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Latent Chinese Demand, a Potential Cure-All
With the People's Bank of China starting to pull back liquidity, and talk of even higher RMB interest rates on the horizon, we may be at a turning point in world trade where a latent and underestimated potential source of global aggregate demand is activated.
Simply summarized, the past policy of the Chinese government has been to subsidize its exporters by devaluing its own currency. It does this by buying US dollars on foreign exchange with newly printed RMB to keep the currency rate generally pegged. Doing this aggressively over the past decade, it has built enormous world capacity and stimulated world demand for the goods it produces.
By China saying it wants to decrease the rate of money supply increase (by restricting loans and raising interest rates), it is communicating to the world an end of this RMB devaluation policy, necessary to maintain their US dollar foreign exchange peg. The Chinese central bank can't have lower RMB money supply and a maintained US dollar peg, unless of course they make an agreement with the Fed to also reduce its money supply simultaneously. In this political and economic environment, this is an impossibility.
The People's Bank of China has two policy choices. The first is they can keep up the status quo, printing RMB to buy US treasuries in order to continue to subsidize exporters, with the unwanted side effect of continued local price inflation and asset bubbles (real estate in particular). The alternative is that they raise interest rates and impose higher reserve requirements, reducing the rate of money growth. They have already embarked on this path, so there should be very little to guess (especially in the longer run) on where the RMB goes from here.
A stronger RMB means the US and Euro zone (China's largest trade partners) import less from China, while China imports more from the US and Euro zone. Such a change signifies a reversal of what many view a predatorial trade policy on the part of the Chinese. It also means the $2.4 trillion US dollars of accumulated reserves will have less buying power going forward.
In such a change, China's trade partners will have to deal with higher import prices, and will thus have lower GDP as a response. In the long run, their economies restructure and their exports increase (GDP rises). This reflects the J-curvemodel in international trade economics.
With China already the number one consumer of autos in the world, the Chinese consumer with the benefit of a strong currency would spell a voracious appetite for potential consumption. Certainly, with Chinese demand for transports growing at an exponential rate and global crude oil demand once again increasing, Chinese policymakers now have all the incentive in the world to let the RMB strengthen, keeping input and fuel costs under control, as global supplies of key commodities dwindle.
In the long run, a strong RMB means strong Chinese consumer demand, less price inflation in China, and increased exports (and thus economic growth) from the OECD. It also signifies a trend reversion of trade account deficits to possibly surplus, especially within the US. In a most extreme case where the Chinese government decided to sell off its stash of US dollar assets and then spend those dollars, a significant amount of latent aggregate demand is represented here. Contrary to Robert Samuelson's suggestion in Newsweek that "The massive disgorging of dollars could trigger another global economic collapse," it could in fact trigger quite the opposite, in the form of spending stimulus the US has never seen before. $2.4 Trillion US dollars represent an enormous amount of real economic activity, and any near term economic risk a short term rise in interest rates would more than be offset by the increase in US GDP, employment rates, and correlating rising government tax revenues.
Inevitably, there are many undealt with moving parts here, resulting in more questions. Post-RMB revaluation, will the new strong Chinese consumer offset the losses the former Chinese exporter suffers? Will the surge in Chinese consumer demand be a one-off event, as their exporters languish? Will the US and Eurozone, with now weaker currencies, be able to be competitive exporters with the side effect of increased commodity costs? How long will it take for the US economy to restructure back into increased manufacturing and other industries clearly destroyed by Chinese predatorial trade subsidies? With a future US having increased real GDP activity and better government fiscal status resulting from corresponding increased tax revenues, a stronger US dollar may be a long run effect, contrary to any near term movement against the RMB.
The only near term certainty is that such a significant policy change will create volatility and result in enormous real economic change. An overshoot weakening of the US dollar would be likely. As well, gold may do well and US treasuries may suffer (as a significant buyer disappears from the market). Furthermore, since significant structural changes would need to occur in the US economy to adjust to a strong RMB, it may take a long time for exporters to adjust. This points to a lag in increased tax revenues. Short term, with a dollar devaluation, notional value of imports would increase, putting negative pressure on US GDP and making the US fiscal condition look all the more dire.
Inevitably, policymakers might invoke accelerated money printing and fiscal stimulus to ease the pain. Uncertainty may drive up inflation expectations as well, increasing the likelyhood of higher long run interest rates. Such an inflationary move in the US may be just what the doctor ordered, as nominal wages rise and accumulated debts currently stifling lending (reflecting bank insolvency) would be rendered non-issue.
