Chinese savings rate to plummet?

Speaking of collapsing Japanese savings rate, could the Chinese savings rate take the same dive in the not to distant future? BIS has come out with a new report that answers with a resounding yes.

Instead, we argue that tough corporate restructuring……, a marked Lewis-model transformation process…… and rapid ageing process have all played more important roles [in explaining high Chinese savings rate]. While such structural factors suggest that the Chinese saving rate will peak in the medium term, policies for job creation and a stronger social safety net would assist the transition to more balanced domestic demand.

The authors basically see several social and economic factors uniting to drive down Chinese savings rate. First and foremost should be the slowdown in long term economic growth coming from the restructuring of Chinese industries. As China gradually rebalance towards its domestic market, trend growth inevitably slips. You can’t save what you don’t have.

Another factor is simply having less people joining the workforce, having hit the so-called Lewis Inflection Point. The resent labor shortage and unrest in China is another facet of the same demographic change. With less people saving, of course the overall savings will decline.

The last kicker is the aging of the population. Due to the draconian one-child policy, China is aging rapidly. And Japan has already shown the world what happens when your retirees need to draw down on their savings….

If the authors are right, then it doesn’t matter which side of the “savings glut” theory you stand, ’cause it an’t gonna last very long.

What does this mean? Does it imply that China would have to pawn its reserves? Possibly, but I think the reserves would have been long gone by then to pay for the clean up of the bad debts in Chinese banks. It will certainly mean soaring interest rates in China, and across the globe.

China buying more JGB

In an attempt to diversify from the USD, China bought more JGB in June.

China purchased a net 456.4 billion yen ($5.3 billion) of Japanese debt in June, following net buying of 735.2 billion yen in May that was the most in records dating from 2005, according to a report released today by the Ministry of Finance in Tokyo.

This is expected as the nation switched to a soft peg referencing to a basket of currencies.  Although Japan is the 4th largest export market of China, making up about 10% of its exports, the trade is more or less balanced. As such China’s trade surplus against Japan was only about USD20bn in 2009.

Since China has so far bought about USD20bn JGB this year, has it used up its quota then? Not likely. China has been under-weighting JGB in its reserves since 2006. If China does indeed intent to bring its currency to be trade weighted, there’ll be more JGB to buy, at the expense of US Treasuries naturally.

A side effect of buying more JGB is pushing up the Yen and Japanese Finance Minister Yoshihiko Noda commented yesterday that he’s watching the matter. But this may be a price that Japan has to paid, as it becomes increasingly relying on foreign lenders. Savings rate tumbled in  to a mere 2.2% in 2007 from 11.4% of a decade earlier, as economic stagnation and an aging population takes it toll.

The use of nuclear option

From Reuters:

The U.S. Treasury Department again declined to label China a currency manipulator in a long-delayed report issued late on Thursday that is likely to provoke Congressional calls for tougher methods with Beijing.

So this was what all that chatter of China’s Treasury holdings as the nuclear option was  about. The blogosphere was rife with snarks of how China would be suicidal by going nuclear. But the use of nuclear weapon has always been in deterrence. NOBODY really goes nuclear, but it helps to have it to scare the other guy into cutting you some slack.

China ups JGB holdings, sees no gold standard

The FT mainly attributes this to jitters about Europe:

Chinese investors bought up a net Y541bn ($6.2bn) in Japanese government bonds in the first four months of the year, amid ongoing global concerns about Europe’s debt woes.

Analysts said the scale of the buying – which was more than double the full-year record total of Y253.8bn set in 2005 – was notable when compared to the rate of increase in China’s foreign exchange reserves in the first quarter.

Yes, this is possible, but I was surprised that it did not connect the dot at all with China’s recent change in currency regime. Switching to a dirty peg of a basket of currencies, requires, well, more diversified currency holdings, like for example…Yen. The WSJ  pointed out this possible angle of interpretation, but rightly noted that:

“They still haven’t bought much in the longer-end, with a comparatively small level of purchases of maturities greater than two years, so whether they expand their buying beyond of the short-end will be crucial,” Mr. Inadome said.

