Wednesday, April 07, 2010

China Watch 7: Rising Yuan, Economic Bubbles

There is a growing literature and op-ed articles arguing of an "impending" China economic bubble burst. A few Chinese scholars argue otherwise. One such guy is Dr. Fan Gang, a professor of economics at Beijing University and the Chinese Academy of Social Sciences (CASS), director of China's National Economic Research Institute (NERI), secretary general of the China Reform Foundation, and a member of the monetary policy committee of the People's Bank of China.

I have met him in 2004 in Hong Kong, during the Economic Freedom Network (EFN)- Asia Conference. He presented their study on "China marketization index" then.

Fan Gang wrote an article that was published in the WSJ Asia, reprinted in Mint newspaper in India, entitled "Illusion of a Chinese economic bubble".

For me, economic bubble is 100 percent part of a market economy, it's part of corporate and capitalist expansion. The same way that bubble burst and corporate bankrupties are 100 percent part of a market economy.

So the terms "Chinese bubble", "Korean bubble", "US bubble", "European bubble", etc. are not illussions, they are realities. Like political coercion, it's just a matter of degrees. So, one can say there's "35% Chinese bubble", "80% US bubble", "25% Indian bubble", "10% Philippine bubble", and so on. The bigger the bubble, the sooner it will burst. Once an economic bubble bursts, it pours some sense and more realistic assessment of the valuation of assets (housing, education, banking, etc.) and capitalism or the market economy goes back to a bit lower level, but not "zero" as implied by the term "economic collapse".

What Fan Gang is saying is that the Chinese bubble is not too big yet. Either it will become bigger, or the current precautions of a "bubble burst" will prevent it from becoming bigger and hence, a "hardlanding" burst may not happen, at least not this year or next few years.

A friend from the Lion Rock Institute (LRI) in HK, Simon Lee, argued that

"Fan has totally ignored the fact that China's RMB is a currency under a managed peg, or more appropriately a dirty float system with currency control. Yes, RMB is still not freely convertible and Chinese on mainland do not have the choice to keep their wealth in instrument other than RMB denominated ones! So what happen then is they horde whatever they can buy with RMB: stock, real estate, commodities. The "administrative control" causes bubble bursting in one domain and the creation of one in another. This is the state-made bubble and Fan remains zip about it."

On second reading, Fan appears more of a statist apologist than a free marketer analyst. Well, he's a member of the monetary policy council of China's central bank.

Anyway, exchange control is exchange control. No different from price control, trade control, or political control. It's government control, period. I agree with Simon that on this account alone, bubble is being created somewhere. Once a control and heavy regulation is introduced, the quick solution to avoid a big bubble is to remove such controls, not to reinforce with new controls and regulations. LIke raising the bank required reserves (RRs). But I guess central banks around the world are just doing their work: they are the central planners of the monetary system, so they centralize policies.

I guess Fan is correct though, when he asserted that people in fast-growing economies, in crisis-free economies (for at least 3 decades), tend to become less risk-averse. But as I argued earler, allow those people to do so, to become less risk-averse, to become less financially responsible and are financially wild and high risk takers. So long as the government will NOT give any signal, any hint, any policy, that it will come to rescue those guys later on.when a financial crisis would hit them big.

I am slowly writing a "China watcher". And being a resident of the Philippines which benefits from the continued economic boom of China -- rising number of Chinese tourists here, rising exports of the Philippines to China, investments of both Filipino and Chinese businessmen in both countries, etc. -- I will not be happy to read that China will suffer a hard landing someday. But neither am I happy that there is continued political monopoly and political coercion by the Chinese government.

So let nature take its course. People invest where they can make money, and run away if they will lose money. China's economic bubble will definitely burst. It's just a question of when. Perhaps not this year, perhaps not in 2011, perhaps in 2012 or beyond.

Below is the link to his article.

Illusion of a Chinese bubble
Fan Gang
Mint, 3 April 2010

On the eve of Chinese New Year, the People’s Bank of China (PBC) surprised the market by announcingâ€"for the second consecutive time in a monthâ€"an increase in banks’ mandatory reserve ratio by 50 basis points, bringing it to 16.5%. Shortly before that, China’s government acted to stop over-borrowing by local governments (through local state investment corporations), and to cool feverish regional housing markets by raising the down payment ratio for second house buyers and the capital adequacy ratio for developers.

