China Translated

I had an opinion piece on China’s FX reserves in the WSJ China on Monday.  Chinese readers can see the original here.  For everyone else, the English version is below: 

The Real Drivers of Diversification in China’s FX Reserves

Where is China hiding its USD2.5trln in foreign exchange reserves?  The answer to that question is one of the best kept secrets in the world of finance.  The State Administration of Foreign Exchange (SAFE) - the organisation charged with the management of the USD2.5trln - certainly isn’t telling anyone, and for good reason.  When you are moving around the kind of money that SAFE is moving around,  telegraphing intentions to the market can make everything you want to buy terribly expensive and everything you want to sell awfully cheap.

But in the absence of real information, rumours proliferate, and sometimes fire the imagination of the markets.  This is one of those times.  First, at the end of May, came reports that SAFE was growing tired of the ups and downs of the euro, and reconsidering its holdings of European debt.  Those rumours were enough to send the euro plunging 1.5% against the dollar over the course of a single day’s trading.  A denial from SAFE calmed the markets.  But a few weeks later, rumours from Tokyo suggested that, despite its protestations to the contrary, SAFE was indeed growing weary of the euro, and was switching to Japanese government debt, with purchases of USD6.3bln over the first four months of the year.  The next week, another rumour, this time suggesting that SAFE was back in the euro game, with a purchase of E400mln (USD516mln) in 10-year Spanish bonds. 

Japanese bonds one week, Spanish bonds the next, if the press is to be believed, China is buying anything but US Treasury debt.  But what have we really learned from the  claims and counterclaims of the last few weeks?  Not a lot that we did not know already.  If China’s FX reserves are allocated in roughly the same proportions as global FX reserves as a whole - a reasonable assumption - then around 61% should be parked in dollar debt, with 27% in euro debt, 3% in yen, and the rest invested in other currencies.  That means that SAFE has something like USD675bln in euros, and a smaller but still sizeable USD75bln in yen.  In this context, the purchase of a few million in Spanish bonds and a few billion in Japanese government debt can hardly be regarded as anything other than business as usual.

A continued focus on dollar debt by China’s FX managers should come as no surprise.  Advocates of greater diversification point to risks to the value of China’s FX reserves from an excessive concentration in US Treasury debt.  Fair enough.  Inflation in the US, or a depreciation of the greenback, would both impact the purchasing power of China’s dollars.   But value is only one consideration, and not the main consideration, in the allocation of China’s FX reserves.  The fundamental reason for the allocation of China’s FX reserves to dollar debt is Beijing’s decision to manage the exchange rate against the dollar.  As long as China wishes to continue running a massive trade surplus with the US, whilst holding the yuan stable against the dollar, the brutal logic of supply and demand in foreign exchange markets dictates that every cent of that trade surplus be recycled into dollars. 

But the management of the exchange rate and the decision on where to invest FX reserves is a two step process.  SAFE might have to buy dollars in the first step - to manage the exchange rate, but once it has those dollars could SAFE not declare ‘mission accomplished’ and use them to buy European or Japanese government debt?  Not really.  Let’s take diversification into European debt as an example.  Use of dollars purchased in the FX market to purchase euro debt would weaken the dollar against the euro.  As the yuan is managed with reference to the dollar, that also means that the yuan would weaken against the euro.  That implies a reallocation of some of China’s trade surplus from the fast growing and dynamic US to a sclerotic EU.  As the current European sovereign debt crisis makes clear, the old world’s capacity to live beyond its means is substantially less than that of the new. 

The choice on the allocation of China’s FX reserves is not simply dictated by SAFE’s much repeated commitment to the principles of safety, liquidity, and returns.  It is also dictated by China’s choice of exchange rate regime.  It is not the micro-level investment plays but the macro-level economic policies that determine the allocation of China’s FX reserves.  Chasing after rumours from London bankers or Japanese bureaucrats - sources that have their own self interested axes to grind - will not bring us any closer to the truth.  But careful attention to shifts in China’s exchange rate policy just might. 

