Yukon Huang, “China can let the renminbi depreciate”

By Yukon Huang, Financial Times

Published: June 10 2010 23:13 | Last updated: June 10 2010 23:13

The plunge in the euro and threat of persistent economic instability has caused the Chinese government to take a more cautious approach to adjusting its exchange rate. But ironically, the collapse of the euro presents a golden opportunity for China to introduce greater exchange rate flexibility. China should do this now, rather than wait for the crisis to abate. And to the surprise of many, it should begin by letting the value of the renminbi depreciate rather than appreciate.

Chinese authorities have been reluctant in the past to appreciate the exchange rate in response to global pressure because when markets are convinced that the renminbi will rise – even gradually – in value over the foreseeable future the rise will encourage speculative capital inflows. Over the past decade, estimates suggest that perhaps 20-40 per cent of the annual capital inflows have been “hot money” pursuing the likelihood that the currency would appreciate either steadily or in measured steps. Such inflows intensify pressure for further appreciation and create negative results that China is already struggling to address.

Damaging consequences include excess liquidity and lower than desired interest rates that help push up investment – notably real estate – to unsustainable levels, and raise the prospect of a major collapse in asset values. Housing prices in Beijing and Shanghai are clearly inflated and demand continues to grow unabated. While unit values have doubled in many cases in the past year, rents are stagnant. Apartments remain empty as owners wait to “flip” their holdings. With these concerns, one-way bets on the exchange rate are not something China should encourage.

There are two problems with China’s exchange rate: one, the value of the renminbi and, two, its flexibility. Despite conventional wisdom, it is actually more important to tackle the latter first, rather than fretting about the former. China and the rest of the world have more to gain from Beijing adopting a flexible exchange rate.

The renminbi has been pegged to the US dollar for nearly two years and since November the euro has fallen nearly 20 per cent against the renminbi. Given the importance of the European market to China – and east Asia as a whole – the renminbi’s sharp appreciation relative to the euro provides China with an opening to begin the process of allowing the renminbi to fluctuate within a wider band. Chinese officials have publicly indicated they would allow this. Initially, the renminbi – to the surprise of many – could depreciate a few percentage points relative to the dollar before going up, due to the temporary turbulence in the eurozone.

China’s key objective should be to move to a more flexible exchange rate system that does not have any pre-ordained bias in moving up or down. When China broke the fixed peg to the dollar in 2005, it embarked on a steady but gradual appreciation of the renminbi until August 2008, when the renminbi was repegged to the dollar.

During this period, the unspoken rule was that the rate of appreciation would not exceed 6-7 per cent a year. Anything more than 7 per cent would encourage excessive capital inflows as investors would be guaranteed an attractive return after allowing for differentials in interest rates between financial centres and the costs of transactions for moving funds across markets. Even with an appreciation of about 20 per cent over these three years, capital inflows continued and pressures to appreciate did not fade.

With pressures building over the past two years, market watchers are speculating that the needed adjustment is much larger than a gradual appreciation of 6 to 7 per cent. Still, the government remains adamantly against any major or sudden adjustments and reluctant to embark once again on a gradual appreciation in one direction that would not necessarily solve the problem – and, in fact, could make it worse.

The question remains: if the market determined the value of the renminbi, would it be higher or lower in five years? It is widely believed that the currency would appreciate owing to persistent trade surpluses and China’s abundant foreign reserves. But, even with the lack of movement in the renminbi’s value, China’s competitiveness is already eroding as inflation accelerates, pressures for significant increases in real wages mount, and property values continue to rise. Perhaps the most challenging aspect for the government is the pressure on labour markets as reflected in the highly publicised strikes in southern China, which reflect not so much a shortage of labour per se but more the unwillingness of the newer generation of migrants to relocate when equally attractive opportunities nearer to home are now emerging.

It is also worth noting that most Chinese households and companies find it difficult to move funds abroad given existing capital controls. Many have yet to consider the possibility that owning property in another country could be even more attractive. But with growing sophistication in considering investment alternatives and greater flexibility in transferring funds, the Chinese – like all others with significant assets – will diversify their holdings more quickly by shifting capital abroad. Prudently diversifying assets could mean the renminbi will get weaker rather than stronger over time on a “market basis”. Its value in the next few years is anyone’s guess – the way it should be.

