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China’s Rigid Currency Policy Threatens Growth

Published February 12, 2012 China Closed

Eswar Prasad, Senior Fellow at Brookings, writing for the WSJ June 2011:

(…)

China’s currency regime is now beginning to look more like political dogma rather than sound policy. The rigid policy threatens to upset the delicate balance between keeping growth strong and inflation at moderate levels.

(…) In this scenario, a significant currency appreciation would serve the dual objectives of tamping down inflation and helping to shift the balance of growth toward private consumption. A more flexible currency would also give the central bank a freer hand in changing interest rates. A rising yuan would raise the purchasing power of domestic households, first directly through the fall in the price of imported goods and second by giving the central bank room to raise deposit rates, so that households get a better rate of return on their savings.

Yes, there has been some apparent progress on the currency front. Much was made of last June’s announcement by Beijing that it would let the yuan slowly appreciate. Over the past year, the yuan has appreciated by about 5% against the dollar, or about 7% to 8% in inflation-adjusted terms. But if we consider that the dollar has been in broad retreat against other major currencies, the yuan’s trade-weighted multilateral exchange rate—which determines its overall export competitiveness—has been relatively flat. This has kept pressure on the currency to appreciate.

And China’s central bank continues to intervene massively in foreign exchange markets to keep the yuan’s value stable, suggesting the currency is still significantly undervalued. Such intervention boosts the stock of international reserves by about $200 billion each quarter, adding to the government’s headache as this inevitably means more purchases of U.S. treasuries.

Beijing can avoid this headache if it frees up the yuan-dollar rate. Given the direction the dollar is headed, China could easily allow its currency to appreciate more without losing much in terms of its overall export competitiveness.

The mantra that a significant shift in currency policy is in China’s own interest is now truer than ever. Policy makers should realize that the impact of inflation could be much worse for overall growth: Once the inflation genie escapes from its bottle, the sort of drastic policy actions that will be needed to cool things off will hurt the economy a lot more than a few lost jobs in the exporting sector now.

(via Instapaper)

The Renminbi’s Role in the Global Monetary System

Published February 11, 2012 China Closed

There’s an excellent audio (and video available) podcast of the captioned Brookings seminar. The topic is the just-released paper “The Renminbi’s Role in the Global Monetary System” [PDF] by prof. Eswar Prasad and Lei (Sandy) Ye.

Stephen Roach commented that he had been reading twenty-five papers on the Renminbi — but this is the only one you need to read. Here’s the panel:

Moderator

Greg Ip

U.S. Economics Editor
The Economist

Panelists

Donald Kohn

Senior Fellow, Economic Studies

Eswar Prasad

Senior Fellow, Global Economy and Development

Stephen Roach

Senior Lecturer and Senior Fellow of the Jackson Institute, Yale University
Non-Executive Chairman of Asia, Morgan Stanley

There is a full transcript.

Low-Carbon Development in the United States and China

Published February 10, 2012 China , Energy Policy Closed

Brookings recently published the audio of the captioned Feb 2, 2012 seminar; led off by Qi Ye of the Climate Policy Initiative (CPI) and Tsinghua University.

Also on the panel was DOE’s Casey Delhotal, Director, East Asian Affairs. Very interesting commentary on the US/China cooperation, especially the IP issues.

Altogether a very worthwhile conference, though I was disappointed there was no discussion of US/China nuclear cooperation, especially 4th generation.

The Brookings transcript is here.

The Qi Ye presentation slides are here.

China’s 11th five-year plan is here.

Nuclear cost competitive with coal in China and the US Southeast

Published February 9, 2012 China , Nuclear Costs 2 Comments

Harry is my goto source on electrical generation industry perspective. E.g., coal prices vary widely around the world depending especially on transportation costs (and grade obviously). Harry’s comment on BNC caught my attention. Our quest for new-build zero carbon electricity that is “cheaper than coal” is already happening in certain markets:

As a rule of thumb Nuclear is ‘cost competitive’(not considering externalized costs) in a ‘new build environment’ with coal at $4/MMbtu and Natural Gas at $6/MMBtu.

Those conditions exist in China and the US Southeast. That is where AP1000′s are being built. Those conditions also exist in the UK where the government position is ‘nuclear without subsidy’. They also exist in a good many other places in the world.

Australia and the US West have considerable quantities of coal that can be extracted and delivered a reasonable distance to market for well under $4/MMBtu. The discussion as to how to make cleaner technologies financially competitive with coal is therefore a much more difficult discussion.

Imagine how much lower the US cost will be once the “lawyer-protester” risk falls away, and the plants are mass-manufactured.

