The exact allocation of China’s USD2.5trln in FX reserves is a closely guarded secret.  One of the only public sources of information on the subject is provided by the US Treasury’s TIC data.  The TIC data represents the Treasury’s attempt to keep track of foreign investments in US securities.  It provides, amongst other things, a headline reading on China’s holdings of US Treasuries.

TIC data for June came out yesterday and it made interesting reading - showing China’s holdings of Treasuries down USD24.0bln to USD843.7bln, from USD867.7bln in May.  Even worse, the fall in holdings came mainly from net sales of long term notes and bonds, not short maturity T-bills. 

What does it mean?  Is China finally loosing faith in the US?  My view is that the monthly TIC data does not do a very good job of capturing China’s purchases and that we need to wait for a few more months data, and maybe even the Treasury’s annual survey, to see what is really going on. 

But Zhang Ming of the Chinese Academy of Social Sciences thinks this might be a turning point in the allocation of China’s FX reserves.  This is my translation of the main points of an opinion piece he ran in the 21st Century Business Herald today:

‘The latest TIC data shows China’s holdings of US Treasuries down for a second month.  Even more striking is that most of the fall comes in our holdings of long term Treasuries - which are more risky investments. 

This might mark a turning point in China’s allocation of its FX reserves.  It might mark the point when Chinese investors came to understand the risks of investment in US Treasuries from inflation in the US or a depreciation of the US dollar.

At the moment, markets are focused on the risks in Europe.  But actually, in the long term perspective, the risks in the EU are less than they are in the US.  The average fiscal deficit and debt/GDP ratio for eurozone members is lower than in the US.  And whilst the eurozone countries have plans for fiscal retrenchment, the US fiscal deficit is set to grow.

Japanese sovereign debt obviously also has risks attached - an ageing population and high debt/GDP ratio are not positives for the Japanese economy.  But these are not risks that are correlated with risks in the US and so diversification of foreign investments in this direction is also a sensible option.’

You can see the original piece in Chinese here.

EU-China Relations, Financial Crisis, International Relations, US-China Relations

China and US leaders are about to kick off this year’s meeting of the Strategic & Economic Dialogue with opening remarks.  I have an op ed on the talks in today’s South China Morning Post.

SCMP subscribers can read the article here, or I’ve pasted it below:

Don’t Mention the Currency

A sunk ship in South Korea and a sinking economy in Greece may be enough to scupper hopes of movement on the exchange rate at the US China Strategic & Economic Dialogue

China is a currency manipulator and unless they change their wicked ways we will take them to task: that was the message from Senator Barack Obama on the 2008 Presidential campaign trail.  Back then, the exchange rate was 6.83 yuan to the dollar.  Almost two years and one global financial crisis later, the exchange rate is still 6.83 yuan to the dollar, and President Barack Obama and his team have fallen strangely silent.

One reason for that silence might be that an informal understanding between Beijing and Washington has been reached.  Back in April, the US Treasury decided to delay publication of a report to Congress on international exchange rates - a report which might have officially designated China as a currency manipulator.  That decision came shortly after a visit to the US capital of one Zhong Shan, China’s vice Commerce Minister.  Whispers from Washington suggest that, though no concrete assurances were given, Zhong’s visit did at least result in a meeting of minds.  The US would dial down the rhetoric on the exchange rate and China would proceed with appreciation, at its own pace, but within a reasonable time frame.

For many in Washington, a reasonable time frame meant before the next meeting of the Strategic & Economic Dialogue - the annual US China talk fest which is set to take place in Beijing on the 24th and 25th May.  But with the talks about to commence, expectations of an early resumption of appreciation appear increasingly misplaced. 

Why the delay? Look no further than the European sovereign debt crisis.  The EU might have belatedly mounted its white horse to ride to the rescue of the Greek damsel in distress.  But the episode has rung alarm bells in Beijing, suggesting that the global financial crisis has yet to run its course and the time for the resumption of yuan appreciation is not yet right.

If a resumption of appreciation in advance of the meeting was too much to hope for, maybe a little table thumping in the meeting itself will do the trick? 