The writer is a senior associate at the Carnegie Endowment for International Peace and former country director for the World Bank in China

Fred Bergsten, “New imbalances will threaten global recovery”

New imbalances will threaten global recovery, Financial Times
By Fred Bergsten

Published: June 10 2010 03:00 | Last updated: June 10 2010 03:00

Global imbalances are about to jump again. New estimates from the Organisation for Economic Co-operation and Development suggest that the sharp decline in the exchange rate of the euro, along with tepid European growth, will produce eurozone surpluses of at least $300bn (€251bn, £208bn) annually within the next few years. The tightening of fiscal policies throughout Europe in response to the crisis, along with the new balanced budget amendment in Germany, will both depress domestic demand and require easier monetary policy that will weaken the euro further.

No one would accuse the eurozone of competitive devaluation. However, there is considerable satisfaction throughout Europe with the weak currency. Martin Wolf of this newspaper has already characterised Europe’s de facto strategy to export its way out of stagnation as “stumbling into a beggar-my-neighbour policy”.

Whatever the intent, these European developments will have effects similar to the overt steps taken by other major countries to enhance their trade competitiveness. The most extreme case is the massive intervention by China and surrounding countries to keep their currencies severely undervalued. Other emerging markets are likewise seeking to expand further their war chests of foreign exchange by running large external surpluses. Switzerland has intervened substantially to hold its currency down. The eurozone has joined this “new mercantilism” and the result will be a sharp rise in global imbalances.

The counterpart increases in deficits will again accumulate mainly in the US as no other country could attract the requisite financing. The large deficit countries within the eurozone must reduce their imbalances. Along with the large surpluses of China and other Asian countries, the new European surpluses will probably double the American current account deficit beyond its previous record of $800bn in 2006. The US could then maintain its recovery only by continuing to run large budget deficits and again tolerating debt-financed consumer demand. This is the opposite of the rebalancing strategy agreed by the Group of 20 leading economies as critically important for sustaining global expansion and reiterated by its finance ministers last weekend.

Many regard this scenario as a desirable resolution of the current European crisis. Investor proclivities to buy Treasury securities and dollars could finance the American deficits for a while. The US would provide the global collective good, as in the past, by accepting increased dollar overvaluation and further increases in its external debt and deficits.

There are three glaring problems with this vision, however, all centred on the US. First, the sharp escalation of its own domestic and international imbalances would intensify the risk of future market attacks on the dollar and US financial assets. As soon as Europe and other alternatives regain their acceptability to investors, the unsustainability of the US situation would return to centre stage at even more dangerous levels.

Second, the higher imbalances themselves could sow the seeds of a new financial crisis just as they helped sow the seeds of the last crisis. Such huge inflows of foreign capital would keep US financial markets excessively liquid, hold interest rates down, promote underpricing of risk and thus again generate irresponsible lending and borrowing.

Third, a renewed explosion of the US trade deficit could well trigger the outbreak of protectionist trade policies that has been largely avoided to date. With unemployment remaining very high, job losses to the “new mercantilism” abroad are likely to incite strong political reactions. The virtual absence of a positive trade policy under President Barack Obama has created a dangerous vacuum in which new import restrictions, especially aimed against “unfair exchange rates,” could readily prevail.

At its upcoming summits in Toronto and Seoul, the G20 must adapt its rebalancing strategy to prevent this new threat to continued recovery and lasting global stability. Surplus Germany, along with China and Japan, must stimulate domestic demand. China must let the renminbi strengthen substantially. Joint intervention in exchange markets should prevent or reverse any significant further fall in the euro. Additional allocations of Special Drawing Rights would enable countries to build reserves without running trade surpluses.

Most importantly, the US must convince the world it is unwilling again to become the consumer and borrower of last resort. Only then will other countries stop relying on rising trade surpluses and become serious about generating domestic demand. Such a US strategy will of course focus on medium-term fiscal correction and increased private saving. But it will also have to end the chronic dollar overvaluations of the last 30 years, and euro depreciation along with continued renminbi manipulation will inevitably push currency issues back to the top of the global agenda. The writer is director of the Peterson Institute for International Economics in Washington

J.R. WU, “China Suggests Yuan Won’t Rise Until Europe Is Stable”

China Suggests Yuan Won’t Rise Until Europe Is Stable, Wall Street Journal

May 21, 2010

By J.R. WU

BEIJING˜A senior Chinese finance official called on major reserve-currency nations to keep their exchange rates stable amid the euro-zone debt crisis, suggesting that China will wait for more clarity in Europe before allowing its own currency to fluctuate in value.