The announcement by the People’s Bank of China (PBOC) of a shift to a more flexible exchange rate, set with reference to a basket of currencies, has far reaching implications for the growth and allocation of China’s FX reserves.  First, on the growth of reserves, appreciation of just 0.7% against the dollar in the month since reforms were announced is unimpressive.  But over time, a stronger yuan will be one of the factors changing the balance between China’s imports and exports, and reducing the size of the trade surplus.  At the same time, two way movement in the yuan dollar exchange rate will reduce the incentive for currency speculators to dodge China’s capital controls, and hot money inflows should also be reduced.  This does not necessarily have any implications for the way reserves are allocated.  But a smaller trade surplus and reduced capital inflows will slow down the growth of China’s FX reserves and reduce SAFE’s budget for Treasury purchases.  The US Treasury got a taste of what that might look like in May this year, when capital outflows contributed to a substantial fall in the value of China’s FX reserves, and China’s holdings of US Treasuries fell by USD32.5bln. 

On the allocation of reserves, a more flexible exchange rate will also break the mechanical link which requires SAFE to recycle the trade surplus into dollars, and constrains their choice of where to park those dollars once they have bought them.  That means Beijing can push forward with another innovation: the privatisation of China’s FX reserves.  The first move in this direction, a shift in policy to allow Chinese firms to retain a portion of their overseas earnings, was announced quietly and without fanfare in 2009.  This might seem like a minor technical change, but it signals something rather significant: the end of SAFE’s monopoly control of China’s FX reserves.  The intention is to shift toward something like the Japanese system - where only a fraction of FX reserves are held by the government and the majority are in private hands.  This is a transition that will happen over time, but the bottom line is less cash for SAFE to buy Treasuries and more funds for Chinese companies to make foreign acquisitions.  The Chinese government might end up with a smaller share of the US public debt, but Chinese companies will end up with a bigger share of the Fortune 500.  Diversification of China’s FX reserves is happening, but it is these structural shifts, not this or that investment decision by SAFE’s money managers, that are the real drivers.

Exchange rate, Monetary Policy, Trade, US-China Relations

Second quarter growth in China’s FX reserves was a tiny USD7bln, despite more than a USD40bln addition from the trade surplus.  Slight growth in reserves despite the robust trade surplus suggests hot money was flowing out of China in the last two months of the quarter.

Two years of stability in the exchange rate knocked hot money off the policy agenda for the government: with little chance of yuan appreciation there was less reason for speculators to bring capital into the country.  But the recent announcement of the next stage in exchange rate reform will bring hot money back into vogue. 

Either appreciation against the dollar will be rapid and one way and the result will be increased incentives to bring hot money into the country - providing the real estate and equity markets pull themselves together.  Or appreciation will be faltering with the possibility of two way volatility - in which case speculators will probably find somewhere else to park their cash.

The interest in hot money in China’s policy circles is partly a relic of the Asian financial crisis, and, to a lesser extent, the speculative attack which forced the British pound to crash out of the European Rate Mechanism in the early 1990s. 

Chinese policy markers were horrified by the ability of foreign speculators to bring the governments of Asian neighbours to their knees, and by the humiliation at the hands of the IMF and its austerity programmes that followed. 

China has a closed capital account, so the chances of a similar attack are slight.  But that does not stop the Chinese media worrying about attacks by ‘big financial crocodiles’ (金融大锷 jinrong da e) - as George Soros style currency speculators are referred to.

This is my translation of a short section from a recent SAFE Q&A on the subject:

‘Our investigations in the first half of the year reveal that the vast majority of capital flows were legal and legitimate.  We have not discovered any large organised attempts to circumvent capital controls.  Most hot money is brought into the country through small transactions. 

As for so called ‘big financial crocodiles’, as we still have controls on capital account transations,  any speculative attack would be illegal - and this means that hedge funds and other financial institutions would think twice before trying their luck.

Hot money mainly enters the country disguised as legitimate trade and investment flows.  There are many and various routes.  But typically speculators are not particularly skilled at disguising hot money flows, so it is not that hard to pick up the signs of irregular transactions: 

-Companies in the processing trade will often under price inputs and over price outputs - with the collusion of their customers - to bring hot money into the country. 

-Shipping companies will take payments early and make payments late to increase their holdings of foreign capital. 

-Service companies can charge foreign customers for transport or consultancy services that are never provided, in order to have an excuse to bring hot money into the country. 

-Foreign investment is often disguised hot money, with investment advisory companies playing the role of broker for foreigners who want to make investments in the real estate or equity markets.’

You can see SAFE’s statement here.

