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Unlike America, China Is Embracing Bold Reform
The contrast of the past week has been telling. In the U.S., you've had the yawn-fest otherwise known as the debt ceiling debate. All too predictably, the Republicans caved because their politicians will be up for re-election soon enough whereas Obama won't be (he can only serve two terms). It wasn't hard to work out the endgame in advance, despite all the hoopla, and the markets nailed it from day one.
What's received far less attention is the rise of the Chinese yuan to a 20-year high versus the U.S. dollar. That's big news, comparable to the U.S. debt ceiling resolution. And it may have a hugely beneficial impact not only on China, but the rest of the world.
The reason for this is that significant yuan undervaluation was one of the key drivers behind the 2008 financial crisis. It allowed China to become an exporting powerhouse. For that to happen though, China needed willing consumers for its exported goods and it found them in developed markets, particularly the U.S. Given stagnant real incomes, American consumers were only too happy to rack up debts to pay for these goods. And those debts eventually brought the U.S., and the world, unstuck.
Now China is actively pursuing a strong yuan policy. The reason that it's doing this is because the country's exporters are strong enough to withstand a higher yuan. And more importantly, China knows that it needs to re-balance its economy, which has been over-reliant on exports at the expense of consumption. A stronger currency promotes consumption as it allows the Chinese to import cheaper foreign goods and enjoy less expensive overseas holidays.
A rising yuan is not only good for China though. It also goes a long way to removing a central problem in global trade: that of a significant trade imbalance between China and America.
Today I'm going to further explore why a rising yuan is such a big deal. But also why it isn't a cure-all for China's problems, or the world's for that matter. The development should be welcomed though as genuinely good news in an otherwise downbeat global economic environment.
Economic fault lines
At the outset, I must confess something: I've developed a bit of a man-crush. It's embarrassing because I'm not naturally inclined to put people up on a pedestal. But India's new central bank chief Raghuram Rajan deserves many of the accolades which he's already received.
Rajan is relevant to the discussion because of his book, Fault Lines, published in 2011. Reading through the book this week, it does a great job of outlining the underlying issues which caused the financial crisis and remain threats to the world economy today.
For those that don't know, Rajan is famous for warning of impending economic problems at the glamorous (at least by economist standards) Jackson Hole conference in 2005. His speech went down like a lead balloon then as Alan Greenspan was still at the height of his powers and the world could seemingly do no wrong. Or at least that's what everyone thought, bar Rajan.
Anyhow, the book details a number of the key threads from the 2005 speech. It suggests that there were four primary causes for the 2008 crisis:
- Rising inequality and the push for housing credit in the U.S.
- Export-led growth and dependency of several countries including China, Japan and Germany.
- A clash of cultures between developed and developing countries.
- U.S central bank policy pandering to political considerations by focusing on jobs and inflation at any cost.
The first cause is fascinating as it's one that few people have focused on. Rajan suggests that rising income inequality in America created the political pressure to push easy credit conditions. Everyone knows of the increasing inequality in the U.S. but Rajan has a unique take on it, placing the blame on a poor education system and inadequate social safety nets.
Technological progress has meant that the labor force requires ever-greater skills which the U.S. education system has been unable to provide. That's resulted in stagnant paychecks for the middle class and growing job insecurity. Politicians have felt the pain of their constituents but fixing the education system is a long-term solution which they've been unwilling to promote. Instead, they've opted for short-term fixes. Namely, they created the conditions for easier credit so their constituents could afford things via debt which they couldn't afford via their own incomes. That ultimately contributed to the subprime and housing crisis.
This brings us to the second cause for the 2008 meltdown: the export-led growth of several countries including China. Normally, debt-fueled consumption in the likes of the U.S. would push up prices and inflation there. Then the central bank would have to raise rates to stem the consumption.
But what happened prior to 2008 was that increased U.S. household consumption was met by exporters from abroad. China, Japan and Germany needed other countries to consume their excess supply of goods and the U.S. came to the party. It was a win for the exporters and a win for the U.S. as it kept a lid on inflation. That is until high household indebtedness in the U.S. limited further demand growth and everything eventually unraveled.