Very good sentences

Published February 6, 2012 China , Politics Closed
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Pres. Obama should read Tim Harford via Tyler Cowen:

From Tim Harford, about the UK:

…as Mr Summers pointed out, even China seems to have been shedding manufacturing jobs over the last couple of decades. Perhaps the data deceive here, but the Chinese manufacturing boom seems to be more about increasing output per worker than employing more workers. If the Chinese can’t generate jobs through manufacturing I am not sure we should be expecting too much from that strategy.

China Financial Markets: Building Debt

Published February 6, 2012 China Closed
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Discussing the Flyvbjerg paper in the light of China’s massive infrastructure spending, Michael Pettis wrote:

It is not a very happy paper in general, but I am pretty sure that many people who read it probably had a thought similar to mine: if infrastructure spending can be so seriously mismanaged in relatively transparent systems with greater political accountability, what might happen in a country with a huge infrastructure boom stretching over decades, much less transparency, and very little political accountability? Isn’t the potential for waste vast?

Michael Pettis at China Financial Markets has been looking into China’s capital misallocations for some time. Here he quotes from a recent Caijing article:

(…) rail lines were built where few people live on the outskirts of the Hunan Province city of Changsha, said Wang Chengli, an urban transit professor at the city’s Central South University. Today, exit gates for some of the city’s finished subway stations lead to farm fields.

Wang said Changsha authorities installed far fewer kilometers of track in the city’s center than in its suburbs. Each project was approved by the central government, he added.

Zhang says China learned important lessons from the fast-track subway program. For example, he now thinks subways should never have been built in “many cities.”

Doesn’t this mean defaults? Not in China, because the central government will backstop the defaults. But the debt service can only be managed by means of more financial repression. In that light how can China grow the consumer side of the economy?

The fact so few of the companies have accumulated that much debt suggests a bigger problem, says Fraser Howie, the Singapore-based managing director of CLSA Asia-Pacific Markets who has written two books on China’s financial system. “You should be more worried than you think,” he said of Bloomberg’s findings. “Certainly more worried than the banks will tell you.

(…) The problem, then, is not that there will be defaults. The problem is that the only alternative to default is to service the debt, and this is what will cause the real damage to the economy. If the economic benefits generated by the investment are less than the correctly-valued debt-servicing costs, as they almost certainly are, the difference has to be made up in the form of a transfer of resources from some sector of the economy.

As we saw in the last debt crisis, a decade ago, debt-servicing costs are only manageable in China thanks to financial repression – i.e. extremely low lending rates funded by even lower deposit rates — which implies a huge transfer, equal to several percentage points of GDP annually, from household savers to corporate and government borrowers. Households, in other words, typically clean up banking messes.

Only consume!

The problem with this solution is in what it implies about future growth in demand. If investment is being wasted, it must be reduced or it will create a debt crisis eventually. If the external environment is tough, the demand impact of a sharp drop in investment cannot be made up for by a surge in the trade surplus – in fact the trade surplus may actually contribute negative demand. So where will the demand come from needed to pull the Chinese economy? The only possibility is a surge in domestic consumption.

Can consumption possibly surge? No, not if the household sector is going to be forced to clean up the banking mess again. This is the same problem that caused household consumption to drop after the last banking crisis from a very low 46% of GDP in 2000 to an astonishing 34% in 2010.

(…) It isn’t about household savings

The only way to boost household consumption is either to redistribute income from the low-consuming rich to the high consuming poor, or, better yet, to redistribute wealth from the state to households. Both of these have serious political implications that have to be resolved and are unlikely even to be addressed with consumption subsidies. After five years of this argument, during which time consumption has plummeted relative to total savings, you would think they would start to abandon the idea that all we need to do to get consumption to surge is to reduce household savings a little.

FYI, Fraser Howie is coauthor with Carl Walter of “Red Capitalism”. I’m currently reading their book. I recommend you do not read this before sleeping.

Corruption may undo China’s economic miracle

Published January 30, 2012 China Closed

(…) this corrupt system deadens incentives for real innovation and customer service in many sectors. After all, why innovate when a company can bribe government officials for contracts or a guaranteed monopoly?

Northwestern University prof. Victor Shih at FT.com examines some examples of the cascading corruption , which led to the fire that consumed 58 lives in Shanghai last November. It is hard to imagine real reform from within the communist party, but Victor has some suggestions:

(…) At minimum, two major reform needs to be carried out to reverse the corruption. First, the state economy continues to be sprawling and continues to enjoy soft-budget loans from the banks. This creates ample opportunities for connected insiders to set up dummy companies to take advantage of government contracts. Because senior managers of SOEs are not remunerated according to profit (and profit not tied to capability), they are only weakly incentivised to maximise profit but strongly incentivised to take advantage of rent-seeking opportunities, which allow them to privatise state wealth.

