export constraint. By Michael Pettis - 4/10/2008 1:48 PM