Assistant Finance Minister Zhu Guangyao also appeared to urge the U.S. not to press China on the currency issue during strategic talks between the two countries next week. While U.S. Treasury Secretary Timothy Geithner had been expected to push China to allow its currency to appreciate, this key U.S. goal is no longer expected to dominate talks because of the European sovereign-debt turmoil.

Mr. Zhu, echoing earlier statements by Chinese leaders, said how and when Beijing adjusts its exchange-rate system will be based on the world’s economic situation and China’s own economic performance.

“I want to specifically point out that we will not succumb to external pressure, while promoting the process,” Mr. Zhu said in a news conference. He added that China and the U.S. “should maintain quiet communication” on the exchange-rate issue.

Chinese Vice Premier Wang Qishan and Mr. Geithner will lead the economic discussions at the bilateral Strategic and Economic Dialogue, as hundreds of government officials from Washington and Beijing convene in the Chinese capital for the second round of high-level talks since President Barack Obama took office. The two-day talks start Monday.

Mr. Geithner in April delayed a report to Congress on the currency policies of major trading partners, including China, saying the coming meetings would be the best channels for advancing U.S. interests.

But since then the euro, hurt by the sovereign-debt crisis in Greece that has affected much of Europe, has sunk to four-year lows.

Mr. Zhu said that just as all countries worked together to tackle the challenges of the global financial crisis that erupted in September 2008, “in the face of the challenges posed by the sovereign-debt crisis, China, the U.S. and European countries need to strengthen macroeconomic policy coordination.”

Beijing has said its move toward a more market-oriented exchange rate was put on hold to provide stability and help China weather the global financial crisis.

While market expectations had been building for Beijing to let the yuan appreciate to counter domestic inflationary pressures, Mr. Zhu’s comments reinforced analysts’ expectations that China will hold off any currency adjustment until the euro-zone crisis eases.

In March, People’s Bank of China Gov. Zhou Xiaochuan said China would exit the special exchange-rate mechanism˜a reference to the de facto peg the yuan has held to against the U.S. dollar since July 2008˜at some point.

˜Liu Li contributed to this article.
Write to J.R. Wu at jr.wu@dowjones.com

Printed in The Wall Street Journal, page A8

Geoff Dyer, “Renminbi truce creaks amid Beijing jitters over Europe”

Renminbi truce creaks amid Beijing jitters over Europe, Financial Times
By Geoff Dyer in Beijing

Published: May 21 2010 03:00 | Last updated: May 21 2010 03:00

If showing up is half the battle, the Obama administration will do well in China. At next week’s annual US-China summit, there will be a total of 15 cabinet secretaries or agency heads in Beijing in an impressive display of diplomatic force.

With so much to discuss, neither government wants the agenda to be hijacked by a ritualistic argument about the level of the Chinese currency. Yet the delicate compromise they have established over exchange rates is at risk of breaking down.

Only a few weeks ago, the issue seemed to have been deftly resolved. Tim Geithner delayed the publication of the Treasury department’s annual report on whether China is manipulating its currency and Hu Jintao, president, travelled to the US for an international summit about nuclear weapons, a sign that tensions were easing.

China said little in public, but US officials seemed convinced it was a matter of weeks before China abandoned its currency peg with the US dollar. Even if no fireworks were expected from Beijing – maybe an appreciation of 2-3 per cent – it seemed enough to take heat out of an issue with the potential to spark a trade war.

Beijing could still follow this script in the weeks before the G20 summit in Canada next month. But there is a good chance that the European crisis has prompted a change of heart in China.

At the very least, Europe’s travails have given those parts of the Chinese government opposed to a stronger currency a new argument and, sure enough, the commerce ministry has wasted no time in pointing to the likely damage to China’s exports. After all, the weaker euro means China’s currency is already getting stronger.

Even officials in favour of abandoning the dollar peg have said privately they are worried about the European crisis. The dollar peg was reinstated in mid-2008 as a way of navigating the global crisis. Why change course now, some argue, when a double dip is a realistic possibility?

Such arguments will do little, however, to persuade China’s critics in the US. Only this week, Charles Schumer and nine other US senators wrote to Mr Geithner telling him to take a tough line on Beijing’s refusal to let the International Monetary Fund publish a report they believe concludes that China manipulates its currency. If China does not budge, the level of the renminbi could yet become a mid-term election issue. Is it true, a Chinese contact asked this week, that Mr Schumer wanted to be majority leader if Harry Reid lost in the autumn?

