RGE’s Wednesday Note: Still No Tightening in China

A credit-fueled investment boom successfully boosted China’s growth to 8.7% in 2009, but cheap money drove up asset prices as well, especially in property markets. As China’s output gap closes, loose money is now set to become inflationary, particularly if China’s potential growth rate has come down slightly, as RGE thinks it has. The People’s Bank of China (PBoC) has twice hiked banks’ required reserve ratios (RRR) in 2010, following a return to net liquidity reductions through open-market operations in October 2009, but RGE suspects that the tightening moves have had little effect. As discussed in a recent RGE analysis, “China: No Exit,” which is available exclusively for RGE clients, China’s monetary policy has shifted toward a neutral stance in recent months, but it will have to tighten further if inflation and the property bubble are to be contained.

China has not yet started to tighten liquidity significantly, nor has it laid out a clear path for its exit from the extraordinarily loose monetary conditions put in place at the end of 2008. The recent RRR hike, which comes into effect on February 25, will drain just over RMB300 billion in liquidity, but in the first two weeks of February, the PBoC injected a net RMB508 billion into the banking system through open-market operations to ensure banks had enough cash on hand for last week’s Chinese New Year holiday. It is widely expected that the bank will drain this liquidity after the holiday, and the RMB300 billion withdrawn through the RRR hike will prove helpful but insufficient in this effort. Tuesday’s RMB17 billion one-year bill sale suggests that the central bank may be waiting to see the effect of the RRR hike before moving to a more aggressive tightening stance. It will be difficult, however, for the central bank to tighten very much, even if it had the political backing to do so.

Other sources of liquidity make this task harder. There are RMB1.2 trillion in central bank bills and repurchase agreements set to expire in the next two months. In March alone, RMB680 billion in bills will expire, more than double the RMB290 billion monthly average over the past four months. Banks are already thought to be holding about 1.5% of deposits in additional excess reserves at the PBoC, dulling the impact of the RRR hike even further.

The political will to tighten monetary conditions looks weak in China, particularly concerning any appreciation of the RMB. On Monday, President Hu Jintao headed a Politburo meeting on economic issues that reiterated the “active” fiscal and “moderately loose” monetary policies put in place at the end of 2008. On March 5, Premier Wen Jiabao will present the government’s work plan to the National People’s Congress (nominally China’s highest government authority), likely reiterating this stance.

Still, RGE expects the gradual tightening of monetary policy will continue in the coming weeks and months. Rising inflationary pressures are likely to push China’s policymakers to tighten monetary conditions in Q2. This will cause some pain to important interest groups this year, and in RGE’s view, policymakers will look to distribute the pain, including allowing higher consumer inflation.

Credit is likely to be tightened only moderately, through administrative controls and higher interest rates, as significant tightening could spark a large jump in non-performing loans. As highlighted in the Q1 2010 outlook for China, quasi-official municipal and development companies will soak up a greater portion of lending in 2010, which will lead to tighter conditions for all other borrowers. Small- and medium-sized enterprises would be hit the hardest, but even state-owned enterprises would be forced to tap their retained earnings to cover their financing needs, which could push them out of the market for levered bets on property price increases.

Thus, RGE expects lending to grow by around 20%, slower than the 30% in 2009 but still reaching slightly above the RMB7.5 billion targeted by regulators. Interest rates should be hiked modestly over the year, as early as Q2, and the RRR has at least another 100 bps or so to climb. These moves would let some of the air out of the property market, though probably avert a collapse, and would lead to a slowdown in investment growth. In order for this strategy to work, however, renminbi (RMB) appreciation will have to contribute to containing inflation.

Exporters, and their political backers, are the main source of domestic opposition to RMB appreciation. The Commerce Ministry has made Premier Wen’s tirades against currency appreciation look polite by comparison. The RMB’s relative strength against the euro, a result of re-pegging to the USD, and concerns about hot money inflows also will dampen China’s enthusiasm for using RMB appreciation to contain inflationary pressures. As such, RGE expects only modest RMB appreciation in 2010, with a small step-up of maybe 2% coming as early as Q2, and another 3% or so of appreciation to follow at a gradual pace. Assuming that the dollar remains strong on a trade-weighted basis, this move will dampen some of the inflationary pressures from imported goods, but will counteract the credit slowdown’s effect on asset prices.

