Archive for the ‘China’ Category

China: Responsible economic policy

October 5, 2010

Higher prices for GI Joe? Source: Google Images

Very nice, short piece today from CSFB (below) on what China is doing to correct the global imbalances (i.e., to reduce its trade surpluses, which mirror US and other countries’ trade deficits) and to shift its economy to a healthier foundation based on domestic demand.  While President Obama gets pre-election press pressuring China’s prime minister to let his currency appreciate, and while Dems in Congress led by Chuck Schumer grandstand, threatening to raise tariffs on China before the election, the Chinese authorities have instituted large wage increases across the board.  As a result, the real value of the Chinese currency could appreciate sharply, even if the nominal value (the focus of American politicians) appreciates in baby steps.  Hopefully, Schumer, Obama and Co., and above all the angry voters they are courting, understand the economics: that wage inflation undermines the competitiveness of a country’s goods as much as does currency appreciation.  

In spite of President Obama’s tough talk (or because of it?), he appears to have received a boost from China’s prime minister, who lauded his administration’s economic policies, much-maligned these days by the Republicans (who have few ideas of their own).  But, what China bashers don’t realize, and CSFB points out, is that low inflation in the US (i.e. the affordability of America’s consumption binge) has been underpinned over the last 10-15 years by China’s low wages cum undervalued exchange rate, Sir Alan Greenspan’s claims to perfection notwithstanding.  From computers to home improvement, Chinese goods have been cheap.  We won’t be able to count on this any more.  With America still in a near-recessionary funk, we’re not worried about inflation, but that could change.  Enormous government budget deficits have been accommodated by a massive monetary stimulus.  Hence, inflation, and all the economic distortions implied, may be one of a slew of economic problems facing the world’s leading (though declining) power in the years to come. 

From CSFB today: 

In contrast to the exchange rate, wage rates among migrant workers have risen much more aggressively, and we believe that this marks the beginning of the end of China’s export empire. Among 31 provinces, 27 have raised the minimal salary by an average of 22% this year and the remaining four will introducing legislation for salary hikes later this year. We think the move has been pushed by Beijing as part of an effort to shift the economy from export-driven to domestic-consumption-driven. In a survey Credit Suisse conducted, 39% of CEOs from multinational corporations placed a wage increase as something about which they were “very worried” or “extremely worried,” versus 18% for exchange rate appreciation.

The key question to be answered is whether foreign direct investments will leave China or move to the inland provinces. We believe most will move inland rather than leave China. China’s domestic demand is a major attraction for FDI. Besides, China’s infrastructure and administrative efficiency probably will keep FDI coming, for now. However, we project 20%-30% salary increases at the migrant workers’ market every year over the next four years (at least). This would eventually erode China’s competitiveness and push up its export prices. Perhaps we have seen the best time for China as the anchor of global disinflation, though it may take more than a decade for China’s export machine to fall.

Dong Tao +852 2101 7469

Christiaan Tuntono +852 2101 7409

05 October 2010

The RMB exchange rate saw a surge in appreciation in recent days, but we doubt the trend will last long. The Chinese currency saw nine consecutive days of appreciation against the USD, amidst USD weakness and heightened pressure from the White House and the Capitol Hill. But to us, Beijing has, in fact, been pushing for real exchange rate appreciation through salary increases, much more aggressively than with the nominal exchange rate. With export orders softening and domestic salary surging, we project only marginal nominal appreciation, which is politically motivated. We look for USDRMB at 6.67 by end of 2010 and 6.35 by 2011.

China: Would Machiavelli be proud?

September 22, 2010
Chinese President Hu Jintao reviews army troops.  Source:  CCTV
Chinese President Hu Jintao reviews army troops. Source: CCTV

Machiavelli, more than any thinker in history, made his name synonymous with a type of human behavior — self-interested, cunning, ruthless.  He wrote about ancient Rome as well as Italy and the Mediterranean world of the 15th-16th centuries, extolling such leaders as Ferdinand of Aragon, the successful king of Spain who oversaw his empire’s aggrandizement, as well as the expulsion of alien elements from the Iberian peninsula. 

The extent to which a truly Machiavellian leader must be  cruel has been exaggerated.  If you read his treatises closely, the Florentine statesman was no fan of cruelty if it failed to strengthen the state.  Orgies of killing usually engender hatred in a state’s subjects, and Machiavelli argues that being hated is worse than being feared.  Being feared is better than being loved, he says, if one cannot be both.  According to Machiavelli, leaders must imitate both the lion and the fox — employing both military power and diplomacy — in order to outwit the wolves. 

I have argued for some time in this blog that the West, led by the United States, has done a fairly good job of anchoring China into international institutions wrought after the Second World War (see my post “Anchoring the Dragon,” of October 2009).  Privileges and power must be matched in international relations in order to avoid instability and conflict.  Machiavelli, were he around today, might not criticize Western diplomacy on the China question. 

Since 1979, China too has managed its foreign relations relatively well.   Deng Xiaoping, who led China after 1978, opened his isolated nation to the world, culminating in 2001 in China’s accession to the World Trade Organization, which this giant nation has used as a platform to become the greatest manufacturing juggernaut the world has known.  Likewise during the Cold War, China and the U.S. deftly used each other in classic Machiavellian fashion to balance against their mutual enemy, the Soviet Union, a quasi-alliance that deserves some credit for burying the Soviet empire late last century.