Probably not.  On the US side it is the State Department that’s calling the shots, and that means a focus on the strategic, not the economic, half of the Dialogue.  The sinking of a South Korean navy ship, with the deaths of 46 sailors on board, has raised the temperature on North Korea.  With an official investigation placing the blame squarely at the door of Pyongyang, shaping a response has risen to the top of the agenda for the Dialogue.  And with the focus of attention elsewhere, there is little hope of progress on the exchange rate.  Officials on both sides have already begun to talk the issue down.

A sinking economy in Greece and a sunk ship in South Korea might be enough to scupper hopes of a move on the exchange rate at this week’s Dialogue.  But excuses will do little to appease an increasingly vocal domestic lobby in the US.  Trade unions, industrial interests, and a Congress spoiling for a fight might have bought into the Treasury’s softly softly approach in the run up to the Dialogue.  But continued inaction may well use up scarce supplies of patience. 

The Treasury has signaled that it wants to see a multilateral solution to the problem - hinting at a resumption of appreciation ahead of the meeting of the G20 in Canada in June.  But if no action is forthcoming by then, domestic interest groups might start to ask what President Obama has done to make good on his campaign trail promises.

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

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

‘It’s our currency and your problem’ - that’s what then US Treasury Secretary John Connally declared when President Nixon ended the dollar’s convertibility to gold - much to the consternation of European countries, which at the time held very large quantities of US dollar debt.

Today, in the opening paragraph of a front page editorial in the official China Securities Journal, the author writes: ‘Former US Treasury Secretary Connally once famously said ‘it’s our currency and your problem’.  Now, China can say ‘The yuan is our currency and our problem’.’

The value of the dollar is still a problem for China, as a decline in the dollar threatens to erode the value of China’s FX reserves.  But as the editorial suggests, the US is not the only country in the world that can create international waves with the value of its currency.  The tone of recent announcements from Beijing suggests that China is in no mood to bow to international pressure to allow an early return to appreciation of the yuan.

China’s holdings of US Treasuries popped up in another context today.  An article in Outlook Weekly - a popular paper with Communist Party members and government officials - quotes Luo Yuanshao of the Chinese Military Academy as suggesting that one way to sanction the US for the recent decision to sell arms to Taiwan would be to sell a portion of China’s holdings of Treasury debt.

This kind of suggestion pops up from time to time, and the mood music might even be useful for Beijing as it attempts to use what little leverage it has to keep the US honest on its fiscal deficit and monetary policy.  But as Luo recognises elsewhere in the article, the economic interests of the US and China are intimately interlinked.  Engineering a collapse in the dollar would no more serve China’s interests than it would those of the US.

Here’s a link to the China Securities Journal editorial.  Here’s a link to the Outlook Weekly story.

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

Did anyone notice a new world order emerging at the recent meeting of business leaders in Davos?  Me neither.  But we must have been looking in the wrong place, because everyone’s favourite Communist Party magazine - Outlook Weekly - saw it quite clearly.

Here’s my translation of the main points of an article on Vice Premier Li Keqiang’s trip to Switzerland, from the latest edition:

‘The summit at Davos was happily timed to coincide with two ’saying goodbye to the old and welcoming the new’ moments.  The first was the end of the 00’s and the beginning of the 10’s.  The second was the waning of the old Western dominated world order, and the dawning of a new world order, where large emerging countries will have greater power and influence.

The world is becoming multi-polar, and this process is leading to rapid reform of global systems of governance.  International power and influence is shifting from the West to the East and from the North to the South.  Western countries are being compelled to share their influence with emerging countries in the East.

After the financial crisis, the centers of global influence are the US, EU, China, Russia, Japan, India, and Brazil.  ‘One super power many strong powers’ （一超多强）has become ‘One super power six strong powers’ （ 一超六强).  The US might still be the only super power, bu the six other powers now includes four developing countries.’