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Wow. This article was unadulterated...........
FANTASY BULLSHIT.
If you think the RMB is going to be allowed to float upwards you are sorely mistaken - this post demondstrates not only a lack of knowledge of Chinese mercantilist policies but of actual currency flows.
If the $US rallies from here do you think the RMB will be re-valued up or devalued ? Simple question, not so simple answer eh ?
The DoeLarr will lose one third of it's value yoy for the next 5 years until it is nothing but a corpse....bleed doelarr bleed.
Your economic analysis is about as solid as your taste in music.
The worst article I have read here in a long time. Nice work scrub. January 1994 they devalue by 30%+ and they go from tank driving killers to a supercharged economy.
Way to extrapolate one years worth of data. So they ramp up lending to unsustainable levels, throw in massive stimulus amounts, and drive M2 up a staggering amount in one year just to "achieve" 8%+ annual growth. (Why do you even bother with Chinese numbers we all know are garbage.) Now you think they will adjust the peg? Are you that big of an assclown?
They will continue to attempt to manage bubbles as they always have. This time will be no different. Good luck.
http://www.bloomberg.com/apps/news?pid=20601087&sid=aNpOCUK8o.O4&pos=5
Anonymous, go figure.
STFU, Bloomberg quoting GS. Go Figure. I will figure , you you are a complete moron.
Chinese growth is at a human cost, significant human cost.
The communist government is focusing on using massive semi-slave workforce to generate cheap goods and build a cash reserve for buying US and Europe government debt.
Intentions are not only to keep RMB low to stimulate export but also to use its reserve as a political weapon when time comes.
Anyone thinking that RMB will be a reserve currency is fooling themselves. You may borrow money from a loan-shark, but you do not park you savings with one. China is a like Mafia and no sane country will trust their money with them, not even Russia.
Decades ago, I heard this same story with Japan-adjust the currency and this will make US exports competitive.
Never happened...
China needs jobs more than they need expensive US imports.
How are they going to keep these jobs without an export market?
The Chinese keep a two million man army to crush internal dissent. They also don't have labor unions.
An OK point... but you take it too far.
JPY is roughly 2.5x most valuable today than it was in the 1980s... approx 4%/yr appreciation.
First, I would think that all tariffs would need to be lifted. Second, American consumers purchased Made In China due to the cost; cheap Chinese labor to be specific. Will Americans accept the same salary as Chinese laborers to play into this role reversal of American manufacturers/Chinese consumers?
first there are very few tarrifs to life - if you
are speaking of american tarrifs on chinese goods....
americans have already been forced into role
reversal due to the massive capital flight from
the usa to china....the results can be viewed
in the latest deceitful bls numbers understating
unemployment....
standards of living have been falling since 1973
and will continue to fall at an alarming rate
once the peg is lifted (if it ever happens)....but
it is a given regardless of what happens....
low chinese wages do not explain the price
differential in goods - there is much much more in
play than wages....
"a strong RMB means strong Chinese consumer demand, less price inflation in China, and increased exports (and thus economic growth) from the OECD
What products are the rich OECD countries going to export to China?
The Balance Trade theory has as much legitimacy as the Efficient Market Hypothesis.
This is one of those crazy silly statements.
When I am in China -- I see western products EVERYWHERE!
When I am in the US -- I see next to ZERO Chinese products.
"Made in Mexico" makes me no more impressed with the Mexician economy than "Made in China" makes me of the Chinese. Low-end manufacturing is highly over-rated.
The Chinese already consume and only want more of the premium western products -- iPhones, pharmaceuticals, luxury goods, heavy industrial equipment, etc.
what regular people in china are buying furniture, appliances, computers, phones, tvs, clothes, made in US? Even if they buy an Iphone, it was not made in US, Apple gets rich 9and the money goes to whoever owns their stock - stock owners are from all over world) and a few white collar folks in Cupertino do well but not manufacturing types. If they buy Nike shoes, they are not made in US. Again, Nike corporate HQ employees some people, but they are a tiny shell of the total labor involved in producing and distributing the shoes.
We may to sell a few things that are made in US like Catepillar heavy equipment, some cars etc but even that won't last, has been eroding.
And you see next to zero products made in China??? There is not a tire manufacturer left in US. find any clothes made in US lately. Almost all books are printed in China. 80 percent of furniture is made in China. Where do TVs and computers come from?