China’s exchange rate policy can be called Machiavellian.  The currency is kept low to promote exports in order to avoid the dependence on foreign capital that drove China’s Asian brethren — Korea, Thailand and Indonesia — to the brink of bankruptcy during the 1998 Asian financial crisis.  Still, China periodically revalues its currency in baby steps in order to blunt the anger of its trading partners, whose external borrowing expands to finance nagging trade deficits.

A NYTimes article today discussed how China is currently seeking to mend fences with the Obama administration over its exchange rate policy, as well as over tensions related to the Korean peninsula, the South China Sea and Taiwan.  Things are not as cozy with the United States these days because the US government is run by Democrats.  Democrats are more prone to grandstand against China on currency manipulation, human rights, and the environment than Republicans were.  The Chinese will compete this century with the U.S. for hegemony in Asia, not to mention globally, yet today they wish to do so quietly.  Surpassing Japan as the world’s second largest economy this year with GDP in excess of $5 trillion, the Chinese economy still falls well short of US GDP of over $14 trillion.  Hence, the need to be both a lion and a fox.   

Do not doubt that China intends to take over its renegade province of Taiwan one day, or to become the dominant power in East Asia.  China does not yet have the actualized military capability to obtain these prizes, so it bides its time and makes nice with the global hegemon as necessary.  On the other hand, China builds strong economic and diplomatic links globally to secure sources of raw materials and moral support, and continues to pump money into its military.  It plays a cute game on the Korean peninsula (see The Economist article below), alternately prodding and bolstering the tottering regime in Pyongyang, in order to show the Americans it is a player to be reckoned with on all things Asian.   Machiavelli would be proud.

(From a Sept. 9, 2010 post.)

From The Economist, September 2:

What lies behind the Dear Leader’s latest trip to China?

Sep 2nd 2010 | Beijing

NORTH KOREA’S leader, Kim Jong Il, must have been on an urgent mission when he boarded his bulletproof train and headed to China for the second time in less than four months on August 26th. With America’s former president Jimmy Carter in town, devastating floods in the north and a rare conclave of his ruling party only days away, Mr Kim had much to keep him at home. But buttering up China appears to be a new priority.

Both China and North Korea, as is their wont, kept quiet about the visit until after Mr Kim’s return on August 30th. By then Mr Carter had left with an American, Aijalon Gomes, who had been serving eight years’ hard labour for entering the country illegally in January. Mr Gomes’s release was a rare gesture of conciliation to America after months of heightened tension caused by the sinking in March of a South Korean naval vessel.

America responded, however, by giving details of sanctions on several North Korean individuals and entities suspected of “illicit activities”, such as dealing in weapons or drugs, or procuring luxury goods for Mr Kim or others. The decision to impose them had been announced in July.

China has complained loudly about America’s recent muscle-flexing, particularly its joint military exercises with South Korea. These are due to resume on September 5th with drills in the Yellow Sea, which China regards as uncomfortably close to its own shore. China began its own naval exercises in the Yellow Sea on September 1st. The official news agency, Xinhua, called them “routine”, but a decision to draw attention to them could be intended to show resolve in the face of the American and South Korean manoeuvres. The results of an international investigation into the sinking of the South Korean ship, which blamed it on North Korea, were released after Mr Kim’s last trip (his first foray abroad in four years). China has refused to accept the findings. By rolling out the red carpet again, it showed it has no plans to reconsider.

Less clear is why Mr Kim wanted to go back so soon. Much speculation has suggested that it could be related to the forthcoming party conclave, the first on such a scale since 1980. North Korea says it will be held early in September. One popular theory is that Mr Kim wants the gathering to endorse the appointment of his son, Kim Jong Un, to a senior party post. The idea would be to groom him to succeed his father, whose health has not been robust. The younger Mr Kim is in his late twenties and is believed to be jobless. Rumours of his rise as heir apparent have long been circulating, and it is plausible that his father would want to inform China if confirmation of this is imminent.

No mention was made of Kim Jong Un or the succession issue in official Chinese and North Korean reports. It is not even known if he went on the trip. But Kim Jong Il did spend some time inspecting sites related to the revolutionary days in China of his own late father, Kim Il Sung. Mr Kim spoke of the need to “hand over to the rising generation the baton of the traditional friendship” between the two countries.

China’s president, Hu Jintao (pictured with the Dear Leader), wished the party meeting in Pyongyang a “signal success”. The Chinese media played up Mr Kim’s reported agreement with his hosts on the need for an “early resumption” of multinational talks on North Korea’s nuclear programme. Prospects for this remain dim, but some analysts believe that North Korea might try to get negotiations restarted as a way of relieving economic pressure. For the moment, China is North Korea’s lifeline. Diplomats say trade between the two countries has picked up in recent months. In return for food, North Korea has given China a new lease on harbour facilities in the north-eastern port of Rajin.

The prospect of a power transfer in Pyongyang worries China. Global Times, an English-language newspaper in Beijing, accused America and South Korea of wanting to “create turmoil” in North Korea and said a smooth transition there was “vital” for stability in north-east Asia. Victor Cha of the Centre for Strategic and International Studies, a Washington think-tank, says that Mr Kim’s mysterious visit at least made it clear that China would stick with its ally to “the bitter end”.

China: the price of directed lending

September 21, 2010
China: How long can that heart rate stay elevated?  Source: Google Images
China: How long can that heart rate stay so elevated? Source: Google Images

China is an economically successful country.  Growth rates of 8-11% per year.  Fx reserves north of $2.4 trillion, closing in on 20% of US GDP.  Investment rates that represent 40-50% of GDP (vs. 15-20% in the US).  Private credit growth of 32.5% last year, vs. 5.6% in the U.S.   A Human Development Index that now stands at 49.7, vs. 26.5 in India, and per capita income (PPP basis) that is twice as large as India’s.  Can China keep this up?