Given that a public confrontation over currencies would probably encourage the Chinese to dig in their heels, it is no surprise that the Obama administration appears to want to prioritise a different economic issue in China next week: the mounting restrictions facing US companies in China.

China has always tried to get foreign companies to hand over technology in return for access to its market, but some multinationals believe this has been ramped up in the past six months.

As James McGregor, a former chairman of the American Chamber of Commerce in China, described the latest push in a blistering op-ed piece this week: “The tools to accomplish this include a foreign-focused anti-monopoly law, mandatory technology transfers, compulsory technology licensing, rigged Chinese standards and testing rules, local content requirements, mandates to reveal encryption codes, excessive disclosure for scientific permits and technology patents, discriminatory government procurement policies, and the continued failure to adequately protect intellectual property rights.” Some companies, especially in the IT sector, are up in arms.

These fears are by no means universal among foreign businesses in China. Many consumer goods companies are unable to manufacture goods quickly enough to meet demand. And China has its own complaints in this area, from “Buy America” policies to restrictions on high-tech imports from the US.

But by focusing on industrial policy, the Obama administration can not only help shift the conversation away from stale currency debates. It would also be doing what a large chunk of US groups in China actually want their government to do.

Keith Bradsher, “Europe’s Debt Crisis Casts a Shadow Over China”

Europe’s Debt Crisis Casts a Shadow Over China, New York Times
Published: May 17, 2010
Keith Bradsher

HONG KONG — The pain of the European debt crisis is spreading as the plummeting euro makes Chinese companies less competitive in Europe, their largest market, and complicates any move to break the Chinese currency’s peg to the dollar.

Chinese policy makers reached a rough consensus early last month about breaking the dollar peg and letting the currency, the renminbi, rise in value somewhat, according to people close to Chinese currency policy makers. Uncoupling the currencies would make American goods more competitive against Chinese products. But for various reasons, China has not yet put that policy into place.

And in light of the euro’s nose dive, such a move could be difficult. Letting the renminbi rise against the dollar would also mean a further increase in the renminbi’s value against the euro, creating even more problems for Chinese exporters to Europe.

The euro has plunged against the renminbi in recent weeks, at one point Monday reaching its lowest level since late 2002.

The steep rise of the renminbi prompted a Commerce Ministry official in Beijing to warn Monday that China’s exports could be threatened.

The official’s comments were the most explicit yet on the implications for China of Europe’s recent financial difficulties. The comments also suggest that even China — the world’s fastest-growing major economy and increasingly the engine of global growth — is not immune to the crisis that started in Greece and threatens to spread across much of Europe.

“The yuan has risen about 14.5 percent against the euro during the last four months, which will increase cost pressure for Chinese exporters and also have a negative impact on China’s exports to European countries,” Yao Jian, the ministry’s spokesman, said at a news conference in Beijing, according to news services, using another term for China’s currency.

It is a potentially awkward moment. The American secretary of commerce, Gary Locke, is in China this week leading the first cabinet-level trade mission of the administration of President Obama.

Some economists warn that China may face more problems. The biggest reason Chinese exports plunged early last year was not weakening demand in industrialized countries but a sudden, temporary disappearance of trade finance from Chinese and foreign banks. The availability of trade finance could easily become a serious problem again soon, said Dong Tao, the chief Asia economist at Credit Suisse.

Chinese exporters rely very heavily on bank letters of credit to finance their shipments. The availability of the letters of credit is closely linked to overnight lending rates between banks. When banks have trouble borrowing money themselves — as has been happening as a result of worries about European banks’ possible losses from the region’s sovereign debt crisis — they tend to cut sharply the issuance of letters of credit for trade finance.

The banks see that as a quick, easy way to conserve cash without violating the terms of other financial obligations, like established lines of credit for big corporations.

Interbank lending rates surged late last week and on Monday and must now come back down very quickly to persuade banks to keep issuing letters of credit, Mr. Tao said. “Without trade finance, trade won’t happen,” he said.

The Shanghai stock market plunged Monday, with the composite index falling 5.1 percent on worries about global demand as well as concerns about possible further moves in China to limit a steep rise in real estate prices this spring.

Some Chinese companies are already running into difficulty because of the euro’s fall against the renminbi.

“We have been receiving calls from some European clients who signed contracts with us earlier this month, and they all want to cancel their orders, since the depreciation of the euro has eroded all their margins and then some,” said Elvin Xu, the sales manager of Guangdong Ouyi Electrical Appliance in Zhongshan, China, which makes gas stoves, heaters and water heaters.