China thus looks likely to be slow in exiting from its excessively loose monetary conditions, and somewhat higher inflation looks to be the path of least resistance in 2010. With core G3 central bankers set to remain on hold through 2010, Chinese authorities will be reluctant to increase interest rates, even though deposit rates are set to become negative in real terms as early as Q1. Any increase in the interest rate differential with the U.S. could further increase the attractiveness of investing in China, putting yet more pressure on China’s capital account. Should it want to limit the pace of appreciation, China might not only strengthen the implementation of its existing capital controls, as it has been doing for some time, but could also impose new controls on inflows.

Still, given the role that inflation has played in past episodes of political unrest, policymakers should move to rein in inflation once it surpasses 3% y/y growth for a couple of months. RGE expects the measures outlined above to halt inflation’s upward climb around July, when it will exceed 4% y/y. As RGE argued in “The People’s Bank of China and the Road Not Taken,” the Chinese monetary exit strategy could add to volatility in global asset markets, particularly of commodities, given the role that China has played in supporting Asian exports and its commodity dem
. A reduction in Chinese liquidity should reduce speculative demand for base metals.

All rights reserved, Roubini Global Economics, LLC. Opinions expressed on RGE EconoMonitors are those of individual analysts and may or may not express RGE’s own consensus view. RGE is not a certified investment advisory service and aims to create an intellectual framework for informed financial decisions by its clients.

0 Responses to "RGE’s Wednesday Note: Still No Tightening in China"

  1. Greg   February 24, 2010 at 7:35 pm


  2. JLarkin   February 25, 2010 at 1:45 pm

    This sounds like China is facing the same liquidity trap as the USA. Choose between inflation or tightening & recession. Wouldn’t the odds be good that they will choose inflation, i.e. not really tighten much? Citizens may grumble about inflation, but they will riot if too many jobs are lost, or if the stock market crashes.

  3. PeterJB   February 25, 2010 at 5:08 pm

    The Good news:A Global socio-economic Collapse, if the form of a social Dark Age for the West, demographically speaking, is rapidly accelerating to a corner, near ————————>>> You, but it hasn’t arrived ——->> Yet and all this while “leadership”, that consensual collective of posing and pretending incompetent morons and know-nothings, rush around making everything far worse than necessary, and trying to convince everybody else that we are neither human beings, a superior life form and capable of creative thought, er , like themselves.The Bad News:When the hard part of this accelerating force impacts the Global Community, ably assisted by the morons and incompetents of “leadership”, the realities, er, in the form of horrible pain and torment, indescribable, will be fused into the Western populace, never to forgotten throughout the continuity of written history, yet to come.The Fear:The greatest fear to life itself, the planet and perhaps even the Solar System and the Galaxy, if not the Universe, is that the “morons-in-charge”, that is, “leadership” will again, default to WAR, Full Nuclear War (notice the share price of this industry?) in order to secure their tenure of “faith-based” belief, and its imposition onto others, as “leadership” over the general masses.Applied “Ignorance” now reigns supreme throughout the Western World with this hysteria being frantically fuelled by the fools of the incompetent and irresponsible MSM and believed by the unfortunates of those who have nothing but faith and who will feel the full blunt of the pain of pure and utter ignorance.I say to you: War in any form is NOT an Option!It is time to realize our humanity. It is time for Man, the Heretic!You mileage will, er, undoubtedly… vary. It comes!The Project for the New American Century, PNAC, is totally wrong and totally invalid, being an absurd tribute to insanity alone, and was penned by morons, irresponsible fools and crazed know-nothing pseudo-intellectuals who would be far better off being contained and incarcerated in institutions for lunatics, the demented/deranged and mentally challenged where they could benefit from compassionate help and assisted by those skilled in the cures for neurological insanity, rather than being placed in position of influence and worshipped and academic Gods, and running the affairs socio-economic of the World, and, our lives!Alice in Wonderland predicted the current scenario where nothing makes any sense ——————————————>>> at all.It is time for tea.Ho hum