I have long said in this blog that China is not strictly comparable to Western market economies, where governments use market signals such as interest rates to nudge the massive private sector in a certain direction.  In China the central government directs banks to lend and pushes local governments to invest.  Not to scoff at the stimulus packages in Western countries — featuring government spending and liquidity injections, but in China, when the authorities mandate a stimulus, they sure get one.   The lead lining in the silver cloud, however, is that when loans and investment projects “season” in China, sizeable loan losses and fiscal liabilities can result.  This is just what rating agency Fitch argued at a conference in Shanghai and Beijing last week (see press release below).   

China has the wherewithal to handle some deterioration in its banks and sovereign balance sheet, given its low level of government debt (under a quarter of GDP), small deficits (under 3% of GDP), and full inoculation against a balance of payments crisis (featuring its Chinese wall of fx reserves and current account surpluses in the neighborhood of 5-10% of GDP).  Nevertheless, with a massive banking sector (broad money represents over 180% of GDP) and heavy state involvement in the sector, banking problems could conceivably become sovereign debt problems.  Fitch assigns China a Banking System Risk Indicator of D/3 (vs. C/3 in the US and B/1 in Canada).  This statistic ranks countries based on the quality of their banks (A-E, E being the lowest) and on systemic banking risk (1-3, 3 being the highest risk).  So, directed lending and stratospheric credit growth have a dark side. 

Furthermore, as Fitch suggests, China, like Japan, will have to shift to an economy driven more by its consumers and less by external demand (i.e. exports) in order to respond to angry trading partners like the U.S. and to have a more sustainable trajectory of economic growth.  Such a shift will be even more difficult with problems in the banking system and higher government debt.

Fitch: China’s Ratings Supported By Strong Sovereign Finances, But Possible Stimulus ‘Hangover’
17 Sep 2010 2:01 AM (EDT)

Fitch Ratings-Beijing/Singapore-17 September 2010: Fitch Ratings says China’s ratings remain supported by the sovereign’s strong finances, underpinned by the foreign reserves stockpile, and by the economy’s strong growth track record. However, the agency raises concerns over a potential ”hangover” from the government’s aggressive stimulus efforts in 2009, including strong credit growth, which could still see the emergence of problems requiring sovereign support to clear up, for example in the banking system. The hesitant recovery of the global economy remains a background source of risk for China.

Leading off Fitch’s annual Sovereign and Banking Conference in Shanghai and Beijing this week, Andrew Colquhoun, Head of Asia-Pacific Sovereigns, reviewed China’s robust economic performance through the global crisis. China’s strong growth owes much to the government’s stimulus efforts, but Mr. Colquhoun noted that some of the costs of the stimulus may be yet to materialise on the sovereign’s balance sheet, such as debts of local government investment companies and, in a downside case where banking sector problems emerge, holes in bank balance sheets. Mr. Colquhoun also discussed the longer-term prospects for a transition to a more consumption-led growth model in China in the context of a still-hesitant global economic recovery – potentially a bumpy transition.

Speaking on the prospects for Asia-Pacific banks, Jonathan Cornish, Head of Fitch’s North Asia Financial Institutions team says the agency sees risks building in banking systems across the region, particularly in China due to rapid asset growth – even though Asian banking systems have generally proved resilient during the global financial crisis, and have in general continued to benefit from a relatively benign operating environment as a result of the robust performance of many Asian economies.

Charlene Chu, Fitch’s Senior Director of Financial Institutions, provided an update of Chinese regulators’ efforts to curb the risks surrounding the growing popularity of informal securitisation, or the re-packaging of loans into wealth management and/or trust products, by Chinese banks. Ms. Chu was one of the earliest analysts to raise awareness about informal securitisation in China. She said that despite the recent tightening in regulations, net issuance of some wealth management and trust products has not slowed thus far in Q3, owing to a number of grey areas in the new rules that offer banks significant room to maneuver with this activity.

Li Zhenyu, director of financial institutions and structured finance at Lianhe Ratings, Fitch’s JV partner in China, also discussed the evolution of formal asset securitisation in China.


Andrew Colquhoun
+852 2263 9938

Jonathan Cornish
+852 2263 9901

Charlene Chu
+86 10 8567 9898 ext 112

China: Growth slowing

July 15, 2010
China: the government tries to manage the economy.  Source:  Google Images China: the government tries to manage the economy. Source: Google Images

Shallow piece in the NYTimes today on a modest slowdown in economic growth reported in China for the second quarter, prettily written by non-economists.  For a better analysis, not so elegantly written, have a look at the CSFB note from today (below) that explains that growth has slowed due to slackening investment (in Chinese terms — down from a strong expansion of 3% per month in April and May to 1.4% month/month in June) and to downturns in the property and stock markets.  CSFB sees this modest slowdown as exactly what the Chinese authorities are looking for to keep inflation in check and as giving no indication that monetary policy will be tightened much further from its current setting.  CSFB notes that consumer demand and, notably, exports remain quite robust in China.  

What should be underscored about China is that the state still calls a lot of the shots in that economy, much more so than in Western economies (well, okay, there is always France).  The central government directs banks to lend and regulates credit to local governments, which impacts investment, including real estate and infrastructure.  So, in addition to the traditional levers of fiscal and monetary policies which we’re familiar with in the West, the Chinese government has more heavy-handed policy tools (although in the wake of the financial bailouts in the West, we shall see how interventionist the state becomes). 

