The most
pressing question facing China today is what US President-elect
Barack Obama will do on trade issues, and specifically what he will
do about the debate on whether the US Treasury should designate
Chinese as a "currency manipulator."
Obama wrote in a letter to the National Council of Textile Organizations released on Oct. 24 that China must stop manipulating the currency.
In the fall of 2003, we began advocating the idea that a maxi revaluation of the yuan was the only fundamental solution to dampening capital inflows into China’s economy. We argued that a maxi-revaluation of 15-20 percent versus the US dollar was the “least worst” of a number of unpleasant policy options China faced at the time because if China did not use an appreciation of the currency to dampen foreign capital inflows, the inflows would not slow or reverse until a domestic economic crisis forced an inevitable reversal.
Chinese policymakers eventually broke the de facto peg with the US dollar in 2005, but instead of a large revaluation, they opted for what is a de facto "managed-crawl." The managed crawl has proven dangerously counterproductive as it has only exacerbated the capital inflow problem by providing a one-way bet for “speculators” as manifest in an unprecedented surge in hot money inflows into China and foreign reserve accumulation in the 1Q08.
There are growing signs that slowing growth is starting to cause profit erosion and higher inventories in other sectors of the economy besides automobiles, including related industrial sectors like aluminum production. While these trends are still nascent, we believe they are important early warning signals that the China macro boom faces a potentially A domestic growth slowdown risks triggering a self-reinforcing spiral of higher inventory, lower profits, higher non-performing loans, weaker bank balance sheets, slower loan growth and eventually even slower economic growth. This is exactly the scenario China faces over the next six to 12 months if, as seems likely, the global economy slows into recession next year. If our negative spiral scenario is bad enough to trigger a full-fledged domestic banking crisis in China and large-scale capital flight, the next big move for the yuan may just be sharply weaker versus the dollar, not stronger as still assumed by conventional wisdom.
massive unwinding.
China's economy follows the natural laws of market economies just the same as every other economy in the history of capitalism: namely, that monetary inflation-fueled credit booms always result in deleveraging busts.
Obama wrote in a letter to the National Council of Textile Organizations released on Oct. 24 that China must stop manipulating the currency.
The key question is whether Obama will figure out a face-saving way to avoid designating China a currency manipulator. This will be very difficult. Donald Straszheim, vice chairman of Roth Capital, was quoted in Bloomberg regarding how difficult it will be for Obama to avoid pushing China hard on the currency.
"Obama will be regarded as another old type politician who promises one thing during the campaign and does another in office if he doesn’t take specific action following his comments to the National Council of Textile Organizations that China is manipulating the yuan," Straszheim told reporters.In the fall of 2003, we began advocating the idea that a maxi revaluation of the yuan was the only fundamental solution to dampening capital inflows into China’s economy. We argued that a maxi-revaluation of 15-20 percent versus the US dollar was the “least worst” of a number of unpleasant policy options China faced at the time because if China did not use an appreciation of the currency to dampen foreign capital inflows, the inflows would not slow or reverse until a domestic economic crisis forced an inevitable reversal.
Chinese policymakers eventually broke the de facto peg with the US dollar in 2005, but instead of a large revaluation, they opted for what is a de facto "managed-crawl." The managed crawl has proven dangerously counterproductive as it has only exacerbated the capital inflow problem by providing a one-way bet for “speculators” as manifest in an unprecedented surge in hot money inflows into China and foreign reserve accumulation in the 1Q08.
There are growing signs that slowing growth is starting to cause profit erosion and higher inventories in other sectors of the economy besides automobiles, including related industrial sectors like aluminum production. While these trends are still nascent, we believe they are important early warning signals that the China macro boom faces a potentially A domestic growth slowdown risks triggering a self-reinforcing spiral of higher inventory, lower profits, higher non-performing loans, weaker bank balance sheets, slower loan growth and eventually even slower economic growth. This is exactly the scenario China faces over the next six to 12 months if, as seems likely, the global economy slows into recession next year. If our negative spiral scenario is bad enough to trigger a full-fledged domestic banking crisis in China and large-scale capital flight, the next big move for the yuan may just be sharply weaker versus the dollar, not stronger as still assumed by conventional wisdom.
massive unwinding.
China's economy follows the natural laws of market economies just the same as every other economy in the history of capitalism: namely, that monetary inflation-fueled credit booms always result in deleveraging busts.
Sam Baker is director of Asia research for Trans National Research Corporation, a US-based political and economic consultancy specializing in global emerging market research.
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