My Blog

March 28, 2008

FRI 28 MAR

Damned firewall By Michael Pettis

Things started getting very difficult with the internet about six months ago as the great firewall got tighter, but in the past few weeks internet access has been far more frustrating than it has ever been during my over six years living in Beijing.  It takes me hours (literally) to post anything on my blog.  My Peking University students tell me that they waste two or three hours a day more than they used to trying to access information on the internet.  When I ask them why it has become so difficult, they tell me that there are a lot more things now that the government doesn’t want them to know – although they don’t usually specify what that may be.

 

So if my postings become more erratic in timing, please don’t assume that I am becoming lazy or that China’s financial markets have suddenly become less interesting.  It may just mean that after too many hours of playing solitaire waiting for my blog to load, I finally gave up and went out to enjoy the rare good weather we are currently enjoying in Beijing.

 

Fortunately there isn’t much to discuss today except that after yesterday’s brutal beating the local stock markets surged today by around 5%.  This may seem like a huge run-up to many, but I should warn you that any day the local stock market rises or falls by less than 2% my assistant, Zhang Ning, usually reports to me that “nothing happened today”.  Still, as I am long B-shares, up 5% makes me a lot happier than down 5%.

 

The Financial Times had an interesting article today titled “Chinese exporters shun flagging dollar”.  The article says that “According to Alibaba.com, the online company that matches Chinese suppliers with international buyers, the vast majority of their almost 700,000 Chinese suppliers no longer use dollars to settle non-US transactions to minimise foreign exchange risk.”

 

It goes on describing how Chinese companies are using different ways to index revenues so as to protect themselves from the decline in the value of the dollar.  For example:

 

Other companies have taken more unusual approaches, such as setting their own exchange rates and therefore in effect raising prices.  Xiao Zheng, chairman of Dongguan City Shima Toys in southern China, said its price quotations were valid for three months but were calculated based on an exchange rate of Rmb6.6 to the dollar.

 

With the official exchange rate at Rmb7.01 to the dollar on Thursday, this in effect raised prices 5.8 per cent. “We are thinking about renewing our quotations every other month and we are also going to offer quotations in euros very soon,” said Mr Xiao.

 

This is obviously good news.  It means that Chinese exporters have the ability to re-price their goods in an environment of a strengthening RMB and it also means that they are learning how to hedge foreign currency risk.  Of course given strict limits on what they are allowed to do, they are still pretty protected from reality, but the more they learn how to hedge and to adapt to declining revenues, the more likely they are to survive any sharp change in the value of the RMB.  One worry, though, there is a tendency for Chinese corporations to project past price moves indefinitely into the future.  For example soy prices have risen pretty steadily over the past few years, but every time there is a temporary reversal we get an onslaught of bankruptcies among Chinese soy pressers who took massive long forward positions on the assumption that rising prices can only keep rising.

 

Right now the great insight seems to be that the dollar can only fall against the euro, so it makes sense to enter into contracts in which future deliveries are invoiced and/or indexed in euros.  This way even though the RMB is rising against the dollar, it is steady or falling against the euro, and so revenues can be more safely matched against RMB costs.

 

Needless to say, this reasoning is only good if the dollar falls forever against the euro.  Unfortunately currency prices follow the same iron law that JP Morgan claimed stock prices follow: they fluctuate.  I was at my family home in Spain last December and then in my home in New York in February, and I can say that expressed in purchasing power parity the dollar is extremely cheap against the euro.  Should the dollar ever reverse part of its weakness (which I think is not only highly likely but nearly inevitable), Chinese exporters are going to get killed as the RMB strengthens against the dollar and the dollar strengthens against the euro.

 

Still, when it comes to risk management, experience is the only good teacher.

 

Today’s daily report by Credit Suisse has an interesting comment on why there seems to have been so little policy action by the government in recent weeks.  Rather than summarize and comment on their argument (any good economist would have predicted that the increasing probability that I will not get through to my blog to post this entry will naturally reduce the amount of work I am willing to put into it), let me just quote the most interesting paragraph:

 

In our observation, policy decisions in Beijing are stalled, waiting for new guidelines from Wang Qishan, the new vice premier in charge of finance.  We understand that officials have divided opinions regarding future policy directions. Premier Wen Jiabao and his camp place great emphasis on inflation and seek further price control and credit tightening.  First Vice Premier Li Keqiang and his followers are more worried about the rising growth risk, especially in view of a possible US recession and global financial market turmoil. The division grants Vice Premier Wang Qishan the position to call for a future policy move.  Wang apparently has been visiting various government departments since he was officially appointed to the vice premier post but has refrained from providing any instructions or guidance.  He may remain silent and keep   listening before finishing his visit of the entire organization in mid-April.  Until then, we expect a continued lack of action in terms of new and substantial policy initiatives. Wang made his reputation in handling the GITIC bankruptcy and other economic/market issues during the Asian financial crisis.