  4. blindman   February 25, 2010 at 11:09 pm

    my initial comments from the dark valley of the learning curve…..rebooted, in the mix, reminders for further wonder – ings…. ( dream..time ) ancestors and brotherhood digested inthe “belly” of the python. ( brothers share a common “time” /breathing and digestion. )note: i have been told that if you ever consider gettinga pet python as company / companionship for your new born,or infant, that you must be careful*. normally the python willsleep in a coiled position. if it begins to rest straight,not coiled, this could mean it is sizing up your infant fora snack, and pythons can grow deceptively quickly. even fasterthan your toddler!.not to be read as a judgment against all forms of companionshipor husbandry, pet ownership, in general. yes, someone has actuallyappreciated / had to receive / this warning from a concerned friend. orso i have heard. anyway.. varying growth rates and commensally incompatible naturalsignatures call for caution, at least, if not direct intervention.!.*”careful” only if your “primary” concern is the life of the infant.if feeding the python is the concern then caution / intervention is not required. it will feed itself..@ pjb.”http://verbewarp.blogspot.com/2006/03/warning-to-ea­s­t­.­h­t­m­l”time” only exists as the innate temporal nature of each life phenomena or that current sustainable simplicity which has arisen out of unknown complicit complexity. All contenders to “time” today are false-pretenders as well as false prophets, which badly impacts our will to build our civilizations in permanent states. It depicts our infancy in matter scientific as well as clearly indicates our immaturity if affairs of the serious nature.IOW, there are perhaps maybe, only a few, out of 7 billion persons on this planet, that even begin to comprehend just what “time” is and what this means.”..http://www.henryckliu.com/page214.html.part one. comprehension and appreciation of what “time” is.perhaps “is” is the misleading / wrong word here implyingdiscrete and contained existence? implying that we cancom-modify and exchange and posses “it”. i don’t know.spend “it”. use “it”. ..wisely, so we will have more of it?energy / time / matter in space…? money / time / money ..? ha. time, elementally derivative / conceptually elemental. likemoney, hehe…part two. implications and what it means in relation to””time” only exists as the innate temporal nature of each life phenomena or that current sustainable simplicity which has arisen out of unknown complicit complexity.”.part three. the center. internalized and held. ego, theater,projection, illusion and “unknown complicit complexity”. imagination, analogy, etc… language. and voices of varyingcredibility. madness as in the mad hatter, his structure andits foundation? his timepiece. ….? rolex? hehehe….Financialization of the Global EconomyFinancialization of the deregulated global economy through excessive debt and structured finance speculation supported by fiat dollar hegemony has detached asset values from underlying economic fundamentals to form financial bubbles. The adverse effects of this type of globalization on the developing economies are obvious. It robs the people of the meager fruits of their exports and keeps their domestic economies starved for capital, as all surplus dollars from export must be re-invested in US sovereign debt instruments to prevent the collapse of their own domestic currencies.The adverse effects of this type of globalization on the US economy are also becoming clear. In order to act as consumer of last resort for the whole world, the US economy has been pushed into serial debt bubbles fueled by unsustainable over-consumption and fraudulent accounting. The unsustainable and irrational rise of US equity prices, unsupported by revenue or profit, had merely been a devaluation of the dollar. Ironically, periodic adjustments in US equity prices, known to the public as market crashes, merely reflect a trend to return to a stronger dollar, as it can buy more deflated shares.Overcapacity Caused by Wage StagnationThe world economy, through technological progress and deregulated markets, has entered a stage of overcapacity in which the management of aggregate demand is the obvious solution. Yet we have a situation in which the people producing the goods cannot afford to buy them and the people unfairly receiving the profit from goods production cannot consume more of these goods. The size of the US market, large as it is, is insufficient to absorb the continuous growth of the world’s new productive power in the emerging economies.For the world economy to grow, the whole population of the world needs to be allowed to participate with its fair share of consumption. Yet neoliberal economists and monetarist policymakers continue to view full employment and rising fair wages as the direct cause of undesirable inflation, which is deemed a threat to sound money.Demonizing China is not a Policy OptionProfessor Krugman should know that demonizing China for its monetary policy, which under dollar