Re: Revaluation of the YUAN?

Euming yeow
1/11/10


to Alan


Hi Alan,

REVALUATION OF THE YUAN?

Yes, I have read Paul Krugman's article - I assume you are referring to his NYT Column article called "The Chinese Disconnect" dated October 23, 2009.

His is one of the typical Western economists' cry of "Foul" and "Wolf" in the way China handles its own foreign exchange reserves. Many countries - especially in the Asean region scarred by that 1997/1998 Asian economic/financial crisis triggered by US hedge funds attacks on the Thai baht which then precipitated this crisis - are tying their own currency to a basket of currencies, including the USD, Euro etc., and you see this arrangement in Singapore, Malaysia, Thailand etc. And why not? Why should Asian countries again be at the mercy of the mighty greedy US currency speculators, since, to them, currency is a "commodity" to be played about!

Krugman's bitching is that since the Chinese yuan (also called "renminbi"or RMB) is always kept at a fixed rate to the US$, with the continuing deterioration of the $ value, the Yuan is in effect being constantly devalued, making Chinese goods extremely cheap on the world market. So, is this China's fault or is it the $ which is the main culprit?

Perhaps it is pertinent here to look at China's banking policies in relation to its continuing economic development.

China's Economic Development and Monetary Policies:

China's exports totalled US$1.07 trillion for the first 11 months of 2009, overtaking Germany's 734.6 billion euros or US$1.05 trillion for the same period - to become the world's top exporter.

In actual fact, the Chinese government, and elsewhere globally, is faced with a continued uncertain global environment, so much so, that in the first 8 months of 2009, exports actually dropped by 22.2%, whilst imports by 22.7%. So the task of structural adjustments remains formidable.

On Thursday January 7, 2010, China's central bank - The People's Bank of China - raised the interest rate on its three-month bills by four basis points - which analysts see as an incremental step in its desire to mop up excess liquidity, but which could also indicate the beginning of a more serious tightening of credit. It is a sign that its policymakers are not going to allow a repeat of last year's record expansion of credit, as that gave rise to fears of asset bubbles.

Since September 2008, People's Bank of China has lowered the benchmark interest rates five times and reduce the reserve requirement ratios on four occasions, for the purpose of maintaining adequate liquidity for the banking sector and promoting stable growth of monetary and credit supply. In this respect, China expects to maintain stable economic growth by boosting domestic demand and reducing dependence on external demand, thus helping in its efforts to stabilize the global economy.

It is estimated therefore, that new credit will fall to less than 2.6 trillion yuan ( US$381 billion) in Q1 2009 against 4.58 trillion yuan (US$671 billion) in the same period a year earlier.

Rating Problems and the "Herd" Mentality Arising from Outsourcing:

The global financial system relies heavily on the external credit ratings for investment decisions and risk management. This rating industry is dominated by a few large players, e.g. Moodys, and specific ratings from the big three tend to be highly correlated and they combined to form a strong cyclical force. Virtually all market players adopt these ratings from the three agencies, creating massive "herd behaviour" at the institutional level. Moreover, these rating process is filled with conflicts of interest e.g. issuers also pay for the rating agencies' advisory services on restructuring their products. So can we say they are all truly "objective" in their analyses?

The rating models for mortgage-related structured products have now been found to be fatally flawed. The current global financial crisis arising from the US subprime mess saw high, unrealistic ratings assigned to many subprime products which crashed with massive huge and fast downgrades, leading to huge unprecedented losses of well-known financial institutions like AIG, Citibank, Bank of America etc.

The institutional users viz. the money managers and financial institutions, of credit ratings should be ultimately accountable to their customers and shareholders and should exercise their own judgement of risk, not just outsource risk assessment duties to the rating agencies. You still don't see this happening in US or ECC countries to date!

Thus, financial instruments to control these excesses were virtually non-existent and/or ineffective - if we want to believe in the US version of "fair play" and should every other country including China suffer from their greedy excesses?

China's US$2.1 Trillion Holdings of US Bonds and Foreign Assets:

Krugman believes, he said, like many other economists, that "China's asset-buying spree helped inflate the housing bubble, setting the stage for the global financial crisis".

I reckon this is unbelievable crap coming from a Nobel Prize in Economics holder! Everyone knows, as shown above, that the subprime mess was created and nurtured in US' own backyards and is the main cause of their own housing bubble, and, if anything, all these sophisticated crooked bundling of inflated and highly-rated "assets" which were then sold off worldwide to all and sundry financial institutions, fell down fast like a pack of cards, when redemption time came! The greediest of all - AIG - even upped the ante by "re-insuring" these paper assets, and, of course, lost billions, only saved again by Uncle Sam's generous bailout using US citizens' $!

