The stock market had a decent day today, with the SSE Composite rising 1.25% to close at 1895. Bad news about manufacturing was overshadowed by an announcement that the government will expand a plan to subsidize household appliance purchases by farmers. That helped appliance manufacturers, who led the market up. I suspect that we will see an increasingly worried government propose more of these consumption-boosting measures, although for now there is not enough information to gauge how effective these will be.
The release of the proposal to boost consumption by helping farmers buy appliances came on the back of a string of related proposals by government officials. According to Friday’s South China Morning Post:
Zhang Ping, the director of the National Development and Reform Commission, yesterday gave a bleak outlook for the world’s fourth-biggest economy, a day after the central bank cut interest rates by the biggest margin in 11 years. ”The global financial crisis has not bottomed out yet and the impact is deepening in China,” Mr Zhang told a briefing. “Some domestic economic indicators point to an accelerated slowdown in November.”
The government might cut interest rates and lower banks’ reserve requirements further, National Bureau of Statistics officials, led by spokesman Li Xiaochao, wrote on the Ministry of Finance’s website. The government might also raise the threshold for personal income taxes to exempt more people and further stabilise the yuan, the officials said.
Any such measure is good news, although as I have written often in earlier posts, the sheer size of the global adjustment will make it very difficult for China to create sufficient domestic expansion. Meanwhile news from the manufacturers continues to get grimmer. Today two separate Purchasing Managers’ Index numbers were released, one by the China Federation of Logistics and Purchasing (the “official” one) and one by CLSA. Both of them showed record contractions in export orders, output and new orders, suggesting that manufacturing is contacting at a faster pace than most expected. On a slightly more positive note, Dong Tao of Credit Suisse thinks we “may be getting close to a bottom in this cycle, cushioned by orders from government projects and the near ending of inventory de-stocking.”
The most interesting news recently, however, was related to a speech President Hu made yesterday at the weekend’s Politburo meeting. According to today’s People’s Daily, besides warning “that the global financial turmoil will make it harder for China to maintain the pace of its economic development in the near future”, he said, in a widely noted comment, that “with the spread of the global financial crisis, China is losing its competitive edge in the world market as international demand is reduced.”
What exactly does this mean? It is worth noting that this has come in the context of recent RMB weakness. According to a Bloomberg piece today, “China’s yuan fell by the most in seven weeks, three days before U.S. Treasury Secretary Henry Paulson visits Beijing for trade talks, on speculation the central bank wants to weaken the currency to spur the economy.” Meanwhile calls for depreciation of the RMB are getting more common, and more and more commentators are beginning to wonder if we might not see a conscious strategy of RMB depreciation.
Several people have pointed out that even with the RMB’s weakness against the dollar, the surge in the dollar against the euro has meant that the RMB has strengthened on a trade-weighted basis. This may be true, but it seems to me that the meaningful exchange rate is the dollar/RMB rate (most of Asia is effectively dollar bloc), and the dollar/euro exchange rate does little more than determine how the trade deficit shifts between the US and Europe.
So to get back to President Hu, what exactly does it mean that China is losing its competitive edge? China has better infrastructure than most developing countries, and it has never been strong in technological or management innovation, and its financial system has always been poor at allocating capital, so which “edge” is China losing? If this means that labor costs are getting too high, this comment is worrying because actually I think rising wages are necessary to China’s long-term adjustment (whether they will have the much-needed short-term effect in increasing consumption is doubtful). I hope this isn’t a prelude to constraining wage increases.
But I think the biggest worry is that this may be a hint that the RMB has appreciated too much. The one thing that China absolutely cannot afford to do, in my opinion, is to fix its “competitive edge” by lowering comparative costs via RMB depreciation. Maureen Fan of the Washington Post asked me last night what I thought of this comment, and my response was:
Chinese exports aren’t being priced out of the market. The problem is a contraction in global demand, and all export economies are going to lose sales. If China tries to “regain” competitive edge by subsidizing exports – for example, by depreciating the currency – that could make global conditions worse by increasing overcapacity, when what we really need is to increase global demand.
I have written about this a lot in previous postings, so I won’t rehash all my arguments, but the problem China is facing is not that its exports are less competitive but rather that the US economy has to shift towards higher household savings, and the inevitable corollary is a significant reduction in household consumption. This means that the US imports must decline (and European imports are likely to decline too, by the way), or to put it another way, that foreign exports to the US (and Europe) must decline. If China tries to maintain its export growth in the face of contracting global demand, it inevitably means that someone else must bear more than 100% of the full cost of the necessary adjustment, and I find it hard to believe that other countries, especially net importing countries, will accept this with much good grace.
Currency depreciation – even failure to continue appreciating the currency – along with any other export-boosting measures, will almost certainly lead to a significant rise in trade tensions, and as I have argued many times before, a trade war will hurt current-account surplus countries far more than it will hurt deficit countries. In fact as I see it (and will write in a future entry) this crisis will come in two stages. In the first stage, countries with excess debt-fueled consumption get hit, and as a consequence they are forced to cut consumption and raise savings.
In the second stage, countries with excess debt-fueled production get hit as they fail to accommodate their excess production to the cut in global consumption. Countries like China should be wary about production-boosting measures (Smoot-Hawley-with-Chinese-characteristics, I call them) and should focus largely on consumption-boosting measures. The more they do, the less the chance of international trade constraint and the faster they get through the crisis – but make no mistake, this will not be an easy process no matter what they do.