China’s Lip Service
June 20, 2010 Leave a comment
Headline news: China wants to give more flexibility to Yuan. Seems great and all prissy doesn’t it, finally the Chinese are giving in to all the pressure that the methods of keeping their currency low for the sake of cheap exports is coming to an end. The official report is here. This statement comes amid pressure from the G20 to appreciate the Yuan. Elsehwere an ANALYST from SocGen said that stocks should go higher based on the statements.
However if you took a closer look like Yves from naked capitalism did, you would probably have a better perspective and understand why this all just political lip service at play. Below are the salient points he made
1) China is contending that it has been using a basket of reference currencies, rather than just the dollar for pegging since 2005, but the language allows for the possibility for a change in the mix. Thus this signals China’s intent to move away from a dollar reserve currency regime (it has taken other measures along these lines, for instance, encouraging invoicing in currencies other than the dollar). The problem is that a permitted trading band vs. a basket of currencies is what China supposedly implemented in 2007, and the results have looked an awful lot like a dirty float against the dollar.
2) They contend that a weakening surplus, i.e. their trade surplus with the deficit in march, shows that they in a do not have to appreciate their Yuan so much as the deficits will reduce the trade surplus. But there are 2 problems with this argument. First the trade surplus is the largest ever in modern history as a percentage of global GDP and secondly many people point out that this might just be a one off event or there might be a need for more telling data.
He concludes that:
The Chinese officialdom clearly can, at any point, announce and implement policies to move the RMB either higher relative to other currencies and/or allow wider trading bands as a way to move towards a less controlled currency regime. But I don’t see any reason to expect it to happen until China gets more pushback from its trading partners. Their enthusiastic responses to this noncommittal announcement seem likely to insure that has been kicked down the road until China’s continuing trade surpluses force politicians to turn the heat back on.
Elsewhere the government might be more concerned about suring up more capital for their banks Patrick Chovanec Notes:
Chinese banks have already announced plans to raise at least 300 billion yuan ($44 billion) over the next few months by selling both stocks and bonds. In addition to ABC, the last of China’s “big four” state banks to list, the other three — Bank of China (BOC), Industrial and Commercial Bank of China (ICBC), and Construction Bank of China (CCB) — are set to raise tens of millions in secondary share offerings. The Bank of Communications (BoCom), China’s fifth largest bank, hopes to raise 33 billion yuan ($4.8 billion) in a rights issue later this month, after paring back its initial plans this week by 20%. At least a half dozen other midsize banks are also actively planning to raise capital following the ABC listing. Even if you’re bullish on China’s banking sector, you have to wonder whether the market has the appetite to buy all these stocks in one go…
…First, Chinese banks were originally sold to global investors not only on their limited downside, but an upside story as well: that they were being reformed into commercially viable, profit-driven enterprises. Their reversion, last year, into mere conduits for government stimulus spending calls that upside story into question. Today, Chinese banks earn hefty profits on the guaranteed spread in regulated interest rates. But as China moves toward a more convertible currency, those protections can’t last forever.
Second, when Chinese banks were last bailed out, the government was the only shareholder. A similar recapitalization in the future would almost certainly mean stock market investors would face dilution. China’s big state banks may be too big to fail, but their private shareholders may not be so invulnerable.
In addition, Michael Pettis believes that there will be a lot discontinuity of policy making in China due to panic. In May he wrote that he expected policy makers to slow down the cooling down measures such as increasing make capital ratios and other measures to stop as soon as that affects growth, more liquidity and stimulus will arrive. He guesses that:
After a few weeks of official posturing, with the concomitant fear and market contraction, the markets will stabilize for a while, and then take off again. If Beijing is really successful in halting real estate speculation in the primary cities, expect the secondary cities to take off. Also after a period of stability we will probably see great action in the stock market as liquidity pours back in. Last Friday the SSE Composite closed at 2688. I bet it is much higher by the end of the summer.
But remember at the end of the day, its not the appreciation of the Yuan that will solve the humongous unsustainable surplus that China has. China has to look for more import orientated structure and open its markets, an appreciation of the Yuan would most likely force people to look for other ways to make their products cheap and then export them again. In addition it must seek to improve its welfare, as we can see from instances at Honda and Foxconn there are pressing needs to be address to the average worker in China. There was even a suggestion of a Service sector revolution.