Officially the Chinese do not believe in revaluaing the Yuan, amongst other things, the political leadership seem hesitant to appear giving in to US demands. But, in practice and unofficially, the Yuan is steadily but surely appreciating in value.

Furthermore, despite recent appreciation's approaching 20% in value since 2005, there are very good reasons to expect the Yuan to keep rising in 2008 and probably beyond.

The reason for the forecasted rise in the Yuan includes several factors.

Inflationary Pressures in Chinese Economy.

The Chinese monetary (and political) authorities are increasingly worried about overheating in the Chinese economy. With economic growth close to 10% it is hardly surprising that inflation has started to creep up, reaching 6.9% last year. An appreciating exchange rate is an effective method to slow down growth. It makes exports more expensive and reduces demand in the export sector.

Chinese Trade Surplus.

Despite modest rises in the exchange rate, there has been no reduction in the size of the trade deficit. With all this surplus foreign country it is increasingly difficult to keep the exchange rate down. In the past the Chinese bought large amounts of dollar securities. They are still doing this, but with US interest rates falling and Chinese interest rates rising, it is becoming less attractive. Also the weakness of the dollar is discouraging a further build up in US Assets.

Last year the US current account surplus rose from 4% of GDP in 2004 to 11% of GDP. Although a trade surplus is not directly related to currency valuations, it nevertheless is a reflection of the imbalances in the Chinese economy, which could be reduced by a revaluation.


Dollar to Yuan Exchange Rate Forecast

When the Dollar / Yuan peg was dropped the Yuan stood at 8.26 to the Dollar.
In the beginning of 2008 it has fallen to 7.27

• Stephen Green, head of research in China for Standard Chartered, predicts the Yuan will rise further to 6.17 by the start of 2009.

Whilst other investment firms share this bullish outlook for the Yuan, it remains to be seen how much the Chinese government will be willing to alter its stance to the currency. despite concerns about inflation, it is still perhaps more concerned about unemployment and inequality. It holds a deeply cherished belief that an undervalued Yuan is essential for a strong economy.

Whilst, a revaluation of the Yuan may help both China and the rest of the world in dealing with surplus, there is still no guarantee it will occur.

One thing is very likely - in the long term the Yuan will continue its remorseless upward appreciation. - Expect more Chinese students wishing to take advantage of UK and US education

Sources:

• Chinese Yuan at Telegraph
• Chinese Yuan at Economist
  
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Labels: Chinese economy

The Chinese economy is growing by close to 10% a year. It far outstrips the growth in other developed economies. By various predictions, the Chinese economy is forecast to be the world's biggest economy within the next decade. Should this be an issue of concern? Or is a real boon for the rest of the World?

Benefits of the Chinese Economic Miracle

1. Low Inflation.

The Chinese economic miracle is founded upon the success of its manufacturing sector in keeping prices down. This is strongly related to the elastic supply of Chinese labour and consequently low wages. This has enabled falling prices for many manufactured goods; and this has helped keep global inflation low.

2. Cheap Imports.

Related to the first point, Chinese goods have provided many consumer goods at lower prices for UK and western consumers.

3. Growing export market.

With economic growth there is a growing Chinese middle class. This economic group is turning into an important consumer of Western goods and services. In the future, there will be an increasing export market in China. Also the Chinese middle classes may take increasing advantage of western education. Although we currently have a current account deficit with China, this may be reversed in the future as Chinese consumers begin spending their new found wealth.

4. World economy less dependent on US.

There was a saying that if the US coughed, the rest of the world caught a cold. This was related to the fact that a downturn in the US economy infected the global economy because of the American economic dominance. However, with the rise of China and India, a US recession is likely to have less impact on global growth.

5. Financial Surplus.

Currently the Chinese are financing the US current account deficit by purchasing US dollar securities. This means they use up their surplus foreign reserves. It also means that China has a vested interest in preventing a massive dollar devaluation - they would simply lose to much money.
However, some people would argue that this is not a good factor. The fact that China owns so much US debt is a cause for concern. - In effect the Chinese could hold the US economy to ransom. If they sold all their US securities it would cause a huge run on the dollar.


Concerns of Chinese Economic Growth

1. Rising Commodity Prices.

Because the Chinese economy is so large, economic growth has a powerful effect on the rest of the global economy. For example, Chinese growth is placing increasing demand on Raw materials. This has caused rising commodity prices; and is a concern for the future. There is a danger that in the future, Chinese growth could start exporting inflation

2. Environmental Costs.

It is argued that Chinese growth is occuring at the expense of environmental costs. For example, air quality in major cities is a significant problem. Chinese growth is liable to have a very damaging impact on issues such as global warming.

3. Increasing Inequality.

The Chinese economy is creating inequality within their own economy. As the gap between rich and poor, north and south, increase their is scope for increasing social unrest in China.