The article goes on to set out China’s ‘four principles’ for global economic governance, as set out by the Chinese representative at the G8 meeting in September 2009.  These are:

1. The objectives of governance: to push forward economic globalisation, with a focus on mutual benefit and win-win solutions

2. The subject of governance: all countries should participate on an equal basis in global governance

3. The process of governance: the process should be consultative, with the interests of all countries - especially developing countries - considered

4. The system of governance - at different levels and in different spheres, to increase the representative nature of global governance, a new framework for economic governance should be constructed

Finally, the article notes that at a briefing for Chinese media ahead of Vice Premier Li’s trip, a spokesman for the Foreign Ministry added his own three principles for reform, which can basically be boiled down to a greater role for developing countries in global governance, and respect for all countries’ right to determine their own development model.

The main points and general tone of the argument in this article certainly supports the idea that post-crisis China has growing confidence about its weight in world affairs.  The authors use of the term ‘one super power six strong powers’ is also interesting.  The term ‘one super power many strong powers’ has been in China’s international relations vocabulary since the end of the cold war, expressing the hope that multiple smaller powers would be able to check the influence of the US.  The transition from ‘many strong powers’ to ’six strong powers’ might be wishful thinking on the part of China, but also indicates some crystallisation of thought in Beijing as to who those ‘many strong powers’ might be.

China - Africa relations, China - Latin America relations, EU-China Relations, Financial Crisis, IFIs, International Relations, 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

Late last year, the 3rd Quarter Monetary Policy Report of the People’s Bank of China sparked some excitement by changing familiar wording on the exchange rate policy.  In particular, the Central Bank dropped the reference to the ‘basic stability’ of the exchange rate.  This lead some to speculate that the Chinese authorities might be about to allow the CNY to resume its stalled appreciation.

In fact, the significance atttributed to the omission of the ‘basic stability’ phrase was excessive.  The change in wording appeared on page 46 of a 47 page report.  And China is hardly likely to strip away the main support for exporters at a time when the recovery is still  in its early stages, external demand remains weak, and the focus remains on protecting growth and jobs. 

Today, almost as if it knew it was missed, the committment to the ‘basic stability of the exchange rate’ has reappeared.  In a statement on its website following its annual work meeting, the People’s Bank says that in 2010 they will: ‘according to the principles of self-initiative, control, and gradualism, continue to perfect the CNY exchange rate mechanism, and maintain the basic stability of the CNY within an appropriate and balanced level.’ 

This exactly mirrors the language in 2009’s 2nd Quarter Monetary Policy report.  In short, the message from the PBOC appears to be that no change in China’s exchange rate policy is imminent.

You can see today’s statement from the PBOC here.

EU-China Relations, Exchange rate, Financial Crisis, Monetary Policy, US-China Relations

Outlook Weekly is an official magazine with a focus on political, economic, and international relations issues.  Apparently it is widely read by government officials and party members.  To coincide with the Obama visit, the latest issue has a  lengthy piece explicating Hu Jintao’s 5-principles for the conduct of international relations. 

Here is my translation of the 5-principles:

1. The principle of deep change (深刻变革论) - today’s world is going through a process of unprecedented and historic changes, our world is everywhere a world of opportunities and challenges.

2. The harmonious world principle (和谐世界论) - the need for peace, the urge for development, the importance of cooperation - these are unalterable historical trends.  International society should work hard to construct lasting peace, shared prosperity; and a harmonious world.

3. The shared development principle (共同发展论) - the relationship between countries is one of collective interests, with joys and sorrows borne together.  We must work toward a way of thinking about our collective development that places greater emphasis on communication and cooperation, learning from each other, win-win solutions and shared development.

4. The principle of shared responsibilities (共担责任论) - international society has to establish the idea of shared responsibility.  Considering matters from all sides, we should join hands together to face shared challenges and threats.

5. The principle of active participation (积极参与论) - China’s fate is more and more interwoven with the fate of the world.  We must synthesis the objectives of retaining our independence and participating in the global economy, taking account of domestic and international interests as we play our part in the high task of promoting peace and development.

The other noteworthy point about the article is that there are lots of pictures of Hu in friendly mood with other world leaders, including former US President George W. Bush, the leaders of Brazil, India and Russia, and some African leaders.  But the following article on the meeting with Obama shows Hu looking decidedly less welcoming.

China - Africa relations, China - Latin America relations, EU-China Relations, International Relations, US-China Relations

Brussels and Frankfurt are decamping en masse to Nanjing for the next few days for a series of EU-China summit meetings.  I have an oped on the subject in today’s South China Morning Post.  You can see the SCMP version here or read the text I have pasted below.

