China's freer yuan brings risk of speculators
By David Barboza The New York Times
SATURDAY, JULY 23, 2005
SHANGHAI A day after China moved to revalue its currency, the country is
bracing for a huge influx of speculative capital as investors bet that the yuan
will continue to appreciate against the dollar.
Economists said Friday that if tens of billions of dollars in speculative
capital, or "hot money," flood into China over the next year, it could disrupt
or overheat an already sizzling economy.
The move by the central bank to revalue its currency and drop its peg to
the dollar was praised by economists as an important step for China as it moved
toward a more market-oriented economy.
But experts say the country now faces a difficult balancing act as it
tries to control the amount of capital that flows in and out of the country,
trying to profit from appreciation of the yuan, which is still widely believed
to be undervalued.
"This is the most important thing for China right now," said Andy Xie of
Morgan Stanley. "China has to be really careful not to encourage hot money to
come in, and not to push it out."
The move Thursday was seen by analysts as an effort by China to appease
its biggest trading partners, many of whom had complained for more than a year
that a weak currency gave it an unfair advantage in global commerce.
But analysts said that in moving toward a more flexible currency system
with only a 2 percent rise in the yuan's value against the dollar, Beijing was
signaling that a larger yuan appreciation was in store for the coming year -
and thereby inadvertently encouraging currency speculators to rush into China.
The huge speculative capital inflows that are being forecast could bring
inflationary pressure and further complicate the Chinese government's effort to
manage the fastest-growing major economy. The Chinese economy expanded by a
stronger-than-expected 9.5 percent in the second quarter of this year. One
measure of the capital coming in is foreign exchange reserves, which now exceed
$711 billion, second only to Japan.
"As long as China's economy continues to grow, there will inevitably be
hot money betting on the value of the currency increasing," said Zhang
Yuncheng, a researcher at the China Institute of Contemporary International
Relations.
Nicholas Lardy, a senior fellow at the Institute for International
Economics, said: "When you have $1 trillion in trade transactions it's very
hard to control that money. They've dodged the bullet so far on inflation. But
if they have more inflows it may be difficult to keep this up."
Some economists say the risks of overheating the economy are overstated,
that the speculative inflows have begun to slow, and that the government has
found new ways to prevent money from entering the country.
"Each year about $50 billion to $60 billion in hot money comes in," said
Frank Gong, chief Greater China economist at J.P. Morgan Chase. "But that only
accounts for 8 percent of fixed-asset investments. That's a small portion. So
the impact on the economy will be small."
Thus far, inflation has been under control, despite the huge increases in
capital flows. Economists say the government has aggressively used banking
measures to "sterilize" the foreign money coming into the country, but they say
that is growing increasingly difficult.
Some of the speculative money entering China is being used to acquire
property and other hard assets; other foreign money has been invested in the
stock market or simply sits in bank accounts awaiting a currency move, experts
say.
The authorities have tried to crack down on the flow, calling some of it
illegal or fake investments controlled by "international speculators."
Much of that money - by some projections more than $300 billion - has
come from overseas during the past few years and piled up in China on the
expectation that a significant currency revaluation would bring easy profits
when converted back into dollars.
Many investors and speculators were betting on a 10 percent to 20 percent
appreciation in the yuan this year, far more than what the bank actually did.
Its move allowed the yuan to appreciate by just over 2 percent, with the dollar
easing to 8.110 yuan from 8.277 yuan.
But most economists are predicting that the authorities will let the yuan
appreciate further this year and that within 12 months the currency could be
worth as much as 10 percent more than it was at the start of this year.
A World Bank study projected that by 2010 a dollar would be worth about
5.80 yuan, reaching 2.80 yuan by 2020.
"If China stokes market expectations that they will move over the next
few months, that will make it even more difficult for them to manage these
flows," Cliff Tan, chief currency and interest rate strategist for Citigroup in
Singapore, said of the speculative money.
Other analysts say speculators have used a variety of complicated methods
to get into China. Some companies overinvest in China, acquiring hard assets,
like property, that can later be sold at a higher profit denominated in the
yuan. Other companies in China arrange to overpay for overseas assets, when in
fact they are simply bringing overseas currency back to China to invest.
Some analysts say that much of the money is coming from Chinese citizens
who "parked" billions of dollars in assets overseas and are now bringing it
home to invest in real estate, start companies or speculate on the currency
move.
