My Blog

July 4, 2008

FRI 4 JUL

Hot weather, cold market By Michael Pettis

For the past few weeks Beijing weather has been either hot and drizzly or, even worse, ferociously hot.  Today we got a little bit of variation by interspersing ferociously-hot with the occasional tropical downpour.  I really hope things get better before the Olympics or else soon enough we are going to have a lot of very bad-tempered out-of-towners running around the city monopolizing all the taxis.

 

At least the gloomy weather more or less matches the mood of the stock market.  The market was up 2.0% yesterday and down 1.2% today to finish the week just over 2.3% down, at 2670.  Banks are surprising on the upside with better-than-expected profits, but higher oil prices drove most of the rest of the market down.

 

Meanwhile the RMB dropped 0.116% today to 6.859.  The PBoC, as even little children are now widely aware, is trying to curb speculative inflows by adding dollops of “uncertainty” to the RMB’s upward trajectory.  Unfortunately, the fact that everyone knows what the PBoC is doing and why they are doing it isn’t likely to make this measure particularly effective.

 

We will probably see the currency fairly flat over the next couple of weeks before it shoots up again.  Even the daily newspapers are saying this.  I have had this discussion many times on this blog, so I don’t want to reignite it, but I am afraid that the net effect of all this “uncertainty” is likely to be nothing more than that people who were very eager to bring money into China as quickly as possible may be, if they really believe that the trajectory is slowing down for a week or two, in a little less of a hurry.  Some of the June inflows, in other words, will show up only as July inflows.  This isn’t going to make much of a difference.  I think the last time they did this was in April, during which month reserve accumulation, at $75 billion, hit at an all-time world record.

 

One final thing, I was discussing with my students over coffee the effect of the new export-management controls on inflows announced Wednesday night (and discussed in Thursday’s entry).  We agreed that if these measures are at all effective in seeking out hidden hot money inflows, the monitoring period would probably add a few weeks to the time between when foreigners pay for an exported good and when the cash is actually disbursed to the Chinese exporter.  One of my students, whose uncle is a Southern-province-based exporter, told me that he believed (he wasn’t sure) that typically exporters would need to find financing for this period, and since most of them are excluded from commercial bank financing, they would need to take short-term loans from the informal banking sector.  This sounds pretty plausible.

 

I have heard that short-term loans are going for 5% a month, and my friend Victor Shih tells me that he has seen even higher rates for “prime” borrowers.  That means that if we assume that disbursals are two weeks later than payments for export shipments, the cost of production, including financing, for many Chinese exporters will go up by a minimum of 2-3%.  Given razor-thin margins in many of the export sectors, I wonder how exporters are going to deal with this.

 

My guess is that after a few weeks of this we are going to see a lot of pressure by exporters to roll back the measures announced Wednesday, or else many of the provinces, especially Guangdong and nearby provinces, will quietly let the monitoring process slip.

 

FRI 4 JUL

Internal debate intensifies By Michael Pettis

Just a very quick post today, largely consisting of two news articles.  The first comes from Xinhua. 

 

Yesterday, according to the article, Li Yining, a leading economist and member of the all-important Standing Committee, told the Second Meeting of the Standing Committee of the 11th NCCPPC, the country's political advisory body, that:

 

China is facing a pressing challenge of preventing inflation turning into stagflation.  He said stagflation, the co-existence of high unemployment and high inflation, might occur if improper measures were taken to fight inflation so as to disrupt market expectations, or the economy failed to survive the global slowdown…

 

The economist said China should continue to take a firm grip on the country's foreign exchange flows, and be alert to problems that might occur in the context of a global slowdown given the huge forex reserves.

 

He said the government should not over-reach itself in fighting inflation or be misled by the concept that only a low inflation rate would be a complete success in the anti-inflation campaign.  "The inflation rate, if controlled at about 60 percent of the growth rate, would be appropriate, such as keeping the rate at around six percent for a 10-percent growth in economy," he said.

 

I don’t have an awful lot to say about his comments except that his warning of stagflation risks is even more interesting to me because of the play it got in the Chinese press (The very large headline is “Economist warns of stagflation risks to China”).

 

The second article, first pointed out to me by blog reader Jonathan Lerner, appear in various forms in a wide number of papers.  The best account I think was Denise Tang’s “State academics push temporary yuan free float” in the South China Morning Post.  She says:

 

China should temporarily let its currency float freely to control runaway inflation and speculative capital inflows, said two government-backed academics, rekindling the debate on the politically sensitive issue.  He Fan and Zhang Yue of the Chinese Academy of Social Sciences see the temporary free exchange of the yuan as a quick and cost-effective way to thwart speculation, especially as inflation rises and the room to tighten monetary policy shrinks, according to their commentary in China Securities Journal yesterday.

 

The government think-tank academics painted a gloomy picture for inflation in consumer and producer prices, and they warned of a cash crunch at companies as well as a possible jump in banks' non-performing loans as side-effects of existing currency measures.

 

As Jonathan points out in his email to me, major policy changes, especially on economic and financial issues, are almost always preceded by non-official or quasi-official commentary and debate in the official press.  That doesn’t mean, of course, that they are about to float the RMB, but it does mean that there is some discussion and debate going on in policy circles about what is, after all, a pretty sensitive topic.  I would assume that academic researchers with CASS are unlikely to propose something that seems so radical without some sense that there are people in the government willing to listen.

 

I don’t want to read too much into this, but if we see more articles along this line it would be significant.  By the way, one way of interpreting the debate about a free float is in the context of the debate over a one-off currency revaluation.  The more extreme idea of a free float may make it easier to reach a compromise position on the amount of revaluation necessary.