4. Is the Miracle Sustainable?

Chinese growth has averaged 10% for several years. However, there are fears that the economy may begin to overheat. If growth is too fast and inflation occurs, the period of growth may be followed by a downturn in the economy which could have an adverse effect on the rest of the economy.

One thing is for certain - whether we like it China will have increasing economic influence - and with that an increasing political influence.

Related

• Chinese Economy predictions for 2008
  
• Chinese Economy and costs of Growth
• Chinese Yuan Dollar forecast 2008
  

Labels: Chinese economy

Readers Qu. how china using pro growth policies can cover all the negative externalities of growth through its net inflow of income. any ideas???

Yesterday I wrote about some of the Problems of Chinese Economic Growth

China is trying to maintain growth as fast as it can. In particular their current economic policy includes:

1. Undervalued Yuan. The Chinese currency is undervalued against most currencies. Tied to the dollar it has dropped further in the past 12 months. A weak currency makes Chinese exports cheaper and increases exports. This helps to boost demand in the economy.
2. Relatively Low Interest rates. Chinese interest rates are relatively low for its stage in the economic cycle. (although they have increased interest rates this year) The one year lending rate is 7.02%. The rate for deposits is 3.6%
3. Done little to reduce the housing and property price boom

The high economic growth and exports has created a current account surplus. (value of exports greater than imports). This has given the Chinese economy a surplus of foreign currency. They mostly invest this overseas. For example, buying US bonds. I presume this is what they mean by net income flow of money.

The Chinese government should also receive greater tax receipts as a result of the strong economic growth.

Negative Externalities of Chinese Growth include:

• Pollution
• Inequality
• Regional inequality
  
• Unemployment
• Congestion
  

(see problems of Chinese growth for more details)

Can the Proceeds of Growth be Used to Combat these negative Externalities?

• Higher incomes should enable the government to invest in measures to reduce pollution. E.g. public transport.
• Taxes could be raised on the use of cars and polluting industries.
• Growth is the best solution for the unemployment created by privatisation. If growth slowed down it would be difficult to create jobs.
• The regional inequality is more difficult to address. Despite government attempts there is a strong incentive to set up a business in the South East, near to ports. Therefore, there continues to be a flow of people from north to South
• Shortage of power and raw materials is also difficult to deal with. Especially since creating more power is likely to cause more negative externalities.
  

However, just because the Chinese government could use extra income to combat pollution, it doesn't mean that it is doing so effectively. At the moment, they seem relatively unconcerned about taking steps which will reduce pollution.

• Should China revalue currency?
• China economic growth breaks records
• China raises interest rates at NY Times
  
• China Interest rates still too low at Economist
  

Labels: Chinese economy

IT is reported in the WSJ that some economists felt "6% lending rate in china is too low, for an economy growing at 14% nominally"

please explain what is the relavance of the level of interest rate in an economy growing at a high rate? should the interest rate be less than the growth rate? or should it be more than growth rate or should be similar?


Firstly, it is important to be aware of the real Interest Rate.

• Real interest Rate = Nominal Interest Rate – Inflation
• UK interest rates = 5.75%: Inflation = 2.7%. Therefore real interest rate = 3%
• Basically, if you save money then after the effects of inflation, the purchasing power of your money will increase by 3%.
• If inflation in the UK was 5% it means that the real interest rate would be: 0.75%

Effect of Interest Rates

Interest rates are used by the MPC to control inflation and economic growth.
For example, because there have been inflationary pressures in the UK economy, the MPC increased nominal interest rates.

Higher interest rates reduce the growth of consumer spending and economic growth. This is because:

1. More incentive to save in a bank rather than spend
2. More expensive to borrow, therefore less spending on credit and less investment
3. Increases cost of mortgage repayments, therefore, reduces disposable income and therefore consumer spending

Therefore, because the MPC feel the UK economy is growing too fast (currently just under 3%) they believe inflation could occur and therefore they are increasing interest rates to reduce the rate of growth. They hope higher interest rates will avoid future problems of inflation and a boom and bust economy.

see also: interest rates explained

Chinese Economic Growth

• In 2007 the (real) rate of economic growth in China is 10-11%.
• The nominal rate is 14% - inflation of 3%.
• Inflation in China is just above the 3% comfort level, but some economists feel it could rise on the back of a shortage of goods and raw materials
• Therefore, with economic growth of 10% in China, you would expect inflation to be more of a problem. UK’s growth is 7 % points less yet has the same interest rate as China.

Why China should increase interest rates.

1. Higher interest rates would reduce the rate of economic growth in China to a more manageable level. Therefore, it would avoid inflation and maintain sustainable economic growth (avoid boom and busts)
2. Inflation worry hits china at BBC
3. Evidence of property boom in key cities
4. Banks lending is getting out of control

Why China doesn't increase interest rates.

