Paulson: China, Yuan Out-of-Step With markets..

Wednesday, November 14, 2007 5:20
Posted in category The Big Picture

In yet another attempt to put pressure on China to revalue the RMB, Secretary Paulson is out on his stump.. and I am beginning to wonder if perhaps he is off his rocker as I hardly see how rising interest rates in the U.S. (see below) is going to improve the situation in the States….

Correct me if I am wrong, but putting pressure on China to “appropriately value” the RMB could lead lead to higher interest rates and inflation in the US should they actually take his advice and knock the RMB to say 6.50USD …. and with the U.S. economy teetering on a recession driven by an inability of people to pay back their debt..

After all, the mear suggestion that China was looking at diversifying their portfolio away from “weaker curriencies” (USD) into “stronger curriencies” (Euro, Yen… Peso) sent the dollar reeling to all time low against Euro and a couple of other currencies.

Follow my posts Would 6RMB/ USD Be A Good Thing?: Part 1 and Would 6RMB/ USD Be A Good Thing?: Part 2, and I think it is pretty clear that a 6RMB to the USD would have a damaging impact on both economies.

1) China’s banks would hemmorage from the currency losses

2) US would see immediate inflation as goods from China would jump overnight

3) The US would have to raise interest rates to attract investors into the bond market

Now, I am not an economist, but the three of those events occuring at the same time leads me to believe that a RMB revaluation is out-of-step with sound economic policy..

The best quote for me though was where the author writes

Analysts’ estimates vary, but the median consensus suggests that the U.S. trade deficit with China would be cut by 30% or more, if China’s currency floated freely. If allowed to float freely, the yuan would rise to 5 yuan to the U.S. dollar or even 4 yuan to the U.S. dollar, boosting the price of China’s goods and making U.S. goods more cost-competitive. No one expects China to freely float the yuan any time soon, but a yuan revaluation consensus has emerged among key nations and economic policy analysts, according to Paulson.

Now while I am glad he correctly states that no one expects China to free float the currency, but if anything, a 4RMB/ USD would cause 30% increase in the deficit by value (not volume).

I would love to see the analysis on that. If anyone can find it, please send it to me or link in the comments section.

Seriously, the ONLY way that is true is if the major retailers, consumer product goods firms, FMCG, auto, and other companies have a redudant supply chain already in place that could simply be switched on.

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9 Responses to “Paulson: China, Yuan Out-of-Step With markets..”

  1. China and I says:

    November 14th, 2007 at 5:39 pm

    Personnally, I think an increase in productivity is the key for a more balanced economic relationship between China and its main trading partners. Inflation climbs, salaries improve on average by 12-20% per year but productivity is stagnant.

  2. Rich says:

    November 14th, 2007 at 8:38 pm

    C&I,

    Just think about the savings that could be found in terms of logistics alone. It currently accounts for 20% of GDP (US/ EU averages 8-10%).

    Overall though, I think an increase in productivity would do China a world of good, but I think the economies of China need to reach internal parity first…. got to make sure all of Santa’s little helpers are able to spend too!

  3. China and I says:

    November 14th, 2007 at 9:42 pm

    Build a safe pension system shall be in my opinion a primary concern. When it is done, Chinese will start to buy all kind of goods. Growth due to investment and export trig the economic boom but it can not last. I think the Chinese government is aware of that. Not easy to do. No hope until then!

  4. Rich says:

    November 15th, 2007 at 1:16 am

    C&I.

    Pension system? Who needs a pension system? I think the people just need to keep working!!!

    If you were a reader last year, you will know I covered the graying of China on a few posts, and it is definately a big issue. I have worked with the gov’t here on a project where we studied the problem of the aging population in their district. Shanghai currently has 18% over the age of 60 and that is expected to jump to 22%+

    Any wonder why Chen Lianyu went to jail for gambling the Shanghai pension fund?

  5. China and I says:

    November 15th, 2007 at 1:51 am

    It was just a reminder. The problem still exists and publicly this HUGE problem hasn’t been raised. How about Chen Liangyu? I think pretty soon we will here about his fate. The Congress is over, the new team is in place so they shall make an example. As we always say: “Kill the chicken to scare the monkey!”

