Chinese devaluation is a bigger danger than Fed rate rises
The yuan has fallen to the lowest in five years against the dollar. If China devalues in earnest, it will be an earthquake
By Ambrose Evans-Pritchard
Chinese Premier Li Keqiang has vowed to avoid devaluation, but he is not fully in control Photo: AP
The world has had a year to brace for monetary lift-off by the US Federal Reserve. A near certain rate rise next week will come almost as a relief.
Emerging markets have already endured a dollar shock. The currency has risen 20pc since July 2014 in expectation of this moment, based on the Fed's trade-weighted "broad" dollar index.
It is a safe bet that Fed chief Janet Yellen will give a "dovish steer". She has already floated the idea that rates can safely be kept far below zero in real terms for a long time to come, even as unemployment starts to fall beneath the 5pc and test "NAIRU" levels where it turns into inflation.
Her apologia draws on a contentious study by Fed staff in Washington that there is more slack in the economy than meets the eye. She argues that after seven years of drought and "supply-side damage" it may make sense to run the economy hotter than would normally be healthy in order to draw discouraged workers back into the labour market and to ignite a long-delayed revival of investment.
There are faint echoes of the early 1970s in this line of thinking. Rightly or wrongly, she chose to overlook a competing paper by the Kansas Fed arguing the opposite.
Such a bias towards easy money may contain the seeds of its own destruction if it forces the Fed to slam on the brakes later. But that is a drama for another day.
The greater risk for the world over coming months is that China stops trying to hold the line against devaluation, and sends a wave of corrosive deflation through the global economy.
Fear that China may join the world's currency wars is what haunts the elite banks and funds in London. It is why there has been such a neuralgic response to the move this week to let the yuan slip to a five-year low of 6.4260 against the dollar.
Bank of America expects the yuan to reach 6.90 next year, setting off a complex chain reaction and a further downward spiral for oil and commodities. Daiwa fears a 20pc slide. My own view is that a fall of this magnitude would set off currency wars across Asia and beyond, replicating the 1998 crisis on a more dangerous scale.
Lest we forget, China's fixed capital investment has reached $5 trillion a year, as much as in North America and Europe combined. The excess capacity is cosmic.
Pressures on China are clearly building up. Capital outflows reached a record $113bn in November. Capital Economics says the central bank (PBOC) probably burned through $57bn of foreign reserves that month defending the yuan peg.
A study by the Reserve Bank of Australia calculates that capital outflows reached $300bn in the third quarter, an annual pace of 10pc of GDP. The PBOC had to liquidate $200bn of foreign assets.
Defending the currency on this scale is costly. Reserve depletion entails monetary tightening, neutralizing the stimulus from cuts in the reserve requirement ratio (RRR). It makes a "soft landing" that much harder to pull off.
The RBA said Chinese exporters are trying to keep their foreign earnings in dollars and large discrepancies are building up under "errors and omissions". There has been a "reduction in the willingness of China’s foreign suppliers to receive payment in RMB (yuan)," it said.
It also revealed - as long suspected - that the vast holdings of US bonds registered to investors in Belgium are actually PBOC assets held in Euroclear. These have halved.
This week's tweak to the "yuan fix" comes after trade data showed that Chinese exports stalled in November following a tentative rebound over recent months. Shipments fell 6.8pc year-on-year, but what is most ominous is that the export tally included re-exports sales of refined oil products and a 22pc rise in steel sales.
It comes just as Beijing sends a terrible trade signal by cutting the export tariff on steel billets and pig iron. "Put simply, China is exporting its excess output onto a saturated global market, and there is certainly far more where that came from," said Neil Mellor from BNY Mellon.
Whether China has an over-valued currency is a hotly debated question. It also has a current account surplus that may soon reach $800bn, a sign of calamitous imbalances.
What is clear is that China has suffered a major currency shock. The yuan has been strapped to the rocketing dollar through its peg at a time when it needed a weaker exchange rate, and this has been made worse by Japan's devaluation game next door and by crumbling currencies in Russia and East Asia.
China's real effective exchange rate has risen by 30pc since mid 2012. Wages have been rising at near double-digit rates as the country crosses the "Lewis Point" and runs out of cheap labour from the villages.
The twin-effect is a relentless squeeze on Chinese corporate margins. Profits have fallen for the past five months, dropping by 4.6pc in October. The carnage in the shipbuilding industry is gruesome.
East Heavy Industry and Mingde Heavy Industry have gone bust. Rongsheng Heavy Industries Group has stopped production. Fujian Crown Ocean has stopped paying its workers.
It is the same story in the Chinese steel industry, now responsible for half the world's production, and sitting on 300m tonnes of excess capacity. The state giant Sinosteel has already defaulted - to state banks.
Premier Li Keqiang has so far resisted devaluation, knowing that this would draw out the agony, would lead to Japanese-style "zombie" companies on life-support, and would play into the hands of vested interests and party dinosaurs he aims to defeat. As he has repeatedly warned, China is heading straight into the middle income trap unless it can reinvent itself in time.
