The PBoC has raised minimum reserve requirements for the seventh time this year, after three increases last year, from 12% to 12.5%, which is expected to drain about $25 billion from the banking system (equal, by the way, to a little more than two week's reserve inflows). In a televised speech two days ago premier Wen Jiabao said the government needs to prevent the economy from overheating. Yesterday Zhou Xiaochuan, the PBoC governor, said in a speech that the central bank hoped to see positive real interest rates, although he also made the very reasonable comment that inflation is not just what has happened this month but must be measured over a longer period of several months.
I am not very optimistic that inflation numbers will come down dramatically in the near term, so I interpret this to mean that rates are going to go up quite a bit over the next few quarters. But here is the conundrum. If rates do go up sharply, the speculative profit from investing in China also goes up and, perhaps more importantly, the incentive for Chinese to invest abroad goes down. This measn that capital inflows are going to get worse, not better.
If you believe, as I do, that it is the monetary expansion caused by the currency regime that is at the root of China's money problems, it is hard to see how this can possibly help. I believe the PBoC is very worried about capital inflows and the currency regime, but it is an indication of how much inflation terrifies the government that they are willing to do something that just six months ago seemed almost inconceivable -- increase the incentive for speculative inflows.
I am convinced more than ever that until the government allows a rapid increase in the value of the RMB -- and perhaps the least damaging way would be to engineer a sudden, maxi-revaluation of around 15% -- there will be no good way of dealing with the problems. I was interviewd on CCTV's Dialogue Thursday on the subject of inflation and one of the things both my co-guest, Tang Min, the Deputy Secretary General of the China Development Research Foundation, and I agreed is that the combination of rising inflation and previous and current excess money growth -- which in the past had been deflationary thought its impact on expanding industrial production -- was something new, and it wasn't clear what impact it might have on subsequent inflation. If inflation keeps up, as I suspect it might, it may be tough for the PBopC to engineer sufficiently high positive real rates anyway.
Inflation terrifies the Chinese government as it was what finally brought down the Kuomintang, and inflation in early 1989 was what was the trigger for the events of the summer of 1989.
Right now Chinese have very little ability to invest overseas even if they want to, and this is reflected in the huge premiums that Chinese companies have in Shanghai over NYC and HK. Right now the PRC seems to be trying to open the floodgates to overseas investment to get all of the money out of there.
Also, I don't think that the linkage between rates and speculation isn't going to be that tight. The people who are going into real estate and stocks are expecting 50% returns. I don't think that an increase in interest rates by one or two percent is going to change capital allocation that much.
You may be right about the limited linkage but it seems to me that earlier this year the PBoC was acting as if they were very concerned about the impact of interest rate rises on hot money inflows. We keep blowing hot and cold on the subject.
To your list of inflation scares I would also add the high inflation of 1993-94, which forced the authorities to bring in the very unpopular but credible reformer Zhu Rongji, essentially to bail them out. A Tsinghua professor once told me that foreigners always think 1989 was a crisis for the Party. In fact, according to him, 1989 was an embarrassment but not a real threat to their authority. 1993-94, he claimed, was much worse -- so serious that there were worries about the whether the Party could survive.
I don't fully understand why it was such a crisis, besides the obvious, but he himself seemed convinced, and he has and had strong ties to the leadership. What really struck me about the conversation was how different could be the views from inside and outside.
Michael Pettis is a professor at Peking University's Guanghua School of Management, where he specializes in Chinese financial markets. He has also taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business. He is a member of the board of directors of ABC-CA Fund Management Co., a Sino-French joint venture based in Shanghai.
Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups. He has also worked as a partner in a merchant banking boutique that specialized in securitizing Latin American assets and at Credit Suisse First Boston, where he headed the emerging markets trading team. Besides trading and capital markets, Pettis has been involved in sovereign advisory work, including for the Mexican government on the privatization of its banking system, the Republic of Macedonia on the restructuring of its international bank debt, and the South Korean Ministry of Finance on the restructuring of the country’s commercial bank debt.
Pettis is a member of the Institute of Latin American Studies Advisory Board at Columbia University as well as the Dean’s Advisory Board at the School of Public and International Affairs. He is the author of several books, including The Volatility Machine: Emerging Economies and the Threat of Financial Collapse (Oxford University Press, 2001). He received an MBA in Finance in 1984 and an MIA in Development Economics in 1981, both from Columbia University.
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Comments (3) for "What to do about money?"
- 9/8/2007 11:26 AM
January, 2008