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  • Dec 24, 2014
  • Updated: 3:06am


The Chinese yuan, also known as the renminbi, is already convertible under the current account - the broadest measure of trade in goods and services. However, the capital account, which covers portfolio investment and borrowing, is still closely managed by Beijing because of worries about abrupt capital flows.


Does the yuan matter?

With China's closed capital account, the most important factor for its economic partners is the country's financial subsidies rather than its currency policy

PUBLISHED : Monday, 24 March, 2014, 9:08am
UPDATED : Tuesday, 25 March, 2014, 2:13am

The mainland's currency policy is not worth the attention it is getting. It is not at all important compared with other market distortions in the Chinese economy, and it is not even very important in how China affects the world economy.

There have already been two heavily reported events concerning the yuan this year - its decline in nominal value against the US dollar and the widening of the daily trading limit against it.

Much has been written about the harm supposedly inflicted on other economies by China's currency policy, and while the latest headlines shout that the yuan is at 12-month lows against the dollar, what is missed is that it is still less than 2.5 per cent off its nominal peak against the greenback.

This decline could easily be erased in a week. It could almost go in a single day, now that the yuan's trading band has been doubled from its previous daily limit of 1 per cent on either side of an officially set midpoint.

The biggest problem for China’s foreign partners – repression of competition

These are just the most recent developments. The ongoing yuan story is one of heavy international criticism for being undervalued. The United States makes the most noise, charging Beijing with following a cheap-currency policy that costs American jobs.

From the middle of 2005, when appreciation began, to the middle of last year, the yuan rose from 8.27 to the dollar to 6.17. Yet the US labour force participation rate fell from 66 per cent to 63 per cent.

Obviously, there are other factors that matter more than the yuan exchange rate to US jobs.

In fact, for the US and nearly all of China's economic partners, the most important factor is subsidy. Financial subsidies are discussed most often, and the explosion in borrowing by Chinese firms since the global financial crisis began has made it much more difficult for foreign goods and services to enter the market.

Currency policy pales against the 48 trillion yuan (HK$59.8 trillion) in formal bank lending extended from mid-2005 to the middle of last year. In addition, trillions more in shadow bank credit were created over that period.

Some observers have described the yuan band's widening as an important component of now urgent financial reforms.

It must be noted the yuan is not a genuine currency as long as money cannot flow freely in and out of the country. Rather it is a derivative of the dollar. Money cannot move freely because of the closed capital account. This is such a fundamental distortion of how markets should work that it is unclear whether the yuan would rise or fall if the capital account were opened.

In other words, the mainland's financial system is so distorted it is impossible even to tell if the yuan is undervalued and, therefore, what policies should be adopted and what impact they will have.

The biggest problem for China's foreign partners is the biggest subsidy of all - repression of competition.

A guaranteed market share, sometimes extending to outright monopoly, makes it very difficult for foreign producers to compete against firms blessed in this fashion by the national or local governments. This is true for trade and for the internal Chinese economy.

For example, anti-competitive regulation outweighs currency policy for foreign firms operating in China.

Multinationals do want strong and predictable earnings, and the value of the yuan matters to that. But it pales against the protection afforded large domestic enterprises, which has lately extended to damaging attacks on multinationals by state media and the National Development and Reform Commission. Being unable to compete freely is the ultimate hindrance.

Addressing this hindrance by enhancing the role of the market was supposed to be a linchpin of the Communist Party's renewed reform efforts. Unfortunately, there is no sign competition is actually being allowed to increase.

Ostensible reform to date involves bringing private capital into state-owned enterprises, which is the exact opposite of allowing private capital to compete more freely.

Getting larger is still seen as superior to becoming more efficient; orchestrated consolidation of industries is still preferred to letting the better firms win in the marketplace.

At the intersection of financial and competition reform is competition in finance.

The privatisation of the banking sector is seen as urgent by Beijing and is only tenuously connected to currency policy. How Beijing proceeds with regard to financial and other competition is what matters, not the yuan.

Finally, the integration of the urban and rural land and labour markets have been presented as long-term reform goals.

Ordinary Chinese would overwhelmingly insist these are far more important than currency policy. And those companies facing fast-rising labour costs or extremely high land prices (or barred from buying land because it is state-owned) would agree.

The yuan's continuing shadowing of the dollar is worthy of note. It is odd and somewhat embarrassing that China does not have a truly independent currency.

But the fuss over the yuan's movement, trading band and the value itself is wildly out of proportion to the impact of currency policy on the domestic economy and even trade.