Exchange rate, IFIs, Investment, Monetary Policy, Property, Stocks, Trade

Although China’s exports to the EU and US have held up pretty well this year, all things considered, it’s clear that the fiscal consolidation just getting underway in these two big markets will make things tough going forward. New avenues to pursue export growth will have to be found, and these are likely to come increasingly from the emerging world. You can already see evidence from the trade numbers that exporters are making headway in penetrating new markets - exports to Brazil were up by an eye-popping 98% year on year in the first five months of 2010, and those to ASEAN markets by 46%.

All of which helps to explain why emerging nations like Brazil and India are beginning to join the US and EU in the interminable finger-pointing over the renminbi. India has also begun to use anti-dumping measures against China on a regular basis across a number of sectors. Is this a sign that a new front in China’s trade wars is opening up? I doubt it. India, Brazil and a few others (Mexico and Turkey spring to mind) have the mass market and the strategic global clout to get in China’s face on trade, but any other emerging nations that try throwing their weight around in this way are likely to receive a bruising reminder of Chinese-style trade diplomacy.

Take Argentina, which earlier this year imposed restrictions on imports of Chinese-made shoes, pipes and other products. China was not happy, and responded with quality control measures on soy bean oil imports that hit Argentine exports. Five months on it’s pretty clear who’s winning this argument: according to the China customs administration Chinese exports to Argentina were up by 75% year on year in January-May, while its imports from the country were down 42%. Given that few emerging markets will be willing to risk losing out on the Chinese bonanza like this, I think most will remain wary of trying to curb the Chinese import surge.

Incidentally, given the clarity of the Chinese trade numbers (regarded as some of the stronger data in China’s somewhat rickety statistical base) it is funny to see Xinhua running with the Argentinian data. These portray a far more harmonious picture, with both China’s exports to Argentina and Argentinian exports to China rising, by 39% and 19% respectively. Trade flows are also much higher than shown by the Chinese side’s data. Sadly in this case, given the background of events on the ground and the poor reputation the Argentinian government has for statistical truth-telling, I’d put more faith in the Chinese numbers.

Duncan Innes-Ker is a senior economist with the Economist Intelligence Unit

China - Latin America relations, Guest contributor, International Relations, Statistics, Trade

I have an opinion piece in the South China Morning Post today on Beijing’s latest moves on the CNY and the implications for this weekend’s G20.

SCMP subscribers can read the piece here.

Everyone else can read it below:

US Might Miss an Open Goal on the Exchange Rate at G20 Summit

China’s hapless soccer team might not have qualified for the World Cup, but when it comes to playing the game of global politics, its leaders have shown considerably more finesse.  So whilst China’s soccer eleven are polishing their boots, China’s economics A-team is on the way to Toronto for the latest summit of the G20.  There has not been this many Chinese faces arriving in Canada since Hong Kong’s reunion with the mainland.

One week ago, it looked like the latest meeting of the world’s self appointed high council on all things financial crisis would be a festival of China bashing, with the exchange rate the main focus of attention. 

Back in April, when the US Treasury delayed publication of a critical report on China’s exchange rate regime, the unspoken trade off was that China would start the yuan appreciation ball rolling ahead of this week’s pow wow.  The attack dogs in the US Congress latched firmly onto that informal deadline, threatening that if there is no movement on the exchange rate by the G20, they will take matters into their own hands.  If China had not acted last weekend, the US would have been compelled to go on the offensive at Toronto. 

The European debt crisis has Brussels gazing at its own bureaucratic navel.  But with emerging markets like Brazil and India adding their voices to the paean of protest, and rumblings of discontent from East Asian neighbors, China looked set to find itself isolated at the international negotiating table.

By signaling the end of the yuan’s 22-month peg to the US dollar, China has done just enough to calm the storm.  In the few days that have followed the announcement, the yuan has been little moved.  A 0.2% appreciation against the dollar will hardly be enough to bring the competitive shine back to manufacturers in the US rust belt. 

But China has won itself the benefit of the doubt.  The same voices that were, last week, raised in protest, are now offering a cautious welcome for Beijing’s promise of increased flexibility.  The US Congress remains on the war path.  But China has given the Obama administration the fig leaf it needs to justify its softly softly approach to dealing with Beijing, and done just enough to ease tensions in relations with other emerging markets. 

Leaders in the US and elsewhere want China to translate its words into actions - they want real change not just a commitment to change.  But for now, Beijing has moved the exchange rate to where it wants to be - off the G20 negotiating table.