• Well inflation is still relatively low.
• China’s economic growth is different to the UK, there is still a lot of spare capacity because:

1. High level of labour willing to work at low wages (supply is elastic in economic terms)
2. Spare capacity from privatisation of inefficient state industries.

• Unemployment is a problem in China, despite very high growth levels.

Chinese Yuan undervalued?

Related to the low interest rates is the fact China keeps its currency devalued. By having a weak currency it makes Chinese exports cheaper. This boosts export sales and maintains high growth. Allowing the exchange rate to appreciate would have a similar effect to raising interest rates. Although again, the reason they don’t is that they are fearful higher exchange rates will damage economic growth and cause unemployment.

Related posts

• Should China Revalue Yuan?
• Chinese economic growth breaks records
  

• Chinese inflation at FT
• China's growth: Heading for Car crash? at New Economist
• China's bubble in perspective at Economist
  

Labels: Chinese economy

Evaluate the impact of a sustained rise in the value of the Chinese Currency (Renminbi) against the dollar?


If The value of the Chinese currency increases, it will mean it is cheaper for Chinese consumers to import from abroad. It will make Chinese exports relatively more expensive.

The US currency will be weaker and therefore it will be more expensive for American consumers to buy imports from China.

Therefore this may lead to a reduction in the Chinese current account surplus and a reduction in the US current account deficit. This is because Chinese exports become less competitive and so will import less from China.

However, it depends upon the elasticity of demand for imports and exports. For example, if US demand for Chinese exports is inelastic, then an increased price of exports will not reduce their value. Also, the US may simply switch to buying these imports from related Asian economies.


Benefits of an Appreciation in the Chinese Currency

1. Improvement in current account deficit
China's trade surplus with America was $233 billion in 2006, this is almost 30% of America's total deficit. However, the improvement in the deficit may be much smaller than anticipated. A revaluation will not tackle underlying problems of low US savings and changing comparative advantage

2. Help Reduce Chinese Inflation.
Higher exchange rate will help reduce inflationary pressures in China for 3 reasons;

• Lower AD falling Exports (Exports is a big component of Chinese AD)
• Price of Imported goods is cheaper.
• Chinese exporters have greater incentive to cut costs and increase efficiency. This can benefit the economy in the long run.

this is important, because the Chinese economy is growing above 10% per annum. (11.1%) most recent. There are concerns this could lead to inflationary pressures. An appreciation will help to moderate growth; in particular reduce the investment and borrowing boom, which results from low interest rates

3. Help economic growth and reduce unemployment in US.

It is argued that many American exporters are losing out to Chinese firms. If the Chinese Renminbi was revalued, it would allow an increase in demand for US good. This could be important with American growth slowing. However, American politicians exaggerate the impact of a low Chinese currency on the US economy. Firstly, US unemployment is quite low at 4.5% and the US trade deficit is merely a reflection of the low US savings ratio (and high consumer spending) if the deficit wasn't with China it would be with somebody else.



Problems of an appreciation

1. Could lead to lower economic growth in China

An appreciation will reduce economic growth, this could exacerbate the problem of unemployment resulting from privatisation. This is the main reason the Chinese government is reluctant to revalue. However, with growth of 10%, maybe they do not have the right priorities. Even though Exports are the main determinant of growth, an appreciation is unlikely to cause any serious damage to economic growth. A slightly lower growth rate would have several advantages, primarily low inflation.

See also:

• Exchange Rates

• China and US currency at Economist.com

Labels: Chinese economy, exchange rates

Due to China's huge current account surplus there stock of foreign currency reserves continues to mount. Jin Renqing a Chinese Minister recently announced plans to create a special agency to look into the best way to invest their $1,000 bn foreign currency reserves.

Upto now the Chinese have invested a significant % in United States Treasury bonds. This is seen as a low risk investment strategy. However for various reasons the Chinese are likely to diversify their investments. For example they could take holdings in companies around the world. In particular they are likely to invest in commodity producers. Chinese rapid growth is causing the demand and price of commodities to rise. In the long term this will give China greater political sway over other countries who benefit from their investment. Up to now the Chinese have taken an inward looking approach to world affairs. But this could change as they increasingly flex their economic muscles.

If the China loose their appetite for low interest bearing dollars it could mean that US interest rates will have to rise, to attract other investors. It will also make it difficult to finance the current account deficit. Therefore the dollar is likely to fall further.

However the Chinese own so many dollar assets they have a vested interest in preventing a significant fall in the dollar. With nearly $1 trillion to invest they are likely to continue buying bonds.