A beggar-thy-neighbour policy would be hard to square with China's ambition to be a stabilizing pillar of the world's economic order, newly annointed as a member of the International Monetary Fund's currency basket (SDR).
Mr Li has vowed to keep the yuan "basically stable". Chinese officials say the PBOC is targeting a trade-weighted index. So far this has stayed level. There has been no devaluation yet.
China bulls argue - and on this I agree - that the "new economy" is doing fine as the country ditches its obsolete development model and shifts up the technology and service ladder. The trade share of GDP has dropped to 41.5pc from 64.5pc in 2006.
The flip side of this is that services have jumped from 44pc of GDP to 51pc over the past four years. Healthcare is booming now that hospitals have been opened up to market forces.
Bears rely on the Li Keqiang index to discern economic collapse - usually from a safe distance, without straying into Chinese territory. It is based on Mr Li's Wikileaks comment in 2007 where he admitted relying on electricity use, rail freight and credit growth for the truth on GDP.
That was seven years ago, The index fails to capture the deliberate switch away from heavy industry, or the galloping gains in energy efficiency. It dwells on a 16pc fall in rail freight, ignoring a 6.5pc growth in road freight, which is 10 times larger. It relies on an old measure of credit that does not include bond issuance by local governments. It is useless.
Craig Botham from Schroders said acidly in a "postcard from Beijing" that if China is really collapsing, "the country is hiding it well". The best estimates are that China's growth has slowed to around 5pc, but the labour market is still tight and employers are crying out for workers.
Yet there are winners and losers in this traumatic shift from one economic model to another, and the old guard of the Communist Party still controls much of the Central Committee. The patronage system of the party bosses depends on keeping the giant state companies (SOEs) alive.
President Xi Jinping is chiefly concerned with harnessing "reforms" to smash rivals, centralize all power in his own hands, and restore the hegemony of the party - and party control is ultimately incompatible with the free market.
His military and strategic expansion in the South China Sea show that he would not have slightest hesitation in dumping yet more of China's excess capacity on everybody else if he thought it to be in his political interest.
Li Keqiang commands the economy on sufferance only. Rumours constantly surface that he has been isolated in the Standing Committee.
The real danger for the world is that he is simply shoved aside. The stability of the yuan and the world currency system rests on thin political ice.
Emerging markets have already endured a dollar shock. The currency has risen 20pc since July 2014 in expectation of this moment, based on the Fed's trade-weighted "broad" dollar index.
The tightening of dollar liquidity is what caused a global manufacturing recession and an emerging market crash earlier this year, made worse by China's fiscal cliff in January and its erratic, stop-start, efforts to wind down a $26 trillion credit boom. The shake-out has been painful: hopefully the dollar effect is largely behind us.
The central bank governors of India and Mexico, among others, have been urging the Fed to stop dithering and get on with it. Presumably they have thought long and hard about the consequences for their own economies.
It is a safe bet that Fed chief Janet Yellen will give a "dovish steer". She has already floated the idea that rates can safely be kept far below zero in real terms for a long time to come, even as unemployment starts to fall beneath the 5pc and test "NAIRU" levels where it turns into inflation.
Her apologia draws on a contentious study by Fed staff in Washington that there is more slack in the economy than meets the eye. She argues that after seven years of drought and "supply-side damage" it may make sense to run the economy hotter than would normally be healthy in order to draw discouraged workers back into the labour market and to ignite a long-delayed revival of investment.
There are faint echoes of the early 1970s in this line of thinking. Rightly or wrongly, she chose to overlook a competing paper by the Kansas Fed arguing the opposite.
Such a bias towards easy money may contain the seeds of its own destruction if it forces the Fed to slam on the brakes later. But that is a drama for another day.
The greater risk for the world over coming months is that China stops trying to hold the line against devaluation, and sends a wave of corrosive deflation through the global economy.
Fear that China may join the world's currency wars is what haunts the elite banks and funds in London. It is why there has been such a neuralgic response to the move this week to let the yuan slip to a five-year low of 6.4260 against the dollar.
Bank of America expects the yuan to reach 6.90 next year, setting off a complex chain reaction and a further downward spiral for oil and commodities. Daiwa fears a 20pc slide. My own view is that a fall of this magnitude would set off currency wars across Asia and beyond, replicating the 1998 crisis on a more dangerous scale.
Lest we forget, China's fixed capital investment has reached $5 trillion a year, as much as in North America and Europe combined. The excess capacity is cosmic.
Pressures on China are clearly building up. Capital outflows reached a record $113bn in November. Capital Economics says the central bank (PBOC) probably burned through $57bn of foreign reserves that month defending the yuan peg.