hegemony is fundamentally a reactive derivative response to of US monetary policy, serve no useful purpose. Instead of pushing China to revalue the exchange value of its currency upward, he should be pushing both China and the US to raise domestic wages aggressively. Until US workers doing the same work are not paid more than their Chinese counterparts, US-China trade cannot be balanced. The preferred solution is for Chinese wages to increase at a faster rate than US wages and not for US wages to decrease. Cooperation on the front is urgently needed in US-China bilateral trade talks.Trade Needs Not to be a Zero Sum GameMercantilism is a trade theory that assumes international trade to be a zero-sum game. In such as game, a trading nation’s prosperity is dependent on increasing its procession of capital in the form of gold through trade surplus denominated in specie money. The theory has since been invalidated first by Adam Smith’s trade theory of absolute advantage and later by Richardo’s trade theory of comparative advantage.Adam Smith (1723-1780) argues that a country should produce and export commodities for which it has an absolute advantage and import commodities from countries that have absolute advantage in producing other commodities. Such terms of trade will benefit both trading partners by expanding both economies. Protectionism works against such mutual benefits.The theory of comparative advantage as espoused by British economist David Ricardo (1772-1823) asserts that trade can benefit all participating nations, even those who command no absolute advantage, because such nations can still benefit from specializing in producing products with the lowest opportunity cost, which is measured by how much production of another good needs to be reduced to increase production by one additional unit of that good.Ricardo’s theory reflected British national opinion in the 19th century when free trade benefited Britain more than its trade partners. However, in today’s globalized trade when factors of production such as capital, credit, technology, management, information, branding, distribution and sales are mobile across national borders and can generate profit much greater than manufacturing, the theory of comparative advantage has a hard time holding up against measurable data.Today, in a global financial market operating under fiat dollar hegemony, the world’s interlinked economies no longer trade to capture Ricardian comparative advantage, only to capture fiat dollars to service their fiat dollar debts.Mercantilism not possible under Do
    llar HegemonyMercantilism cannot be pursued by any nation in a world trade regime denominated in fiat dollars which has not be backed by gold or other species since President Nixon took the dollar off gold in 1971. Dollar hegemony is a geopolitically-constructed peculiarity through which critical commodities, the most notable being oil, are denominated in fiat dollars. The recycling of petro-dollars into other dollar assets is the price the US has extracted from oil-producing countries for US tolerance for the oil-exporting cartel since 1973. After that, everyone accepts dollars because dollars can buy oil, and every economy needs oil. OPEC had no option except to accept payment for oil in fiat dollars not backed by gold.Oil and Gas ImportsUS consumption has been fairly constant in the past few years. In 2007, about 13.7 million barrels were imports daily and only 5.9 million barrels from OPEC. At $100 a barrel, the aggregate oil bill for the US comes to $2 billion a day, $730 billion a year, about 5.6% of 2007 US gross domestic product (GDP). About 50% of US consumption is imported at a cost of $1 billion a day, or $365 billion a year. Oil and gas import is the single largest component in the US trade deficit, not imports from Japan or China. And unlike low-price import from China, oil import at high oil prices contributed directly to US inflation. This is one of the main reasons why a strong dollar is in the US national interest.Dollar HegemonyDollar hegemony separates the trade value of every currency from direct connection to the productivity of the issuing economy to link it directly to the size of dollar reserves held by the issuing central bank. Dollar hegemony enables the US to own indirectly but essentially the entire global economy by requiring its wealth to be denominated in fiat dollars that the US can print at will with little short-term monetary penalties.World trade is now a game in which the US produces fiat dollars of uncertain exchange value and zero intrinsic value, and the rest of the world produces goods and services that fiat dollars can buy at “market prices” quoted in dollars. Such market prices are no longer based on mark-ups over production costs set by socio-economic conditions in the producing countries. They are kept artificially low to compensate for the effect of overcapacity in the global economy created by a combination of overinvestment and weak demand due to low wages in every economy. Such low market prices in turn push further down