If large SOEs, including state banks, were genuinely privatised, owners of firms would be more interested in generating profit and even building the reputation for their own firms, instead of taking advantage of rent-seeking opportunities.

Of course, China’s weak regulatory environment is also to be blamed. With more transparent public oversight, a free media, and accountable officials, the tragedy in Shanghai could also have been avoided.

China’s Top 10 Business Stories in 2011

Published January 30, 2012 China Closed

To motivate you to read the whole dispatch I will highlight two of the debt-service issues discussed Patrick Chovanec’s 10 top stories, high-speed rail and the Wenzhou credit crisis:

1. High-Speed Rail. It was the best of times, it was the worst of times — China’s ambitious high-speed rail program embodied the highest highs and the lowest lows the country experienced this year. In January, President Obama cited the planned 20,000km network in his annual State of the Union address as a prime example of how America needs to catch up to the Chinese. As if to prove his point, June saw the grand opening of the much-heralded Beijing-Shanghai line, timed to coincide with the Communist Party’s 90th anniversary celebrations.   But even before then, there were signs of trouble on the horizon, starting in February when the powerful head of China’s railway ministry — the project’s godfather — was abruptly fired as part of a massive corruption scandal. Then a crash on a line near Wenzhou, in which at least 35 people were killed, unleashed a wave of fury on the Chinese internet, forcing the government to re-think the entire project amid charges of cover-up and sloppy construction. By November, with high-speed trains running at chronically low capacity and construction debts piling up, the railway ministry was asking Beijing for a rumored RMB 800 billion (US$ 126 billion) bailout just to pay the money it owed suppliers.

(…)

4. Wenzhou Credit Crisis. In September, reports began circulating in the Chinese media that dozens of business owners in the southeastern coastal city of Wenzhou had fled for parts unknown, leaving behind a shambles of unpaid debts and ruined companies. Two had even killed themselves by jumping from their office towers.  Facing pressure from rising wages and input costs, as well as a less competitive Renminbi, these entrepreneurs had apparently gotten themselves enmeshed in informal lending schemes that had gone belly up — China’s own version of a “subprime” crisis. After Premier Wen arrived on the scene and directed local banks to extend emergency loans, many were quick to call it an isolated instance of Wenzhou’s trademark brand of seat-of-the-pants entrepreneurship gone awry. But others saw it as an alarming example of a much larger trend: an explosion in risky, off-books ”shadow” lending as a way around the government’s efforts to rein in runaway bank lending, a hidden, casino-like money market Fitch estimated at RMB 10 trillion (US$ 1.5 trillion). If so, they argued, Wenzhou’s woes could be just the tip of the iceberg.

Read the whole thing »

Chovanec: China data part 2

Published January 29, 2012 China Closed

Patrick Chovanec [CV here] is writing a series on China’s prospects for a hard or soft landing. In this post Patrick takes a closer look at the real estate sector and its connections to the broad economy. This is a necessarily long post with lots of data. I won’t attempt to summarize – except to say that Patrick’s evidence weighs more on the side of less 2012 growth. I continue to wonder about China’s impact on the Australian dollar – it is hard to see much upside for the AUD.

As China enters 2012, concerns that its economy may face a “hard landing” have entered the mainstream. In recent weeks, Paul Krugman (“Will China Break?” in the New York Times) and Robert Samuelson (“China’s Coming Slump?” in the Washington Post) both penned hand-wringing op-eds warning of an impending Chinese downturn. It’s interesting to see the rest of the world starting to wake up to the worrying trends we’ve been discussing on this blog for some time now.

When people talk about a “hard landing,” they’re usually talking about a sharp deceleration in GDP growth, which brings with it both business failures and unemployment. In two earlier posts (Parts 1 and 1A), I examined a variety of data points that suggest China’s real estate market is in the midst of a serious downturn. In this post, I want to take the next step beyond this and explore the impact of collapsing property prices on the pace of broader economic growth, and the prospects of a “hard landing”. (Originally, I promised to discuss the impact on China’s currency and inflation, but in thinking about it, I realized this places the cart before the horse. I’ll turn to this question in Part 3).