Many other policy choices - anti-competitive regulation, gargantuan overlending, bank privatisation and the opening of the capital account - are much more important.

Market participants and policymakers would do better to ignore the yuan for a while.

Derek Scissors is a resident scholar at the American Enterprise Institute


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This article is now closed to comments

Excess capacity and insufficient demand are two sides of the same coin.
China shouldn’t just concentrate on the side of excess capacity, she should also pay attention to the side of insufficient demand.
Through the proposed Asian Infrastructure Investment Bank (AIIB), China can create external demand for her products, like high-speed trains, so as to utilize her steel mills’ (and coal miners’) excess capacities.
To solve China’s problem of too much foreign reserves, they can create a Eurodollar-market-like Asiandollar bond market (without opening China’s capital account) and allow foreign enterprises to issue bonds denominated in US dollar.
Rather than just concentrating on yuan internationalization and how to profit from it, Hong Kong’s finance officials should also heed the importance of AIIB and the Asiandollar market.
The relative dominance of Russia in the present Crimean issue implies that China should greatly increase her armament expenditure in the coming years.
At the end of the day, it's might that makes right, not China's diplomatic arguments in the TV press conference.
Much of what China manufactures can't be exported, or can only be exported to other poor countries, due to China's poor quality. China produces a lot of good, but quality is poor and maintenance is even worse. I recently visited a 50 year old power plant in the U.S. that had just had a USD 500 Million environmental upgrade. In China power plants typically only last 10-20 years. I suspect China's high speed rail program is far more successful for it's quantity and price than for it's maintainability and life span. China's political economic decision-making process leads to lots of notable accomplishments (airports, skyscrapers, high-speed rail), but neglects projects of less obvious benefits: air pollution reduction end fixes at individual plants, widely scattered water treatment facilities.
The foreigners often argue that China should balance her economy away from exports and investment and toward domestic consumption.
One reason put forward by them is that there exists overcapacities in some of China’s industries.
But the overcapacities are caused not only by China’s 4-trillion-yuan investment in the past, it’s also caused by still-too-weak-after-the-great-recession western demand for China’s exports (perhaps because of the jobless recoveries of the Amercan and European economies, and their weaker and busy-to-deleverage middle classes).
So far as tradable products are concerned (unlike the domestic nontradable service sector), there is really no such thing as excess capacity.
The world’s demand for the products is potentially infinite --- we are talking about world demand, not just domestic demand.
In China, to employ the still-in-ample-supply workers, the country needs to have more employment opportunities, which means more investment in the country.
The resulting increased tradable products must be balanced by increased exports.
Lower exports (caused by weak external demand, but also affected by tighter credit in China, overvalued yuan, and too high real-wage-rate/worker-productivity ratio in the country)
and tight monetary policy also encourage manufacturing capital to move to the finance (shadow banking) and property sectors,
resulting in the present weak chain of debts.
China’s present serious bubbles should be gradually squeezed by higher (not lower !) future economic growth,
through a lower and lower debt/GDP ratio,
which means lower, not higher, interest rate,
the yuan should fall further to encourage more exports,
and more expansionary fiscal policies enacted, say for the coming hukou system reform,
not by Russian-like shock therapy,
in the form of restricting the amount of credit available,
and hence causing relatively high market interest rates (in the name of interest rate liberalization).
In a high-interest-rate environment, the subsequent deleveraging process is like having a surgery without using anaesthetic.
The present relatively tight one-size-fits-all monetary policy causes high interest rates in the market,
hurts the SMEs in particular,
leads to the continuous drop in the HSBC PMI manufacturing figures recently,
attracts hot money inflow into the country (in the form of carry trades, foreign loans, RQFII products),
feeds the Ponzi-scheme-like property and shadow banking markets,
creates further pressure to revalue the already-overvalued yuan,
and affects China's ability to independently manipulate the interest rate and yuan's exchange rate to her own advantage under strict capital control (through the impossible trinity).
A similar and more macroeconomic viewpoint regarding the order of economic reforms is provided by the author of the following article, which should be required reading for the PBOC officials in China.
(Chinese readers: ****cn.wsj.com/big5/20140324/OPN075423.asp)
I don’t know whether there is an English translation of this article available.
Former US Assistant Treasury Secretary Dr. Paul Craig Roberts says, “The fate of the dollar is the fate of United States Power.”
The US won’t easily forsake the world dominance of its own currency.
China’s capital account should act as an important firewall or dam, and should be the last to let go in the future.


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