“The US get toys, the Chinese get Treasuries, and we get screwed.” That was the succinct summary of the relationship between Brussels, Beijing and Washington expressed by one European official.

But hope springs eternal, and the next few days will see not one but two delegations of European Union leaders head to Nanjing. On Sunday, European Central Bank President Jean-Claude Trichet and other representatives of the euro area will make a push for greater exchange-rate flexibility. On Monday, the EU-China summit will bring Swedish Prime Minister Fredrik Reinfeldt and European Commission President Jose Manuel Barroso face to face with Premier Wen Jiabao, with climate change at the top of the agenda.

For the EU, limping out of recession and with unemployment still rising, the unequal trade relationship is the main focus of concern. European exporters have suffered in the past eight months as the yuan has held steady against a falling dollar but depreciated against the euro. That depreciation makes European goods more expensive and Chinese goods cheaper.

With the cries of anguish from European capitals increasing in volume, the euro area’s top brass will be eager to extract some concessions from their Chinese counterparts to bring greater balance to the trade relationship.

But what hope do the eurocrats have of making any progress? China showed how seriously it took the relationship with the EU last year, when the decision by French President Nicolas Sarkozy to meet the Dalai Lama “hurt the feelings of the Chinese people” and the Chinese side cancelled the summit. To underline the contrast in relations with the EU and those with the US, in October 2007 then-president George W. Bush gave the Dalai Lama a Congressional Gold Medal and caused barely a ripple.

Arrangements for the upcoming wave of meetings do little to inspire confidence in the EU’s negotiating position. Separating the euro-group visit from the rest of the summit might make sense back in Brussels - after all, not all European member states belong to the euro zone. But, if the exchange rate were discussed together with the complete set of bilateral issues, the EU could offer concessions or threaten sanctions in other areas to encourage movement on the Chinese side. By treating the exchange rate separately, Trichet and the other representatives of the euro area will find themselves bereft of both sticks and carrots.

For the Chinese, their target of 8 per cent growth this year is virtually assured, and the outlook is even better. But with the latest data on exports disappointing and foreign demand uncertain, there is little appetite to begin thinking about yuan appreciation. China has showed no signs of altering this stance in the face of US pressure. And where the US failed, the EU has little chance of success.

US President Barack Obama came to Beijing, asked for little, and left with nothing. With the EU unable to get its own house in order and China in no mood to compromise, Trichet, Reinfeldt and Barroso are unlikely to do any better.

EU-China Relations, Exchange rate, Trade

The People’s Bank of China’s (PBOC) 3rd quarter monetary policy report, published yesterday, is getting a lot of attention.  In particular, its contents are being minutely examined for signs of a change in the approach to managing the exchange rate.

With signs of a recovery in the world economy, with President Obama about to wing his way to Beijing, and with an ever increasing volume of complaints from the EU about the unfairness of the CNY’s peg to the USD, it’s no surprise that this aspect of the report is getting a lot of attention.

But I’m not sure the slight changes to the PBOC’s boiler-plate language on the exchange rate can sustain the weight of interpretation that has been placed on them.  This is my translation of the relevant passage from the report:

‘The fourth priority… according to our own priorities, and in a gradual manner, taking account of international capital flows, and trends in the movements of major international currencies, is to perfect the exchange rate system.’

The first point to make is that this section appears on page 45 of a 46 page report - hardly the place to announce a major change in policy direction.

The second point is that almost all of the surrounding text is boiler plate language that appears in every monetary policy report and has done for several years.

The final point is that the meaning of the new language - ‘taking account of international capital flows, and the trends in the movements of major exchange rates’ - is ambiguous.  It might mean that as the USD has been depreciating, the CNY should end its peg to the USD.  But it might also mean that the US should end the depreciation of the USD as a precondition for the Chinese to begin to allow the appreciation of the CNY.

With China’s exports still looking very shaky, we are probably a long way from the beginnings of a resumption in CNY appreciation, and in my view the PBOC report doesn’t give cause to believe anything different.

Here’s the link to the PBOC report.

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