Unlike the US, which keeps interest rates at zero to fuel debt-fueled asset-price speculation, at least China has a plan to generate savings among her citizens (with a savings rate of return of better than zero for sure!).

US household savings rate is currently around 4%, whereas China's exceed 20%. the same is true for most Asian countries, where household savings rates are all higher than US - that is, we don't spend our way to bankruptcy as US citizens are doing and have been doing all these years!

The US has got to get its act together, since high savings rates, including government and business savings, are one of the surest indicators of a country's long-term financial health. By running massive perennial deficits - 2009 it is US$1.4 trillion! - is definitely unsustainable.

China has much reasons to worry about the Fear Factor - the US Dollar has fallen some 15% since March 2009, in large part because of increasing fears that the US' huge debts are becoming unmanageable.

So, is China just to sit back and watch its own investments in USD going down the drain by the billions? Krugman is definitely not a "panda hugger" - that time-worn epithet used for anyone who has anything good to say about China - but, regrettably, he is part of a string of China-bashing "experts" who will not accept the fact that China is striving to become what it has not yet become. It is upwardly mobile, consciously, avowedly, and proudly so.

Some Highlights of Pump-Priming Exercises of US and China:

Of the first US stimulus spending package of $787 billion passed by Congress, only $144 billion went to direct infrastructure spending up to end 2009 - against an American Society of Civil Engineers that the US must invest some $1.6 trillion over the next five years to upgrade and revamped its overall ageing infrastructure.

When the financial tsunami hit China late last year, Beijing approved a stimulus package of $585 billion to be spent over next two years. Nearly 50% of this emergency spending was directed at projects that accelerated China's massive infrastructure programs.

These targetted massive infrastructure spending includes the unveiling on Saturday December 26, 2009, of the fastest rail link in the world - a train connecting the modern cities of Guangzhou and Wuhan, at an average speed of 350 kilometres (217 miles) an hour. This super-high-speed train reduces the 1,069 kilometre journey to a three hour ride, cutting the previous journey time by more than seven and a half hours!

It's fastest speed in the world is rated at 394.2 kilometre an hour - against Japan's bullet-train (Shinkanshen) at 243kmh, and France's TGV at 277 kmh.

Work on this route started in 2005, and it will connect to the capital Beijing later. By 2012, 42 high-speed lines are expected to be built, increasing the national rail network from current 86,000km to 120,000km, making it the most extensive rail system outside the US, and definitely, the most modern.

China's high-tech rail system uses technology developed in cooperation with foreign firms such as Siemens of Germany, Bombardier of Canada, and Alstom of France.

The point I am trying to make here is that this kind of infrastructure spending goes straight into the real economy - exactly going back to our University-days Keynesian economics, which has now found flavour again! Krugman must know this surely!

China is at the same time going "Green" as fast as possible, and one section of this plan calls for 13 of China's biggest cities to have all-new and all-electric buses within five years - whilst the US (and Australia? Or is Penny Wong working harder here?) still struggles with its endless debates on carbon emission. A single China new company (I never heard of it though) - BYD Company - is in the forefront of developing a reliable, cheap electric-car battery - and they employ 10,000 engineers on this job!

Conclusion:

I don't think Krugman has got all his sums right: he looks at how the US is suffering vis-a-vis China's booming international reserves, but China rightly sees it its own way - these are mine, I have to be careful how I spend it, not spend it the way you want me to spend it!

Do you know for example, that General Motors, in JV with a local Chinese auto company, is China's biggest car seller - and in the US they are bankrupt! Their US chiefs should get down on their Chinese shopfloors and see how this is possible, notwithstanding now they are forced to give up their private jets!

China holds US$2.2 trillion of the world's $6.5 trillion in USD as at only end Q1 2009, which is some 50% of its GDP, and of this total, some 35% remains invested in US Treasuries.
China knows it must get out of this mighty $ trap in view of the continuing weakness of the US$, exacerbated by its Government's excessive spending and imprudent financial policies, but can the Chinese Yuan ( or Renminbi RMB) ever become an international reserve currency?

The Triffin Dilemma:

A Reserve Currency (RC) means that foreigners can hold large amounts of that currency that can move freely in and out. Hence, one of the pre-requisites of any RC is the ability of the issuing central bank to control the value of the RC though its appropriate monetary policy. This implies a stable exchange rate and a low level of inflation.

