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Wednesday, January 07, 2009


RMB weakness and hot money flows

i've been intimating recently that china is managing its currency peg in such a fashion that it is devaluing its currency vis-a-vis the dollar, which has the effect of shifting the necessary global contraction of excess capacity onto the united states by making chinese exports more competitive. brad setser among others has highlighted how china has actually backtracked toward its export-growth model in this crisis, even as the ultimate adjustment cannot be in that direction.

The global slump seems to have prompted China to cling to its existing export-led growth strategy. China seems to be rethinking is its previous willingness to move out of low-end labor-intensive exports as higher-end export sectors expand. With jobs scarce, that no longer seems like a great idea. China also seems to be rethinking its exchange rate policy. Here too it seems to going back to the past. Over the past several months the RMB has been effectively repegged to the dollar — going up when the dollar went up (October) and going down when the dollar went down (December). Neither policy shift constitute a real change; both reinforce the old model of trying to spur growth by subsidizing exports.

it hadn't struck me fully that china might actually be defending its currency against collapse and capital flight. but that's what apparently is underway -- which stands as evidence that china is a far worse place than most anyone believed.

China faces a threat of "abnormal" cross-border capital flow because of global financial tumult, the country's foreign exchange regulator said Tuesday...

More money flowing out of the border could increase the risk of liquidity strain in the country, which is especially dangerous amid the global financial crisis...

China's foreign exchange reserves had fallen for the first time since December 2003, Cai Qiusheng, a SAFE official, told a conference last month. He didn't give specific data of when that happened or by how much.

He said the current reserves were below 1.9 trillion U.S. dollars, the level recorded at the end of September. It was the largest reserve in the world.

this could have downstream ramifications for american government finance as well. the chinese government is essentially one of two net foreign buyers of american debt, and commenter ndk notes:

Apparently right now China is defending against a fall in the yuan, instead of a rise in the yuan, as their reserves are falling. To do so, they might sell some of their treasuries, or more likely agencies, into the open market for dollars. Then, they would sell the dollars to repurchase some yuan. The yuan are then essentially retired, resulting in a contraction in the monetary base. A further rise in U.S. real interest rates could result. ...

Now, China's still running a large and growing current account surplus, but it's possible to imagine a world in which this surplus ceases to grow. For example, if the price of raw materials begins to surge again in response to worldwide devaluation of fiat currencies and government spending, while overcapacity and weak market demand for end products limit demand, margins, and profitability, it's not a good mix. It's easier to mothball upstream too, as Alcoa demonstrated tonight. That's dissociated from the hot money's impact, but still worth keeping in mind.

henry c. k. liu has thoughts on how china might try work credits exchangeable as commerical paper to emerge from what is becoming a terrible slump

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from perrone: gee, Liu's piece sounds an awful lot like my argument. and he sounds like regime-sanctioned mouthpiece, too. maybe China can see the light after all.

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hey p -- not that you can't use google :) but for my own reference here's liu's homepage. his stuff is interesting always and i should add him to the sidebar. his bio from asia times:

Henry C K Liu was born in Hong Kong and educated at Harvard University, US, in architecture and urban design. His interest in economics and international relations started when he participated in interdisciplinary work on urban and regional development as a professor at the University of California Los Angeles, Harvard and Columbia. He is currently chairman of a New York-based private investment group.

no mouthpiece, perhaps.

btw, his awesome critique of the monetarism of greenspan and bernanke is his latest.

The Fed under Greenspan and Bernanke violated the basic rules of both monetarism (money supply management) and Keynesianism (demand management). Fed monetary policy created false prosperity with excess money supply to fund debt manipulation and simultaneously to support income disparity as a source for capital formation to exacerbate overcapacity amid demand weakness.

that is an extremely bleak reading, but probably the correct one. this economy likely needs both debt liquidation to restore a real savings base and a redistribution of real income away from capital gains to productive wage earners. these processes will occur irrespective of monetary policy, i imagine -- should bernanke insist on inflating hell-or-high-water, he risks wiping real savings and real incomes to near-zero in a currency collapse.

i think you might find his series on hyperinflation challenging/interesting. a snippet from a more general october piece on the futility of central bank intervention into asset pricing:

Either wage income must rise or asset prices must fall to restore financial equilibrium. Government intervention to prop up inflated asset prices without compensatory wage rise will only end in hyperinflation.

A sharp decline in assets prices will unavoidably spell widespread bankruptcy for many financially overextended companies and individuals. This will constrict demand temporarily to delay inflation effects but hyperinflation will result as certainly as the sun will rise because modern democracies cannot allow deflation to cause widespread bankruptcy even in a debt bubble. In January 2006 (see Of debt, deflation and rotten apples, Asia Times Online, January 11, 2006) I wrote (Central banks fear deflation more than inflation):
"Although Greenspan never openly acknowledges it, his great fear is not inflation, but deflation, which is toxic in a debt-driven economy. 'Price stability' is a term that increasingly refers to anti-deflationary objectives, to keep prices up rather than down."

By now, it is becoming clear that government policy has been mostly focused on maintaining asset prices at levels that the market has rejected. Logic suggests that such a policy will result in hyperinflation at the end of the day, which will lead to more bankruptcies down the road in a protracted downward spiral. The government's attempt to save overextended financial institutions may well cause the total destruction of market capitalism. And if past experience is any guide, unless wage income is indexed to inflation, the dilution of asset value through inflation will only hasten the arrival of total market failure and the total meltdown of the market economy.

So far, not much is heard from official circles that suggest the solution to the current credit crisis can only come from an immediate and substantial rise in wage income. Instead of bailing out insolvent financial institutions, the government should use sovereign credit to maintain full employment and boost wage income to catch up with inflated asset prices. If the Fed must print new money to save the system, the new money should go to job creation and wage increases rather than to recapitalize insolvent corporations. Full employment and rising wages will halt the fall of asset prices with a rising floor.

obviously, he considers the current period as a "sharp decline in assets prices [which] will unavoidably spell widespread bankruptcy for many financially overextended companies and individuals... [which] will constrict demand temporarily to delay inflation effects" but ultimately transitory in nature.

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from perrone: no, the guy's brilliant, I deeply agree with his most central tenets. it's absolutely true that the only real (eventual) way out of this is for productivity gains/profits to start flowing back to wages, depositing wealth where it can really drive an economy instead of causing speculative havoc and waste. the development of society and politics in general might actually wax healthy in that case, too.

the mouthpiece crack was facetious. the guy knows his Mao, though. it's fascinating (and rather awe inspiring) how in touch he remains with the homeland, in all respects.

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