Even if something is actually assembled in US, like Cats, many of the parts are imported.
But don't take our word for it, just analyze Long Beach, Oakland, Seattle port data...do we import or export more? We are always a net importer. And consider what we export...much of it is commodities like wood to build furniture in China and ship it back to us.
The finished goods we export are largely limited to some internet sites, guns, hollywood/tv, hip hop and metal music, and financial fraud.
But why do you guys only focus on who MAKES the goods?
Every product is designed, marketed, financed, strategized, etc... most of the happens HERE. Right?
So sure, I am buying a Vaccuum. It was probably "made in china". But its not really a Chinese product, right? Repeat with all appliances, clothing, toys, snacks, etc.
Then there are lots of the softer "products" that are ultra-high value where we dominate -- financial services, software, internet, hollywood tv movies and music, etc.
Remember when we were all "worried" about Japan. In hindsight, that was silly. Lets not do it again.
when you are in the usa you must be a frequent
shopper at neiman marcus, louis vuitton, versasci
and other elite markets where chinese goods
are the kiss of death...
if you shopped where the schmucks shop such
as walmart, kmart, and any x-mart with a chinese
dependency you would see a different picture....
take off the rose colored glasses...
now if the chinese want only premium western
products on 3400 usd per capita income (whose
ppp is probably significantly lower than that)
i wonder what that says of the usa consumer and
pricing...
the truth as that the fake recovery in the usa
has been built upon transnational top quintile
markets...which means that the demand for
western goods means nothing to the west - except
for the elite producers and consumers...
I am one of those schmuks, I guess. Would rather save my money than pay for the label. Its' getting almost impossible to find consumables NOT made in China. I would rather pay somewhat more for a product that lasts a bit longer. For example - China made shoes in Wallys for ~$15. Last about 4 months before the innersole disintergrates. Mexican or Brazil for $20 last ~8 months. Paki, Cambodia, Indonesia for $30 last 1 1/2 year or so. Italian designer last 5 years but cost $300. Haven't seen US made in years. Sweet spot on cost is not China. But try finding something NOT made in China. Us schmucks aren't that stupid. Pinching pennies doesn't mean buying the cheapest crap around. There is not a lot of selection though. Different brand name, same crap. And just try to find something that is repairable. I bet you can't find ANYTHING that states user servicable parts inside.
"China's trade partners will have to deal with higher import prices, and will thus have lower GDP as a response."
I can see number of scenarios where the above is not the case. Let's not forget that China's imports are not raw materials hence it does not have natural monopoly over those. And while an initial shock might be semi significant, within 6 months those prices will level down and go back to averages because it doesn't take as long to move production into lower price areas. Actually since the movement of production is easier than development of new technology (as the case with OIL shocks) the effects of higher cost imports from China will be much smaller than the effects from OIL embargo.
P.s. In order for Chinese demand to be sustainable, the party has to redistribute some of its reserves back to the citizens via tax cuts & has to improve their labor safety and conditions laws so the wages actually enable their middle class to consume. As long as the above mentioned does not happen, the Chinese consumption is not sustainable exempt 70 ml of upper class spending on luxury goods.
70 million of Chinese upper class compares to how many here ??. That number would dwarf what we think of as upper and middle class combined ?.
Nikki.
They do not have the middle class in our understanding of the middle class unless you are willing to call people that make 4 - 8 K /year the middle class. The largest problem of any developing county is that middle class is nonexistent. Most of the people could be divided into ether poor or wealthy and inequality between those two classes is usually huge.
Nah, there's no need to read too much into their latest tightening. They do this every 4 yrs or so, whenever the econ overheats. But despite the stock markets here dropping like flies, this is actually very encouraging news - i almost feared they have lost their heads in the mad rush to be #2.
As for stimulus through infrastructure improvements, it improves the flow of people and goods. This creates greater economic efficiency, thus boosting future GDP growth. Export is helped along the way.
The chinese can (and already do) produce almost everything they'll ever need, you know. A stronger RMB raises their purchasing power, allowing cheaper imports of food, energy and raw materials at the same time spurring domestic consumption of domestic goods - ie, increased standard of living. Sounds like a good strategy to me.