“They say they cannot increase the prices at their end to their customers, given intense competition in their marketplace,” Mr. Xu added.

The renminbi is rising along with the dollar against the euro. The Chinese government has continued to intervene heavily in currency markets in recent weeks to prevent the renminbi from rising against the dollar, maintaining an informal peg of 6.827 renminbi to the dollar, the level since July 2008.

Because American companies in particular compete in the Chinese market with European companies in many industries, the euro’s weakness against the renminbi is putting American companies at a disadvantage. The American commerce secretary, Mr. Locke, said Monday in Hong Kong that Mr. Obama’s goal was to double American exports by 2015. Short-term currency fluctuations do not detract from that goal, he said in an interview, adding, “Who knows what the euro will be next month, six months from now or a year from now?”

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Alan Beattie, “Renminbi at heart of world trade imbalances”

Ralph Atkins and Richard Milne, “Tensions brew as Euro disparities appear”

Tensions brew as Euro disparities appear

By Ralph Atkins in Frankfurt and Richard Milne in London

Published: October 25 2009 23:10 | Last updated: October 25 2009 23:10

A stronger euro is adding to the tensions in Europe’s 11-year-old monetary union, with the greater vulnerability of some countries and their industrial sectors complicating the job of policymakers.

The euro last week broke through the $1.50 level for the first time in more than a year. On a trade-weighted basis, Europe’s common currency has risen 3 per cent since early September and is fast approaching the all-time highs seen in 2008.

So far, the euro’s appreciation has had little apparent impact on the pace of economic expansion. Growth is thought to have resumed in the third quarter and purchasing managers’ indices last week showed the eurozone on course to expand robustly in the fourth quarter.

But with currency effects typically taking many months to feed through, the risk is that the euro’s strength, which stems largely from the dollar’s weakness will act as a brake on activity in 2010 and exacerbate divergences in performance between the eurozone’s main economies.

As the global economic storms abate, the currency’s rise is exposing countries’ failures to adapt policies that can ensure competitiveness when the option of currency devaluation is no longer available.

Aurelio Maccario, an economist at Unicredit, says: “Now the worst of the crisis is over, performance will depend crucially on how the eurozone countries cope individually with a new order that will probably see the euro remaining strong for a sustained period.”

Each eurozone country’s vulnerability will depend on their reliance on exports to countries that do not use the euro – and the scope companies have to squeeze profit margins. Mr Maccario says: “Ireland looks most exposed because exports to non-eurozone countries account for such a large share of GDP … and companies are also facing pressure because of rising unit labour costs.”

The flexibility of the Irish economy in cutting costs, however, may act as a significant counterforce.

On the same basis, Belgium, Finland and the Netherlands also appear exposed to the rising euro.

At the other extreme are Spain and Greece, where exports to non-eurozone countries are relatively unimportant. But the collapse of the housing market and high unemployment in Spain means it can no longer rely on domestic demand to power growth as it has in the past. The hit taken by Spanish exporters will be an additional blow.

Germany’s reliance on exports would also appear to make it vulnerable. But industrial leaders in Eur­ope’s largest economy argue that sales of their high-tech products are less price sensitive than elsewhere.

The country’s BGA exporters association said last week that although the currency’s strength was creating “certain problems”, it expected up to 10 per cent export growth in 2010, after an 18 per cent fall this year. Chinese demand was making up for lost trans-atlantic exports, it said.

Businesses, meanwhile, have become used to living with a strong currency. Across Europe, industrial companies such as Siemens and ABB might see an impact of 5-6 per cent on revenues from the strong euro.

But the impact on profitability would be marginal, according to analysts at Morgan Stanley, because the big industrial companies can switch between production sites round the world according to demand.

Hedging can also help preserve profitability, and carmakers such as BMW and Daimler, which have lost hundreds of millions of euros in recent years from currency movements, are expanding US factories to boost “natural hedging”.

Airbus, the European aircraft manufacturer, will probably be less sanguine: in the past it has estimated that a one cent shift in the dollar costs it $100m.

Fabrice Bregier, chief operating officer, said earlier this month: “At current levels, the situation is becoming very difficult for all industrial companies that have their costs in euros. We can only appeal to monetary authorities to ensure currency stability.”

http://www.ft.com/cms/s/0/29a48d2e-c18e-11de-b86b-00144feab49a.html