Chinese Yuan Rising? -- But What About China?

The Chinese government has already allowed a gradual appreciation of RMB over the next few years.

The rationale behind recent hefty acquisition of China's properties(particularly Shanghai and Beijing) by institutional investors such as Morgan Stanley and Citicorp is due mainly to enormous potential for RMB appreciation.

I like your blog and generally agree with a lot of what you have to say. And you make some decent arguements in this post. However, your point about the potential for China's economy to overheat was off the mark. You contend that the huge population and large numbers seeking jobs will keep inflation in check. Those things may keep WAGE inflation in check, but they cannot and are not keeping raw material inflation in check. Steel, coal, copper, oil, nickel, cement and many other commodities have increased dramatically in price. In some cases by rates exceeding 100% per year. Here on this blog you have noted that China and its banks continue to loan money at what is likley an unsustainable level with hundreds of billions in bad loans already in place.

See posts here: http://snipurl.com/tme4
here: http://www.engagingchina.com/blog/_archives/2006/7/18/2134989.html
and here: http://snipurl.com/tme2

China may indeed be 'talking down' groth strictly for a Western audience, but if these articles are accurate, they are also taking concrete steps to reign things in, while firms themselves are looking to raise their prices.

But dont worry, the (in my view mistaken) assumption you are making about inflation is the same one many in the US (including the Fed)are making about inflation here.....

Thanks for checking in. You make some excellent points. I agree with your facts, but dispute your conclusions.

Here goes:

1. I agree China is anything but immune to commodity price increases and to the extent they are happening and do happen, it raises the cost of goods for China. One of the things we see in our practice is that smaller American companies often fail to account for the fact that the price of commodities in China, including for such things as plastic, is essentially the same as everywhere else in the world. But though rising commodities prices lead to increased inflation, I am less than sure they lead to overheating. Indeed, I could argue that rising commodities prices actually fight against overheating because it raises the cost of goods produced in China, which in turn decreases the number of sales. Also, would not allowing the Yuan to rise just increase the cost of these commodities for Chinese companies, at least in Yuan terms? Commodities prices have already zoomed without any overheating. Why then do you see overheating as inevitable now?

2. I do not recall writing about China continuing to lend at unsustainable levels. I have written about Chinese bad loans and how the extent of those loans is probably higher than the official numbers. I have also written about how Chinese banks lend mostly to state owned companies. I see the banks continuing to lend to state owned enterprises and I do think far too many of those loans have little to no basis in commercial reality. I tend to believe that loaning money to a state owned business to produce more product that the market does not really want would help lead to overheating, but I certainly do not think this is in any way sufficient. If it were sufficient, why has overheating not yet occurred?

3. You cite to the proposed new law (which by all accounts is going to be passed very soon) attempting to slow down real estate prices as proof that the government is serious about slowing down growth. I disagree and actually see this as proving the opposite. The Chinese government is clamping down on foreign investment in real estate and is doing so because it is good politics. The government is concerned here with housing affordability in certain cities and blaming it on the foreigners is good politics. A concern about housing affordability is not the same as a concern about an overheating economy. If rapid and steady increases in real estate prices in places like Shanghai equals overheating throughout China, does this mean that the rapid and steady increases in real estate prices in Seattle, Los Angeles, and San Francisco presage an overheating of the U.S. economy? And again, when does real estate appreciation lead to overheating and why if it does has it not yet occurred?

4. I agree that China's huge pool of workers will keep wages in check is not the same thing as keeping overall inflation in check. But are not wage rates a key driver of inflation and if wages are not rising, does not big time inflation becomes less likely?

5. I like your analogy to the United States because it prompts me to wonder if governments anywhere are ever willing to bear the political heat necessary to slow down an economy when almost all of the non-economists out there (obviously including yours truly) are so enamored with growth. Is not slowing down an economy always bad politics?

6. You keep talking about inflation as though it is the equivalent of overheating. Is it?

I liked the issues raised by your comment so much that I used it in my most recent post.

Certainly some interesting comments on this blog. You seem, however, to conflate several issues that have correlation but not causation.

1) The Chinese government wants growth. Fair enough. But all growth is not equal, with some forms being more sustainable than others.
China's current growth is driven by enormously high levels of investment (funded by savings at the individual and corporate level) and reliance on exports.

So the real question is not whether China wants "growth" but the type of growth it wants and can ultimately sustain. A more balanced growth based on increased consumption, reduced savings and hopefully more balanced net exports would be ideal. None of this is happening without a revaluation, but unbalanced growth in itself can actually cause more problems over the long-term.

2) You imply the relationship:

Economic growth will lead to a reduction in the 87,000 protests. Not according to basic economic theory, in fact, unless China is currently at the highest point of income inequality (as measured by the Gini Coefficient) accelerated economic growth is actually going to lead to more protests as inequality widens, economic externalities increase, and the inability of local governments to deal with protestors complaints decreases. Once again it�s not only growth (in aggregate) that matters but also the type of growth. Your argument only makes sense if you assume that China is already at the zenith of inequality (which it isn�t) and that China�s bureaucratic can adequately distribute wealth (which it can�t). Indeed, many of those protests were a direct result of China�s economic growth model (i.e., pollution and corruption) and such protests aren�t likely to decrease.

Your connection between 87,000 protests and students not having work is also not clear. Students not having work seem to be a consequence of an emerging and not yet robust service sector. This transformation will only happen as China moves out the current economic model and moves up the value added scale to a bigger sector. Yuan revaluation would actually help this goal, by making cheap exports more expensive it would force China up the development ladder.

3) Is the Chinese economy overheating? Signs say that it is probably is, and Chinese inflation statistics 1) probably aren�t accurate with their determined by their basket of goods. A point has already been made that wage inflation is not the same as inflation in general with many different inputs determining the final number. China also has extensive price controls where they can selectively inject inflation.

Ultimately, therefore, I don�t think this is outside powers forcing China to slow growth, if China doesn�t slow growth with their limited monetary tools they consequence could be far greater than a blip in economic growth.

"China's economy is booming. Wildly. That cannot be disputed. I actually think it is growing much faster even than the official statistics indicate." - I have to agree with this statement. China's growth seems to surpass their own expectation and though its a good thing, there might also be consequences of such situation.