But then again we're talking 20 yrs into the future, for this to be realised to any appreciable extent.
i agree whole heartedly that the yuan and dollar must delink or unpeg....the link is a severe warping of natural market forces which serves no valuable purpose and in fact has been pathological....
the theory of floating exchange rates is that currencies rise and fall based upon their own supply and demand characteristics....when that mechanism is corrupted it sends malignant signals throughout the currency and capital markets leaving in its wake destroyed economies and lives....
without a free floating yuan i propose massive tarrifs....
the effects on the dollar will be nearly catastrophic for a while but that is its true state anyway.....it is time for change and transparency....unmask the dishonest currencies and let market players effect repairs...
The Chinese would be wise to scoop up key properties in Hawaii.
Now that many populated areas in China reflect a policy that would make the EPA catatonic. Clean air and clean water will be "commodities" in high demand for wealthy Chinese.
Intel I have been getting from Americans married to China Girls say all is not well inside China. I'll give DaddyWarbucks my two cents though.
If they really want to unleash purchasing power, they should give national health care. From what I understand much of Chinese saving is for health care spending.
I higher RMB and reduced treasury purchases would be a disaster for the dollar.
"they should give national health care."
ROFL. I mean this kindly when I say the Chinese don't give a flying fig about sanitation. It's just a reflection.
I guess this thought process is indicative of "Peak Oil" in the American Progressive Movement. We here in America are about to clobber these people into the fetal position. It certainly will not resurface in China.
i can only hope that you are clobbered back into
the fetal position first.
I'm aware that the chinese have many internal and external problems of their own. I'm not an expert of any sort but I have family and family business connections there and we spend enough time there every year that we maintain multientry visas and a residence in Beijing. My two cents is Do not underestimate the chinese.
This is all well and good were it the case that most economic "investment" recently in China was economical. A stronger RMB means that empty factories and cities recently built are a BK.
China's stimulus program was intended to build more export capacity.
Interesting article, thanks.
Certainly, I'm not too knowledgeable about China. (I read Michael Pettis on China Financial News at http://mpettis.com/ for good insight.)
My question and concern is can China manage the transition from a producer to a consumer nation without triggering widespread social unrest? (I have a similar concern about US trying to do the reverse).
Also, is the China bubble already so big that it cannot be deflated, only popped?
Don't get me wrong, the Chinese probably have a better chance of pulling this off than the US (since China has lots of reserves and US has huge debts, China is moving toward higher standard of living, US is moving toward lower SOL.)
Finally, mild inflation can help a debtor (hurts economy overall) but to inflate down the US debt to reasonable historical levels (consumer and government) would require a long period of moderate inflation (maybe 20 years at 4%/year or a decade of 8%/year). Can the FED hit the sweet spot without causing hyperinflation. Plus to really help, all entitlements would have to be de-linked from inflation (resulting in 50% decrease in lifestyle for have-nots).
Bottom line, maybe the Chinese have political will and smarts to pull this off (doubtful) but I think it is clear that US doesn't. How anyone does well if US fails is unclear to me.
Sorry to be a pessimist but there you are.
Your numbers are all wrong. 1 single year at 4% core CPI would completely reliquify all asset-based lending and restore debt balance. This creates ~8% nominal growth in GDP.
We have not seen 4% inflation since 1991. We are unlikely to see it again.
You may be forgetting that at 4% interest rates, we can service far more debt than at 8% interest rates, and that "more debt" is a natural consequence of "more savings". Of course, these are two sides of the same coin.
we currently have 6% inflation and it is accelerating....
marginal productivity of debt is negative and
as far as gdp is concerned it doesn't really
matter what the interest rate is - 4% or 8%....
both your numbers and your analysis are very
wrong...which is not unusual for cia or fed flacks...
I dont understand... I am looking at Bloomberg's chart of "Core CPI" which has been below 4% every year since 1991. We could look at headline CPI, but this is simply more volatile... sure it peaked at 6% for 1-yr, but also posted some negative years. The headline CPI measure has not been systematically different than core over long periods.
Headline CPI also has been below 4% for 90% of the readings since 1991. It has averaged about 2%. It seems you favor your own homegrown measure of inflation? What do you see inflating at 6%? Houses? Gasoline? Prices on everything are going down, right?
How is the "marginal productivity of debt" negative? Say I borrowed money last year at 3% and invested in businesses and real estate for rent. I would be doing very well in both. Many businesses I am invested in are looking forward to improved credit conditions and will borrow to expand. Operations are solidly profitable. I see many other good businesses producing strong earnings, cash-flow and expanding.
It was a recession, crisis, etc. Its effect continue to linger. But mainly, its over. Back to business. Things are getting much better, right? I was surprised how much shopping and activity I saw this weekend.