Baby steps towards full convertibility for RMB

China has been aggressively promoting the usage of RMB in international trade, preparing it for the eventual full convertibility of the currency. Besides opening access to its domestic bond market to selected foreign investors that I blogged before, it also starts to allow trading of the RMB against Malaysian Ringgit in its domestic FX market today. The Ringgit is a good guinea pig. Since China is already Malaysia’s largest trading partner, it makes sense to try to settle bilateral trade in their respective currencies rather than through the USD. On the other hand, both are effectively soft-pegged to the dollar, eliminating possibility for wild currency swings.

Separately, McDonald’s is selling $29mn RMB denominated bonds in Hong Kong. This is the first non-financial foreign entity to try this issuance. Yes, China is sticking to its game plan, that is to promote more usage of the RMB in international trade and in financial products. All these efforts eventually will lead to full convertibility a few years down the road, and challenge the USD’s role as the global reserve currency for real.

Andy Xie: Inflation exported from the US will come back to haunt it

In an interview on Bloomberg, Andy Xie explains how US stimulus is causing inflation in emerging markets and how this will be re-exported back to the US via higher commodity prices.

Stimulus is prescribed as a panacea for recession. In today’s global economy, it isn’t effective in the best of circumstances and is outright wrong for what ails the West now.

Trade and foreign direct investment total half of global gross domestic product. Multinational corporations drive both. They shop around the world for the lowest-cost production centers and ship goods to wherever the demand is. Demand and supply are dislocated. So when a government introduces stimulus, the initial increase in demand doesn’t necessarily boost local supply. More importantly, if multinationals decide to invest somewhere else, there wouldn’t be an increase in jobs to sustain the growth in demand beyond the stimulus.

Before you scream traitors, please bear in mind it’s only natural that capital seeks growth, real growth that comes from either productivity or population growth. And within the developed economies, both are in short supply. Japan’s stagnation is NOT due to any policy failure or “stimulus not big enough”, but rather because it has seen both peak productivity and declining population.

Just as water flows down, stimulus affects low-cost economies more, wherever it is initiated. As the West pours money into the global economy through large fiscal deficits or central banks expanding balance sheets, the emerging economies are drowning in excess liquidity. Everything is turning red-hot.

These words are so true. I have blogged about wage increases in all kind of places before.

However, he then went on to explain how unemployment will not be able to check this imported inflation, and here’s where I disagree with him. While I do believe in imported inflation for the matured economies, I don’t think the workers in these economies are in a position to bargain for wage increases. Instead, inflation will have a double whammy on the average Joes as their assets prices and wages keep falling while everyday living expenses increase. The only spin you can put on this nightmarish scenario is that being squeezed on both sides, the painful adjustment will be quicker, or as Xie put:

The West must wait for the Wangs and the Gandhis to become rich enough so that they demand Western wages and spend like the Smiths and Gonzalezes.

It is a long and painful process for the West. And there is no way around it.

Chinese labor saga continues

Local HK media is reporting that 300 workers at the Beijing factory of Korea’s Lotte Group have been striking for 3 days over wages, shutting down production completely.

The workers allege that Lotte, while officially pays them Rmb1,700 a month, deducts many “fees” from their paycheck, resulting in real monthly pay of only Rmb900, which is lower than Beijing’s minimum wage.

The strikes at Honda etc.had received wide publicity and tacit governmental support. Although this newest episode of labor dispute is different in that it happens in the nerve center of China, I expect it to be resolved in favor of the workers, as their quest is inline with the government’s goal of rebalancing the Chinese economy.

The real threat to the dollar

Much have been made about China’s call to use SDR to replace the dollar as the global reserve currency and scare-mongering abound about it’s dumping Treasuries as a “nuclear option”.

Well, real threat seldom comes with such thunder and lightning. It tends to be small and innocent enough, like allowing foreign central banks and overseas lenders to start investing in China’s bond market. From the FT:

The People’s Bank of China, the central bank, said on Tuesday it had launched a pilot project to allow greater foreign access to its largely closed domestic interbank bond market in order to “encourage cross-border Rmb [renminbi] trade settlement” and “broaden investment channels for Rmb to flow back [to China]”.

Getting more countries and companies to use the currency in cross-border trade transactions would reduce China’s exposure to the US dollar, which is used for most Chinese trade.

“This is an integral part of pushing the internationalisation of the Rmb,” said Wang Tao, chief China economist at UBS. “In order to encourage foreign institutions to get involved in Rmb settlement, you need to give them somewhere to invest.”

Most commentators expect that it’ll take 7 years for the RMB to be freely convertible, with the optimists are arguing for 5 years. Either way, it will come, and the dollar’s reign will end.

China’s share of global GDP

Why is China overtaking Japan to be the 2nd largest economy newsworthy? But for some strange reason, it’s all over the place, some more interesting than others. The Economist has recycled Angus Maddison’s data to give some historical background.

As to The Economist’s rhetorical question,

China and India were the biggest economies in the world for almost all of the past 2000 years. Why they fell so far behind may be more of a mystery than why they are currently flourishing.

many readers have resorted to a chicken and egg answer: that China and India had the biggest populations. Hello! Doesn’t having a large population in an agrarian economy in and of itself suggests higher productivity (due to whatever reason), and hence more surplus? Chinese population was almost HALVED after the fall of the Eastern Han Dynasty in 220CE. There were numerous accounts of the horrendous famines and population loss in the early 17th century, before the fall of Ming. So it’s in fact large economies that make large populations sustainable, instead of the other way round.

As to China and India’s sudden fall from the first league, the quick and easy answer is colonialism, which I think is wrong again in terms of cause and effect. Colonialism is like germs that populate our living world. It simply invades countries that have been weakened by other reasons. By the 19th century, China was already in her dying throbs. As such, the GDP share seems like a lagging indicator of a nation’s economic wellbeing.

One of the best books that deal with this fascinating topic is The Great Divergence, by Kenneth Promeranz. Mind you, the writing is horrible, but it’s well worth the effort.