Friday, January 23, 2009

The Brave New World of the RMB Valuation Debate

As China settles in for the New Year holiday, its leaders can chew over Treasury Secretary designate Timothy Geithner’s declaration, made in a written statement to the Senate Finance Committee as it reviewed his nomination, that President Obama—” backed by the conclusions of a broad range of economists”-- believes that China is manipulating its currency.

Before the U.S. recession hit, China might have had more reason to worry that a new Democratic administration might settle in for some serious China bashing to placate its base. Formal designation of China as a currency manipulator would have been the first of a series of big stick measures meant to improve the position of American exporters and labor vis a vis their Chinese competitors.

Geithner’s response is, of course, a long way from the official formal designation by Treasury of China as an intentional currency manipulator for the purpose of gaining an unfair trade advantage under the Omnibus Trade and Competitiveness Act of 1988 that would trigger the sanctions process.

I’m not expecting aggressive moves by the Obama administration to sanction China into adopting a floating exchange rate, at least at this moment.

The Obama administration is pushing a $850 billion stimulus package through Congress and an amount of U.S. Treasury securities conservatively estimated to be “oodles” will have to be sold to China to finance it.

The need to market U.S. government debt to Beijing is perhaps the most important headache in America's China policy. But the financial crisis has also undermined America's prestige as the world's financial arbiter, provoked fresh displays of Chinese assertiveness, and limited the credible diplomatic options available to the Obama administration.

Concerning the bond market fallout, The New York Times tells us:

Prices of Treasury debt fell modestly after news of Mr. Geithner’s comments, reflecting worry among investors that China might be less willing to buy United States debt if the new administration pushed the country to further revalue its currency. The yield on the 30-year bond, which moves in the opposite direction from its price, climbed to 3.247 percent from 3.159 percent on Wednesday afternoon.

So, ixnay on the trade war, I would say.

The main Chinese media outlet, Xinhua, reported on Geithner’s statement in detail.

The assembled Chinese pundits were eager to fit President Obama with the robes of Herbert Hoover, significantly reframing the RMB issue as part of the Democratic Party’s protectionist agenda instead of accepting it as an orthodox free market nostrum for rationalizing exchange rate regimes and ameliorating trade imbalances.

Mdme. Zuo Xiaolei , Chief Economist of the Milky Way Securities Company, dismissed U.S. remarks on the undervalued RMB as “the same old song” (老调重弹), and warned darkly, “ Obama made no statements opposing protectionism, either on the campaign trail or in his inaugural address…add to that the inclination of the Democratic Party, and American protectionism has already become the greatest concern of the international community.” [emph. added]

American protectionism is the biggest concern of the international community? Bigger than, say, the Western financial system going tits up? Ya think?

In another piece of interesting framing, the article talks of the “China-U.S. economic relationship” as “by far the most important economic entity in the world”, one that accounted for 20% of global economic growth in the last year.

It is, of course, noteworthy that the United States, instead of being feted in its traditional role as “the engine of the world economy”, is now presented as an economically and ideologically shaky co-partner in the joint Sino-American free market economic enterprise.

Welcome to the 21st century.

Unfortunately, America’s forensic disadvantage in the U.S.-China RMB valuation debate go beyond the obvious difficulty that we are flat on our ass and in a poor position to give marching orders to China.

The RMB exchange rate issue has always included a backstory of opening up China’s financial markets to wider participation by foreign companies.

It goes back to 1997, during the Asian financial crisis.

The dominant Western narrative—that the East Asian tigers fully deserved their forex asskicking by George Soros for struggling to sustain improperly valued dollar pegs—endured some difficulty dealing with the awkward fact that since then China kept its undervalued RMB to USD peg (with a modest managed float after 2005), refused to open up its financial markets to significant global capital flows, declined, in short, to let the invisible hand rummage around in its wallet, and has yet to suffer the dire consequences ordained for countries with misvalued currencies. In fact, it's done rather well.

Western economists assumed their position would eventually be vindicated as the large capital inflows associated with an undervalued currency fueled a growth in the domestic money supply that the Chinese government would be finally unable to sterilize through bond sales, inflation would rear its head, and the government would be forced to float the RMB to protect the economy and manage the value of the RMB through monetary and interest rate policies.

It was possible that the Chinese banking system, undercapitalized, saddled with non-performing loans, over-regulated, and driven by government demands instead of market forces, would be ill-equipped to raise and allocate capital and distribute government debt efficiently enough under this sophisticated new regime to protect the economy from an arbitrage-driven meltdown, domestically driven but otherwise similar to the one that happened in Asia in 1997.