  6. JD says:

    November 15th, 2007 at 5:28 am

    Rich, the problem is not China’s valuation of the RMB, per se, but the fact that China’s whole financial system is out of whack. Appreciating the RMB would be a good start towards putting the house in order but it’s only a small part of the real work that needs to be done. The more pressure China lets build, the higher will be the eventual price that has to be paid. Think long-term investment overhang and economic underperformance to match the excessive investment-powered growth that is actually taking place. What would that do for stability,I wonder.

    As for the specific points: 1. isn’t plausible as Chinese banking assets are largely in RMB 2. is incorrect as the portion of US consumption derived from domestically-priced Chinese inputs is virtually insignificant 3. is unlikely given the depth of the US bond market.

    If a US recession comes it will be caused by the unwinding of a systemic mispricing of risk. As for China, it will only find long-term stability through a floating currency (given its size and integration with global markets) and development of an effective domestic financial sector. China had best get to work.

  7. Rich says:

    November 15th, 2007 at 6:57 am

    JD,

    I would agree that the system here is out of whack… and I would say the US system is as well. The RMB float is something that wil occur, and I agree that it should, but it cannot happen all at once.. and I predict that any significant move would have the three effects I wrote above.

    1. Chinese banking assets are largely in RMB, but that does not mean that a 200M USD currency loss is insignifanct either

    2. If what you say is true, then why push for the RMB revaluation at all?

    3. The US Bond market has depth, but a/ the primary buyer now is China, and if you lose a the primary buyer you must find ways to attract new one right?

  8. JD says:

    November 15th, 2007 at 5:40 pm

    Rich, I’m not sure what the $200M is that you are referring to (yes, that amount is insignificant in terms of the whole economy), but I suspect its the $200B SWF , of which only $133 B really remains after the funding of the old NPLs and even less after the cleanup of the agricultural bank. There’s no prospect for a rapid and large change in the RMB value, so in local currency terms those funds are safe.

    On RMB revaluation, trade and currencies are not very strongly linked to begin with. For China, 1/2 the exports remain processing trade, which are foreign imports (intl currency) + local labour (in RMB) exported in intl currency, so it’s only the labour value added (or other local inputs) that are directly and immediately affected by an RMB revaluation. Trade and inflation have an even weaker link than trade and currency, so you’re really looking at quite a modest (though not unimportant) effect. Pushing for RMB revaluation is all about China getting it’s house in order, and cleaning up its part of the global imbalance equation.

    China doesn’t have a great deal of leverage over the US bond market – it’s an important player but one amongst numerous others. If they were to stop buying, the rates would probably go down in a flight to quality (as an unstable, unpredictable China is in nobody’s interest). China’s international portfolio is $1.4 trillion in a global bond market of $50 trillion, and whatever it does it has to put the money somewhere.

    Thanks for the exchange.
    JD

  9. Rich says:

    November 15th, 2007 at 7:31 pm

    JD

    Thanks for the exchange as well. As I have always said, I am not an economist and as such, I am not fully equiped to judge a lot of these movements. Were I, I really would have been long on oil 2 years ago.

    the 200 M USD was a figure I saw in a paper here for one of the big 4 banks. I will look to see if I can find that, but you are correct in that their NPL holding is probably much larer. That being said, the NPLs are something “in their control”, and even though they needed to be written down long ago, they haven’t. Just another sign of a system in need of strength and stability.

    On your second point, I agree at the 95% level and I say much the same when saying a revaluation is really nothing more than political jibber jabber. the 5% that I will withhold though comes from the fact that if there is a revaluation, trade values will be impacted. In my own experience, I can tell you that the change from 8.28 to now has impaced pricing gradually and to date (in my categories) the market has been able to accept absorb. Some of the rise was absorbed by us, some by my client, and to date it has not been passed on. I am confident that is true for many who supply WalMart as well.

    However, if you introduce a 15% RMB change into the system, that is going to change. the full 25% will probably be passed onto the US/ EU/ other consumers.

    On your third point, I as a layman just cannot see how they don’t have a great deal of leverage at this point. Are Japan, U.K., others going to be willing to buy up more debt with the dollar reaching all time lows against their currencies or will they also diversify? there are obviously many more factors than the RMB in play here, but I suspect that if the Chinese stopped buying USD debt the Fed would need to attract others through a rate increase. This is an area where I should have paid more attention in Fin 101 and Econ 101…

    Hope all is well
    R