As Global Markets Rattle, Is China Shifting Economic Policy?

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After the S & P downgrade of U.S. debt, China's concerns over the safety of its reserve assets in the States may prompt some changes

Ma Aug 30 p1.jpg

Reuters

Normally an uneventful month, August proved to be restless. Earthquakes and hurricanes aside, the markets swung wildly as a slow global recovery reduced consumer confidence. It didn't help matters that the month opened with a paralyzed Washington that eventually delivered, at the final hour, a meek and unsatisfying interim solution to US fiscal woes -- only to be followed by the S&P downgrade. Meanwhile, across the Atlantic, the Eurozone is facing one of the toughest political and policy coordination challenges since the Europeans cast aside wartime animosities and conceived an embryonic economic unit in 1958. Judging by the events of last month, it is little wonder that perception of risk in western developed countries (except maybe in Sweden) has heightened considerably. Who wants a political system that can't get its act together when necessary?

Not China, a point that Beijing has hammered home ad nauseum. But has August made China reassess its own economic policies and heavy dependence on the US economy? Here I direct you to an interesting but slightly dated Reuters piece that would suggest it did:

Chinese editorials flaying Washington for fiscal recklessness over its debt dramatics and downgrade mask a growing unease in Beijing: a fear that China's own economic policies are shifting too slowly.

Interviews with a dozen high-ranking Chinese officials and government economists revealed frustration with China's self-imposed fetters to the U.S. dollar and louder calls for a change, but no clear short-term plan to break free.

The obvious answer -- allowing the yuan to rise more rapidly -- carries economic and political costs that China is probably not yet prepared to pay...

China's public response to the U.S. debt troubles, expressed in a series of scathing commentaries in the state-controlled media, has been to censure Washington for neglecting its responsibility as issuer of the world's primary reserve currency and trying to "borrow its way out of messes of its own making".

But in interviews with Reuters, some officials quietly acknowledged Beijing's own policies have put China in an uncomfortable position, and argued they would have to change.

China has already laid out a five-year plan that envisages promoting domestic consumption, something the United States has urged for years as a way to reduce a gaping trade imbalance and shrink the vast heap of dollars Beijing invests in Treasuries.


This is where Yu Yongding's op-eds come in. Yu was a former adviser to the Chinese central bank and has been arguing for a floating Chinese currency for years now. Here he is in the Financial Times:

Chinese officials are understandably angry about the irresponsible brinkmanship demonstrated by their American counterparts in recent weeks. Unfortunately, anger counts for little in international finance. The danger facing the US is that after Tuesday's debt deal any sense of urgency over a dire fiscal situation will dissipate. The danger for China is that it does not learn the right lesson - namely, that now is the time to end its dependency on the US dollar...

China has run a current account surplus and a capital account surplus almost without interruption for more than two decades. Inevitably this has led to an accumulation of foreign reserves. It is clear, however, that running these surpluses persistently is not in China's best interests. A developing country, with per capita income ranking below the 100th in the world, lending to the world's richest country for decades is not reasonable. Even worse is the fact that, as one of the largest foreign direct investment-absorbing countries in the world, China essentially lends money it borrowed at a high cost back to its creditors, by buying US Treasuries, rather than importing goods and services...

If there is any lesson China can draw from the US debt ceiling crisis, it is that it must stop policies that result in further accumulation of foreign exchange reserves. Given that many large developed countries are simply printing money (and the recent rumors are that the US might return to quantitative easing), China must realise that it can no longer invest in the paper assets of the developed world. The People's Bank of China must stop buying US dollars and allow the renminbi exchange rate to be decided by market forces as soon as possible. China should have done so a long time ago. There should be no more hesitating and dithering. To float the renminbi is not costless. However, its benefits for the Chinese economy will vastly offset those costs, while being favorable to the global economy as well....

It's not just Yu. Current central bank advisers like Xia Bin have also jumped on the bandwagon.

"The Chinese government is certainly worried about (the safety) of its foreign exchange reserves," Xia told a forum.

"China should reduce the portion of financial assets in its reserves and increase the portion of non-financial assets," he said.

