China Should Return More Wealth to Its People

Includes: CNY, CYB
by: Kehong Wen

As G20 finance ministers gather in South Korea, the central issue discussed is around exchange policies and avoiding the outbreak of a global trade war.

China is under intense pressure from the U.S. and other emerging markets to revalue its currency, which is pegged to the U.S. dollar and widely believed to be undervalued by 20-40%.

China has resisted such pressure by pointing out to potential disruption to its export-led economy and its recent efforts in stimulating domestic consumption. The central bank PBOC has recently raised benchmark interest rates by a quarter point, the first time since the onset of the 2008 financial crisis, despite signs of cooling economic growth. This may be the beginning of a series of interest rate hikes to rein in inflation.

Much of China's recent growth has been fueled by injecting loose credit into the banking system, which may have caused excessive domestic inflation, especially in the property sector.

These are happening in an environment that developed nations are trying to continue or enhance their loose monetary policies in a bid to spur growth, or at least to avoid Japanese-style deflation.

Recent discussions (e.g. by Li, Dongrong) out of the PBOC make it very clear that Chinese officials are very aware of the international financial environment and the challenge facing China.

Leaving it at the status quo, China may face a greater risk of hot money chasing after higher returns. The flood of easy money, through various channels such as private equity, may contribute to rising asset inflation and consumption-good inflation.

Inflation, while necessary for growth if it's moderate, chips away citizens' purchasing power and helps to increase economic inequality and social unrests.

On the surface, China has become a rich country. Commentators often point to its ballooning exchange reserve (about $2.6 trillions). But much of this money cannot be used to help ordinary citizens; instead it's financing the U.S. government which in turn help to lower the already-low interest rates. In terms of GDP per capita, ordinary Chinese are still quite poor. China should return some of the wealth to its people, by appreciating its currency more and bringing down actual inflation and inflation expectations.

Raising interest rate and the Yuan may actually go hand-in-hand in a gradual fashion, to power both domestic and international consumption. Higher interest rate puts more money in the hands of savers, and a more valuable currency obviously puts more purchasing power to any Yuan holder.

And, a lower inflation gives ordinary people a much needed break in the race to save enough for purchasing an apartment.

Disclosure: No positions