A careful examination of the fine print in Beijing’s announcement on exchange rate reform, however, suggests the US would be well advised not to allow the yuan to slide too far from view. 

China’s trade surplus might have come in at a tidy USD198bln in 2009, but that is still way down from almost USD300bln in the 2008.  Beijing has taken this as evidence that the trade account is coming close to balance of its own accord, and the need for further adjustment of the exchange rate is limited.  The announcement also makes clear that what adjustment there is will be gradual, to give the export factories of the Pearl and Yangtze river deltas time to adapt.  When it comes to exchange rate reform ‘limited’ and ‘gradual’ are not the words that Washington DC wants to hear. 

Even more alarming for the US, China has made it clear that in the future, the direction of travel for the yuan against any particular currency could be down as well as up.  The new plan for the yuan might mean continued stability, or even depreciation, against the dollar, at the same time as the currency appreciates against the euro, the Brazilian Real or the Indian Rupee. 

If Brussels, Brasilia, and New Delhi find the yuan’s new flexibility means appreciation against their own currencies, they will see little reason to support the US on the need for appreciation against the dollar.  By conceding to US demands for enhanced flexibility of the exchange rate, China might have succeeded in turning the international consensus on the need for yuan appreciation on its head.  If it is the US that finds itself isolated at the negotiating table at the next G20, scheduled for Korea in November, they might regret missing an open goal in Canada.

Exchange rate, Financial Crisis, International Relations, Trade, US-China Relations

The US China Strategic and Economic Dialogue has come and gone with no change to the yuan dollar exchange rate.  The US side appear to believe that the G20 in late June will be the new focus for pressure on China.  But market expectations of a resumption of appreciation have collapsed.

This is the view on the pros and cons (mainly cons) of yuan appreciation from Central University of Finance and Economics Professor Guo Tianyong, which I have translated in summary fashion from a recent posting on his blog:

‘We are going through a period of radical transformation in the structure of the Chinese and the world economy.  China will no longer be able to rely on the luxurious consumption of consumers in the West to drive growth, but will have to look to internal drivers.  In this context, rapid appreciation of the yuan would not provide a stable basis for changing the economic structure.

Second, as everyone knows, Chinese industry benefits from controlled domestic prices for important inputs to production - energy and water prices for example.  These controlled prices have been beneficial but have also introduced distortions into the economy and high levels of pollution.  Removing controls and bringing prices up to market levels is now a priority, but this will mean higher costs which will damage the competitiveness of China’s exporters.  Rapid yuan appreciation on top of higher factor costs would place too great a strain on our businesses.

Third, though some people claim that appreciation of the exchange rate can be used to control inflation, and China is faced with inflationary pressure, in fact the relationship between the exchange rate and inflation is not straightforward.  During the period from 2005 to 2008 faster appreciation appears to have been linked to higher inflation - not the other way around.

Turning to the impact on business, the impact of appreciation would vary from industry to industry and from company to company.  For commodity importers, and companies that want to invest overseas, a stronger yuan would be a positive.  For exporters, it would weaken their competitiveness.

For the export sector, textiles, electronics, light industry, and machinery and power generation make up 70% of exports and employ more than 70m people.  These are low value added industries that compete on price and make profits from high volume.  Our research indicates that these firms use mainly domestic inputs, so they would not benefit from cheaper imported input costs if the yuan appreciates. 

Our research also indicates that the after tax profits of these firms is already very low - close to 5% in the second half of 2007.  An appreciation of the yuan would therefore have a serious impact on them, and so on the wider economy.

For importers, the benefits of yuan appreciation would be limited.  China is a major importer of raw materials and an appreciation of the yuan would certainly reduce the cost.  But as the recent debacle over the pricing of iron ore indicates,  control of the price of commodities lies outside of China’s hands, and this would be the case no matter what the value of the yuan.

Summing up, the evils and maladies of a large yuan appreciation outweigh the benefits, and gradual appreciation is still the best strategy.’

Professor Guo is not adverse to the use of loaded rhetoric (references to the ‘luxurious consumption’ of the USA) or examples (the iron ore price negotiation - which has little to do with the subject at hand but is an emotive point for Chinese nationalists). 

But he is an influential economist within China, and it is interesting to see how points which  in the US and elsewhere would help make the case for rapid appreciation are here used to make the case for a more gradual approach. 

