I found the following article in today’s issue of Pakistan’s The Financial Daily.
I find it interesting that China’s monetary and exchange rate policy is a front page story in Pakistan. Pakistan business compete head-on with Chinese firms for global customers. Look at a map and you will see why Pakistan has a direct stake in Chinese economic, financial, social and political stability.) There were also articles today on China’s food price driven inflation rate, which may come in as high as 8% in February and, to my knowledge, the first terrorist attempt to hijack a Chinese airliner, which took place in Xinjiang province.
Two months ago I had the chance to talk with Wu Xiaoling, just before she left the central bank. The problem of hot money finding its way into the China capital markets referred to in the article is a serious one for China.
Both fixed exchange rate systems and freely floating systems contain built-in defenses against currency speculators. With fixed rates there is no point; with floating rates you can lose your bets. I prefer the former for China because monetary stability is so important for a country going through such rapid changes.
Today’s system is a speculator’s heaven. By giving in to political pressure from the American government to increase the value of the RMB, and trying to increase the currency gradually over time, to maintain some sense of stability, the authorities have created a situation in which a speculator has a one-way bet.
It’s today’s version of the carry-trade. If you borrow money in dollars, exchange it into RMB, and hold RMB assets, you will gain from the RMB appreciation at no current cash cost. The money is pouring in from everywhere.
The hitch, of course, is that the people who buy your dollars in China have to then sell them to the central bank (China’s currency is still largely inconvertible.) The central bank buys the dollars with new bank reserves, which swells the domestic monetary base (with a valiant, but largely ineffective, attempt to sterilize the impact by selling central bank paper to offset the impact on domestic liquidity). The central bank raises domestic interest rates for the umpteenth time to slow the monetary aggregates to contain the resulting price increases, which makes the speculative trade more profitable, and so on. Meanwhile, foreign exchange reserves have grown, and the pressure intensifies. (If there is $500 billion of hot money in China, then it follows that China’s foreign exchange reserves are $500 billion as a result.) This rarely ends well.
It was a mistake for China’s government to give in to American pressure and begin gradual revaluation. It was a mistake for the US government to press for the changes. Devaluing your currency in an attempt to stimulate growth is a fool’s game.
BEIJING: China’s stock market may have come off the boil but hot money is still likely to be attracted by the country’s robust growth, appreciating currency and comparatively high interest rates, senior officials said on Sunday.
Last year, China abandoned its strategy of keeping yuan interest rates below dollar rates in an attempt to cool down stock and property markets that were sucking in money.
But the weak outlook for other markets because of the U.S. subprime crisis, combined with aggressive U.S. rate cuts, have made Chinese markets attractive again.
“I see no less of an incentive for speculators to put their money in China even though the stock market is cooling. Our huge growth potential is also a key attraction,” said Wu Xiaoling, deputy head of parliament’s finance and economic commission.
“We realised that when the yuan is rising, the U.S. economy is softening and many countries are grappling with the fallout from the subprime loan crisis, more money will flood into China for higher returns,” she told reporters on the sidelines of the annual meeting of China’s parliament.
Wu, who retired as central bank vice governor two months ago, said a lot of speculative capital can flow into China through various channels under the current account, which is fully open.
The central bank raised benchmark interest rate six times last year, which, together with other cooling policies, has brought the main stock index down 30 percent from its Oct. 16 peak of 6,124.
China’s foreign exchange reserves jumped by a record $61.6 billion in January to reach $1.59 trillion, according to sources familiar with the figures.
The increase was twice as great as the combined inflows from the trade surplus and foreign direct investment in the month, reviving debate as to whether Beijing is attracting new flows of speculative capital. There is now about $500 billion of hot money in China, according to research cited by former statistics chief Li Deshui. -Reuters