There are two ways that the drop in the property market translates into slower economic growth: direct and indirect. The direct impact is fairly obvious: to the extent that China’s real estate developers are overextended, and preoccupied with selling off their existing inventory in order to stave off bankruptcy, they won’t be commissioning any new projects — maybe not for quite a while. That means no work for construction companies, which in turn won’t be buying any new construction equipment. It also means less demand for steel (construction reportedly accounts for 40% of China’s steel demand), cement, glass, copper pipes and wiring, etc. It also means less furniture and fewer appliances to fill those new homes (although, as we know, many Chinese investors already leave the units they buy empty anyway). The estimates I’ve seen say these sectors dependent on property construction account for between 20% and 25% of China’s total GDP.

Frankly, you don’t need a real estate collapse in order to trigger a serious slowdown in these sectors. All you need is a pause in the hitherto frantic pace of construction. (…)

[snipped]

Read the whole thing » Here are several of Patrick’s recent related posts on the China outlook — I highly recommend a careful reading of the series:

Update: here is an excerpt from China’s 2011 GDP Numbers which updates the real estate sector fractions used in this post:

There are two pieces of data I saw, easily lost in the fine print, that I found particularly revealing. First, the NBS disclosed that real estate investment accounted for 13% of China’s GDP in 2011 (compared to Stephen Roach’s estimate of 10%), and grew at a rate of 27.9%. However, I noticed something that I admit I missed before, in my earlier calculations — that this is a nominal rate (not adjusted for inflation) whereas the GDP growth rate figures are real (they take inflation into account). The real (and therefore comparable) rate of expansion for real estate investment in 2011 was 20.0%.

Let’s close with the closing paragraph from Patrick’s most recent 20 January post:

I also want to emphasize — before we get totally preoccupied with the fate of the property bubble — that the property story is really just one aspect of a much broader investment boom that has been driving the economy. If real estate accounts for 10-13% of GDP, investment in fixed assets accounts for roughly half. The health of the property sector is particularly important in China because of the pervasive role that land values play in underwriting lending, but the risks to China’s economy extend far beyond the market for homes and offices. For China, real estate is just the tip of a much larger iceberg, one that I’ll explore in my next “China data” installment.

If you have counters to Patrick’s analysis please comment.

Cities are key to global carbon limits

Published January 16, 2012 China , Energy Policy Closed

Harvard’s Ed Glaeser was interviewed by the European Magazine. Ed is author of the excellent Triumph of the City: How Our Greatest Invention Makes Us Richer, Smarter, Greener, Healthier, and Happier. There are many important points, including the possibility that development policy could significantly reduce the per capita energy intensity of the ongoing urbanization. The future much richer Chinese peasant could require an energy footprint more like Hong Kong than Houston.

Such an ultradense pathway is not a sure thing – just look at the sprawl of Beijing and Shanghai, which have less than one tenth the density of NYC and half the density of LA. The challenge for the West is to help the Chinese, Indians et al achieve the French path (of 80% nuclear electricity).

Here’s an excerpt on that point:

The European: Could moving people into cities be a sustainable solution for emerging economies dealing with the issues resulting from growth?

Glaeser: From an environmental standpoint it seems very clear that it needs to be done. But you have got to do it in a way that makes sense: Part of the issue with African poverty is that as long as people remain rural, they will be whipsawed by every environmental hazard that comes along. By engaging in subsistence agriculture, there is no way to for them to take advantage of the global trading system. I want to make it clear that I am not an environmental expert, but some regions may end up losing as a result of changes of the environment and others regions may end up benefitting. Areas that now are cold may end up being easier to grow on just as areas that are hot now may end up being worse to grow on. If you are part of the global trading system, you will be able to take advantage of wheat grown in Canada or in Siberia. If you are not, if you are a subsistence agriculture country, then every famine that hits rural Nigeria will leave thousands dead. It is easy to see the benefit that comes from a transition out of agriculture towards a more urban future.

Concerning the environmental impact, it is clear that if everybody remains in rural poverty, there won’t be much going on in terms of carbon emissions. But I don’t think we can possibly hope for that. If you compare countries that are more than 50% urbanized with countries that are less than 50% urbanized, incomes are five times higher in the more urbanized countries and infant mortality rates are less than a third in the more urbanized countries. The path of rural poverty really is awful. But there are different paths and if for example the great growing economies of India and China see their carbon emission levels rise to the level seen in sprawling United States, global carbon emissions will go up by 120%.

But if they stop at the level seen in hyper-dense but still prosperous Hong Kong, global carbon emissions go up by only 25%. So, density is a way of managing growth so that it involves less carbon emissions in the future.

Highly recommended. Read the whole thing »

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