A study by the Reserve Bank of Australia calculates that capital outflows reached $300bn in the third quarter, an annual pace of 10pc of GDP. The PBOC had to liquidate $200bn of foreign assets.
Defending the currency on this scale is costly. Reserve depletion entails monetary tightening, neutralizing the stimulus from cuts in the reserve requirement ratio (RRR). It makes a "soft landing" that much harder to pull off.
The RBA said Chinese exporters are trying to keep their foreign earnings in dollars and large discrepancies are building up under "errors and omissions". There has been a "reduction in the willingness of China’s foreign suppliers to receive payment in RMB (yuan)," it said.
It also revealed - as long suspected - that the vast holdings of US bonds registered to investors in Belgium are actually PBOC assets held in Euroclear. These have halved.
This week's tweak to the "yuan fix" comes after trade data showed that Chinese exports stalled in November following a tentative rebound over recent months. Shipments fell 6.8pc year-on-year, but what is most ominous is that the export tally included re-exports sales of refined oil products and a 22pc rise in steel sales.
It comes just as Beijing sends a terrible trade signal by cutting the export tariff on steel billets and pig iron. "Put simply, China is exporting its excess output onto a saturated global market, and there is certainly far more where that came from," said Neil Mellor from BNY Mellon.
Whether China has an over-valued currency is a hotly debated question. It also has a current account surplus that may soon reach $800bn, a sign of calamitous imbalances.
What is clear is that China has suffered a major currency shock. The yuan has been strapped to the rocketing dollar through its peg at a time when it needed a weaker exchange rate, and this has been made worse by Japan's devaluation game next door and by crumbling currencies in Russia and East Asia.
China's real effective exchange rate has risen by 30pc since mid 2012. Wages have been rising at near double-digit rates as the country crosses the "Lewis Point" and runs out of cheap labour from the villages.
The twin-effect is a relentless squeeze on Chinese corporate margins. Profits have fallen for the past five months, dropping by 4.6pc in October. The carnage in the shipbuilding industry is gruesome.
East Heavy Industry and Mingde Heavy Industry have gone bust. Rongsheng Heavy Industries Group has stopped production. Fujian Crown Ocean has stopped paying its workers.
It is the same story in the Chinese steel industry, now responsible for half the world's production, and sitting on 300m tonnes of excess capacity. The state giant Sinosteel has already defaulted - to state banks.
Premier Li Keqiang has so far resisted devaluation, knowing that this would draw out the agony, would lead to Japanese-style "zombie" companies on life-support, and would play into the hands of vested interests and party dinosaurs he aims to defeat. As he has repeatedly warned, China is heading straight into the middle income trap unless it can reinvent itself in time.
A beggar-thy-neighbour policy would be hard to square with China's ambition to be a stabilizing pillar of the world's economic order, newly annointed as a member of the International Monetary Fund's currency basket (SDR).
Mr Li has vowed to keep the yuan "basically stable". Chinese officials say the PBOC is targeting a trade-weighted index. So far this has stayed level. There has been no devaluation yet.
China bulls argue - and on this I agree - that the "new economy" is doing fine as the country ditches its obsolete development model and shifts up the technology and service ladder. The trade share of GDP has dropped to 41.5pc from 64.5pc in 2006.
The flip side of this is that services have jumped from 44pc of GDP to 51pc over the past four years. Healthcare is booming now that hospitals have been opened up to market forces.
Bears rely on the Li Keqiang index to discern economic collapse - usually from a safe distance, without straying into Chinese territory. It is based on Mr Li's Wikileaks comment in 2007 where he admitted relying on electricity use, rail freight and credit growth for the truth on GDP.
That was seven years ago, The index fails to capture the deliberate switch away from heavy industry, or the galloping gains in energy efficiency. It dwells on a 16pc fall in rail freight, ignoring a 6.5pc growth in road freight, which is 10 times larger. It relies on an old measure of credit that does not include bond issuance by local governments. It is useless.
Craig Botham from Schroders said acidly in a "postcard from Beijing" that if China is really collapsing, "the country is hiding it well". The best estimates are that China's growth has slowed to around 5pc, but the labour market is still tight and employers are crying out for workers.
Yet there are winners and losers in this traumatic shift from one economic model to another, and the old guard of the Communist Party still controls much of the Central Committee. The patronage system of the party bosses depends on keeping the giant state companies (SOEs) alive.
President Xi Jinping is chiefly concerned with harnessing "reforms" to smash rivals, centralize all power in his own hands, and restore the hegemony of the party - and party control is ultimately incompatible with the free market.
His military and strategic expansion in the South China Sea show that he would not have slightest hesitation in dumping yet more of China's excess capacity on everybody else if he thought it to be in his political interest.
Li Keqiang commands the economy on sufferance only. Rumours constantly surface that he has been isolated in the Standing Committee.
The real danger for the world is that he is simply shoved aside. The stability of the yuan and the world currency system rests on thin political ice.
0 comments:
Publicar un comentario