The tyranny of the trinity
The People's Bank of China is doubling the size of the yuan's trading band, another step in its internationalisation.
SCMP, April 15
My pardon if you think you have seen the triangle chart in my column before. You have. I got it from a speech made here by that notable economist Milton Friedman many years ago and I think it neatly sums up China's problem with the yuan.
The rules of the triangle are simple. In any economy you can have any two points of the triangle but you cannot have all three. If you go for all three you set up a pressure cooker without a safety valve. It will blow up in your face sooner or later.
Thus, if you want open borders to trade and capital flows and you want to control your currency's interest rates, you have to keep your hands off your currency's exchange rate and let it be determined by the market. This is the model in the United States and most of the developed world.
Alternatively, you may want those open borders but choose to have control of your currency's exchange rate. You must then keep your hands off domestic interest rates and let the market establish them. This is our model in Hong Kong with the peg.
The third option is to control both your currency's exchange rate and fix your domestic interest rates. In that case you have to shut your borders to all flows of money except, perhaps, those that go to pay for the president's Mercedes. Some things are essential. That's North Korea.
In China, Beijing wants all three points of the triangle. It wants final authority on the exchange rate, it tells the banks what interest rates to charge and it cherishes its position as the world's biggest exporter, the ultimate boast in open borders.
And the needle is climbing steadily higher on the pressure cooker.
It's not an absolutely airtight pressure cooker, of course. Jets of steam spout out of leaks here and there. In banking, a growing number of unofficial lenders defy interest rate guidance, in currency matters, Beijing has had to let the yuan's exchange rate drift upwards, and the ordinary citizen still cannot take his money across the borders.
But in all three cases the general effects of these partial liberalisations are dire. Manipulation of the yuan has resulted in a build-up of US$3.3 trillion of foreign reserves funded on the other side of the balance sheet by debt and forced exactions from domestic banks. This is not savings. This is a misuse of resources.
Meanwhile, central control of interest rates has made it impossible to price industrial effort properly. No one really knows what the market rate for a two-year yuan advance to a creditworthy electronics plant should be. There is no valid benchmark. There are only state instructions.
As a result, such enterprises conduct their affairs in foreign currencies and, not surprisingly, are largely under foreign control and ownership. Reluctance to accept market pricing of industrial investment has reduced much of China's industrial economy to low-tech assembly shops of foreign-branded goods.
And while well-connected people and companies can always find ways of getting their money abroad through the porous capital controls at the borders, ordinary citizens cannot and have to put up with poorer returns in state-controlled domestic markets. Thus the rich get richer and the poor get poorer, the result of restricting money flows across borders but still letting some people do it.
Sometimes there is no halfway position in these affairs. The light switch is either on or off. The borders are either open or they are closed. The gradual approach just gets you a mess.
That's what I see in this latest 'liberalisation' of the yuan by expansion of the daily trading band to 1 per cent from 0.5 per cent of the guided rate. It's only an admission that things are not working well and the desperate application of a non-remedy - 'Here, take two aspirin and call me in the morning.'
The morning will show just more corruption, inefficiency and polarity of wealth.