China: Stimulus, Response and the Renminbi Problem

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Some worrying numbers from economist Ben Simpfendorfer at the Royal bank of Scotland. As the government is aiming to get the Chinese consumer to be one of the planks of its economic stimulus plan, some optimists (Ok. ok. I did write a story about a possible soft landing including these figures; the basic points remain valid, though) have latched onto the fact that October retail sales figures continued the cracking expansion of previous months, posting a virtually unchanged 22 per cent year-on-year growth. However, Simpfendorfer points out that the retail sales figure is highly suspect and includes all sorts of items that would normally not be present, seriously skewing the accuracy of the number. He points out that a more accurate reflection of reality (and complete the opposite of the official figure) can be found at the the China Association for General Merchandise, which estimates that department store sales fell 10% month on month in the final weeks of October. With a huge chunk of the 4 trillion renminbi stimulus package headed for infrastructure works, which can take months and even years to materialize, and consumers evidently battening down the hatches as you’d expect, it’s going to be a rough few months. Or maybe quite a bit more. As the economist notes:

PBOC policy committee member, Fan Gang, yesterday warned that the 4 trillion yuan fiscal package will take time to have effect. He rightly raised the possibility that the effects are likely to most obvious in 2010, implying risks of a demand shortfall in 2009. 

Simpfendorfer concludes by speculating that the grim numbers mean that on top of the announced stimulus package and the interest rate cuts, Beijing will likely introduce further stimulus measures in the near future. The speed and scope of the reaction by the government demonstrates its depth of concern, which in turn makes one wonder what figures top economic policy makers have seen (and which ones the rest of the world will never see). On December 4th, Beijing announced another series of moves, nine in all, aimed at further loosening credit, increasingly liquidity in the financial system and stabilizing the battered (understatement of the year) stock market. Unlike the rest of the world, Beijing still has plenty of bullets left in its stimulus gun. One measure that some overseas analysts worry about –allowing the renminbi to depreciate making exports cheaper—is not going to happen if Beijing can avoid it—but it may not have much choice. Although the yuan has weakened in recent days, falling to its lowest level against the dollar in a year. But there’s no way this is a deliberate policy by the People’s Bank of China, which if anything, would want the exact opposite to happen at a time when half the U.S. cabinet is in Beijing for the fifth Strategic Economic Dialogue, much of which is focused on Washington’s efforts to get China to allow the renminbi to strengthen. Indeed, Commerce Minister Chen Deming explicitly said yesterday that China definitely had no policy of allowing the yuan to weaken. But as Simpfendorfer points out, capital flows and the market are making it very difficult for China’s central bankers to control the renminbi, even though it is by no means freely traded:

These are uncharted waters. FX flexibility and large capital flows only emerged after 2005…..The government may not have a choice in the matter. The experience of the past six months suggests that policy makers are struggling to control an increasingly market-driven economy. This is a major change from the 1990s when the legacy of the old command economy meant that the government still wielded significant ability to control demand and supply, as well as the flow of domestic credit and foreign capital……I’d expect the PBOC will first attempt to draw a line in the sand by defending the CNY and drawing down on FX reserves. ….In this respect, a drawdown of FX reserves worth $300bn cannot be ruled out.

This is serious stuff. If the yuan weakens significantly Congress in Washington will be up in arms, and would probably relish finding a convenient scapegoat amidst all the financial turmoil that can only be blamed on the U.S. Tarriffs and trade barriers would by no means be impossible. And we all know where that leads. 1929; Smoot Hawley; Depression 2.0. Ok. That’s a bit extreme. But the danger is there.

                 

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