Two related papers that I wrote the past few months:

(1) Weakening $, Rising Yuan

May 14, 2009

April of every year is tax deadline month, so revenues rise like a tidal wave, then ebb in the succeeding months. This is the tax schedule in the US, Philippines, and many other countries. But last month was the first time that the US experienced a deficit (in about 26 years) in the month of tidal wave revenues. Why? Because its expenditures were a mega tidal wave. And such kind of development (or underdevelopment) creates a bad image for the US $.

Super loose monetary policy of near zero interest rate. Super-spending fiscal policy of nearly $2 trillion budget deficit in 2009 alone by the federal government alone.

Since interest rate and inflation rate behave the same way in general, then US inflation rate should be very low. Might be in the short term, but not for long. With too much $ roaming the banks, shops and government spending, high inflation should be just around the corner. And the weakening of the US$ becomes just a question of when it will happen.

Below are 2 of the many articles today on the weakening US$.

(a) Geithner’s biggest problem is dollar, not China

Written by William Pesek / Bloomberg
Monday, 20 April 2009 22:03

It’s a bit rich for US politicians to berate Treasury Secretary Timothy Geithner for not labeling China as a currency manipulator.

Perhaps Sen. Lindsey Graham, a South Carolina Republican, hasn’t seen a newspaper in the last 12 months. With near-zero interest rates, the likely issuance of trillions of dollars of government debt and massive taxpayer-funded bailouts, the US will soon make China look like a manipulation piker.

Memo to Graham and his ilk: Your economy has lost any moral high ground as it drags the world down with it. That will be even truer as the dollar eventually pays the price for ultra-loose monetary and fiscal policies. And it will....

(b) The Almighty Renminbi?

May 13, 2009

THE 19th century was dominated by the British Empire, the 20th century by the United States. We may now be entering the Asian century, dominated by a rising China and its currency. While the dollar’s status as the major reserve currency will not vanish overnight, we can no longer take it for granted. Sooner than we think, the dollar may be challenged by other currencies, most likely the Chinese renminbi. This would have serious costs for America, as our ability to finance our budget and trade deficits cheaply would disappear.

Traditionally, empires that hold the global reserve currency are also net foreign creditors and net lenders. The British Empire declined — and the pound lost its status as the main global reserve currency — when Britain became a net debtor and a net borrower in World War II. Today, the United States is in a similar position. It is running huge budget and trade deficits, and is relying on the kindness of restless foreign creditors who are starting to feel uneasy about accumulating even more dollar assets. The resulting downfall of the dollar may be only a matter of time....

(2) China's Boom: Going Bust?

January 12, 2010

China now the world's biggest exporter (overtook Germany), biggest car market (overtook the US), to overtake Japan shortly as world's 2nd biggest economy. Is economic "bubble burst" near for China? I don't think so. With the bulk of its 1.3 billion people still in poverty, there is still huge room for economic expansion.

See this news report below:

As China Rises, Fears Grow on Whether Boom Can Endure
Published: January 11, 2010

BEIJING — As much of the world struggles to clamber out of a serious recession, a gradual flow of economic power from West to East has turned into a flood.

New high points, it seems, are reached daily. China surged past the United States to become the world’s largest automobile market — in units, if not in dollars, figures released Monday show. It also toppled Germany as the biggest exporter of manufactured goods, according to year-end trade data...

A friend commented via this news link,

China Boom, or China Bust?
By Ian Mathias

01/08/10 Baltimore, Maryland – Is the great hope of the investment world little more than hype? We like to visit the “China boom or China bust?” debate every once in a while, and the argument today is pretty one-sided… the “busts” have it....

It's true that to go "bust", there should be credit excesses. I don't know much about personal and corporate debts, but on the fiscal side, China's govt is sort of mercantilist, surplus thinking, not deficit and borrow thinking. This is not to say that I sing Jalleluiah to a socialist government.

Another friend voted "bust". For me, it is important that China won't bust in the coming few years. The China-ASEAN free trade agreement (FTA) will be the largest free trade area in the world, about 2 billion consumers (1.3 + 0.7 billion, China-Asean countries' population, respectively). China will become ASEAN countries' biggest export market in the coming years.

* See also:
China Watch 1: World's Largest Economies, Population, 2005, April 20, 2006
China Watch 6: China-India Blog, Eco-Protectionism, August 30, 2009

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