RMB appreciation is going to slow temporarily

The very authoritative People’s Daily had a widely discussed front-page article yesterday calling for policy-makers to do the necessary to prevent the economy from slowing down.  It implicitly criticized the anti-inflation policies of the PBoC by arguing that “The current performance of the economy is sending us a warning signal: when we fight inflation, we should prevent stagflation and an economic hard landing.  Curbing inflation should not be at the expense of economic development.”

The PBoC is fighting back.  Vice-governor Su Ning insisted in a speech yesterday that “the economy in the first half developed smoothly in accordance with the macroeconomic controls put in place at the start of the year.”  They continue to argue for RMB appreciation, although I get the impression that the failure of inflation to come down has made them less eager to stress the importance of a rising RMB in combating inflation.  I think they are right and wrong – RMB appreciation is necessary to fight inflation, but only because it will eventually permit them to regain control of monetary policy.  However a more or less rapid appreciation has an impact on money inflows that in the short term seriously undermines monetary policy.  This won’t work until they get to the end-point, and the sooner the better.

The fighting between the two factions seems to be getting increasingly fierce, although it seems that the pro-growth camp currently has the upper hand.  The Ministry of Commerce has traditionally been wary of RMB appreciation because of its strong relationship with exporters, especially in the South, and there are rumors that they submitted an internal report to the State council calling for a slowdown in the rate of appreciation.  According to Xinxin Li of Observatory group:

The MofCom seems to have many allies.  Within the cabinet, the powerful National Development and Reform Committee (NDRC), the Ministry of Finance (MoF) and the Custom Authority all view the current appreciation pace as too fast.  At the local government level, provincial officials unanimously complained about the negative impact of RMB appreciation.  These complaints have made a strong impression on Beijing’s top leaders in their recent fact-finding missions to the East seaboard provinces.   

One of the things that struck me was the different ways in which China Daily and the People’s Daily discussed the results of Friday’s meeting of the Central Committee Politburo, headed by Hu Jintao.  The China Daily started its article (“Controlling inflation remains the top priority”) by saying:

Party leaders on Friday named curbing inflation as the nation’s economic priority for the remainder of this year, while also ensuring steady growth with macro-control measures. 

Meanwhile the People’s Daily started its article (“Maintaining steady, fast economic development remains top agenda”) by saying:

The Political Bureau of the Communist Party of China (CPC) Central Committee said on Friday it would continue to put maintaining a steady and fast economic development and stabilizing basic prices at the top of its agenda for macroeconomic control in the second half of 2008. 

Perhaps they each attended different meetings, although the China Daily report did quote Zhao Xijun, a finance professor at Renmin University, as saying “The meeting conveys an important message that concern about economic slowdown is picking up. The decision-makers are now also preparing precautionary measures for a drastic slide instead of just overheating at the beginning of the year.”  Later on in the article they did cite Zhao again as saying: “China will still face serious challenges in terms of inflation. The surging producer price index and the possible resurgence in food prices mean policymakers have to keep a close watch on the consumer price index.”

I think, and I suspect I am not in a minority here at all, that concerns about slowing growth and the yelping from southern exporters means that it is going to be hard for the central leadership to resist pressure for a slowdown in the RMB’s appreciation.  The old – and badly conceptualized – argument, that an appreciating RMB would slow inflation by directly reducing the prices of imports, has been seriously discredited.  This is not at all surprising, in my opinion, since the inflationary effect of the currency was never on direct pricing, but rather on monetary policy.  The more correct argument in favor of appreciation – again, in my opinion of course – is that we need a rapid rise in the RMB (probably in the form of a maxi-revaluation) to slow hot money inflows or else domestic monetary expansion will continue.  This argument has been made several times by some of the think tanks and policy advisors, but I do not think it has been made very forcefully.

What will make it easier for the growth camp to argue for a slowing rate of RMB appreciation is that the improving trade balance with the US probably means that there will be less US pressure on adjusting the currency.  The bulk of the adjustment is being made by Europe, and although they are starting to complain seriously, I don’t think the Chinese really care what Europe thinks.  Europeans rarely speak with a single voice and they seem largely incapable of exerting any real pressure.

Here is my prediction: 

  1. The appreciation of the RMB will slow for the next few months.
  2. Hot money inflows will also slow, as will the pace of reserve accumulation, but the latter will continue at last year’s breakneck pace.
  3. After declining slightly in May, June, July and maybe even August, inflation will start to accelerate again by the end of the years as the huge money expansion from the end of 2007 and the first half of 2008 kicks in.
  4. With rising inflation the monetary camp around the PBoC will become increasing powerful as the debate shifts back in their favor, and perhaps we will even see a more rapid RMB appreciation pace (with all the attendant hot money evils), until at some point either very high inflation or a maxi-revaluation stops the game. 