Also worth understanding is that while China now plays a major role in the world economy, it cannot alone drive the world out of its doldrums.  Whether or not there is a double-dip recession, and odds are there may well be in some countries, will be determined in the massive economies of the US, Europe and Japan, still reeling from the financial shocks and consequent poor public debt dynamics of the last few years. 

From CSFB today:

Dong Tao
+852 2101 7469
The economy expanded by 10.3% yoy in Q210, less than the market consensus of 10.5%. While the headline growth figure seems acceptable, we estimate that annualized quarter-on-quarter growth dropped to about 1.9%, from 2.7% in Q110. A large part of the growth deceleration came from inventory corrections and a slowdown in fixed asset investment. Based on our calculations, total fixed investment growth moderated to about 9% qoq (sa) in 2Q from about 13.4% in 1Q. However, the growth momentum was supported by robust consumption and rebounding exports. Meanwhile, inflationary pressure has eased.
Retail sales grew by 18.3% yoy, versus 18.6% yoy in May. Sales have remained very solid despite the anecdotal evidence of slowing auto and home appliance sales. We think it is the consumers from smaller cities and rural areas, who are less exposed to the property and stock market downturns, who have delivered. The resilience in private consumption continues to be the pillar of our argument that economic growth will moderate but not collapse in H210 and that Beijing is in no hurry to ease.
Fixed asset investment grew 24.5% yoy in June, versus 25.6% in May, and, on our calculations, fixed investment growth moderated to 1.4% mom (sa) in June from over 3% in the previous two months. In view of tightened credit conditions faced by local governments, we expected infrastructure investment to decelerate further, although remaining large in absolute terms. Housing construction activities seem to have held up well for now, but we anticipate a sharp slowdown in H210 if transaction volumes do not pick up quickly. The slowdown in fixed asset investment will be the key determinant for growth over the next 12 months, in our view.
Industrial production growth saw a sharp fall to 13.7% yoy in June, from 16.5% in May and 18.6% during the first five months. On a seasonally adjusted month-on-month basis, we estimate that industrial production declined by 0.8%, the first decline since November 2008 (excluding the Chinese new year period). This is consistent with the decline in power consumption growth in June and the suspensions of production in the steel and auto sectors. We believe inventory corrections will continue for at least a few more months, based on our discussions with manufacturers, who are concerned about the property sector and a global “double-dip”. Government policies, such as suspending export tax rebates and promoting energy-saving measures, and its supportive stance towards labour compensation, may also play a role. The floods along the Yangtze River are likely to cause production problems as well.
CPI inflation softened to 2.9% in June from 3.1% in the previous month. Inflation softened by 0.6% on a month-on-month basis. This occurred despite bad weather conditions. In view of the slowdown in economic activity in H210, we expect a further small easing in production costs. However, surging wage rates and rising food prices may prove to be stubborn. Food prices have started to rise again in July, as reduced production of summer crops has been confirmed. More importantly, ‘hot money’ is competing with the state purchasing agent in purchasing grain from farmers. A crucial factor that pulled headline inflation down was falling pork prices. However, that trend has reversed and pork prices have edged up over the past 2-3 weeks. The consequences of “foot and mouth disease” and surging feed costs are starting to become evident, and we expect a significant rise in pork prices in H210. Pork counts about 8% of China’s CPI basket. We are revising down our year-average CPI forecast for 2010 to 3% from 3.7%, based on a weaker outlook for growth and falling production costs. However, we set our year-end inflation target at 3.3% to reflect the inflationary pressure from food and services (through wage hikes). We now expect one 27bps interest rate hike in both the one-year lending and deposit rates by the end of this year, and two more hikes in 2011.
While growth momentum may have fallen ‘one notch’, we believe demand for commodities may have gone down ‘two notches’. However, we still think that economic growth is unlikely to collapse in the way it did in 4Q08, as consumption remains solid and liquidity remains ample. Other than for CPI and the interest rate outlook, we are not changing any of our forecasts.
We believe that this set of data will not result in much in terms of policy changes. The moderation in growth is exactly what Beijing has aimed at, in our view, and the pace of softening seems to be acceptable (the government focuses on the year-on-year growth number). The government has already entered a ‘pause’ phase in its tightening strategy, and we do not expect much in the way of new tightening measures. Neither do we expect the policy gear to be shifted to easing mode, at least in Q310. The central bank has resumed the net draining of liquidity in its open market operations this week after the listing of a major commercial bank, and the authorities have reiterated their determination to squeeze the ‘bubble’ in the property market.

India’s infrastructure bottlenecks

June 16, 2010

An excellent New York Times article yesterday discussed how democratic politics and bureaucracy in India prevent the elimination of infrastructure bottlenecks, especially in transportation.  The article focused on India’s railway system, where freight rates are expensive, travel times excessive, and traffic volumes inadequate to the task of fostering strong economic growth…of the pace we see in China.

It is an interesting comparison — China vs. India, one which would require more time and space to adequately address than this blog can provide.  For the moment, I will raise the long-standing dichotomy between two development models — the authoritarian and the democratic.  In Latin America, analysts have often underscored the success of the Pinochet model in Chile, whereby a brutal authoritarian regime from 1973-90 swept away roadblocks and bottlenecks caused by democratic politics, unleashing that country’s growth potential and allowing it to develop more rapidly than many of its historically more democratic neighbors.  Moreover, with a sound economy in place, Chile was able to make the transition to a functioning democracy with two relatively cohesive coalitions of the right and left.  Yet there was a cost in terms of social cleavages, human rights abuses, and at times political stability.  Throwing people out of helicopters is not civilization.