"It is certain that there'll be a lot more hot money coming into China,"
said Ding Jianping, a professor of finance at Shanghai University of Finance
and Economics. "Hot money has put huge pressure on the central bank."
Xie at Morgan Stanley says that if too much of that money comes at once,
China's economy will roar. But if the economy slows significantly, a huge
amount of speculative money could flee the country, depressing the economy,
deflating asset prices and creating a scenario similar to the 1997 Asian
financial crisis.
"It's really a fine balance China has to pull off," he said.
"This is what this game is about for China - stability."
++++
Paul Krugman: China unpegs itself
The New York Times
SATURDAY, JULY 23, 2005
PRINCETON, New Jersey Thursday's statement from the People's Bank of
China, announcing that the yuan is no longer pegged to the dollar, was terse
and uninformative - you might say inscrutable. There's a good chance that this
is simply a piece of theater designed to buy a few months' respite from
protectionist pressures in the U.S. Congress.
Nonetheless, it could be the start of a process that will turn the world
economy upside down - or, more accurately, right side up. That is, the free
ride China has been giving America, in which the world's richest economy has
been getting cheap loans from a country that is dynamic but still quite poor,
may be coming to an end.
It's all about which way the capital is flowing.
Capital usually flows from mature, developed economies to less-developed
economies on their way up. For example, a lot of America's growth in the 19th
century was financed by investors from Britain, which was already
industrialized.
A decade ago, before the world financial crisis of 1997-98, capital
movements seemed to fit the historic pattern, as funds flowed from Japan and
Western nations to "emerging markets" in Asia and Latin America. But these days
things are running in reverse: Capital is flowing out of emerging markets,
especially China, and into the United States.
This uphill flow isn't the result of private-sector decisions; it's the
result of official policy. To keep China's currency from rising, the Chinese
government has been buying up huge quantities of dollars and investing the
proceeds in U.S. bonds.
One way to grasp how weird this policy is would be to think about what a
comparable policy would look like in the United States, scaled up to match the
size of our economy. It's as if last year the U.S. government invested $1
trillion of taxpayers' money in low-interest Japanese bonds, and this year
looks set to invest an additional $1.5 trillion the same way.
Some economists think there is a deep rationale for this seemingly
perverse policy. I think it's something the Chinese government stumbled into as
it tried to protect itself from the 1997-98 crisis, and it is reluctant to
change because the Chinese economy has been doing well. That is, China's
leaders don't want to mess with success.
But pressures against China's dollar purchases are building. By keeping
the yuan down, China is feeding a trade surplus that is creating a growing
political backlash in America and Europe. And China, which is still a poor
country, is devoting a lot of resources to the accumulation of a basically
useless pile of dollars instead of to raising living standards.
The question is what happens to us if the Chinese finally decide to stop
acting so strangely.
An end to China's dollar-buying spree would lead to a sharp rise in the
value of the yuan. It would probably also lead to a sharp fall in the value of
the dollar relative to other major currencies, like the yen and the euro, which
the Chinese haven't been buying on the same scale. This would help U.S.
manufacturers by raising their competitors' costs.
But if the Chinese stopped buying all those U.S. bonds, interest rates
would rise. This would be bad news for housing - maybe very bad news, if the
interest rate rise burst the bubble.
In the long run, the economic effects of an end to China's dollar buying
would even out. America would have more industrial workers and fewer real
estate agents, more jobs in Michigan and fewer in Florida, leaving the overall
level of employment pretty much unaffected. But as John Maynard Keynes pointed
out, in the long run we are all dead.
In the short run, some people would win, but others would lose. And I
suspect that the losers would greatly outnumber the winners.
And what about the strategic effects? Right now America is a superpower
living on credit - something I don't think has happened since Philip II ruled
Spain. What will happen to our stature if and when China takes away our credit
card?
This story is still in its early days. On the first day of the new
policy, the yuan rose only 2 percent, not enough to make any noticeable
difference. But one of these days Chinese dollar purchases will trail off, and
we'll find ourselves living in interesting times.
[Non-text portions of this message have been removed]
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Berdikusi dg Santun & Elegan, dg Semangat Persahabatan. Menuju Indonesia yg
Lebih Baik, in Commonality & Shared Destiny. http://www.ppi-india.org
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