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.

The property lobby is having the upper hand…for now

Despite global weakness, Shanghai actually went up 2.1% today. This is NOT an indication of faith in the global recovery, or any recovery, but rather an expectation of loosening of governmental controls over the property market.

Due to popular backlashes against runaway housing prices, Chinese government launched a series of cooling measures in April, causing a sharp drop in turnover (Shanghai saw a fall of over 75% in turnover) but the impact on prices has been marginal so far. To date, the developers have refused to cut prices, buttressed by record profits last year. However, the war of attrition is gradually starting to bite, and an association representing the developers has plead with the central government in an open letter to loosen the controls.

Despite repeated government responses of “No”, you can’t blame the public for trusting the developers more, as previous cooling measures all ended in sharp policy reversal in the face of economic slowdown. However, I think the government will hold out for longer this time, at least for one more quarter.

1. Chinese slowdown will not be apparent until end of Q3. There’s still a wee bit of time.
2. Popular discontent with extra-orbital housing prices is threatening the CCP’s legitimacy. Contrary to western conception, even an authoritarian government has to deal with popular opinion if it wants to stay in power.
3. Housing policy is believed to be part of the portfolio of Li Keqiang, slated to the China’s next premier. Failing in a key policy initiative will become a major stumbling block on his personal route to power.

As such, I believe housing policy will remain unchanged (i.e. tight money, anti-speculation) till the end of Q3. Since I expect rapid deterioration of the Chinese economy in Q4, the government might be forced to revert its stance then.

Is more money coming for the credit junkie?

Even though imports slowed drastically and inflation has busted the 3% target, some people at least can breath a little easier. Yes, I’m talking about the credit junkies, and they are making their cries for more stimulus heard. From Bloomberg:

“Policy makers may have more room to sustain growth if needed,” said Sun Chi, a Hong Kong-based economist at Nomura, who previously worked for the U.S. Treasury in Beijing. “The lending quota could be loosened to sustain ongoing investment projects.”

This is largely based on expectation that inflation is peaking and, dare I say it, the economy is weakening.

On the first factor, I think it’s still too early to call inflation peaking. Food has been a major driver behind inflation this year, with no sign of abating so far. And there has been a persistent rumor lately that China has purchased 600k metric tonnes of rice from Vietnam, mind you, the nation imported only 174k metric tonnes in H1/2010. So this could point to a severe shortage of rice in the market. Is this rumor true? I don’t know. But it’s at least credible enough for a Vietnamese minister to come out to assure his people of food security.

Besides persistent worries on inflation, the asset bubble is another cause of concern for China. Considering that the bank regulator has ordered the banks to consolidate off-balance sheet items on Monday and clamp down on their credit card activities today, plus the PBoC has drained an estimated RMB187bn from the banking system with its open market operations in three weeks, the fix is not coming, at least not yet.

Is the RMB going to depreciate?

After reporting the highest amount of trade surplus in 18 months, and hearing an expected cacophony of calls for RMB appreciation, the spot Yuan rate has actually traded down. The dramatic fall in foreign currency loans undertaken by Chinese exporters has also indicated sharply lowered expectation for any appreciation, if at all.

According to the Century Weekly, foreign currency loans plummeted by USD5.6bn in July, on the heel of USD0.7bn and USD1.4bn declines in June and May, respectively.

Chinese exporters traditionally take out these loans to supplement their income if they expect the RMB to appreciate. The last time these loans fell was during the 7/2008-2/20009 period, at the height of the financial crisis. In fact the RMB was even expected to depreciate in late 2008.

Could this be a rerun?