General Augusto Pinochet and friends, the junta that ruled Chile from 1973-90.  Source:
General Augusto Pinochet (seated) and friends, the junta that ruled Chile from 1973-90. Source:

Arguably, Russia and China have followed the Pinochet model, Russia after the economic disaster created under failed democrat Boris Yeltsin.  China has done quite well with this model, but nervous Chinese leaders understand that unrest, if not social upheaval, is always a possibility in China if the political monopoly fails to consistently deliver the economic goods.  India labors under a vibrant, if at times inefficient and somewhat corrupt, democracy.  Nevertheless, Indians know that if a government fails to deliver economic growth, they can “throw the rascals out” at the next election.  This introduces a measure of political stability into the system, which is often lacking in authoritarian regimes.  And, given India’s enormous ethnic and religious cleavages, it is perhaps this vibrant democracy that prevents the country from tearing itself apart.  Slow trains and slow growth — the price Indians pay for stability (and decency)?

Image above:  General Augusto Pinochet (seated) and friends, the military junta that ruled Chile from 1973-90.  Source:

Couples therapy: China and the U.S.

June 16, 2010
Nixon & Mao: Mutual dependence goes back a long way.   Source:
Nixon & Mao: Mutual dependence goes back a long way. Source:

I have long said in my China posts that China does not have a lot of options right now besides buying US treasuries.  The AP article below describes how China has increased its purchases of US debt in recent months.  If you are going to hold your currency undervalued in order to run massive current account surpluses and amass fx reserves — because you were spooked by how the likes of Korea, Indonesia and Thailand were brought to their knees with low fx reserves in the 1998 Asian Crisis — then you will have to invest your massive fx reserves somewhere.  The dollar is a logical choice because of trade, deep US markets and the dollar’s reserve currency status. 

Since the beginning of the Great Recession of 2008-09, many observers warned that Chinese fx reserves could be shifted suddenly to other currencies, perhaps the euro and the yen.  Even before the sovereign debt crisis in Europe unfolded earlier this year, I suggested that euro assets did not look so great — given the slow-growth, sclerotic economies in the euro zone.  The same goes for yen assets, given that Japan has barely grown in the last twenty years.   Other emerging market economies (Brazil, India) are growing smartly, but they have small asset markets, compared to the depth and variety of markets in developed countries.  Ben Bernanke used to argue before the Great Recession that capital floods the US market and causes, rather than finances, US current account deficits.  This is because the return on US assets — driven by robust US output growth — is better here than elsewhere.  Now, with the euro crisis in full swing and Japan still stagnant, his argument has some appeal again.  It is still specious because it gets US households with their abysmal savings record off the hook, and it gets Bush and his irresponsible tax cuts off the hook as well.  The latter got Bernanke appointed to the Fed, so was all in a day’s work.

Is there a problem with all this foreign investment in US assets?  Yes.  The US must reduce its imbalances with the rest of the world in order to avoid the financial havoc that a massive dumping of dollar assets in the future could wreak.  We’re okay now because dollar holders have few options and the rest of the world looks a bit dodgy.  But foreign holdings are large.  Foreign holdings of US treasuries represent 28% of US GDP, with China holding 23% of this and Japan coming in second with 20%.  The US government is in hock to East Asia.  

Another nettlesome problem of this foreign appetite for the relative safety of US treasuries is that it keeps interest rates low in America, putting less pressure on Barack Obama & Co. to come up with a medium-term fiscal consolidation plan.  They’re still talking about another fiscal stimulus.  US government debt is set to rise above 90% of GDP next year and deficits will hover near 10% this year and next.  Government debt is often measured relative to GDP, but a better measure is debt relative to government revenues; this is because governments after all must service debt with revenues.  US government debt to revenues last year was 300%, higher than just about any other investment grade country in the world, with the notable exceptions of Japan and India.  (Debt by this measure was likewise higher than in such euro-crisis countries as Greece and Italy.)  So, the US has a fiscal migraine, while the Obama administration fiddles.  The Economist last week said this about Obama: “…he has done little to fix the deficit, shown a zeal for big government and all too often given the impression that capitalism is something unpleasant he found on the sole of his sneaker.”  Scrape that off your sneaker, tell OMB Director Peter Orszag to zip up his pants, and get to work!

And let’s be glad the Chinese are still buying, but not get too cozy in the knowledge of the same…

Image above: Nixon and Mao: Mutual dependence goes back a long way.  Source:

From AP:

China and other countries buy US Treasury debt

China boosts holdings of US Treasury debt by $5 billion, second consecutive monthly gain


Martin Crutsinger, AP Economics Writer, On Tuesday June 15, 2010, 11:38 am EDT

WASHINGTON (AP) — China boosted its holdings of U.S. Treasury debt in April for the second straight month as total foreign holdings of U.S. government debt increased.

China’s holdings of U.S. Treasury securities rose by $5 billion to $900.2 billion in April, the Treasury Department said Tuesday. Total foreign holdings rose by $72.8 billion to $3.96 trillion.

The sizable gains are being driven by fears that Greece and other European governments could default on their debt. Worries over possible defaults have sparked a flight to safety and that has benefited U.S. Treasury securities. Treasurys are considered the world’s safest investment — the U.S. government has never defaulted on its debt.

