China’s plans could set off a dangerous chain of events

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RubberRims's picture
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China’s plans could set off a dangerous chain of events

China’s lesson in economics for America

In October last year, the IMF concluded that for the first time in modern history, China was about to overtake the US in its contribution to the planet’s economy. In expanding by 10%, the country would pump more money into the global system than would poor old Uncle Sam with its paltry 1.9% growth.

For the Shanghai stockmarket, that proved to be the peak - almost to the day.

Although the IMF’s thinkers had factored in a likely economic slowdown in the ‘developed’ world, they were wrong to assume that China would be able to “de-couple” from the West.

Now, with exports collapsing, China’s suffering just as much as Europe and the States. And this week, China’s top men have been telling US Treasury Secretary Hank Paulson exactly where he went wrong.

Our Hank has taken a break from his efforts to ‘save’ the US financial system for a two-day jaunt – sorry, “strategic economic dialogue to discuss long-term bilateral issues” - in Beijing. But it’s no cakewalk. Poor Mr P walked into what the FT’s Geoff Dyer calls “a new lecture about US economic fragilities”.

“Over-consumption and a high reliance on credit is the cause of the US financial crisis”, said Zhou Xiaochuan, governor of the Chinese central bank. “The US should adjust its policies, raise its savings ratio and reduce its trade and fiscal deficits”. And vice premier Wang Qishan urged the Americans “to stabilise the economy and financial markets as well as guarantee the safety of China’s assets and investments in the US”.

Why China wants a stronger dollar

The Chinese may have nailed America’s financial problems. But the trouble is, they aren’t quite as keen to see the US actually stop spending. Because America’s profligacy, and heavy spending on Chinese goods, has been one of the main factors driving China’s economic boom.

With the US consumer out of the picture, China’s domestic economy is getting hammered. President Hu Jintao has warned that China is “losing competitive edge in the world market”. The manufacturing sector has seen its steepest decline since records began, and Chinese workers are not only losing work, they’re getting very angry about it. There have been violent protests in Guangdong due to the mass closure of factories making toys, textiles, and furniture.

So after more than three years of the Chinese currency appreciating some 20% against the US dollar, i.e. making American goods cheaper, the game has now changed.

Twice this week, the Chinese central bank has lowered its ‘dollar band’, including allowing the biggest drop in the renminbi against the greenback since the dollar peg – a fixed exchange rate since 1997 - was ditched in 2005.

This may sound of interest only to currency exchange students. But it isn’t. It means the Chinese are now prepared to start depreciating the renminbi against the dollar. And it has the ammunition, with nearly $2,000bn of foreign exchange reserves, having last month overtaken Japan to become the largest foreign holder of US government debt.

By dropping the value of their currency and so making their goods cheaper, the Chinese hope to gain further export share abroad. And at the same time, they’ll be losing less money on all those US Treasuries they hold.

China’s plans could set off a dangerous chain of events

Yet there’s a very big snag. Any currency policy reversal “risks setting off conflict with Barack Obama’s incoming team”, says Evans-Pritchard. “Obama called China a ‘currency manipulator’ during the election campaign, a term that carries penalties under US trade law”.

In short, just when the planet doesn’t need any extra trouble, a lot more is brewing up. So what does it all mean for investors?

The futures markets are already ‘pricing in’ a 6% renminbi devaluation over the next year. “I really believe we’re on the brink of a very ugly period for trade relations”, says Professor Michael Pettis at Beijing University.

But worse, any slight flickers of reviving manufacturing growth in the West could be snuffed out by a fresh flood of cheaper Chinese imports. China's policy switch could set off a dangerous chain of events, says Hans Redeker at BNP Paribas: “If they play this beggar-thy-neighbour game, it will cause a deflationary shock for the whole world”.

Hardly the ideal recipe for stock markets. But it sounds like it could be well worth hanging onto those government bonds for now.

Jantjedeman's picture
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Joined: Dec 7 2008
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Re: China’s plans could set off a dangerous chain of ...

Economics is just too complicated for me Cool

US citizens buy stuff in China with enormous amounts (and europeans of course). That cost a lot of dollars.

US is constantly borrowing money (from China) to wage Iraq war and to consume like there is no day tomorrow.

All this money is invested in foreign economies.  And the producer is lending the consumer to buy the goods from the producer.

A sane goverment would know that something is wrong, or wouldnt it?


RubberRims's picture
Status: Silver Member (Offline)
Joined: Nov 22 2008
Posts: 145
Re: China’s plans could set off a dangerous chain of ...

U.S. debt is losing its appeal in China 

"All the key drivers of China's Treasury purchases are disappearing," said Ben Simpfendorfer, an economist in the Hong Kong office of the Royal Bank of Scotland. "There's a waning appetite for dollars and a waning appetite for Treasuries. And that complicates the outlook for interest rates."

China's leadership is likely to avoid any complete halt to purchases of Treasuries for fear of looking like it is torpedoing the chances for a U.S. economic recovery at a vulnerable time, said Paul Tang, the chief economist at the Bank of East Asia here.

America is sinking, the inevitable without a shadow of doubt the dollar will slide. Then eneter the Amero.

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