Rajan describes the third cause of the crisis as a "clash of systems". Here, he examines what pushed many developing countries towards export-oriented economic models. And he suggests the 1997 Asian crisis played a key role.
Prior to the this crisis, Asian countries weren't net exporters. Yes, they produced exports sold overseas. But their strong growth entailed substantial investment in machinery and equipment, often imported from the likes of Germany. That meant they often ran trade deficits, having to partially fund their investments via borrowing from abroad.
The financing for the investment mainly came from the developed world. Given the lack of transparency in many Asian countries, these financiers were only willing to lend on a short-term basis. When trouble hit, that short-term financing evaporated. And the Asian crisis ensued.
Due to the crisis, Asian countries decided to cut back on debt-fueled investment. Instead, they focused on boosting exports by maintaining undervalued currencies. In other words, they went from being net importers to substantial net exporters, thereby creating the conditions for a global glut in goods.
Finally to the fourth cause of the 2008 downturn. Rajan says U.S. central bank policy poured fuel on the flames. The bank pandered to politicians wishes by keeping interest rates too low for too long. They did this to maintain high employment, one of the bank's two central mandates. Note that keeping people in jobs was critical to assuage the masses given the stagnant incomes and inadequate social safety nets in the U.S. But low interest rates, ably aided by greedy financiers, helped create the credit bubble.
Rajan believes the four underlying causes for the 2008 crisis are still with us today and they need to be addressed if we're to avoid further trouble.
Let's now draw the discussion back to the significance of a rising yuan.
The impact on China
The undervaluation of the Chinese yuan didn't only contribute to the global problems which precipitated 2008. It also created enormous issues within China itself, many of which are still with us.
I've argued previously that China's 50% devaluation of the yuan in 1994 was a critical event in recent economic history. It was one of several devaluations and resulted in a significantly undervalued yuan. That undoubtedly aided in China becoming the world's largest exporter. The country's entry into the World Trade Organisation in 2001 also kicked things along.
But an undervalued yuan created a long list of problems for China, including:
- An over-reliance on investment and exports at the expense of consumption. An undervalued yuan meant more expensive imports and more expensive overseas holidays, among other things.
- Negative real interest rates. Keeping an undervalued currency via a peg to the dollar meant sterilising excess yuan creation and maintaining rates below the dollar interest rate in order to avoid huge losses on dollar reserves. That pushed people out of low-yield bank deposits into stocks and property, creating bubbles in these areas.
- A side effect from the policies was that state-owned banks tended to lend mainly to state-own businesses as they were deemed less risky. This starved the private sector of funds and ultimately made them less competitive. It also led to alternative financing, such as the recent phenomenon of "wealth management" products.
These issues haven't disappeared. Far from it. But the underlying issue - an undervalued yuan - is being addressed.
Welcoming a rising yuan
The above provides some context to the yuan rising to 20-year highs versus the U.S. dollar over the past week. It represents a dramatic change in Chinese policy. The country's leaders know that the export-led economic model which has powered China over the past two decades isn't sustainable. A stronger yuan will help re-balance the economy, with consumption becoming a larger contributor to growth.
Chinese leaders are also in the process of addressing other related issues. You should to see more on this at a key meeting of Communist Party leaders next month.
As I outlined in a previous post, likely reforms at this meeting include:
- The central government taking over key expenditure functions of local governments, including social security, compulsory education and parts of healthcare. The thinking is that there's a substantial skew in revenue and expenditures of central and regional governments. Currently, local governments account for 52% of total fiscal revenue but 85% of expenditure. Spending at the local government level has spiked from 46% of total to the current 85%. That's why these local governments have had to borrow money and why they've resorted to off-balance sheet vehicles.
- Local governments at the provincial level being allowed to issue bonds. And this financing will replace the problematic local government finance vehicle (LGFV).
- Financial liberalisation - interest rate liberalisation and RMB internationalisation.
- Hukou (resident-ship reform) being opened to small and medium-sized cities as well as a relaxation of the one-child policy.