The problems here are: No country is able to tighten monetary policy alone for fear of inviting "hot money" which will negate such policy. Likewise, no country is able to tighten financial regulations because then foreign businesses will seek migration to other cheaper financial centres. And also, no country by itself can raise taxation without fear of massive tax arbitage.

So the RMB cannot do it: this is precisely the problems faced by the US Dollar - and this is called the "Triffin Dilemma", named after Belgian-American economist Robert Triffin, who first identified the problem in 1960.

This Dilemma arose simply because the US Dollar is of course its country's national currency, but it is used worldwide as the global reserve currency. So whatever US national monetary policy is often conflicted against global monetary policy when such opposing needs arise and often.

In short, the Triffin Dilemma imposes large costs on the reserve currency country, because if the world demands greater liquidity, the RC country must run a huge deficit to increase the global money supply. This the US has done - and continues to do so - by printing trillions of US Dollar paper money. But if the RC country runs a huge deficit - as the US is wont to do - then a global financial crisis is inevitable, and still happening now!

The sad reality today is that we have a global economy without a global monetary policy, global financial regulation and global fiscal system!

The Chiangmai (Thailand) Initiative:

The Finance Ministers and Central Bank Governors of the ASEAN Member States, China, Japan and Korea (ASEAN + 3), and the Monetary Authority of Hong Kong, China, on 28/12/2009, signed the Chiang Mai Initiative Multilateralization (CMIM) Agreement, following the ASEAN+3 Finance Ministers (AFMM+3) Meeting in May 2009 in Bali, Indonesia.

The CMIM, with a fund of USD120 billion, will provide financial support through currency swap transactions to the CMIM participants facing balance-of-payments and short-term liquidity difficulties.

Each CMIM participant is entitled to swap its local currency with USD for an amount up to its contribution multiplied by its purchasing multiplier, for example:

Country Financial Contribution Purchasing Multiple
US$bil % times

China (excl HK) 34.20 28.50 0.5

HK, China 4.20 3.50 2.5

Japan 38.40 32.00 0.5

Korea 19.20 16.00 1.0

Plus 3 96.00 80.00 -

IndonesiaThailand/ 4.77 3.97 2.5
Malaysia/Singapore
- same each:

ASEAN 24.00 20.00 -

TOTAL 120.00 100.00 -

Critics already have their say: This Fund is too small, and it is still in USD!

The Tobin Tax:

There is now a growing renewed interest to implement a "Tobin Tax" in many countries, as a measure of a truly global reform that is urgently needed if we are ever to contain and overcome the current global financial crisis.

Named after the US economist James Tobin who first propounded this idea, the tax is intended to put a penalty on short-teerm speculation on currencies, so that the likes of Soros' making his USD 1.0 billion betting on the Pound Sterling, and the excessive speculation and manipulation of the Thai baht by foreign unregulated hedge fund players culminating in our 1997-1998 Asian Financial Crisis, can be more stringently controlled, and then taxed accordingly.

Global foreign exchange turnover for 2007 is estimated at USD900 trillion - tonnes of paper money! If a Tobin tax of, say 0.005% is imposed on such transactions worldwide, it would yield $45 billion - near equivalent to the US$50 billion pledged for Africa! Imagine if such tax is 1.0%!

A Tobin Tax is a user-pay tax, like a casino gambling tax, and therefore less regressive.

Secondly, such a tax is counter-cyclical, that is, it will increase or decrease depending on the level of speculative fever in any market at any time.

Thirdly, such a tax can help finance the purchase of global public goods for the benefit of the global society.

Fourthly, such a tax will also reduce the excessive profits of financial robber barons like Goldman Sachs, and hence reduce their ability and capacity to pay excessive bonuses (more so when these institutions' 2008 near collapse were saved by Uncle Sam's public US$ trillion generous bailouts!), which comes about through using excessive risk-taking decisions - win all mine, lost all yours!

Thus, in the end, it is not China that is "Disconnect" as Krugman wants to put it - the Fault, Dear Brutus - is firstly the Great US of A itself spending its way to bankruptcy and blaming everyone else, and the resultant US$' weak position as the international RC. The Buck or the "Disconnect" Stops at Obama and he has to put his own house in order before crying "Wolf" too many times!

Eu Ming.






On Wed, Jan 6, 2010 at 7:14 AM, Alan McPhate wrote:
Hi Ming,
Thank you for your humorous comments and your political insights.
I would be interested in your reply to Paul Krugman's request that China revalues the YUAN.
He claims that it would be in every-one's interest
Regards
Alan