Xia said China should use its reserves to buy overseas energy, resources and equity instead of buying more euro debt.

China has long advocated diversifying its war chest of $3.2 trillion reserves away from the dollar, but as much as 70 percent of the holdings are still invested in U.S. dollar assets, including U.S. Treasuries, according to analysts.

Chinese officials and the public have expressed growing concerns over the safety of its reserve assets in the United States after the Standard & Poor's downgrade of U.S. debt.

Xia said China must improve the way it manages the rapidly accumulating foreign exchange reserves by allowing more government agencies to manage the assets to better serve China's "strategic interests."


Neither of these economists is a "decision-maker," and it is difficult to assess the extent of their influence. But the strategic timing of their arguments suggests that they could be the public mouthpieces for a concerted internal push to rethink some of the most politically sensitive policies like currency appreciation and economic adjustment. I say "strategic" because these arguments for reform coincide with the knee-jerk nationalist critiques that often dot headlines in the Western press. (Yes, Global Times will always harangue the "western imperialists" -- honestly, do you expect anything less from the Fox News of China?)

But what's politically interesting here is that as the "nationalists" are calling for dumping U.S. debt and wondering why China holds so many "worthless U.S. assets," the liberal economists are agreeing with them, albeit with very different motives. This marriage of convenience, regardless of how ephemeral, may produce some interesting outcomes. People like Yu and Xia are arguing that if you want to limit China's exposure to U.S. assets, then Beijing has to look itself in the mirror and tackle longstanding export-oriented policies that have only exacerbated this reliance.

Will Beijing then simply decide to float its currency and whittle down its current account surplus? Unlikely and certainly not rapidly. But is this apparently concerted push by economists, who have shrouded the necessary reforms in nationalist clothing, having an impact? Probably and modestly. In the annals of imperfect analogies, think of it as if "green-minded" liberals adopted a national security platform to argue that the U.S. needs a comprehensive clean energy policy to wean off Saudi oil that funds terrorist cells and therefore compromises U.S. security. It's like if Rachel Maddow and Michele Bachmann both agreed that raising taxes on the wealthy is sound economic policy.    

Indeed, there is already plenty of speculation over whether changes in China's currency policy are afoot.

In the past three weeks, China has come tantalizingly close to signaling some sort of a policy shift. The PBOC has fixed the yuan mid-point at a series of record highs, and did so yet again on Monday.

A flurry of articles and editorials in government-controlled newspapers have argued that the time is right for faster appreciation.

But just when investors and economists smelled a change, the PBOC stepped back and let the yuan drift sideways for a week. Reuters spoke with several analysts at Chinese government think-tanks, who said expectations of a big move were misplaced.

Liang Youcai, senior economist at the State Information Center, said a sharp yuan rise could backfire by attracting more investment money into China, worsening the inflation pressures that the PBOC wants to counter.

Still, the yuan has risen about 0.8 percent against the dollar so far this month. That may sound modest, but considering it rose just 2.3 percent over the first seven months of the year combined, it shows Beijing has stepped up the pace even though growth concerns have intensified.

 
Not only is the RMB appreciating against the U.S. dollar on nominal terms, it is apparently also rising on a trade-weighted basis against other currencies, something Beijing has been reluctant to do in the past (and politically, the dollar-yuan exchange rate has been the consistent focus). This is an interesting change from the global financial crisis, when China immediately re-pegged its currency to the U.S. dollar.

The unintended political alignment of the two interests in China is probably not going to endure, in large part because Chinese politics have become so pluralistic and interest-driven. It seems to be a constantly negotiated game where a temporary upper hand assures nothing in the long term. And it bears repeating for the umpteenth time that regardless of the modest steps that Beijing seems to be taking in the right direction, its policies are still restrained by accumulating an obscene amount of U.S. debt. There is no magic solution and the ultimate re-balancing process will take substantial coordination and years or decades to realize. In the meantime, slow and steady management to minimize volatile impact seems to be the Chinese way these days.

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Damien Ma is a fellow at the Paulson Institute, where he focuses on investment and policy programs, and on the Institute's research and think-tank activities. Previously, he was a lead China analyst at Eurasia Group, a political risk research and advisory firm.

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