A stronger yuan and related reforms can help put China on a more sustainable economic path. But it can also assist the global economy. With China consuming more of its production, that may mean less goods being sent overseas. That could go some way to addressing the current oversupply in goods. In other words, it could remove a key impediment to a global economic recovery.
More work to be done
All of this isn't to suggest that China is out of the woods . It isn't. For instance, the GDP figures of the past week show that debt-funded investment remains the key driver to growth. That needs to change and further reform is required.
I'm not as optimistic as some commentators are that the transition to a new economic model will happen fast enough to prevent serious short-term pain for China. But I'm not as pessimistic as others who suggest China will go the way of Japan, which encountered similar issues as a dominant exporter in the 1980s but failed to re-balance its economy. It's likely that China still has some time to avoid the fate of Japan.
And though a rising yuan reduces some of the global economic imbalances highlighted by Rajan, significant imbalances still remain. Japan is trying to export its way out of deflation by turning the yen into toilet paper. Germany is also committed to its export-oriented model. That means the global supply glut is unlikely to rapidly diminish, even if Chinese export growth slows from a higher yuan.
At the other end of the spectrum, reform in the U.S. is as elusive as ever. Central bankers there seem determined to reflate debt-driven consumerism. The politicians are happy to go along with this as it placates disgruntled voters, whose real wages haven't risen over the past 20 years and worry about losing their jobs. The debt ceiling debate largely ignored these inconvenient truths.
In sum, the world's economic problems remain acute but a stronger yuan is a welcome step forward.
This post was originally published at Asia Confidential:
http://asiaconf.com/2013/10/19/china-is-embracing-bold-reform/
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uh huh!
2008 crash was engineered. the cause - FRAUD, AND THEFT. And the reason for it - because BANKS COULD CHARGE FEES FOR THEIR FRAUD AND THEFT on the way up, and sequester SHEEPLE'S MONEY on the way down!
the FRAUDING AND THEIVING has been with us since the beginning.
jesus chased these MO'FO's out of the temple!
2013 crash will be engineered. the cause - FRAUD AND THEFT!
"... inadequate social safety nets in the U.S."
Unempoyment compensation, Medicaid, Medicare, Social Security, Disability compensation, minimum wage laws, hate speech laws, FDA, EPA ...
What else do you want? For the Federal Government to wipe off our asses?
"Now China is actively pursuing a strong yuan policy. The reason that it's doing this ..."
Not one mention of inflation or their teetering banking system, eh?
My you are an incompetent shill indeed.
wait til china's housing bubble burst, then the chinese government will do the only thing it knows how - devalue its currency
Amazing. "China embarcing bold reform."
Really? You mean bold like all the corrupt officials being greased by Chu, Li, and Chien to keep their companies going. Or their daughters to have more than 1 child. Or to shut up when they are starving to death?
The rule of law that takes a person with nothing short of a reading of the accusations and sending them (and their families btw) off to re-education camps or slave pits or to simply be executed.
Or how about the bold reform that says that the Chinese can steal every good idea, every product and claim it is their own and try to sell it back to the world?
Chinese bold change? They can't even feed themselves. Starvation in China has long been an issue, so much so the people there are smaller than the rest of the world for lack of protein. Cut off American bread basket food and China as well as the rest of the world start starving again.
Bold change, when not .1% but .001% most of who are related btw run say 80-90% of the state sponsored companies?
Yep the Chinese are bold. They are bold about taking a communist ideal, turning it into a kind of familial monarchy, and selling it by force to the rest of the public and calling it good.
I'm sorry but if anyone thinks the Chinese are going to somehow replace 'rule of law' with 'rule of communism or rule of the chinese elite' as being bold then my boot can sandwich their head to the pavement.
Funny how many rich Chinese are leaving China to come to the US so they can 'be like the US', marry US citizens, have as many kids as they want. I see them constantly on the streets of college towns, driving their BMWs, spending like no tomorrow, getting fat, drunk, and fucking up just like Americans.
