Tuesday, November 30, 2004

China Tells Currency Speculators to Get Lost:

China Tells Currency Speculators to Get Lost:
William Pesek Jr.

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A further one by Stephen Roach.
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-- The world of currency markets is one of winks, nods and secret handshakes. In it, key policy makers rarely, if ever, say exactly what's on their mind. Chinese Premier Wen Jiabao has done just that and traders should pay close attention.

Wen said, as he often does, that China won't relax the currency's fixed exchange rate to the dollar under pressure from other countries. Yet he went a step further this week, issuing a warning of sorts to currency speculators.

``To be frank, it's not possible to launch changes to the yuan when speculation is so rife,'' he said here in Vientiane, Laos on Sunday. ``Rampant speculative activities on the yuan,'' he added, will make the introduction of any measures ``impossible.''

In other words, traders who test China's resolve may only delay a change in its currency peg. It means that the more investment banks churn out reports predicting yuan revaluations -- and the more speculators react to them -- the longer the process may play out.

Reality, Not Playbook
Wen isn't reading from the playbook of Mahathir Mohammad, the former Malaysian prime minister who infamously did battle with speculators during the 1997-1998 Asian crisis. Wen's comments were less of a threat than an admission of reality.

China understands how much the world wants it to let the yuan rise. Its officials also know it would be a powerful goodwill gesture that would reap political benefits in capitals all over the globe.

Yet China's economy isn't ready for a currency shift, and debt has much to do with it. The four biggest commercial banks in Asia's No. 2 economy are shackled with untold numbers of bad loans, putting its financial system in a highly fragile state.

Standard & Poor's thinks it would cost $656 billion to resolve bad loans at China's banks, though some analysts say the figure is probably much higher. Repairs are indeed under way, though not as fast as credit-rating companies would like.

Bad Loans
In January, China began using tens of billions of dollars of foreign exchange reserves to bail out lenders, and it's been pressuring bank executives to dispose of bad loans. More recently, it set new rules designed to make it easier for overseas investors to buy the more than $450 billion of bad loans held by China's four biggest commercial banks and their asset management companies.

Yet it's a work in progress. The last thing China wants is currency instability for the first time since 1995, when it pegged the yuan. While it's important that China reduce its currency advantage to restore a bit of equilibrium in global trade trends - - and placate the U.S. and Japan -- it's more important that it does it right.

China, Wen said, needs ``a stable macroeconomic environment, a normal market mechanism and a healthy financial system'' before it alters the peg. ``China needs to consider impact of the yuan on China and on the region.''

That's little comfort to Asian governments struggling to adjust to the dollar's 5.2 percent drop against the euro and 4.1 percent slide against the yen this year. As the dollar falls, China grows even more competitive in Asia. The trend threatens the export industries of the 10 members of the Association of Southeast Asian Nations, or Asean.

A Harbinger?
The good news is that this week's Asean meeting here in Vientiane may be a harbinger of Asian governments looking past China's dollar peg and letting currencies rise.

``We have to live with the fact that there will be a weaker U.S. dollar next year,'' Indonesian Trade Minister Mari Pangestu said in an interview. ``I don't think Indonesia should depreciate its currency to maintain its export competitiveness.''

Since Indonesia is by far Southeast Asia's biggest economy, such thinking shouldn't be dismissed. Japan also has shocked currency traders in recent weeks by doing nothing as the yen surged against the dollar. South Korea, which, like Japan, tends to manage its currency closely, also has been more tolerant of the rising won.

Sign of Confidence
It's an important step for this region -- a sign of confidence that may attract more foreign capital and lower bond yields. It will encourage economies and companies to reform instead of relying on cheap exchange rates as a crutch. And letting the dollar fall may be necessary to get record U.S. budget and current-account deficits under control.

A Chinese revaluation has been thought to be the key to getting Asians to let their currencies rise. Yet Japan's is by far Asia's biggest economy; only when Tokyo lets markets set the yen's value will China and others follow suit. If Japan does in fact allow the yen to appreciate, China may feel more comfortable taking a similar step.

Last week, analysts at Bank of America Corp. and Merrill Lynch & Co. made headlines predicting China may relax its 8.3 peg to the dollar by April to slow inflation and cool economic growth. That's probably wishful thinking, as Chinese officials are suggesting these days. Speculators might want to keep that in mind and trade accordingly.


75 comments:

Northwestern Economist said...

Hello, Gil--

I'm really glad you're keeping tabs on Wen Jiabao; I remember when Zhu Rongji was PM and I was constantly kicking myself because because I would overlook important clues that he let slip. Since '99, the PRC President and CCP Gen Secr'y have usually been the same person so the PM has been a little more circumspect.

Still, I think PM Wen is speaking in code. Speculation is always rife. Also, I don't think the currency markets for the renminbi offer enough "strategic depth" (to borrow a term of military art) to mount the sort of massive attack like Soros' on the UK pound a few years back.

One problem with China's compartmentalized economy--which reminds me at times of 26 Malawis welded to 1 Greater HK--I mean Guangzhou and Shenzen, obviously--and 4 South Koreas--is that there is an enterprise governance regime to suit every ideological extreme. I imagine if Adam Smith and Karl Polanyi were hired by Beijing as consultants to reform the country's economy, they would agree on tons of things, chief among them that the internal walls need to come down first and provisions have to be made for endemic misery when they do.

I think this would, however, lead to an increase in domestic Chinese demand for Chinese goods, which is the thing lacking from China's "miracle."

Respectfully,

JRM

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