Secretary Geithner might argue that appreciation of the yuan is part of the adjustment of the Chinese economy.  Prof Guo argues that because China is adjusting the structure of its economy it cannot be expected also to rapidly appreciate the value of the yuan.

You can see the original blog posting here.

Exchange rate, Industry, Trade, US-China Relations, Uncategorized

I have an op ed in today’s South China Morning Post on the impact of the latest trade data and the European sovereign debt crisis on the outlook for China’s exchange rate.

SCMP readers can see the text here.  Or I’ve pasted it below:

Even the tea leaves some questions unanswered
 
 
When will Beijing loose its iron grip on the value of the yuan and allow its appreciation to resume? No one has a definitive answer to that question. But, until quite recently, the signs in the tea leaves suggested a resumption of appreciation was imminent and that a first move might even be on the agenda for this month or next.
Why so confident? Three factors seemed to suggest Beijing was gearing up for a policy shift. First, China’s exports are moving back onto an even keel. The factories of the Pearl and Yangtze river deltas are shifting up to full capacity, and exports for March and April have returned to pre-crisis levels.
 
Second, inflation has returned to the mainland’s economy. Increases in consumer prices might be contained but prices at the factory gate are way up, and one of the main reasons is higher costs for imported crude oil and iron ore. The appreciation of the yuan would help keep a lid on imported price rises.
Third, China’s trade partners are ratcheting up the pressure. A meeting of the US-China strategic and economic dialogue at the end of this month and a G20 summit at the end of next month will increase the volume of calls for appreciation. Beijing faces its own domestic pressures and nationalist sentiment might make it difficult to kowtow to the United States. But with the European Union and other emerging market economies like Brazil and India also calling for appreciation, China’s leaders might find themselves with few friends and many enemies round the G20 table.

The signs in the trade, inflation and political tea leaves seemed to point towards an imminent resumption of appreciation. But a vanishing trade surplus in March and April and the European sovereign debt crisis have thrown the tea leaves into a new configuration.
Central to the case for China’s trade partners is the idea that the appreciation of the yuan will help bring China’s trade account, and so also the world economy, back into balance. An undervalued yuan, the argument goes, gives China’s exporters an unfair advantage and cripples the competitiveness of exporters in the EU and US. The result is bumper trade surpluses in China and corresponding deficits elsewhere in the world.
But a deficit in China’s trade account in March and a tiny surplus in April have called this argument into question. If China’s trade account is moving back into balance at the current exchange rate, what is the urgency in resuming the yuan’s stalled appreciation?
The European sovereign debt crisis has also changed the calculation. For China’s leaders, the Greek drama signals that the international outlook remains uncertain. If the path to recovery is rockier than was previously thought or, even worse, might lead off another cliff, that is bad news for China’s exporters.
The EU seems to have moved decisively, if belatedly, to restore confidence and stability. But with the outlook uncertain, China’s leaders are hardly likely to kick away the main support for the most important sector of the economy.
The Greek crisis also affects the way the European side views the exchange rate. A silver lining to the Greek cloud has been a fall in the value of the euro against the yuan - strengthening the competitiveness of European exporters. With plenty to worry about at home and the exchange rate moving in their favour in any case, Brussels is likely to dial down the volume of complaints on China’s exchange rate regime.
All this changes the calculation on China’s exchange rate regime. The signs in the tea leaves are no longer as clear as they were. If the Greek drama develops into a European tragedy, or China’s trade account stays close to balance this month, it might even be time to brew a fresh pot.

EU-China Relations, Exchange rate, International Relations, Monetary Policy, Trade, US-China Relations

The question of whether China should buy Greek sovereign debt has been in the news this week, and has prompted some reflections from Fudan University’s celebrity economist Sun Lijian.  This is my translation of the main points from his recent blog posting:

‘A few considerations on whether we should invest our precious foreign exchange reserves in Greek debt:

First, if there is no double dip downturn in the US and EU, investment will naturally start to move away from low yielding and liquid products, into higher yielding products.  Buying undervalued products, like this Greek debt, fits in with the spirit of post-crisis investment.  This is especially true as the US dollar will continue to fall in value, and low yields on US Treasury debt will not make up for the exchange rate loss on our holdings of dollar debt.  Investing in Greek debt would help maintain the stability of the value of China’s FX reserves.

Second, if trade surplus countries don’t recycle their surplus back to trade deficit countries, they won’t support the spirit of free trade, and might encourage trade deficit countries to adopt protectionist policies.  Considering the overall interests of the Chinese economy, some diversification of reserves away from just one trade deficit country - the US, toward trade deficit countries in the EU, make sense.’