In the mean time we are going to see continued attempts to exert administrative control over rising prices.  I don’t think these are going to be successful because inflation in China is a monetary problem, but policy-makers here have an instinctive preference for administrative measures over market measures.  On that note Greg Mankiw posts an excerpt from pretty funny WSJ article on his blog.

Venezuelan Agriculture Minister Elias Jaua asked consumers to start bargaining over prices with retailers to try to curb inflation.  “The most important help that people can give us (in fighting inflation) is that they defend their income. We can’t get used to buying everything at any price,” Jaua told reporters. “If we all start haggling over prices, speculators are going to start feeling pressured,” Jaua said. 

So the best way, in Venezuela anyway, to fight inflation is to haggle more.  Mankiw also makes a reference to the WIN buttons (“Whip Inflation Now”) that Gerald Ford used to prefer as his own inflation-fighting policy in the 1970s.  Alan Greenspan’s comment when he first heard of the WIN campaign was “This is unbelievably stupid”.  Probably true – at any rate the WIN campaign (and Nixon’s earlier price controls) didn’t work.

I am sure there is no comparison, but these do sound a little like the regular public exhortations here in China to expose and prevent hoarding and speculation.  But, according to the current Caijing (in an excellent article called “Rethinking China’s Tight Monetary Policy”), “the smuggling of crude oil and oil products out of China is on the rise, encouraged by Chinese price controls.”  If the problem is monetary policy, haggling, wearing nifty buttons and jailing hoarders are hardly likely to help much.  There is something about inflation which seems to bring out fantasy in policy-makers.

Speaking about fantasy, both the South China Morning Post and the Financial Times report that the CSRC wants fund managers to stop being so bearish, at least in the run-up to the Olympics.  According to the latter:

Fund managers in China have been warned to watch what they say about the country’s stock market, in the latest manifestation of a pre-Olympic Chinese government crackdown on everything from Beijing weather to suspected terrorists. In a bluntly worded notice distributed to fund managers, including foreign-Chinese joint ventures, China’s securities watchdog warned fund employees not to say anything publicly that could harm the stability of the market.

The China Securities Regulatory Commission, which issued the notice, did not make overt reference to the Olympics, but the message was not lost on local fund managers, who linked the notice to a broader effort to avoid market turmoil in the pre-Olympic period. 

I wonder what Greg Mankiw would make of this?

On a final note, I am now doing a bi-weekly column (“Money Matters”) for the Saturday edition of the South China Morning Post.  My first column, today, is about why the Asian Crisis of 1997 has distorted our understanding of the risks facing China.  If you’re interested you can find it here.

4 Responses to "RMB appreciation is going to slow temporarily"

  1. Laobaiqing   July 27, 2008 at 4:25 am

    Excellent piece, but what after this year?

  2. Mandarin   July 27, 2008 at 2:29 pm

    Under the given set of assumptions (a continuation of rising prices and only a moderate slowdown in exports) yes, the slowdown in RMB appreciation would be temporary. However, a more severe drop in demand following a deep US or even global recession would halt the currency’s appreciation for a longer period. It might even cause an outright reversal of the trend. Inflation is becoming a chronic problem for the regime, but the government has a grab bag of tools to deflect or restrict it; in contrast, a marked slowdown in growth and an outright loss of jobs would be a social crisis. Under weaker than expected conditions of global demand the leadership would stop listening to its own and overseas bankers in a heartbeat to keep the yuan cheap. The second set of assumptions I believe is equally as likely as the first.

  3. Mandarin   July 27, 2008 at 2:50 pm

    You make an interesting observation about China Daily and People’s Daily: the first played up the anti-inflation angle of the Politburo meeting, while the latter the pro-growth one. As you must have noted before, the Daily is printed exclusively in English and is for external consumption. It’s the velvet glove to the PD’s iron (maybe too strong a metal) fist. China Daily’s rather greater preponderance of stories about western movie stars and Chinese beauty pageants may reflect a more westernized editorial outlook. A bias toward facts that are presumed to please a western audience presents itself more than occasionally. The preference of western governments for a stronger Yuan may have played a part – though maybe this is stretching a point.

  4. Michael Pettis   July 28, 2008 at 1:36 am

    Laobaiqing, in my opinion we are likely to face a very difficult adjustment next year. My guess is that the debate about the currency will continue to rage, but the arguments in favor of a maxi-revaluation will seem much stronger and will eventually carry the day. It may be too late, however, to avoid some sort of banking crisis.Mandarin, I agree that my predictions assume that inflation will continue to rise. Where I disagree with you is over whether the government does indeed have a "grab bag of tools to deflect or resist it." They have been using their adminstrative tools for a while, but the only real effect has been to distort headline CPI inflation dwonwards, which is not the same thing as fighting it. PPI is surging and today’s China Daily has an article warning that there is real pressure on retailers to start passing on price increases.In my opinion, the fact that money is expanding so quickly is almost certainly going to ensure that inflation will not subside (although I don’t doubt that whathever the latest measure the market currently uses to measure inflation will do much better).