Sparring of words over the RMB

All focus has been on the “unusually uncertain” comment by Bernanke, though the hearing touched on Chinese currency issue as well. As reported by Reuters:

Under questioning by one of those lawmakers, Senator Sherrod Brown, Bernanke answered “yes” when asked if he stood by a statement he made several years ago calling China’s exchange-rate policy an effective subsidy.

When pressed how much China’s yuan was undervalued, Bernanke said: “The numbers that you see in the literature range between the 10 and 30 percent range.”

As November approaches, it’s only expected that the US will push harder on this front. But are they going to get their wish fulfilled? This one is from AFP:

“The exchange rate of the currency will decline if it becomes necessary to support exports,” Zhou [Qiren, a member of the central bank’s monetary policy committee] told the Asahi Shimbun [of Japan] in an interview, according to the paper’s English-language website.

I don’t know about you, but I think Chinese exports will weaken substantially in H2 as the US non-recovery recovery sputters and European austerity kicks in. China’s own stimulus is also losing steam, so much so that the banks are quietly relenting on strict lending restrictions.  If you think China’s going to become a good Samaritan in this environment, I’ve got a bridge to sell you.

China to see more trade deficit in April

China’s March trade deficit was written off as an one-off fluke by many commentators. However, it seems that the trend many economists have expected it to continue, at least into April, with a consensus forecast of USD1.2bn in trade deficit.

Granted, this is already down substantially from March’s USD8bn, but it will serve to deflect criticism of China’s currency peg ahead of the Sino-US Strategic Forum in May. As such, those betting on RMB appreciation will likely to be seriously disappointed.

Going forward, it’s entirely possible that things will return to the unsustainable “normal” by May. The main driver of this outlook being a slowdown in imports, which in turn is simply a result of the government’s tightening efforts.

Andy Xie: China should hike interest rate rather than revaluate its currency

From Century Weekly, Xie’s views on interest rates and exchange rate. Insightful as usual.

But acting on the currency first, especially in small steps, would further inflate China’s property bubble and inflation, potentially leading to a major economic crisis in two years. A small increase in the yuan’s value would fail to resolve two pressing problems: inflationary pressure at home, and political pressure from the United States. Moreover, a small appreciation would attract hot money, stoking inflationary pressure.

This was exactly what happened in 2005, making the bet on RMB revaluation a sure win and attracting more hot money inflows. Despite capital control, lots of hot money still manage to get in, as the system is rather porous. A major receptor for these speculative inflows is the Chinese property market.

By all measures (stock value to GDP ratios, inventory value to GDP ratios, new property sales to GDP ratios, price to income ratios, rental yields, and vacancy rates) China’s property market is one of the biggest bubbles ever. It’s probably much bigger than the U.S. property bubble relative to GDP.

Xie doesn’t have much kind words for those who tout currency appreciation as “good for China” in the sense it helps contain inflation.

Why is this policy option so popular among interest groups? Because it would fuel the hot money inflow, which in turn would support and expand the property bubble. Of course, inflating the property bubble will only worsen inflation. And the odds are that a small currency appreciation would only make the property bubble bigger and inflation worse.

In a standard economy, currency appreciation cools inflation by decreasing import prices. China’s imports are mainly raw materials, equipment and components. A small currency appreciation would have virtually no effect toward cooling inflation. So while a small appreciation might be justified politically, it should not be used to fight inflation.

On the other hand, a major appreciation or revaluation could cool inflation by removing further currency appreciation expectations. It would trigger a hot money exit from China, creating a liquidity crunch that would almost certainly burst the property bubble. I doubt anyone would support such a policy move.

For China to achieve a soft landing from the current property bubble – if this is at all possible – interest rates must steadily increase by 2 percentage points in 2010, another 3 points in 2011, and further in 2012. Such a trajectory for interest rates would not burst the bubble, but it would prevent real estate interest rates from further declining in an atmosphere of rising inflation.

And insight on the real cause of Chinese trade surplus: that of suppressed consumption.

I am surprised that China is still running a trade surplus. …The surplus, I think, can be attributed more to distortions in domestic pricing than the currency’s cheapness.

First, high property prices are a major deterrent to middle class consumption…. But first-time buyers, such as newlyweds, have to save more to purchase property. Indeed, since prices are so high, parents have to save to help them…

Second, prices for middle class goods and services are very high. Autos stand out: Prices in China for cars, even those built domestically, are the highest in the world. …

Third, China’s taxes on the middle class are too high. The top marginal income tax rate of 45 percent applies at quite low income levels by international standards. The 17 percent VAT is also among the highest in the world. Because China tends to invest its tax proceeds, high taxes suppress consumption.

So to balance trade and boost consumption, structural changes in the economy is needed rather than tweaking the exchange rate. Yes, this will take a decade to bear serious fruit and won’t help those facing elections in November. Well, too bad. Life sucks.

Is RMB revaluation imminent?

The rumor mill has gone on a overdrive with speculation that the RMB is going to appreciate in the short term. Timmy’s surprise visit to Beijing is cited as a hint. After all, why would he make the trip if not to ask for more? Simply widening RMB’s trading band is seen as not enough to appease this time around.

There may be some truth in this reasoning, but one has to ask is China likely to agree? Even if they do decide to appreciate, how likely is that they will do it now? Bear in mind they’re due reporting the first trade deficit in 6 years, the Sino-US Stretegic & Economic Dialogue is coming up in May and US elections in November. Currency war is NOT going away, and they do have millions of jobs on the stake. Giving it all at the first request simply is not good negotiating technique.

All three members of the freshly minted members of the Monetary Policy Committee of the PBoC have given interviews lately. While they favor a more flexible exchange rate mechanism, they see the RMB to appreciate by 5% within the year at the most. Another adviser to China’s powerful planning commission predicts just 3% appreciation this year. Goh Chok Tong, the Senior Minister of Singapore and the chairman of its central bank comments publicly on the BoAo Forum (the Asian version of Davos for the non-initiated) today that it’s time for China to adopt a more flexible exchange rate mechanism. But the points to take home are the caveats:

The problem that the RMB is facing is not simply appreciation, of real importance is to change the existing exchange rate mechanism. The mechanism to peg tightly to the USD will hurt Chinese economy.

Now a small, paternalistic (some might even argue authoritarian) nation like Singapore doesn’t usually butt in the affairs of China. But there’s talk that China’s new mechanism will bring more currencies to the peg basket, a la Singapore.

So I stick to my earlier assessment that widening of the trading band is all Timmy’s going to show for his efforts this time around. An appreciation of 3%-5% may come anytime between May and November when the political heat from Washington becomes truly unbearable.

China to widen RMB’s trading band

According to the Hong Kong Economic Times, a Chinese government think tank made a rare appearance yesterday during the press meeting held by the Foreign Ministry, focusing naturally on China’s exchange rate policy. A top policy adviser commented that:

As to whether to enlarge the trading band, or to revert to the pre-crisis policy of small-step appreciation, both are possible.

As I said before, I would bet on a widening of the trading band, as China’s trade deficit rules out the need for an immediate appreciation. The strength of the dollar of late has also muted European or Japanese complain on RMB. So basically lip service and no change at all unless, of course, inflation runs amok. China is due to release CPI data later this week, and consensus seem to be around 2.3%, well within the 3% government target. So inflation fear should be held off a bit longer.

As for the time-frame of policy change, the adviser hinted that it depends on the pace of recovery in the US. My take is that it’s likely to be part of a concerted tightening effort among the central banks, i.e. widening trading band plus possible interest rate hike. The upcoming Sino-American economic forum in May should be closely watched for any policy change.