Of course, Sun’s view is not necessarily the view of the State Administration for Foreign Exchange.  The guardians of China’s USD2.3trn in foreign reserves continue to play their cards close to their chests.  But it’s interesting to hear his views on the importance of protecting the value of reserves by seeking out higher yielding investments, and the relation between recycling reserves into trade deficit countries and maintaining trade partners’ tacit support for China’s export-based growth strategy.

You can see Sun’s original posting, in Chinese, here.

EU-China Relations, Exchange rate, Trade, US-China Relations

Currency Wars is a very popular book in China.  It’s author, Song Hongbing, has tapped into a rich vein of nationalism and suspicion about the West, especially the role of US investment banks.

His argument, which is entirely specious, is that  a cabal of investment bankers have dictated the course of world history since the Napoleonic wars, are the gatekeepers to the US presidency, and - should they be allowed into the Chinese economy - would bring the current benign social order crashing down to serve their own evil interests.

I discussed this book with a Chinese friend who works in the financial sector and he said that its popularity was an interesting social phenomenon.  But the author was so obviously a crazy conspiracy theorist that his work had no influence at all in policy or finance circles.

Finance graduates might be able to see through the smoke and mirrors, but the book had a major influence on public opinion, and a follow up - imaginatively entitled ‘Currency Wars II’ - has just hit the book stores.

This is my translation of the main points from a chapter in the first Currency Wars, focusing on the potential evils of allowing foreign investment banks into the Chinese economy, and the benefits of returning to gold as the basis of the international financial system:

‘Control of money supply is key to control of the economy.  You might think that foreign banks have no way of influencing the money supply in China, that the People’s Bank of China controls the supply of money.  In fact, by issuing loans, banks influence the money supply.    Let foreign banks into China, and they would deliberately manipulate the money supply, using excess supply to cause inflation, and restricting supply to cause deflation, crippling the economy, as they have done to destabilize foreign countries throughout history.

The US is already using its influence to disrupt China’s money supply.  By manipulating its trade deficit with China, the US can increase the money supply in China, and that can lead to bubbles in the property sector and equity markets.  China’s Central Bank can only control the problem by selling bonds to soak up the additions to the money supply, but this increases the national debt.

These are the currency wars, and as long as the US dollar is the main international currency, China has no way to fight back.  Only when gold again becomes the basis of the international currency system can we have an independent, fair, and harmonious financial system.’

Of course, there is a kernel of truth in all this.  Hedge funds, many of them US hedge funds, were instrumental in destabilising Asian economies in the Asian Financial Crisis.  China’s trade surplus, combined with the fixed exchange rate, does cause problems for the People’s Bank of China.  The role of the US dollar in the international financial system is beneficial to the US and harmful to its creditors.

But the way all of these facts is put together is completely wrong.  It’s not foreign banks who are creating a problem in China’s money supply, it is domestic banks.  It’s not the US that is forcing China to run a trade surplus with a fixed exchange rate - it’s a deliberate part of China’s development policy.  And a US dollar based international financial system might have its flaws, but the world moved away from the gold standard for a reason - because it tied money supply to the availability of a scarce commodity - and a return is not on anyone apart from Song Hongbing’s agenda.

Banking, Exchange rate, International Relations, Monetary Policy, Trade, US-China Relations

This weekend I paid a visit to Dongguan.  Dongguan is a factory town in Guangdong Province, one of the engines of China’s export economy, and a city made famous by Leslie Chang’s relation of the lives of its many Factory Girls.

An afternoon’s trip to a city of 7m people is not enough to even scratch the surface, but for what it is worth, my main takeaways from the trip were:

-The migrant workers have not yet returned.  On a Saturday afternoon, we walked down a street of factories that was completely empty - no workers enjoying the balmy weather, only a few shop owners bemoaning the lack of customers.  One shop owner we spoke to, whose shop sold snacks, and offered internet access and payphones for migrant workers to make calls home, said business had not been good for the last two years.  ‘Two years ago this street would have been wall to wall with factory workers’ he said.  ‘Now they have all gone home.  Business is so bad all my revenue goes to pay rent.’  The bus station, whilst by no means deserted, was not crowded either.  December’s trade data, published by China’s Customs Bureau last weekend, shows exports making a surprisingly rapid recovery.  But the view from Donnguan street is that there is still a long way to go.