already low wages to further cut cost in an unending race to the bottom. Thus China, together with other exporting developing countries, is essentially a victim of global trade under dollar hegemony. If the developing economies could find a way to shift export towards their domestic market, their economies would all be better off.The higher the production volume above market demand, the lower the unit market price of a product must go in order to increase sales volume to keep revenue from falling. Lower market prices require lower production costs which in turn push wages lower. Lower wages in turn further reduces demand. To prevent loss of revenue from falling prices, producers must produce at still higher volume, thus lowering still market prices and wages in a downward spiral.Export economies are forced to compete for market share in the global market by lowering both domestic wages and the exchange rate of their currencies. Lower exchange rates push up the market price of imported commodities which must be compensated by even lower wages in the export sector. The adverse effects of dollar hegemony on wages apply not only to the emerging export economies, but also to the importing US economy because companies will seek higher profit through cross border wage arbitrage. Workers all over the world are oppressed victims of dollar hegemony which turns the labor theory of value up-side-down..Under fiat dollar hegemony, exporting nations compete in global market to capture needed dollars to service dollar-denominated foreign capital and debt, to pay for imported energy, raw material and capital goods, to pay intellectual property fees and information technology fees, all denominated in fiat dollar. Moreover, their central banks must accumulate fiat dollar reserves to ward off speculative attacks on the value of their currencies in world currency markets. The higher the market pressure to devalue a particular currency, the more fiat dollar reserves its central bank must hold. Only the Federal Reserve, the US central bank, is exempt from this pressure to accumulate dollars, because it can issue theoretically unlimited additional dollars at will with monetary immunity. The fiat dollar is merely a Federal Reserve note, no more, no less.Dollar hegemony has created a built-in support for a strong dollar that in turn forces the world’s other central banks to acquire and hold more dollar reserves, making the dollar stronger, fueling a massive global debt bubble denominated in dollars as the US becomes the world’s largest debtor nation. Yet a strong dollar, while viewed by US authorities as in the US national interest, in reality drives the defacement of all fiat currencies that operate as derivative currencies of the dollar, in turn driving the current commodity-led stealth inflation masqueraded as growth as long as wages stay stagnant.When the dollar falls against the euro, it does not mean the euro is rising in purchasing power. It only means the dollar is losing purchasing power faster than the euro. A strong dollar does not always mean high dollar exchange rates. It means only that the dollars will stay firmly anchored as the prime reserve currency for international trade even as it falls in exchange value against other trading currencies from time to time.Structural UnemploymentIn recent decades, central banks of all governments, led by the US Federal Reserve during Alan Greenspan’s watch, had bought economic growth with loose money to feed serial debt bubbles and to contain inflation with “structural unemployment” which has been defined as up to 6% of the work force to keep the labor market from being inflationary. Central banking has mutated from an institution to safeguard the value of money to ensure wages from full employment do not lose purchasing power into one with a perverted mandate to promote and preserve dollar hegemony by releasing debt bubbles denominated in fiat dollars every time the economy falters.Another effect of mercantilism is that the trade deficit countries will face deflation as the gold-backed money supply shrinks. Between 1770 and 1812, European trade exported bullion to pay for goods from Asia, thus reducing the money supply and putting downward pressure on prices and economic activity. This is the reason why inflation was low in the English economy until the Revolutionary and Napoleonic wars when paper money began to circulate widely.Under dollar hegemony, the US put a new wrinkle in this relationship. The US since 1971, with the dollar de-linked from gold, has been able to print additional dollars without inflation because of low-price imports from China while the Chinese trade surplus dollars are reinvested in US capital accounts. The dollar began to lose exchange value in the last two decades since 1987 as the Fed under Greenspan began to print more dollars than low-price Chinese imports could neutralize their inflationary effect. This was the cause of the recurring debt bubbles that burst every decade: the 1987 crash, the 1997 Asian financial crisis and the 2007 debt crisis.