The April increases eased concerns that lagging foreign demand will force the U.S. government to pay higher interest rates to finance its debt with private economists forecasting strong gains in May as well because of the debt crisis.

“We will state the obvious that flight to safety will most likely continue to favor the United States in the second quarter,” said Win Thin, senior currency strategist at Brown Brothers Harriman & Co. in New York. “Given that the European crisis intensified in May, we would expert further large-scale inflows.”

Gregory Daco, U.S. economist at IHS Global Insight, said that demand for U.S. debt was also being helped by the fact that the profit outlook for many U.S. companies is bright and the U.S. economy is forecast to grow at a stronger pace this year than Europe.

China is the largest foreign holder of Treasury securities. The monthly gains in March and April came after six consecutive months when China was either reducing its U.S. holdings or keeping them constant. The stretch raised concerns that China might shift money away from Treasury securities.

The 1.9 percent rise in total holdings of U.S. debt in April followed an even bigger 3.5 percent increase in March.

The Treasury reported that net purchases of long-term securities, covering U.S. government debt and the debt of U.S. companies, increased by $83 billion in April. That follows a record monthly gain of $140.5 billion in March.

The higher interest in U.S. bonds has helped push interest rates lower. It’s a welcome development for the government, which faces the task of financing record federal budget deficits. The federal deficit hit an all-time high of $1.4 trillion last year. It is expected to remain above $1 trillion this year and in 2011 as well.

Japan, the No. 2 foreign holder of Treasury securities, also increased its holdings in April. It boosted them by $10.6 billion to $795.5 billion.

Other countries registering gains in their holdings in April were the United Kingdom and various oil exporting nations.

Is there a Yuan bloc in Asia?

June 8, 2010
Asian currencies tracking China's yuan?  Source:  Google Images
Asian currencies tracking China’s yuan? Source: Google Images

Interesting Economist article (below) discussing whether other Asian currencies — the Korean won, Thai Baht, Singapore dollar, Malaysian Ringgit, New Taiwan dollar, Vietnamese dong, Indian rupee, Indonesian rupiah — track the Chinese yuan in order to maintain competitiveness in US markets relative to China as well as access to the Chinese market.  There have been a number of econometric studies on the matter.  The bottom line is that many Asian currencies, like the Chinese yuan, track the US dollar closely — some call it Bretton Woods II — though the correlation has declined since the economic crisis, as the US economy and US monetary policy have been going through anomalous conditions.  Tying strictly to the US dollar right now might mean some unwanted inflation in accelerating Asian economies.  Still, China’s currency remains essentially fixed to the dollar.  Ultimately, a revaluation of the Chinese yuan, and its Asian brethren, is needed to address the current account imbalances that persist and threaten global economic stability.  The euro crisis has, however, thrown a wrench into that adjustment, leading to some safe haven capital flows into the US dollar, just when the greenback needs to decline in an orderly fashion.

 From the Economist on-line:

 Asian currencies

Chips off the block

Currencies around Asia are more flexible than you think

Jun 3rd 2010 | HONG KONG | From The Economist print edition

AMID all the diplomatic ding-dong over China’s yuan, it is easy to lose sight of emerging Asia’s other currencies. There is not much din over the dong, for example. While China has kept the yuan pegged to the dollar since July 2008, ignoring complaints that it is artificially cheap, Vietnam’s currency, the dong, has depreciated by 13% against the greenback over the same period, unremarked and unprotested. South Korea and Taiwan, the only countries besides China ever to be labelled currency manipulators by America’s Treasury, have seen their currencies cheapen by 17% and 6% respectively.

China’s critics justify their preoccupation by invoking a “yuan block”. China’s neighbours and rivals are reluctant to allow their currencies to rise too far against the yuan, for fear of losing China as a customer, or losing out to it as a competitor. Thus although China accounts for only 19% of America’s imports, its peg, it is argued, frustrates a broader realignment of currencies in the region.

Does such a yuan block exist? For over a decade before July 2005, it was impossible to say. Since the yuan did not move independently of the dollar, it was hard to know if China’s neighbours were in thrall to its currency or America’s. But for the following three years, China allowed the yuan to crawl slowly upwards against the dollar. A 2007 study by Chang Shu, Nathan Chow and Jun-Yu Chan at the Hong Kong Monetary Authority took advantage of this interlude to measure the influence of China’s yuan on other regional currencies.

Using a method popularised by Jeffrey Frankel of Harvard University and Shang-Jin Wei of Columbia, they looked at the fluctuations of Asian currencies against the Swiss franc. Insofar as the Thai baht and the dollar mirrored each other’s moves against the Swiss currency, the authors could conclude that the baht was under the dollar’s spell. But if the baht and the yuan strengthened against the franc when the dollar did not, they could identify the separate pull of China’s currency.

That pull was strongest on the Korean won, Thai baht, New Taiwan dollar and Singapore dollar. But it also seemed to reach as far as the Indonesian rupiah and even the Indian rupee. The economists’ results suggested that if the yuan were to appreciate by 1%, independently of the greenback, the Singapore dollar, New Taiwan dollar and the Thai baht would rise by 0.58%-0.68% in sympathy. The Korean won would strengthen one for one.

Since July 2008 the yuan has not moved an inch against the dollar. Does that mean that other members of the yuan block have also stood still? Hardly. Malaysia untethered its currency from the dollar one day after China in July 2005. But unlike China it did not retether it during the crisis. The ringgit fell by 15% from April 2008 to March 2009, before regaining much of that ground over the next 14 months. The won’s wobbles have been even greater. It lost 40% of its value from February 2008 to March 2009, and remains 25% below its pre-crisis peak.