In 2003, Treasury Secretary Snow called on China to grasp the nettle, deregulate, and allow foreign capital to romp through its financial markets, so that the value of the RMB would be determined transparently by the free-market interaction between overseas demand and domestic policy:

Market-determined floating currencies are really the key to a well-functioning international financial system. For the world’s major traders, only freely floating currencies bring the accuracy and the efficiency necessary for the proper pricing account settlement in capital flows. That’s really our central point, that floating rates, market-based, flexible exchanges create the signals for a well-functioning flow of resources on a global basis. There’s ultimately no substitute for that.

In 2007, then Treasury Secretary Paulson, in a speech to the Shanghai Stock Exchange that perhaps marked the high-water mark of Bush administration free-market evangelism vis a vis China, painted the orthodox picture as he pushed China to open its financial markets to foreign companies:

"Time is of the essence," for China to develop a strong capital market, Paulson said. "The longer China waits, the more difficult it will be to create robust capital markets.".
"China's underdeveloped financial markets place the nation in a challenging position, trying to balance between a centrally administered and a market-driven economy," Paulson said.

But when the reckoning came, Western, not Chinese financial houses were on the losing side.

The international financial community, instead of playing sugar daddy to mismanaged Chinese banks, is begging sovereign wealth funds from Beijing to Dubai for injections of capital.

Ironically, the U.S. and British banking systems now look a lot like the Chinese system—stuffed with bad loans they can’t digest and propped up by public money because, apparently, the firms are too big to fail and free market forces no longer apply.

More importantly, the fact that the big international banks led the world economy and entire countries like Iceland off a cliff in pursuit of easy profits from an orgy of reckless lending has discredited the West’s financial wizards. It’s fueled the suspicion that Wall Street is not on an eternal search for maximum global economic efficiency—it’s on a neverending quest for the next greater fool.

In September 2008, Bloomberg commented acridly on the current state of affairs (especially bitchy comments in bold):

Eighteen months ago, U.S. Treasury Secretary Henry Paulson told an audience at the Shanghai Futures Exchange that China risked trillions of dollars in lost economic potential unless it freed up its capital markets.

``An open, competitive, and liberalized financial market can effectively allocate scarce resources in a manner that promotes stability and prosperity far better than governmental intervention,'' Paulson said.

That advice rings hollow in China as Paulson plans a $700 billion rescue for U.S. financial institutions and the Securities and Exchange Commission bans short sales of insurers, banks and securities firms. Regulators in the fastest-growing major economy say they may ditch plans to introduce derivatives, and some company bosses are rethinking U.S. business models.

``The U.S. financial system was regarded as a model, and we tried our best to copy whatever we could,'' said Yu Yongding, a former adviser to China's central bank. ``Suddenly we find our teacher is not that excellent, so the next time when we're designing our financial system we will use our own mind more.''

The recent moves by Paulson, the former chief executive officer of Goldman Sachs Group Inc., contradict what the U.S. told Asian governments over the past decade. Thailand, South Korea and Indonesia were urged to let unviable banks fail during the 1997-98 Asian financial crisis.


``It's the end of an era,'' said Shanghai-based Andy Xie, a independent analyst who was formerly Morgan Stanley's chief Asia economist. ``In 1989, when the Berlin Wall fell, socialism was discredited and the whole world turned right. Now financial capital has been discredited and the whole world, including the U.S., is turning left.''

Since China permitted securities backed by assets such as mortgages in 2005, only 14 such instruments have been approved for sale, according to the Web site run by China Government Securities Depository Trust and Clearing Co., the country's biggest debt clearing house.
China's financial institutions were slow to buy the mortgage-related securities that triggered the U.S. meltdown, incurring just $4.3 billion in losses and writedowns, according to data compiled Bloomberg.

Globally, banks have written down more than $520 billion as the credit crisis led to the demise or makeover of Wall Street's five biggest investment banks.

``It's ironic Paulson has become the manager of many large financial institutions,'' said Wang Jun, a finance specialist at the World Bank in Beijing. ``He will have to ask the Chinese leaders about their experience of managing state-owned assets.''

``China's made it clear it won't listen to these snake-oil salesmen who come from Wall Street, even if they're wearing suits issued by the Treasury Department,'' [Arthur Kroeber of Dragonomics Advisory Services Ltd.] said. ``It's strengthened the hands of all the people who are very skeptical about financial liberalization in China.''


So much for the United States holding the moral and intellectual high ground in the RMB debate.

So the Chinese government, unwilling to revalue and exacerbate the pain of its exporters during its recession, finds itself holding quite a few effective rhetorical cards in the debate with the United States.

And the Obama administration finds itself, at least for now, with few persuasive tools to compel an RMB revaluation.

1 comment:

xieuling said...

Thank you.