  5. PeterJB   February 26, 2010 at 12:13 am

    Speaking of Predictions, Vital Clues and the Next Sovereign Crisis:”To conclude, our team suggests a game to convince those who seek where the next sovereign debt crisis will surface: simply look for those states which have called upon Goldman Sachs’ services in the last few years and you will have a serious lead (21)!”http://www.leap2020.eu/GEAB-N-42-is-available!-Second-half-of-2010-Sudden-intensification-of-the-global-systemic-crisis-Strengthening-of-five_a4294.htmlKeywords: Incompetence | stupidity | sub-human | “leadership” |Ho hum

    • blindman   February 26, 2010 at 9:05 am

      pjb,also , another clue. those “sovereigns” that spend,contract, employ and other wise invest in systems, structuresand functions that produce nothing of value to furtherthe survival and development, evolution and growth, of thepopulations. things that are very costly but merelydestroy property and people, inside and out. so the connection or series..large sums of money or credit —- intermediary financialservice / device ——- military expenditure and “investment”—- sovereign debt crisis. result..overcapacity of weapons , shortage of food and ingrained ways and means , infrastructure,dictating furtherance of this ignorant self inflicted imbalance. paranoia and self loathing..and , of course, everyone’s credit is shot as they have proved by prior investment activity that they are irresponsible by virtue of merely participating in the “economy” extant, andignorant and undeserving of the power associated with the thing, ie credit. as credit is the source of the problem orthe miss allocation of credit is..ps. i don’t wear a watch. never have. but i can always tellwhat time it is. seldom necessary and here, there are timeindicators / signifiers everywhere. i do my best to disregardor tolerate or , god forbid … overcome. ?so it is man’s internal clock that is the issue of concern?”the time of man…but life is for learning.”….joni mitchel . “woodstock”question: does rolex make a fine pocket watch? if i neededsuch a thing that would be sweet.http://cgi.ebay.com/Old-key-wind-pocket-watch-compass-in-the-movement_W0QQitemZ270533013385QQcategoryZ398QQcmdZViewItemQQ_trksidZp4340.m8QQ_trkparmsZalgo%3DMW%26its%3DC%26itu%3DUCC%26otn%3D20%26ps%3D63%26clkid%3D8118907822840816319.http://cgi.ebay.com/ws/eBayISAPI.dll?ViewItem&item=230441521293.hmm.

  6. PeterJB   February 26, 2010 at 12:15 am

    Oh, BTW: @ blindmanMy timepiece is a Rolex: Yes! ;-)> Good GuessHo hum

    • The Alarmist   February 26, 2010 at 3:36 am

      Look a little closer … I bet it is a Rolexx.

    • PeterJB   February 26, 2010 at 4:52 am

      @ The Alarmist:”Nice try, but a good case of Post hoc ergo propter hoc.”Ho hum

  7. PeterJB   February 26, 2010 at 12:21 am

    A little reality for the Global Warming fanatics and faith-based true-believers:Everyone knows the Ice Age was a time when the Earth cooled, glaciers moved down from the North, and the mammoths froze. However, everyone is mistaken.Lands in the Arctic get little precipitation, and a mile or more of ice is a lot of water. Before it can fall as snow, it has to evaporate from the ocean and be transported. John Tyndall, a prominent British physicist, realized in 1883 that a mountain of ice in the North requires a lot of energy everywhere else, which means heat. An ice age requires not a cooler climate but a warmer one with a cold spot where the ice is.Ring of Ice – Ring of Firehttp://www.thunderbolts.info/tpod/00current.htmHo hum

    • The Alarmist   February 26, 2010 at 3:39 am

      Nice try, but a good case of Post hoc ergo propter hoc.There would still be plenty of moisture in the atmosphere in absence of warming elsewhere.

  8. PeterJB   February 26, 2010 at 8:42 am

    Remember the Greeks? You know, those that the Egyptians had to save their economic vagaries, (read: asses) er, several times, during times gone bye (:):>]”Meanwhile, Papandreou has had the hubris (a good Greek word meaning overwhelming pride) to demand the EU pay Athens’ debts.In mythology, Greek gods destroy those with hubris.”http://www.ericmargolis.com/political_commentaries/pirates-of-the-aegean.aspxAhhh, the “Gods”, er, at last.Ho hum