Most of emerging Asia’s currencies strengthened against the dollar this spring. The ringgit rose by 8% from February to May, after Malaysia’s independent-minded central bank raised interest rates in March and again on May 10th. In April Singapore’s Monetary Authority said it would allow a “gradual and modest” appreciation of its currency. But since the debt crisis in Greece unnerved investors, these currencies have mostly lost value again.

This block isn’t scared any more

The flexibility shown by Asia’s currencies is noteworthy, even if most of their flexing has been downwards. Economists used to accuse the region of a “fear of floating”. In 2003 Michael Dooley of the University of California, Santa Cruz, with David Folkerts-Landau and Peter Garber of Deutsche Bank argued that a de facto dollar standard prevailed in much of the region, akin to the “Bretton Woods” regime of fixed dollar parities that emerged after the second world war. But a paper published on May 19th by Ila Patnaik and her colleagues at the National Institute of Public Finance and Policy in Delhi documents a gradual thinning out of the Bretton Woods II regime.

They use a similar method to Messrs Frankel and Wei to show how closely Asia’s currencies track the dollar, euro, yen and pound. They give each country a Bretton Woods II score, based on the rigidity of its currency, especially relative to the dollar. In 2003 the average score in Asia was about 0.85 (a score of one represents a hard peg to the dollar). But the score has since dropped steadily to 0.75.

The new flexibility should stand Asia’s economies in good stead. Their ties to the dollar once guaranteed stable prices at home, as well as competitive exports abroad. But America’s monetary policy, suited to an economy with flat prices and high unemployment, is too loose for a region now growing so rapidly. As Asia’s recovery outstrips America’s, the region’s central banks will have to raise interest rates, as Malaysia, Vietnam and India have already done. Their currencies will appreciate as a result.

This appreciation will be easier to stomach if the yuan also strengthens. But China’s neighbours should not wait for this to happen. Even members of the so-called yuan block should not let the yuan block their progress.

China: A bully like Wilhelmine Germany?

June 2, 2010
South China Sea where China and its neighbors dispute control over strategic islands and energy resources.  Source:  Google Images
South China Sea where China and its neighbors dispute control over strategic islands and energy resources. Source: Google Images

People like the analogy.  The rise of Germany after 1890, mismanaged by Germany and its adversaries, and the rise of China today — mismanaged or well-managed?  A NYTimes article today discusses the conflicting claims over rich offshore oil resources in the South China Sea among China and its much smaller neighbors, notably Vietnam, with which China fought a war in 1979 (though that was over Cambodia).  These conflicting claims on China’s flank remain unresolved.  Tension in the South China Sea bubbles dangerously below the surface, not unlike the way Morocco and the Balkans did for decades before WWI.  The US takes no sides in these disputes, but the South China Sea constitutes a potential flashpoint for tension between the US and China, in addition to Taiwan.  Some estimates put the quantity of shipping that takes place through the strategic sea lanes in the South China Sea at around 50% of world shipping, depicted with arrows in the map shown above.

Vietnam is pursuing the negotiating strategy of the weak — internationalize the conflict.  This reminds me of Yasser Arafat’s never-ending call back in the day for an “international conference” over the Arab-Israeli conflict; whereas Israel, like the Chinese, always preferred bilateral talks.  Both China and Israel resist international conferences where smaller countries can gang up on them.  Recall the Madrid Conference on the Mideast in 1991, cobbled together by the Bush administration (with the gifted handiwork of Sec. of State  Jim Baker).  Israel was isolated and ganged up on in Madrid.  Israel ultimately preferred secret bilateral talks with the Palestinians in Oslo.

In any event, the South China Sea issue won’t go away, and one wonders if, like Wilhelmine Germany, China will succeed in alienating everyone with its bullying tactics or will seek to find a mutually beneficial solution.  It is hard to find such a win-win solution in a dispute over territory and resources.

(from a Feb. 5, 2010 blog post.)

China can’t have monetary policy flexibility

April 26, 2010
China's currency:  Can't have it all... Source: Google Images
China’s currency: Can’t have it all… Source: Google Images

In today’s CSFB column on China (see below), Dong Tao and Christiaan Tuntono report that PBoC Governor Zhou Xiaochuan commented that China would like greater monetary policy flexibility in order to combat inflation.  Not that inflation is so high in China, but the Asian giant’s return to breakneck rates of growth (11.9% growth year-on-year in 1Q10) may push prices higher.  But, the Chinese are surely aware that in the world of economics, you cannot have your cake and eat it too. 

Remember the so-called “Mundell Trilemma,” named after ground-breaking economist Robert Mundell, who with Marcus Fleming at the IMF in the 1960s critiqued, or better, refined Keynesianism.  They analyzed the effects of monetary and fiscal policies under different exchange rate regimes (fixed or flexible) and under capital mobility (or not).  The Mundell Trilemma  posits that you cannot have all three of: fixed exchange rates (which China has held to tenaciously, much to the chagrin of balance of payments deficit countries like the US); monetary policy flexibility (which Mr. Zhou announced today he would like); and, capital mobility (on which the Chinese export juggernaut depends — i.e. FDI and other capital inflows).  So, the Chinese have given up monetary policy flexibility in exchange for $2.4 trillion in fx reserves and rising.  Excessively easy US monetary policy for many years (thank you, Sir Alan) has led to easy money in China, sometimes resulting in an inflation problem, though not of late.  Effectively, the Federal Reserve determines the money supply in China.

