5% Revaluation of China's RMB? Are you Crazy?

China’s National Bureau of Statistics released a new batch of interesting information today: “From January to February, urban investment in fixed assets achieved 812.1 billion yuan, with a year-on-year increase of 24.3 percent.” Last year’s increase in investment spending was 25.8%, leading some commentators to talk about evidence of a “modest slowdown”, but the numbers suggest no such thing, especially since the January storms may well have depressed spending temporarily, and more especially since investment in real estate accelerated to 32.9%.

Speculative investment in real estate is a good proxy in China for speculative behavior in general, and perhaps also a proxy for speculative inflows, so the high growth in real estate investment seems to indicate that China’s easy money conditions are doing all the unhealthy things one would expect them to do. The rapid growth in real estate “investment” is particularly worrisome because most insiders worry about the impact of real estate on the banks – banking exposure to real estate is extremely high (and, from the anecdotal evidence, not always recorded as such). In case of a sharp economic contraction that led to a steep fall in real estate prices, banks could be badly hurt, thus exacerbating the slowdown.

The good news is that growth industrial investment slowed (but let’s not get too excited, it is still very high), and that should show itself as reduced growth in industrial production. I am particularly concerned about that number because high levels of industrial production force a rising trade surplus. As long as China produces more than it consumes it must export the difference, and a rising trade surplus increases China’s monetary expansion since the PBoC is forced to buy the accumulating foreign currency.

To make matters worse, the fall of the dollar ($1.5580 to the euro, $2.0310 to the pound, and Y 99.77 to the dollar) is putting unbearable pressure on countries who peg their exchange rate to the dollar. Not only does this reduce the value of their currencies in international trade (and so put increasing upward pressure on their trade surpluses), but because the Fed is dropping interest rates and pumping liquidity into the system it can only increase hot money inflows into countries like China. Referring to Chinese Commerce Minister Chen Deming, the China Daily today said:

Chen's ministry, which oversees foreign trade and domestic consumption, said that during the first two months, investments from the European Union countries rose a whopping 109 percent, while investments from the United States increased 44 percent. Wild expectations abroad that the yuan will continue to rise in value against major world currencies has led to money coming to China.

"When you bring US dollars to invest in China, you need to change it into the yuan. Naturally you would like your funds to enter China at an earlier date. Because, if you are late, the same amount of dollars will turn out to be less yuan bills," Chen told reporters.

Sure enough. So what to do? The China Daily is suggesting that some economists think China should consider a one-off revaluation, “possibly 5%”, to block hot money from flooding into the country.

Yes and no. As I have been arguing for over a year, a one-off revaluation is pretty much the only option available to China to regain control of its monetary policy, and they are eventually going to be forced into doing it. The fact that China Daily is reporting it suggests to me that this “crazy” idea is becoming less and less crazy every week.

But 5%? That would truly be crazy. Not only would a 5% revaluation accomplish very little in satisfying hot money expectations of RMB revaluation – we already expect the RMB to revalue by a lot more than that just this year – but even worse it would be a huge public announcement to the world that the PBoC was forced to do what they said they would never do, and anyone with a calculator and common sense will know that a lot more revaluation would be needed to adjust the monetary imbalances.

You don’t have to be a shadowy, evil speculator to see that 5% revaluation as a very loud signal to bring every penny you can get your hands on into China as quickly as you can.

Meanwhile there is a big debate going on among economists and bank researchers about how many more interest rate hikes, how many more reserve hikes, and so on the PBoC will engineer in order to tighten monetary policy. The debate is interesting because it does give us an idea of what is likely to happen to the stock market and of course what will happen to the cost of financing additional real estate speculation, but I do not think it is terribly useful for understanding what is likely to happen to domestic monetary conditions. China’s problem is not which set of tools can best be used to control the domestic money supply. It has no control over the domestic money supply. It is the currency regime which needs to be adjusted.

Comments

[fjd10595]

ok, I think what you are saying is that the china stock market has to go down in the medium term.

2008 Mar 14 08:11 AM

[Ames Tiedeman]

The United States must radically change its trade policies or become an also-ran in the next 2 decades. We can no longer tolerate Chinese goods coming in and American jobs going out. We can no longer exist in a world where we are closing auto plants and China is opening auto plants to sell us automobiles. This is quite irrational behavior.

2008 Mar 14 09:18 AM

[phdinsuntanning]

dont Worry Ames, those automobiles are not build for the US consumers anymore, current US strategy is that your currency be so cheap you survive selling something to them. Michael, Japan is changing the focus to figth inflation with yen appreciation to avoid social turmoil, Korea is falling in a US like stanflation monetizing oil price increases. China is the top oil importer, but they will be playing the Japanese game instead of the Korean / American devaluation i think. At the end of the day, China and Japan probably will spend reserves to keep inflation down with currency revaluations and the yuan will follow the yen trend without any need of 5% or 10% shock, is the only way to keep the society in harmonic terms in the short term I think,

2008 Mar 14 10:15 AM

[abcde_98]

The US government has not scratched, but severely injured, the US consumer, not only with spending US consumer revenue (taxes, etc) abroad, but not wanting to bite the bullet at home on the cost of health care and retirement pensions.

The worldwide "central bank" concept, influenced by the USA and thus US dollar is in question. Carroll Quigley, a Georgetown University, Washington DC, professor, wrote a 1,300 page book entitled "The Tragedy and the Hope" about the rise and fall o civilizations. The USA is in a decline in the world, doesn't anybody understand that.

There is already outsourcing using persons from Michigan.

US persons have and are in for a major, severe, unprecedented, tsunami, of adjustment of lifestyle. Sovereign funds own a piece of some important US companies, and one day the consumer of China or India will be telling the USA, improve your service or we will go elsewhere.

2008 Mar 14 09:32 PM

[Tao]

Considering the fact the US calls the shots and makes the agreements with foreign countries for trade, then they should require pensions and other retirement such as Social Security be honered in all trade agreements.

People deserve their pensions, they won't disappear if the pensions are taken away. The goal seems to be to make the Social Security benefits the same as welfare.

No one takes into account the steadying of a society that has welfare and also has self funded retirements such as Social Security.

Surely, there is a more intelligent solution than to make Social Security worthless. It should be worldwide, if not the middle class will work until they are 70 and pay for the lush retirements of everyone else from the government, military, judges to the policeman and firemen. A lot of these are paid with federal and state taxes.

2008 Mar 23 09:10 AM