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Let's Hope Tension With China Won't Boil Over

Wednesday, 21 July 2010 01:23 PM Current | Bio | Archive

While most investor attention will be focused on what Federal Reserve Chairman Ben Bernanke is going to say when he presents the central bank’s semiannual report on monetary policy to Congress and what will (and won’t) come out of the 91 European bank stress tests, it’s also important to look for hints of where “global growth” could go from here.

And Chinese authorities are now clearly signaling they expect a slowdown in the second half of the year.

It’s interesting to note that so far this year we have seen a marked slowdown in the pace of Chinese Foreign Exchange reserve growth.

Moreover, with authorities like Xia Bin, an adviser to the People's Bank of China, estimating growth in China will likely slow down by two to three percentage points while, so far at least, the Shanghai Composite has only been able to put in the shakiest of recoveries, it cannot be ruled out that this state of affairs in China could persist for many months to come.

Indeed, recent comments from the State Administration of Foreign Exchange (SAFE) suggest that the authorities believe much the same thing.

In this context, in an interview with Japanese newspaper the Asahi Shimbun, Zhou Qiren, a key member of the Chinese Monetary Policy Committee, an advisory body to the People's Bank of China caught my attention.

He said bluntly that if China's export “juggernaut falters,” the country's central bank will allow its renminbi currency (yuan) to fall against the U.S. dollar, thereby making Chinese goods cheaper overseas.

“Now that there is flexibility in the renminbi (yuan), the exchange rate of the currency will decline if it becomes necessary to support exports,” he said.

“China's exports have declined drastically since summer 2008. But we can't really take issue with the government because it was concerned about how the fall in exports would affect the employment situation,” he said.

“Partly due to the effects of the fixed exchange rate, China's growth rate did not decline drastically. But money accumulated in the domestic market, and real estate prices rose as a consequence. The readiness of export-oriented companies to deal with the changed industrial structure has waned.”

He also says that “high economic growth like this was not necessary.
We should have maintained the quality of economic growth.”

Food for thought, isn’t it?

We could expect Chinese growth to slow more than most investors anticipate for the moment and, in case this occurs, that could rapidly become a major issue with far-reaching consequences for the world as well as for world trade (commodity prices).

Yes, when looking at the numbers at stake, the rate of growth in China will continue to become more important by the day and for a very long time to come.

In this context, recent Goldman Sachs data show a mindboggling incremental GDP growth in China of $7.5 trillion dollars during the next decade, which is about double the expected GDP growth in the United States together with the other three BRIC countries, India, Brazil and Russia.

By the way, Goldman Sachs also expects that this decade, India, Brazil and Russia will generate as much growth as the U.S.

Whether all this will occur in a straight line going forward is another question.

Amid the possible decline in yuan demand and warnings from the Commerce Ministry that it will monitor the performance of exporters during the second half, hopes of seeing the yuan appreciate steadily are starting to fade, which will not please the United States.

After that “relative small” positive move after the de facto de-pegging of the yuan from the dollar in June, the dollar/yuan exchange rate appears to have re-entered a very well-defined range.

It is a fact that the recent Chinese currency’s exchange rate to the dollar is barely unchanged from where it was 10 days ago despite the dramatic movements we have seen elsewhere in the currency markets.

This comes amid reports that the People's Bank of China is using transactions by state-owned banks to adjust supply and demand for dollars on a regular basis.

Will we see renewed frictions?

For now, that is completely impossible to know.

However, what seems clear is that we have not simply gone back to the 2005/2008 Chinese currency policy when authorities allowed the yuan to appreciate a little bit each day.

It remains to be seen if this will help to curb hot money flows even further. It might be good to recall that Chinese foreign-exchange reserve growth picked up sharply between 2005 and 2008.

If the Chinese will not repeat their 2005/2008 currency policy, then their actual behavior could cause renewed tensions between the U.S. and China.

Let’s hope it doesn’t have to turn out like that.

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While most investor attention will be focused on what Federal Reserve Chairman Ben Bernanke is going to say when he presents the central bank s semiannual report on monetary policy to Congress and what will (and won t) come out of the 91 European bank stress tests,it s also...
Wednesday, 21 July 2010 01:23 PM
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