My Blog

March 14, 2008

China’s National Bureau of Statistics released a new batch of interesting information today:  “From January to February, urban investment in fixed assets achieved 812.1 billion yuan, with a year-on-year increase of 24.3 percent.”  Last year’s increase in investment spending was 25.8%, leading some commentators to talk about evidence of a “modest slowdown”, but the numbers suggest no such thing, especially since the January storms may well have depressed spending temporarily, and more especially since investment in real estate accelerated to 32.9%.

Speculative investment in real estate is a good proxy in China for speculative behavior in general, and perhaps also a proxy for speculative inflows, so the high growth in real estate investment seems to indicate that China’s easy money conditions are doing all the unhealthy things one would expect them to do.  The rapid growth in real estate “investment” is particularly worrisome because most insiders worry about the impact of real estate on the banks – banking exposure to real estate is extremely high (and, from the anecdotal evidence, not always recorded as such).  In case of a sharp economic contraction that led to a steep fall in real estate prices, banks could be badly hurt, thus exacerbating the slowdown.

The good news is that growth industrial investment slowed (but let’s not get too excited, it is still very high), and that should show itself as reduced growth in industrial production.  I am particularly concerned about that number because high levels of industrial production force a rising trade surplus.  As long as China produces more than it consumes it must export the difference, and a rising trade surplus increases China’s monetary expansion since the PBoC is forced to buy the accumulating foreign currency.

To make matters worse, the fall of the dollar ($1.5580 to the euro, $2.0310 to the pound, and Y 99.77 to the dollar) is putting unbearable pressure on countries who peg their exchange rate to the dollar.  Not only does this reduce the value of their currencies in international trade (and so put increasing upward pressure on their trade surpluses), but because the Fed is dropping interest rates and pumping liquidity into the system it can only increase hot money inflows into countries like China.  Referring to Chinese Commerce Minister Chen Deming, the China Daily today said:

Chen's ministry, which oversees foreign trade and domestic consumption, said that during the first two months, investments from the European Union countries rose a whopping 109 percent, while investments from the United States increased 44 percent.  Wild expectations abroad that the yuan will continue to rise in value against major world currencies has led to money coming to China. 

"When you bring US dollars to invest in China, you need to change it into the yuan. Naturally you would like your funds to enter China at an earlier date. Because, if you are late, the same amount of dollars will turn out to be less yuan bills," Chen told reporters.

Sure enough.  So what to do?  The China Daily is suggesting that some economists think China should consider a one-off revaluation, “possibly 5%”, to block hot money from flooding into the country.

Yes and no.  As I have been arguing for over a year, a one-off revaluation is pretty much the only option available to China to regain control of its monetary policy, and they are eventually going to be forced into doing it.  The fact that China Daily is reporting it suggests to me that this “crazy” idea is becoming less and less crazy every week.

But 5%?  That would truly be crazy.  Not only would a 5% revaluation accomplish very little in satisfying hot money expectations of RMB revaluation – we already expect the RMB to revalue by a lot more than that just this year – but even worse it would be a huge public announcement to the world that the PBoC was forced to do what they said they would never do, and anyone with a calculator and common sense will know that a lot more revaluation would be needed to adjust the monetary imbalances.

You don’t have to be a shadowy, evil speculator to see that 5% revaluation as a very loud signal to bring every penny you can get your hands on into China as quickly as you can.

Meanwhile there is a big debate going on among economists and bank researchers about how many more interest rate hikes, how many more reserve hikes, and so on the PBoC will engineer in order to tighten monetary policy.  The debate is interesting because it does give us an idea of what is likely to happen to the stock market and of course what will happen to the cost of financing additional real estate speculation, but I do not think it is terribly useful for understanding what is likely to happen to domestic monetary conditions.  China’s problem is not which set of tools can best be used to control the domestic money supply.  It has no control over the domestic money supply.  It is the currency regime which needs to be adjusted.

Comments (7) for "5% revaluation of the RMB? ...

Michael, I have been reading your blog and articles for nearly two years. Not only do you write well and argue vigorously, but as this latest posting shows it seems your crystal ball has been better than most. Keep up the good work. By Sam Crane - 3/13/2008 6:59 PM

One could guess, that those hedge-funds and others, previously involved in the USD/JPY carry-trade, now recognise a benign situation for a USD/CNY carry. There should be two possible scenarios, either carry-trade with the CNY is impossible and effectively prevented by China, then hot money should not be a problem. Or, this carry-trade IS possible, and then its growth should accelerate. Any "stable" correction through the financial markets should be impossibe in my view. Either the peg will go, or inflation will sky-rocket. By Stefan, Tallinn - 3/13/2008 9:38 PM

The food price is dropping. I do not know how long it will last. However, at the current drop rate, it will go back to Sep 2007 level in 3-4 months, at least at wholesale level. I am also trying to find any agri production and import/export data. Regarding Jan/Feb fixed investment, I would like to see the breakdown the data to find out how much money is going to repair and replace the damaged infrastructure. Then we can talk about the bubble and overheat. FDI is no doubt the hot money inflow. I would also like to see the correlation between U.S. asset markets and FDI in China. If there is no natural disarster around the world, I am pretty confident that the worst food price spike has passed. Oil price is another matter. By fatbrick - 3/13/2008 10:12 PM

When factories move inland, more Chinese will have enough money for food. Demand for food will increase, not 10%, may be 10 fold, over the next few years. And these will be demand for better quality food too. I see the food price going down for may be anther month as correction to recovery from the snow storm, but will then climb at much higher rate then before for at least a few years. The more factories move inland, the less agricultural land will be available for agriculture. With the climate change induced drought, food production within China will decline. The only hope would be food production increase elsewhere on earth, like Siberia (which is getting warmer). Technological change in farming will reduce the labour required for farming, but not productivity per unit land. The critical resource for agriculture now is land, not labour, not technology. By Bill - 3/14/2008 12:05 AM

michael, macro-economic events would suggest that insiders in china's leadership have already made their decision about revaluation or prescient traders are preparing to pre-empt them in a massive way. chen is telegraphing the future in typical chinese-speak. consider what has been happening in the equity markets.....japan fell over 3 percent to a new 52-week closing low and hong Kong slumped 5 percent clinging to its double bottom by its fingernails. china’s shanghai comp tumbled over 2 percent to a new 6-month low. as i suggested in the past, should china revalue the renminbi in a big way, the result will necessarily be a huge negative for the chinese equity market. clearly the liquidity bubble that has pushed chinese stocks higher is a direct result of china’s continued support of the dollar. take away that support, the liquidity pump is turned off, and as day follows night, china’s equity bubble will deflate. accordingly, i have been massively short chinese equities for quite some time. have you noticed that the june renminbi futures rose over half a percent today to another new record high despite the spot dollar/yuan barely moving? those in the know are increasingly betting that a revaluation or acceleration in the appreciation of the yuan vs. the dollar is going to occur very soon. By kevinfischer2002 - 3/14/2008 12:19 AM

excellent blog. I have a few questions. This RMB revauluaton seems to be the layup trade of the century. What are some of the things that could go wrong with this trade? In the US besides evertrade.com's world currency/money market accounts, how else can you play this trade. Thanks very much for the time and free information you give. By adam - 3/15/2008 4:35 AM

two questions: 1. Is now the perfect timing for such an one-off revaluation, considering that no one could barely tell how futher down the USD could go? 2. one-off reval might be a good way of blocking FDI in, what is the good way of stopping the existing FDI taking the profit and flowing out? By naiiiive - 3/16/2008 8:13 AM