I'll be the first to say America has turned to shit, but don't even try to sell us this China as the new world leader, not in economy, not in liberty, and certianly not with rule of law or a 'stable currency'.
The only thing China has is a lot of hungry people who will work for a quarter an hour and a government who is happy to have them doing precisely that.
so many words with an Ivy League pastiche. This is so simple. China's slave trade is coming unglued. Its people want higher salaries and are resorting to moblike muggings of essentially the Politburo (after all, they run the companies). China's ruling elite can allow inflation and risk all. oR they can let the currency rise and flip a coin if an economic transition with keep the crony kletocracy in place.
China has these 'ghost citys' they're preparing for this millenium.
The USA has its city's becoming ghost-towns ( detroit ) as the USA dies.
Everything that can be stolen from the USA has been stolen, .. in these later hours wall-st fights over crumbs like 'obama-care' ( frosting for insurance companys ).
There is no fucking way you can compare Asia to the USA.
Probably the biggest difference I see between the two, is that in China there are a zillion over educated kids all looking for that CEO job that doesn't exist. In the USA the majority are morons, all part of the 'free shit army' and on gub-mommy's tit.
In asia if you don't work you die.
Big fucking diff.
I noted back in the 1970's that there was 'wild west capitalism' in China, but in the USA orwellian socialism. Today after some 40 years of 100% raw capitalism china has transformed itself into 1st world nation, in that time the USA has had its core city's become cesspools.
Not even close, chump-change. Even with the decimation of the industrial heart of the US, there are still trillions of assets for foreigners to buy and control.
Your childish impressions of places you've never been are amusing.
Re: " in China there are a zillion over educated kids all looking for that CEO job that doesn't exist."
" adopt the methods used by emperors of Confucian China: Test for the best, cull the rest."
http://www.gregpalast.com/no-childs-behind-left-2/
Cities have always been cesspools, everywhere. Sometimes they manage to scrape the refuse and dead people off the street and paint the place up for some time, but it is the nature of cities to become black holes sucking the life out of their inhabitants. They are Matrix machines feeding the few at the top from the souls of many ants on the streets.
http://www.youtube.com/watch?v=VSWLm2wRHSA
All of this is just about the symptoms of the tyrannical state. Certainly there are a lot of problems; that's the collateral damage inherent to such a state where the government rules the people and its been going on for 5000 years, it's just that mankind has finally outgrown it. And now is the time to exchange that daily operating model of government for its antithesis, which is where the people rule the government; which happens to be the definition of Liberty. And Liberty, once taken root, is a plant of rapid growth. YOU GOT PROBLEMS???
Liberty is your answer as it solves all problems simply through its daily operating model of government. That model requires all the powers of Congress (the people's powers) be returned to Congress and wholly introduced, discussed, compromised, and voted upon exclusively within the Public Forum. This keeps the power of government out of the hands of rascals and the people rule.
It requires the end of the Fed, Dept of Ed, and eviscerates most all other federal agencies, the key being that all laws, policy, or acts must be forged upon the alter of the Public Forum on the floor of Congress. Any assignation of any powers of Congress through the Necessary and Proper Clause (Elastic Clause) must be properly done if it is necessary, and policy must be defined as having to be conducted exclusively upon the floor of the Congress and its public forum.
Liberty cuts budgets, replaces a fiat currency system, provides a completely different foreign policy than our American wandering foreign policy, and changes the world in so many ways that lifts all boats in economic healing. But its greatest attribute is an air and vitality it brings with it of an awareness of our personal relationships with each American, because with Liberty comes the realization that each of our Liberty is dependent upon our neighbor having that same Liberty multiplied millions of times over. Liberty endears a comraderie in society, that in concert with the natural distribution of economic wealth, Liberty embraces all as belonging to the same club so to say, and by doing so, breaks down all barriers.
Liberty brings not only nations together, but all of mankind. We've tried it before and it took about 100 years to break it down. We've now lived under that yoke for the next 100 years and so now it is time to take it back. www.electanewcongress.com
Liberty is indeed the liberator...but it needs nor wants government.