Since 96% of the new JGB purchase was those maturing in less than 2 years, this is not alarming per se. But given the recent change in currency regime, this is an area that is worth paying more attention. Most people are too sanguine in assuming that China has nowhere else to go but the UST, due to the depth and liquidity of the market. Well, while the market depth of UST may remains so, it surely is not liquid for the Chinese, given the size of their portfolio. And they don’t have to actively sell down existing UST holdings to change its reserve mix and alarm the market in the process. Due to its massive trade surplus , China has new money to invest in any number of securities every month, and plowing some of these cash in other basket constituent currencies makes perfect sense.

Separately, in an article published on its website, the SAFE (that’s the folks in charge of China’s reserves) punctuated the hopes of gold bugs by explicitly ruling out gold as a major component of Chinese reserves, on  concerns of market depth and wild swings in prices. This is hardly surprising given the earlier call for adopting SDR as the new reserve currency by Zhou Xiaochuan, the governor of the PBoC.

Impact of the European crisis on China

While the endless rounds of flip-flops are entertaining in a wicked way, it will be stupid to treat the European crisis as just a reality show. For one thing, the EU, rather than the US, is China’s largest export market, and exporters are already howling from the pain of an effective 14.5% currency appreciation in 4 months against the euro.

What else? Most have given up on any prospect of immediate revaluation of the RMB. The US is already harping a different tone regarding currency ahead of the Sino-American Strategic and Economic Dialogue next week. There are also stories of hot money outflow. Michael Pettis rambles on the prospect of more trade conflicts, perhaps even in the form of tariffs. Shocking! Economic basket case resorts to beggar-thy-neighbor policies and trade conflicts (or any sort of conflicts) intensify during hard times. What’s more interesting is actually at the end of the post, almost as an afterthought, he suggests that China might be able to mitigate the risk by buying euros.

By the way is there anything that China can do to head off conflict?  Yes.  It can buy euros, the more the better –just lift every offer out there.  By strengthening the euro, or at least limiting its weakness, this strategy will force the brunt of the adjustment back onto European surplus countries rather than onto the US and, via the US, back onto China.  Sarkozy and other European leaders might not be very happy, of course, but they will be at least partially mollified by the net capital inflows and the reduced humiliation of a collapsing euro.

I know, I know, China had just sold its euro bonds and parked the money in dollar, as per the most recent TIC data. But I still think this scenario is more than feasible. When the crescendo calling for RMB revaluation was at its loudest, western media were full of quotes from “Chinese experts” that seem to readily acquiesce to RMB appreciation. However, when you actually look at their speech, preferably in the original, what those people are advocating is a reform of the currency management mechanism rather than straight appreciation per se. One term that pops up very often is “basket of currencies”, i.e. replacing the USD reference with a secretive brew of multiple currencies, a la Singapore. Li Daokui, member of the monetary policy committee of the PBoC is flogging the basket of currencies idea these days. A central government think tank is also calling for breaking the “predictable path of currency movement”.

In this sense, the current dollar strength actually gives China good cover to carry out with the proposed reform. Instead of maintaining a hard peg with the dollar, China can intervene by buying up some euros, and selling from its dollar reserves to pay for it of course. This diversification will help to halt the RMB’s appreciation against the euro and will appease to US cries for stronger RMB. Parking your wealth in the bunds is way safer than the treasuries, if you ask me.

The natural implication of this change in regime is an inevitable rise in US interest rate. When you have a buyer boycott, it is possible to have higher interest rate despite hollowing deflation. China has not withdrawn her money from the Bank of the US so far, only because it has nowhere else to go. After a substantial fall in the euro, and most of Europe’s problems priced in, things might look quite different.

The irony of it, should it materializes, is that the RMB might appreciate against the dollar just when about everyone has written it off, and those that pushed for it might live to regret it.