Do Mr. Zhou’s comments presage a more flexible exchange rate in China (aka a revaluation of the woefully undervalued RMB)?  Do we have one more set of tea leaves to read on China’s policy intentions — in addition to the U.S. government’s agreement to postpone calling China a currency manipulator in exchange for China’s cooperation on sanctions against Iran and a commitment to at least slowly revalue the RMB?  In any case, Mr. Zhou can’t have his desired monetary policy flexiblity without floating his currency. 

From CSFB 4/26/10:

Dong Tao
+852 2101 7469
Christiaan Tuntono
+852 2101 7409
PBoC Governor Zhou Xiaochuan highlighted the importance of inflation management and policy flexibility for China’s monetary policy. Zhou made his latest comments on China’s monetary policy during his attendance at the G20 meeting in Washington DC. Although the importance of policy continuity and consistency remains intact, greater weight appears to have been attributed to the focus and flexibility of policy measures in view of the potential rise of new economic conditions. At the same time, Zhou also stressed the importance of monitoring price movements and managing inflation expectations in his comments. We think Zhou’s comments reflect the PBoC’s concern about the rise of inflationary pressure in China, and its readiness to adjust the existing policy stance to cope with any new situation. The same message was also conveyed in the PBoC’s 1Q10 macro economic analysis published on 23 April, in our view. The report acknowledged the further strengthening of economic momentum, and identified the management of liquidity, credit growth, and price stability as the PBoC’s main tasks. The central bank also said that it will continue to maintain the balance between growth, structural adjustments, and inflation expectations going forward. The PBoC’s heightened focus on inflationary pressures is in line with our expectation for price levels to rise in 2010 on higher food prices and housing rents. Higher inflation is likely to drag real deposit rates into negative territory, prompting the central bank to raise rates in 2H10, in our view.
Meantime, the Chinese government has reportedly been studying the launch of a new round of stimulus measures, despite the fact that the economy grew by 11.9% yoy in 1Q10. This time, we understand the focus will be on helping economic transformation and establishing competitiveness in selected industries instead of boosting GDP per se. The plan is still at an early stage, but it could be as big as the RMB4trn package launched in late 2008 that prevented the Chinese economy from falling into recession. There is clearly a policy desire to upgrade and transform the economy, as China’s export engine may enter into a structural moderation amidst reduced US consumption and RMB appreciation. Unlike the emphasis on infrastructure investment in the previous stimulus package, we think the government intends to let private capital play a much bigger role this time.

China: Look who’s doing health care reform!

February 4, 2010
Maoist public health poster.  Source:
Maoist public health poster. Source:

Christiaan Tuntono and Dong Tao of CSFB reported today on the only health care reform taking place in the G-2 at the moment, this one in China (see article below).  In the workers’ paradise in East Asia, such welfare state fundamentals as health care, social security, and unemployment insurance are not provided extensively by the state.  This lack is one of the culprits, according to economists, behind China’s sky-high household savings rate that keeps consumption depressed and current account surpluses with the US and others (and therefore China’s fx reserves) in the stratosphere.  Chinese households themselves must save for health care, retirement or job loss.  China is implementing a pilot public hospital program, taking baby steps, designed to yield universal health care by 2020.  This reform is not stuck in some legislature.  This round of reform follows what has been viewed as a failed experiment in introducing market reforms in health care, which only pushed costs higher.  Lessons for America?  Not sure, but have a read of the CSFB report below…

Dong Tao
+852 2101 7469
Christiaan Tuntono
+852 2101 7409
The State Council passed the public hospital reform plan on 3 February, marking another important step in China’s healthcare reforms, in our view, and addressing the problem of over-saving among the public. This policy is in line with the healthcare reform plan announced by the State Council in April 2009, which aims to invest RMB850bn to provide basic medical services to the population by 2011, with the long-term goal of rolling out universal coverage by 2020. Each province will select one to two cities as the trial bases for setting up a public hospital network, according to the policy approved yesterday, while we think 16 small- to medium-sized cities are likely to be selected for the initial launch. In our view, China has reversed the direction of the medical reforms launched by former Premier Zhu Rongji in the late 1990s, which have been widely viewed as a failure. Zhu introduced market mechanisms to the healthcare system, hoping that they could improve efficiency, but that led to a surge in medical costs and a deterioration in service quality at hospitals. The new approach taken by the government now is to identify healthcare as a public non-profit oriented service, and hence the state will assume the main responsibility to provide this, while allowing the existence of private healthcare services. The government will provide subsidies to lower the cost of drugs and other medical fees. High medical costs have been one of the main reasons behind the Chinese population’s high level of precautionary savings. With the aim of promoting private consumption, Beijing is taking steps to address this concern. We believe more fiscal resources will be ploughed into this effort over the coming decade, raising the provision of social benefits.
In other news, it was reported by local journal China Business News that China Investment Corporation (CIC) may receive another $200bn capital injection from the Ministry of Finance. The CIC invested heavily in the second half of 2009, which could have used up a sizable portion of its initial capital. When the CIC was set up in 2007, the Ministry of Finance issued a RMB1.55trn special bond and injected the proceeds into the company as a capital base to purchase $200bn worth of foreign exchange reserves. Given that China now has over $2.4trn of FX reserves, and is expected to maintain a balance of payments surplus in the future, we believe the CIC will accelerate its pace of foreign investments with the aim of diversifying China’s reserve holdings into global blue-chip companies and natural resources.

Image:  Maoist public health poster.  Source: Google Images