I think China is to corrupt for bold reform. If they want to play fair they should float the value of the yuan. The global economy is so interlinked that if one major player bites it then all the others will bite it too in one way or another.
What method, exactly did China Use to achieve this currency re-valuation? Notoriously, nations fail when they try to manipulate their currency exchage rates; the exception being out on the lunatic fringe somewhere with Japan; if you want to cut it in half in a month, you probably can. The US dollar has just gone down relative to all it's trading partner currencies; for reasons which are darkly mysterious to we peasants; or possibly even non-existant, (eg. simply fun manipulation on the part of the FX Banks); what role did that play in China's amazing "re-valuation"? A pretty big one, I would think.
So China is going to rule the world. Remember when Japan was going to rule the world? It wasn't that long age, late 80s or so. There were books and even movies about it. Done deal. Game over man.
Remember? Yeah me neither....
But the 1980's and Theory-Z ( jap ) and now are very different.
The Jap's believed their shit didn't stink, but the USA was doing fine.
I too am sitting here in China, drinking my coffee (KUNMING).
The chinese SAVE money, the Chinese still live a bunch in a house like sardines, ... the chinese buy gold, they don't talk about it, they do it. All asians buy gold, there are shops everywhere.
China is safe. The USA is not safe.
Comparing China today with the USA, ... is like comparing Africa and Switzerland. Sure the Swiss(chinese) have problems, but the Nigerians(USA) are selling their children for organ harvesting.
Much of this is just about change, the USA was 'king' for 50+ years, and now is the time of Asia.
The USA is a fucking mess, but Asia is doing just fine.
If your expecting the new world order of Asians to be benevolent, well FUCK-NO, but the USA was never the good guy, except in projection at home. For now abroad the chinese are 'investors' and not invaders like the USA in Libya, or Iraq, or Syria.
The CHINESE are buying Africa, the USA rob's big fucking difference.
In China when a Politician gets caught, he DIES, in the USA he pay's off the judge. In my 30+ years in China, I have seen COP's killed many times, and in the USA I have never seen such. One of my first visits years ago to Shanghai a cop raped a woman, the same day they took him out and shot him. Justice is swift in China, and that's why its 100X safer than the USA>
LOL. You believe the cop raped a woman. Read it in the paper did you?
Haha.
It may or may not have gone down that way, but your belief in Chinese MSM is kinda cute actually.
More likely he crossed the wrong gang, or there was a criminal reshuffle.
Have fun believing in Chinese justice though, Im going to see if my kids teeth turn into spare change.
0b1knob had the same reaction to the article as I did. I have lived and worked in China off and on for years. I am presently sitting in a coffee shop in China.
So, China is going to rule the world? If so, what a sad world it will be. I am not defending the U.S. and Fed actions buy any means but,...
China is the biggest kleptocracy the world has ever seen. Compared to China (see one of zerohedge's headline stories today "New York Is Drowning In Bribes And Corruption"), NY is strictly amateur. China is redefining corruption to an all new historic level.
Frightening levels of endless rows of empty apartment buildings (and I was used to it, but now even more frightening than ever). Most are owned by government officials as bribes/gifts.
See Jim Chanos for some insight on the non-performing loan numbers. Maybe up to 40% versus U..S. economy tankiing on what, 4%??
A simple Starbuck's coffee here is $5 versus $2+ in U.S. Food, real estate all horribly out of line with reality (just like Japan). PPP is horribly out of line with the U.S. Most inflation is a result of spending by government officials using printed money that makes our Federal government look like amateurs.
Appalling food scares almost every week.
You can look up other articles on the leverage in the banking system. China is creating debt at a level that also makes the U.S. and the EU look like amateurs. The entire banking system is BS.
Actual capital flows are out of the country, not in. The U.S. is happily funding a large portion of their new housing bubble with cash purchases of real estate using money of dubious origins from China (by the way, we are the one's encouraging dirty money in real estate from China, Russia, South America ... wer are as bad as Cyprus in this way).
