Econintersect: Traditional media and the blogosphere have presented a bewildering array of reports and opinion about what China is doing with respect to “managing” or “manipulating” its currency. The People’s Bank of China (PBoC), the country’s central bank, has repeatedly tightened credit and withdrawn liquidity for much of 2013 and the first two months of 2014. There have been reports that China is having a credit crisis, but all the stress points have been temporary and credit markets have not shut down.
Excerpt clip from graph presented at end of article.
Just last week China removed a total of 160 billion yuan ($27 billion) on two different days by issuing 14-day repos (repurchase agreements. In these operations the PBoC “sold” that amount of paper for 14 days which drained the currency from the economy. As opposed to earlier situations, most notably last June, short-term interest rates changed little during the week. The SHIBOR (Shanghai Interbank Offered Rate) has been quote volatile over the past six months, but the shorter terms (up to 1-month) have been in a down trend since the beginning of the year. The longer terms (3-month and up) have been mostly flat so far in 2014 (except for the 3-month, which dipped in that second half of February).
Not shown in the graphs above are the rates from June 2013 when some of the interest rates spiked briefly well above 10%. See the graph below. That extreme has not happened since, although the volatility has still been notable.
According to caijing (28 February 2014):
Some analysts believe the central bank’s recent money-draining moves which were mainly taken to cope with hot-money inflows shouldn’t be interpreted as a signal of a tight monetary policy .
This may be part of the equation but some think there is a different motivation. David Keohane (in a FTAlphaville series “Up Shibor Creek”) thinks China will need to raise rates by 200 basis points, but that it will happen over a period of years. Such action would keep upward pressure on the value of the yuan (as long as the other three major currencies keep rates very low) but it is necessary to achieve a rebalancing away from massive investment toward increased consumer participation in the economy.
The over-valuation of the yuan has been calculated Charles Dumas and presented by Izabella Kaminska (FTAlphaville Shibor creek series):
After two decades of what appeared to be systematically significantly undervaluing the yuan, China has seen overvaluation for the past three years. This has happened while other major currencies have been undergoing exchange rate devaluation (compared to historical average).
The representation above takes into account the massive wage rate inflation that has occurred in China in calculating the “real effective” exchange rate. A more usual representation is that presented by Scott Grannis (hat tip to Jeff Miller). The nominal strengthening has occurred since 2005 but the strengthening relative to China’s relative labor costs really didn’t kick in until after the Great Financial Crisis.
A continuation of these trends will not likely cause a financial system collapse in the middle kingdom, especially if the changes progress gradually as Keohane suggests. And they must proceed if China is going to move its economy away from 50% investment to 50% or more consumption, as Michael Pettis has been saying for several years. For example, in 2012 he pointed out that a competitive appreciation of the yuan was the easiest pathway to successful rebalancing even though it would reduce the export economy growth that has marked China’s success for the past two decades. This has already pulled back from peak levels in the mid-2000s decade. What has not started to rebalance is the very high investment share of GDP and low share of consumption.
China has a distinct advantage in this rebalancing project that the other major currencies do not have: The government is the central bank. This may help manage an appreciating currency value with fewer complications than would be the case for Japan, UK, Eurozone and U.S.
So China is does not appear to be pursuing a tightening monetary policy (in the sense that other major central banks would), except perhaps to reign in “hot money” which is most likely to make mal-investments rather than sound ones (speculative investment).
They are trying to create a systematic appreciation of the yuan which will dampen their trade surplus, make speculative investment less attractive and increase the purchasing power of their consumer sector. As such it is desirable to keep a level of volatility where the yuan falls against other currencies for a short period of time and to a small extent.
Thus the concern about the yuan “falling” in the media is largely noise. The PBoC needs to keep credibility “in the market” and that can be done by “accomodating” volatility such as is seen in the Scott Grannis graph above (at the present time and previously in early 2012 and to a lesser extent at the beginning of 2011).
The yuan must appreciate or China’s rebalancing could take a much more damaging course. That is not going to be allowed to happen, in Econintersect‘s opinion.
- SHIBOR (shibor.org)
- China Central Bank Withdraws Liquidity for Second Time in a Week (caijing, 28 February 2014)
- How high will the rate go? (David Keohane, FTAlphaville, 10 January 2014)
- Devaluation stations: Et to, China (Izabella Kaminska, FTAlphaville, 30 January 2014)
- China does not have a problem (Scott Grannis, Calafia Beach Pundit, 28 February 2014)
- Five Ways for China to Rebalance (Michael Pettis, GEI Analysis, 11 April 2011)
- China: Rebalancing Means Exports Will Be Less Competitive (Michael Pettis, GEI Opinion, 24 September 2012).