An October 24 article on Reuters (“China's NDRC unaware of yuan revaluation report” has a tantalizing story:
A news department official at the National Development and Reform Commission said on Wednesday he was not aware of an in-house report suggesting that China should consider a one-off yuan revaluation of 15-20 percent. Market News International said that the internal NDRC report summarized the economic issues facing China and was distributed to leaders of the planning agency prior to the Communist Party Congress that ended on Monday.
Premier Wen Jiabao has repeatedly ruled out another one-off revaluation. China revalued the yuan by 2.1 percent against the dollar in July 2005 and has since let it rise another 8.2 percent.
In May I wrote pieces for the Far Eastern Economic Review and the Wall Street Journal explaining why I believe a large one-off revaluation (15% or more) followed by a credible peg is the only workable alternative for the PBoC in regaining control of monetary policy. The proposal might have seemed completely crazy at the time and was likely to be rejected out of hand by almost any analyst or government official, but I argued that over time (within a year) I believed that a consensus would develop that this was at least a possible topic of discussion.
It looks like this is beginning to happen, and I think that policy discussions are increasingly going to move in that direction. I think by now there is definitely a consensus that China needs to speed up the process of revaluation, both for domestic reasons and to head off increasingly angry US and European officials, but because of its impact on encouraging hot money inflows I think a policy of faster revaluation is too risky and will cause further destabilizing inflowsIt also runs the risk of significantly overshooting because there is no credible way to signal to the market when enough is enough, and hot money inflows will pour into China even long after the currency has reached a reasonable level, whatever that may be.A speeding up of the revaluation in the trading band will only get China all the well-known evils of revaluation but none of the benefits (a reversal of capital inflows)
My guess?China’s money supply and trade surplus will continue to surge – even a US slowdown will have no impact, as I explain in yesterday’s entry. Inflation will stay high and probably even rise.Some time in the first quarter of next year officials will become so concerned about China’s out-of-control monetary policy that the consensus will move increasingly in the direction of a one-off maxi-revaluation, although that probably won’t happen until after the Olympics.
Two additional points:First, even if the consensus moves in the direction of a maxi-revaluation, the government will flirt with the idea of a much smaller-than-needed jump – perhaps 5-10%. That would be a terrible choice because the markets will know that this isn’t enough to rebalance capital flows and investors and businessmen would immediately make big speculative bets that there will be one or two more moves.The risk is that even when the government has revalued a second time and done all it needs and wants to do, it wouldn’t be credible, and so these “one-off” revaluations would simply encourage more speculative inflows.
Two, monetary growth has been so excessive that China will suffer a financial contraction anyway even if it were to revalue tomorrow.But since the contraction is likely to come after the maxi-revaluation, there will be a terrific temptation to claim a repeat of Japan in the 1980s – the crisis happened not despite but because of the revaluation.It will all be the fault of the US. The argument doesn’t make sense in Japan – the bubble there was created by letting money supply expand too quickly before the revaluation, and when Japan finally accepted the need to revalue, it turned the adjustment process into a one-way bet for speculative inflows. For similar reasons it will not make sense in China, but it will be politically very popular nonetheless to blame the US for the ensuing contraction.
Two days ago my assistant, Peking University undergraduate Oliver Shang, told me very worriedly that the rumors were that PPI was going to come in higher than expected. Yesterday at a news briefing the NDRC said September PPI was up 4.0% year on year, following a 2.6% number in August.
According to Dong Tao at Credit Suisse (and as far as I know he has had the best and most consistent call on Chinese inflation), that brings PPI inflation for the first nine months of 2007 to 3.6%, versus 2.5% for the same period last year.Steel and cement drove much of the rise – so we can’t blame pigs for this one.
Gasoline prices are vulnerable too. The last time the government hiked prices (and still kept them below a real market-clearing rate) was when oil was at $60 a barrel.Might gasoline go up soon, or will we continue to bury that component of inflation in higher taxes?
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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January, 2008
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