Is China Experiencing Dollar Outflows?

The government was actively buying stocks today and as a result, not surprisingly, the market surged on hopes that they are serious about putting an end to the bear market. After declining yesterday by 0.3%, the SSE Composite jumped 76 points today to close the day at its high of 1965, up 4.0%. Central Huijin, a subsidiary of the CIC, increased its stake in China Construction Bank, as it said it would do last September. If this is sustained, it may help relive a little of the gloom, but it is not clear to me that the rally has stronger legs than previous government-inspired rallies.

More interestingly, the dollar market today was acting strangely. Since late yesterday there have been no bid-offers on dollars, until the PBoC came in late in the day to sell dollars (the PBoC is normally a buyer of dollars). This suggests that capital outflows, at least for this week, have outpaced current account inflows, although we don’t want to read too much into this as of yet. January’s 4th Quarter PBoC numbers should prove very interesting as we wade through the increasingly difficult-to-interpret numbers to estimate hot money behavior.

As far as I can piece together today’s currency-market activity from conversations with some of my former students, now trading, and my friend Logan Wright, at Stone & McCarthy, the market has been very short of dollars in recent days as corporations over the past three days have been net buyers from banks. Since banks are not allowed to be net short, there were rumors that they had reached their dollar limits yesterday and were refusing to post prices for fear of being lifted.

Why have corporations been buying dollars? Part of the reason seems to be the NDFs in Singapore are pricing in a depreciation of the RMB, and corporations who can get around the capital control rules are finding it profitable to buy dollars in China and sell them in the NDF market. This is a great arbitrage if you can do it. But part of it may simply reflect the fact that talk of currency depreciation has increased in recent weeks, and until today has been depreciating. Today the central parity appreciated by 0.0025 to 6.8501, although the RMB closed the day at the weak end of the 0.5% band.

It is not irrelevant that Secretary Paulson will be here tomorrow for two days as part of the Strategic Economic Dialogue. His call for a stronger RMB yesterday signals that the currency is still likely to be at the heart of the debate. There has been more and more talk over the past few days about the possibility of RMB depreciation, and of course President Hu’s comments on Sunday about China losing its competitive edge strengthened the talk, but until there has been no real reason to think that there has been a policy shift.

Still, the possibility that pro-depreciation constituencies in China may yet gain the upper hand in the debate is very worrying. At first depreciation might seem like an obvious policy move – if export growth is slowing, and if unemployment pressures are rising, why not engineer demand expansion by increasing foreign demand for Chinese goods? After all, the outlook is increasingly grim. A “Blue Paper” by the prestigious Chinese academy of Social Science forecast GDP growth for next year at 9.3% – insanely optimistic, I think – but they did list some of the problems facing China. According to today’s Xinhua:

The Blue Paper also notes that housing prices will fall dramatically in a short period of time, and subsequently enter a rather long adjustment period in 2009. Economists from CASS believe the real estate industry will be bogged down throughout 2009 as demand weakens under high prices and the global financial crisis. Homebuyers and investors will be more prudent in their activities. Suppliers will also experience a chilly season next year as some small and medium-sized enterprises with limited capital are forced to leave the market.

Risks will increase as some homebuyers become unable to pay their mortgages and some builders will not be able to pay workers to complete projects. On the country’s employment front, the Paper adds that one million college graduates will be unable to find jobs by the end of 2008, a problem that will be exacerbated when more people may lose their jobs in 2009 as more than five million new graduates begin seeking employment the same year.

But remember that Chinese overcapacity is part of the global problem, and as interesting as they may seem at first, capacity-boosting measures only make the global imbalance worse. Yesterday Vice Premier Wang Qing made a speech on the subject in which he both called for consumption enhancing moves as well as export-enhancing moves. An article in Xinhua reported:

Chinese Vice Premier Wang Qishan has called for more concrete measures to tap China’s domestic consumption potential to sustain economic growth. External demand for Chinese goods has fallen markedly amid the global financial crisis, while domestic consumption power also fell, Wang told recent meetings on foreign and domestic trade.

…The vice premier urged a reduction of burdens for businesses, help for them in getting finance and promotion of mergers and acquisitions. He also called for more measures to optimize the export structure and explore new markets to offset the negative impact on the export sector of the global economic slowdown.

That last paragraph worries me if it indicates the direction of policy. I really do believe that we are on the brink of a very ugly period for trade relations, and anyone in China who thinks that trade conflicts will not be devastating for China does not understand China’s role within the global balance of payments. This is not the time to try to strengthen exports at the expense of trading partners without a significantly larger increase in imports.

On that note, the EU Observer had the following piece earlier this week:

EU-China relations usually revolve around trade, with the EU buying €231 billion worth of goods from China last year and exporting €72 billion in return. But human rights concerns came to the fore during the Beijing Olympics, when scores of EU leaders stayed away from the opening ceremony after Chinese troops shot Tibetan protestors.

China is also unhappy that the EU continues to uphold an arms export embargo dating back to the 1989 Tiananmen square massacre. The latest summit and death penalty row could play into the hands of European leaders keen to restrict the flow of Chinese imports during the EU’s economic downturn, experts warn.

“Protectionist sentiment toward China in Europe has been growing for a while,” Center for European Reform analyst Katinka Barysch wrote in the Wall Street Journal. “Anti-China sentiment is on the rise in Germany …Even in traditionally liberal Britain, people who see China as an economic threat outnumber those who see it as an opportunity by four to one.’

The meetings between the Dalai Lama and European leaders is once again inflaming passions both in China and in Europe, and this is not the kind of atmosphere in which trade disputes are easy to resolve. There is (yet again) a movement afoot in China to boycott French goods, but I am not sure countries running large current account surpluses should be talking about boycotting countries who are running deficits with them.

This kind of talk can easily backfire. An interruption of the trade relationship between the two countries is actually likely at the macro level to be good for France in the short term (or, in what amounts to the same thing, it is easy enough politically to make the argument), and bad for China in both the short and long term. Remember, for France any interruption of international trade means they need to increase production to meet domestic demand. That means hiring workers. For China it means reducing its ability to export overcapacity, and this usually means closing down factories. I know, I know, France is not necessarily likely to produce at home what China sells, but in this world, finding a new supplier is a lot easier than finding a new customer.

At any rate this evening rumors have been swirling through the markets that November’s exports have declined year on year by 7%. One of my former students, now a currency trader in Shanghai, just told me this. I have no idea if it is true, but it gives a sense of how nervous markets are.

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About Michael Pettis 166 Articles

Affiliation: Peking University

Michael Pettis is a professor at Peking University's Guanghua School of Management, where he specializes in Chinese financial markets. He has also taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business.

Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups.

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