See also: Why US dollar likely to depreciate

source: China to open fund for investment at NY Times

Labels: Chinese economy, US economy

Since 2001 the dollar has been in steady decline. Against the £ the dollar has fallen from a low of £1 = $1.45 to close to the £1 = $2 mark. Against the Euro the $ has also depreciated from 0.85 to the present level of 1 Euro to $1.35.

From several perspectives the fall in the value of the dollar appears to be following basic economic fundamentals and whilst these imbalance continue the dollar may continue to fall.

Firstly the US current account deficit is remaining at record levels. The exact amount of debt with the rest of the world is predicted to be around $710 billion for 2006 [1] Basically this means America is importing more than it is exporting, causing an outflow of money. In recent years this huge level of debt has been bought by countries like Asia who have been happy to buy into the dollar for its perceived status as a “stable and secure” currency. However there is increasing evidence Asian bankers are no longer so confident in the American economy. Thus they are seeking to divest from the dollar and reduce their dollar holdings. As this occurs the dollar will have to fall as there is insufficient buyers of American debt.[2]

Secondly the future for economic growth is no longer looking so positive. Growth forecasts have recently been downgraded. The OECD has downgraded is growth forecasts for the US economy from 3.6% to 2.4%. Pessimists such as Nouriel Roubini, of Roubini Global Economics [2] are predicting a recession in the US by the middle of 2007. An important factor in declining growth forecasts is the falling US consumer confidence.

Related to this is a signal that the previous ebullient housing market may have at last turned the corner. Whilst new house prices continue to rise. The median price of old houses have fallen by 3.5% since last year. Whilst a fall of 3.5% may not sound that much, it is the biggest on record. Also rising house prices have been a key factor in maintaining consumer spending in recent years. The level of personal debt amongst US consumers is at another all time high. The ratio of consumer debt to disposable income has risen from 62% in 1980 to 127% in 2005 [3]

Thus a fall in house prices will have a powerful knock on effect on the rest of the US economy as consumers struggle to refinance and meet levels of debt. Another consequence of this high level of consumer debt is that the US economy will be particularly sensitive to any rise in interest rates. Higher interest rates would be one solution to a falling currency and may be necessary to attract investors to finance America’s trade deficit. Although the prospect of the Fed raising interest rates is remote at the moment. Continued falls in American dollars would cause a rise in the long term interest rates on American secutities.

However some economists argue that prospects for the dollar may not be as bad as some predict. Firstly as Anatole Kaletsky argues [4] in an era of globalisation and deregulated financial markets, trade deficits are not as difficult to finance as they used to be. Empirical evidence suggests that trade deficits are very unreliable as a guide to exchange rate movements. Firstly one of the few countries with a current account surplus is Japan. Their current account surplus has been growing and yet the Yen is one of the few currencies to have fallen against the dollar. [4]

Secondly although American growth is slowing at the moment it is not doing much worse than the EU and Japan economies. The gap in interest rates between the 2 economic areas is still only about 2%. If there are good reasons for the dollars weakness there are less good reasons for the strength of the EURO. Also some American economists such as Ben Bernanke of the Federal reserve remain optimistic about the state of the US economy arguing growth is only marginally below trend rate.

However it is important not to underestimate the importance of general market sentiment regarding the American economy. Political problems such as in Iraq have to an extent undermined America’s standing as a leader of the World in both an economic and political sense. For 50 years America has been the undisputed global economic superpower, but slowly perceptions are changing that the era of the dollar may becoming to an end. As people switch out of dollars it could create a powerful multiplier effect as investment bankers are reluctant to hold onto their dollar assets.

America to a large extent can’t avoid a period of adjustment as it seeks to deal with its triple deficits, trade deficits with the rest of the world, consumer debt, and US government debt. Whether the period of adjustment is gradual or painful will depend upon 2 things. Firstly how significant will be the fall in US house prices and consequent fall in consumer confidence. Secondly it will depend on the attitude of Asian bankers, in particular the Chinese. Since they hold so many $ assets they may try to manage a gradual devaluation, a continuation of the past 5 years. However if the dollar does lose its status as the reserve currency of the world, there could be a growing stampede as America’s creditors seek to cash in their cheques. This would exacerbate the fall of the dollar, causing real economic hardship for America and the rest of the world.

The only thing for sure is that European consumers are likely to be get some real bargains from shopping in America for the considerable future.

References

[1] http://www.cbsnews.com/stories/2006/01/12/business/main1203762.shtml

[2] http://www.economist.com/finance/displaystory.cfm?story_id=8361260

[3] Available at http://www.federalreserve.gov/releases/Z1/Current/

[4] http://www.timesonline.co.uk/article/0,,630-2485597.html - Demise of Dollar greatly exaggerated

[5] Falling US stock Market adds to pressure on the US economy

[6] Why the dollar is falling so fast

[7] Dollar falling on weakening trade figures

Labels: Chinese economy, dollar, US economy