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October 06, 2004
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Command and control
China has been desperately trying to engineer a "soft landing" for its economy after growth approached unsustainable levels in the past year or so. At first they used market based mechanisms to achieve this, for example by increasing bank reserve requirements (which should have restricted lending). This didn't work. So they moved onto more direct tools, for example the Government started restricting lending to particular sectors by diktat. But now there are fears the efforts have been overdone and in fact will backfire. The Standard quotes economist Andy Xie: "The world is sitting atop the biggest property bubble in history, with the biggest exposure in China and the US, in my view,'' he said.The SCMP also reports the Chinese authorities are now scapping the previous restrictions. While still keeping tight control over money and land supply, the administrative restrictions on lending to certain sectors will be removed. Why? Because the measures were too effective: lending completely stopped for the most part in sectors such as steel, aliminium, cement, property development and car manufacturing. That's the problem with regulations rather than price based mechanisms in an economy. Even more interesting is the role of black market financing in China. From the same article mentioned above: Informal financing is a staple in entrepreneurial corners of China where many resort to banks only for large sums. Citigroup's Huang Yiping puts the size of the informal capital market in Wenzhou at 200 billion yuan (HK$188.46 billion), exceeding the 180 billion yuan in deposits lodged with commercial banks.So where price based mechanisms work, interest rates are high. Real (ie after inflation) interest rates are negative based on the official figures. This means depositing money in the bank actually penalises you, because your deposits lose value in real terms. So inevitably the money flows to other asset classes, which in China basically means property. That is the basis of the fears of a property bubble, much the same as in Hong Kong. In any economy the key in monetary policy is not the nominal interest rate level, but real interest rates. Negative real rates are appropriate when an economy is in recession and needs a monetary stimulus. They are not appropriate when the economy is growing at 9.6% per annum and investment is growing at 15% per annum. Yet China's authorities still refuse to raise official interest rates. With China's households being massive net savers, the wall of money will continue to flow to more speculative sectors until such time as they feel they can get an appropriate return on their money. It's a disaster in the making and it needn't be that way. But China's authorities need to gain confidence in price based economic tools, and raising rates would be a good start. posted by Simon on 10.06.04 at 10:36 AM in the
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Comments:
A question for the smart people out there. I understand that although China has a huge trade surplus vis-a-vis the US plus healthy FDI, their overall trade balance is flat. Why should their reserves in US$ be growing so rapidly. Shouldn't most, if not all, of those $ be needed to buy the raw materials (mostly quoted in USD) or the currencies of those nations in which they have a trade deficit? posted by: kennycan on 10.06.04 at 01:44 PM [permalink]Ken, I think it's because while Wal Mart buys Chinese product in bulk, China in turn buys huge amounts of raw materials and thus runs deficits with those countries that supply it with raw materials. In answer to why their net reserves build up, it's a function of having a fixed exchange rate. If there is net surplus demand for yuan, which there is at the moment, then the Central Bank has to print extra yuan and gets to buy US dollars with the new money. This continues until the demand changes and then they need to start selling the US dollars back to buy yuan. It's why China faces inflation - all that extra yuan chasing the same amount of goods. Here endeth the lesson. posted by: Simon on 10.06.04 at 02:54 PM [permalink]Perhaps I am seeing it now - if they have excess USD coming in because they sell the US more than they buy, then USD would build up in their system. If the US were their only trade partner, then they would have an overall trade surplus. But they have a balanced trade ledger. Which means that some other country, let's say Germany, is selling them more than Germany buys from China. China would then need to buy net Euros. You are saying that instead of selling USD to buy Euros, they "print" RMB and buy Euros. Makes sense as this is why their reserves are growing, their trade balance is flat and they have high domestic money growth. posted by: kennycan on 10.06.04 at 07:04 PM [permalink] |
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