People rave about the wonder of Macau which is strictly a money laundering operation.
All fiat currencies are based on faith. Right now, China has the world conned more than the Fed. This is where they are excelling.
I could go on and on ...
ejblues
...i could go on and on...
please do, fascinating stuff. i'd expected as much, zh has said as much, but as europe now is going to trade in yuan as are several others the impact is going to be (inmhumbleo) profound.
I've just read twice the paper Rajan delivered at Jackson Hole in 2005 http://www.kansascityfed.org/publicat/sympos/2005/pdf/rajan2005.pdf and I don't see anywhere where "warns of impending economic problems". He makes common sense observations like low interest rates will force people to take greater risks if they have set commitments to make, but there's nothing prescient in the speech.
Good on you for checking the references; so then the question becomes why are we being sold a "used Rajan"? What's this Asia Confidential guys' problem.?
"there's nothing prescient in the speech."
Exactly, in fact it reads like something Alan Greenspan might have written, but then, coming from a central banker this shouldn't be too surprising.
I've read a lot of financial/credit market analysis over the years, but for me, the only analyst who consistently hits the mark is Doug Noland. All others pale in comparison. (www.prudentbear.com)
Hi there and thanks for reading my post.
I am not sure that you read through the entire paper of Rajan's though and believe what you've said is highly misleading.
While it is written in academic/economist speak, the paper does a good job of the many risks posed by the financial system at that time and concludes thus:
"They [the risks posed by the financial system] also may create a greater (albeit still small) probability of a catastrohpic metldown."
In the understated tones of academia, this was a clear warning of potential economic problems ahead.
Also, you've got to understand that at that time, very few people were talking about these risks. This was radical stuff, particularly at Jackson Hole.
Rajan's book details more and is well worth a read.
.
"While it is written in academic/economist speak....."
The writing itself is clear enough, the problem is who's writing it, i.e. a central banker. No central banker that I know has ever pointed to central banking as the root of the problem. Likewise, there's no mention of regulatory capture, the role of the GSE's in credit expansion, or the dangers of telegraphing policy (Greenspan put). All these issues were addressed by Noland as far back as 2003.
My starting point for cogent analysis is simple. The analyst has to be outside the system. By definition, central bankers, or anyone tied to the banking system fails that criteria. I'm not arguing for or against central banking, or for that matter, fractional reserve currency, but the possibility has to at least be examined, and quite frankly that can't be done from inside the system, particularly the one that feeds you. This is fundamental.
I'll just add that to read any sort of analyitical work you have to first Consider The Source. What are the interests, biases and constraints of the analyist, in short, what's their Paradigm? I suggest anyone attempting to dissect modern finance first read Thomas Kuhn's "Structure of Scientific Revolutions" with particular attention to chapters 5 (The Priority of Paradigms) and 8 (The Response to Crisis).
Impeach all traitors to the USA, to our basic law, The Constitution. Jail the past presidents who have been complicit in subverting the Constitution. Its not just those in power now who deserve to be caught Holdering the bag
Quick list of subversion of the Bill of Rights here....takes 45 seconds, it will open your eyes.
http://nukeprofessional.blogspot.com/2013/04/bill-of-rights-summary-of-c...
45 seconds? Who's got 45 seconds to spare?
Very interesting.
I love one of Peter Schiff’s lines at a speech, “one of these days Chinese workers are going to get tired of building washing machines and selling them to America. One of these days they will look at that washing machine and want one for themselves.”
It won't only be that they want one for themselves, but also they will be tired of sending those real assets and scarse resources in exchange for bits of paper whose value is backed by the actions of mad men.
sadly, they, too are under statism and central planning. They are productive, no doubt, and have a major proclivity to save (and in PMs, too, at that) but they have a lot of malinvestment and problems Austrian economists will diagnose. I don't know at what point one of their leaders would defect from the current global banking structure and go more nationalist. But they have dealt with way more than American citizens and are far more used to scrimp and save whereas Americans the food stamps, welfare/warfare goes, and it will be pandemonium.
Let's just hope they buy the flush toilet first.