-Purple jeans and Mohawks - two migrant workers we did speak to were crouched outside the entrance to a factory waiting for their friend to finish a shift.  The main thing which struck me was their heightened sense of style.  The woman’s hair was immaculately coiffed and she wore a green mini skirt over black tights.  The man wore purple jeans, a matching purple top, and had his hair styled into a dyed-blonde mohican.  His shoes were one purple and one green.  On inquiry, it transpired that he had bought two pairs of shoes in different colours and was mixing and matching for effect.  For these young people, at least, it was clear that a certain percentage of income, perhaps even a large percentage, was spent on current consumption, not saving or transfers back to the village.

-Dongguan is not a particularly pleasant city.  The woman in the information office at the bus station was slightly perplexed when we asked for suggestions on areas of local interest.  The air is resolutely grey.  Major roads push up against residential areas and some of the waterways we saw were black and iridescent.  All of that said, the city center boasts a modern library, concert hall and museum.  Modern apartments and villas with gardens are under construction.  And on the main conduits into the town, there are well maintained beds of flowers, trees and bushes to at least remind the visitor of the existence of something called nature.

-Retailers have arrived in force, and we saw a fair few gleaming new car show rooms, including a large show room devoted to selling Buicks.  There has been a lot of debate in the last few months on where the surge in car sales in China this year has been coming from, with some arguing that it is government purchases that are driving the very impressive sales figures.  An alternative argument is that government subsides have made cars affordable, for the first time, to a whole new strata of society, and this lower middle income group have been rushing to the shops to buy.  One business journalist we spoke to last week, thought that much of this purchasing was taking place at 3rd tier cities that are off the radar for most China watchers.  The large number of shiny new dealerships in Dongguan provides anecdotal evidence in support of this argument.

Environment, Labour markets, Regional, Trade

A few weeks ago, the People’s Bank of China’s third quarter monetary policy report received a lot of attention because of a slight change in the wording on the future direction of exchange rate policy.  This is my translation of the relevant sections of the second quarter and third quarter reports, so readers can see for themselves the difference in the wording.

In the second quarter report, the relevant section reads:

‘Continue to develop a market based interest rate, and perfect the CNY exchange rate mechanism.  Accelerate the development of the benchmark interest rates in the money markets, make great efforts to improve the capacity of the financial system to price risk, allow a greater degree of market control in the establishment of the interest rate. 

Pay close attention to the exchange rate movements of major currencies, according to the principles of self initiative, control, and gradualism, continue to perfect the CNY exchange rate mechanism, maintain the basic stability of the CNY within an appropriate and balanced level. 

Continue to develop exchange rate control reform, take further steps to facilitate outward investment by domestic organisations, in a stable manner expand the opening of financial markets, actively develop the foreign exchange market, enhance exchange risk management tools. 

Steadily push forward the work of the cross border CNY trade settlement experiment.  Take further steps to improve the efficiency of foreign exchange reserve use, make every effort to improve returns.’

In the third quarter report, the relevant section is:

‘Continue to develop a market based interest rate, and perfect the CNY exchange rate mechanism, strengthen and perfect foreign exchange controls.  Continue to push forward the development of a benchmark interest rates in the money markets. 

According to the principles of self initiative, control, and gradualism, taking account of international capital flows and trends in the movement of major currencies, perfect the yuan exchange rate mechanism. 

Actively develop the foreign exchange market, enhance exchange risk management tools, improve the ability of financial organisations to price and manage risk.  Continue to push forward the work of the cross border CNY trade settlement experiment.  Take further steps to facilitate overseas investment by domestic organisations, in a stable manner expand the opening of financial markets.’

The main differences are: 1) the sentence on the ‘basic stability’ of the exchange rate is present in the second quarter report but absent in the third quarter report 2) the third quarter report has a new clause on ‘taking account of the movement of  major currencies’.

The first difference could certainly be interpreted as a sign that a return to appreciation is more imminent, but how strong a signal it is given it appears on page 46 of a 47 page report is open to question.  The second difference is ambiguous.  One interpretation would be that the US should halt the slide in the dollar before China will consider appreciating the CNY - which would push appreciation further into the future.

You can see the original second quarter report here and the third quarter report here.

Exchange rate, International Relations, Monetary Policy, Trade, US-China Relations