"Utter, Utter Piffle" - Albert Edwards Lashes Out At The Media's China Groupthink
Oh, the ignominy of thinking that China's widening of the Yuan trading band was anything other than uber-bullish and indicative of as soft a landing as can be imagined as the mainstream herd promptly, in a desperate attempt to seek affirmation from other members of the herd as always happens (see Jeremy Grantham's latest letter for more), said this would be a move that guaranteed no hard landing. SocGen's Albert Edwards takes the 'massive over-confidence in the ability of the Chinese authorities to achieve a soft landing' to task and furthermore indicates that between a rapidly diminishing current account surplus, a real effective exchange rate that is arguably (thank you IMF) not undervalued anymore, and the velocity with which nominal GDP has slowed recently (akin to 2007), the very fact that they widened the trading band suggests it is now a lot easier for them to achieve significant devaluation of their currency (to escape the hard landing) both technically and politically. Since widening the band, the PBOC has already devalued two days-in-a-row. Ironically, the bilateral imbalance with the US is reaching new records (seasonally adjusted) and will peak (seasonally unadjusted) just in time for some temperamental headlines right before the US election.
“For everybody who thought China was heading for a hard landing, it's over.”
What a dunce I am. So silly of me to think China might be hard-landing! I now stand corrected. I was reading about China’s widening of the yuan trading band and found a story with the above quote from an expert. Apparently widening the yuan trading band is proof that China is not hard-landing. Why? Because otherwise the authorities would not have sanctioned such a move. What utter, utter piffle. There remains massive market over-confidence in the ability of the Chinese authorities to achieve a soft landing. And as the IMF now agrees with Chinese Premier Wen Jiabao that the yuan is no longer overvalued, it seems to me that on both technical and political grounds, the likelihood of a yuan devaluation has just increased.
...at the other extreme Edwards like us just cannot comprehend the mainstream media's comments that the widening of the bands means, ipso facto, that the Chinese economy must now enjoy a soft-landing.
Just look at the recent tendency of the currency to weaken within the previous trading ±0.5% band (see chart below). With China’s mega current account surplus now virtually gone, the IMF has admitted they were wrong and the yuan is no longer overvalued. As we have long noted, downward forces on the yuan are mounting. Not only is a hard landing in China still likely, but the recent widening of the band makes devaluation even more likely.
In terms of the potential impact of the recent Chinese currency reforms on the future direction of the yuan, our own excellent China economist Wei Yao summed it up nicely: " opening up the capital account and improving yuan flexibility essentially gives incrementally more say to the market in determining the path of the yuan…...After the band widening, there is all the more reason to expect some small depreciation against the US dollar short term, given our expectation for further deceleration in China’s economic growth and the risk-off global backdrop." She goes on to explain that in her view the yuan should appreciate later in the year if, as she expects, there is increasing evidence that a hard landing has been avoided - link.
The concept of a harder landing is justfied by the longstanding observation that China’s external imbalance is virtually gone (see left hand chart below).
With reports of monthly deficits, as seen in February, becoming more frequent, this eliminates much of the argument that the yuan is undervalued.
The IMF in its latest Economic Outlook has done a special analysis of China’s external balance. It is, in part, a mea culpa on why it had previously incorrectly come to the conclusion that the yuan was 'substantially undervalued'. Indeed maybe it has scope to decline as it has been the strongest of all the major currencies (see right hand chart above).
The IMF also notes that while the external imbalances have lessened, this has been at the cost of growing internal imbalances.
From Martin Wolf at the FT "...the domestic adjustment now required is even bigger than before the crisis” – link. Wen Jiabao, the premier, has himself frequently described China’s development as 'unbalanced, unsustainable, and uncoordinated'. Plus ça change! With such extremes of internal imbalances, avoiding a hard landing will be extremely difficult.
and so in conclusion,
In that context it is notable just how sharply nominal GDP growth has slowed in China, as economy-wide inflation pressures – especially in property – go into sharp reverse (see charts below).
We saw exactly that overconfidence in the US in 2007 and we can see it again now.
If we are correct and a hard landing unfolds, the ability of the Chinese authorities to devalue the yuan has increased, both technically in the wake of recent reforms, and politically in the light of the IMF’s changed perspective. Yet from an American viewpoint little has changed. Despite the fall in China’s overall trade surplus, the bilateral imbalance with the US is reaching new records (on a seasonally adjusted basis). And when will this be most apparent in the headline data (seasonally unadjusted)? Just ahead of the US presidential election. Whoops!