竟然做梦梦见Brenda，我竟然喊了句：mom !
醒来实在觉得尴尬。-_-!!!
Tuesday, June 3, 2008
Wednesday, December 12, 2007
China’s Last Option: Let the Yuan Soar
From FAR EASTERN ECONOMIC REVIEW
China’s Last Option: Let the Yuan Soar
June 2007
by Michael Pettis
After their sold-out concert last month, legendary American
punk band NOFX met with Beijing’s leading musicians at
the trendy club D22. Music is moving forward as quickly as
everything else in this wildly interesting country, and as they
interacted drunkenly with the cream of Beijing’s
underground, members of NOFX expressed surprise at the
dizzying speed of change.
It is probably a safe bet that the FX in the band’s name is not
a reference to foreign exchange, and that the changes they
noted have nothing to do with the financial sector, but it turns
out that a rock band is not a bad metaphor for China’s
markets. Monetary conditions are clearly out of control, and
the country is drunk on excess money. What’s worse, there is
a hangover still to come. At some point China must make a
monetary adjustment, and with so few alternatives left among
policy options, this adjustment is increasingly likely to
involve a one-off maxirevaluation in which the financial
authorities engineer a revaluation of the currency designed to
stop capital inflows without causing a banking system
breakdown.
Why would the authorities do something they have
steadfastly and sincerely insisted they will not do? By
coincidence, the day NOFX performed in Beijing,
newspapers around the world noted with awe the huge $136
billion first-quarter increase in central bank reserves reported
the previous day. This latest number brings total reserves
held by the Chinese central bank to $1.2 trillion. First-quarter
imports amounted to $206 billion, up 18% from 2006
first-quarter numbers (exports were up 28%), so that total
central bank reserves cover nearly 18 months of
imports—well beyond the six- to nine-month coverage ratio
that most economists recommend.
A $136 billion rise in first-quarter reserves—equal to 21% of
first-quarter GDP—is by any measure an astonishing
number. For comparison, during all of 2003 China’s reserves
grew by $117 billion, to an already hefty $403 billion. At the
time there was a serious debate about the implications of this
level of reserve growth. Many commentators expressed
concern that the accompanying monetary growth—which
takes place as the People’s Bank of China, the country’s
central bank, is forced to fund the purchase of reserves by
issuing currency or central bank bills—was beyond the needs
of the economy. Such rapid monetary growth was likely to
lead to excessive loan growth at the nation’s already weak
commercial banks, to overinvestment in a number of
industries, including real estate, and perhaps eventually to
inflation, which once ignited would be hard to control.
Since then, reserve growth, and with it the growth in money
supply, has accelerated. In 2004, reserves were up $207
billion to $610 billion. In 2005 they increased by another
$209 billion to $819 billion. In 2006 reserves climbed $247
billion to just over $1 trillion, comfortably ensconcing China
in the position of holding the world’s largest hoard of
central-bank reserves. Add to this the first-quarter growth of
2007, and it becomes clear that growth in reserves is out of
control, and with it, growth in the nation’s money supply.
What explains this first-quarter jump, which surprised most
China-watchers long inured to surprising numbers? Part of it
of course comes from China’s rising trade surplus, which hit
$46 billion in the first-quarter of 2007, double last year’s $23
billion first quarter surplus. China also received $16 billion
in foreign direct investment during the period. Although the
composition of the central bank’s reserves is a secret, Brad
Setser, senior economist at Roubini Global Economics,
estimates that currency appreciation, mainly of the euro, may
have added $5 billion, which when aggregated to another $10
billion to represent returns on investment, still leaves nearly
$60 billion unaccounted for.
In order to head off concern that this might represent a
resurgence of hot money inflows, Chinese authorities took
the unusual step of trying to explain the first-quarter surge.
Three days after the news was released, Wu Xiaoling, a
deputy governor of the People’s Bank of China, speaking at a
seminar in Guangzhou, said that the unwinding of swap
agreements between the central bank and Chinese
commercial lenders had resulted in foreign exchange coming
back onto the PBoC’s books during the first quarter. In
addition some of the funds raised in offshore initial public
offerings by Chinese banks and other enterprises had also
been brought back onshore, driven by the desire to take
advantage of the rising yuan.
Wu Xiaoling’s comments eased market concerns somewhat.
However they gave no information on the actual size of other
inflows (although these were probably still small), and they
didn’t address the fundamental problem that these first
quarter inflows, which included capital inflows that were a
postponement of inflows generated in 2006, will still have an
adverse monetary impact. Excessive monetary expansion is
as much a stock problem as it is a flow problem, and the fact
that reserves are growing rapidly is much more important
than the precise timing of the initial cause of the growth.
The Money Trap
What the first quarter numbers did highlight is that for the
past several years China has been caught in a money trap,
and it is not at all obvious how it can escape. The trap
consists of self-reinforcing structures in which cause and
effect are intertwined. At the heart of this is the trade surplus.
China’s trade surplus means, by definition, that it produces
more than it consumes. If it produces substantially more than
it consumes, as it currently does, the Chinese economy is
forced to run a substantial trade surplus.
This trade surplus is self-reinforcing because it generates
too-rapid growth in reserves as dollars pour into the country
through the export account. As the People’s Bank of China is
forced to buy the incoming dollars, it expands the domestic
money supply, either by creating money or by issuing a close
substitute for money, short-term central bank bills. The
money creation itself forces further expansion in investment,
either directly or through the banking system, which results
in ever-greater production and with it ever-greater trade
surpluses.
The result can be seen in the numbers. For all the attempts to
manage the process over the past five years, including
administrative controls, yuan appreciation, numerous
increases in minimum reserve requirements, and several
interest rate rises, industrial production continues to soar,
along with the trade surplus and the money supply. M2 was
up 17.3% in the first quarter of 2007, against a target of 16%.
Industrial production was up 18.3% over the same period last
year, a 10-year record (versus an already high 16.7% for first
quarter 2006). With this level of growth in industrial
production, it is unrealistic to expect a narrowing of the trade
surplus any time soon, and if the trade surplus doesn’t
narrow, neither money growth, loan growth, nor investment
is likely to slow down. As they continue to surge, they will
put more upward pressure on China’s exports.
The Chinese Academy of Sciences recently forecast this
year’s trade surplus to be 43% higher than last year’s $178
billion. China, it seems, is stuck in what once seemed like a
virtuous cycle but is increasingly a vicious one. As in Japan
in the 1980s, trade surpluses create the conditions for more
trade surpluses. Unless authorities can somehow force down
the surplus—perhaps by going on a massive (and probably
inefficient) international buying spree—it is hard to see what
can reverse this self-reinforcing process, short of a sudden
appreciation in the currency or a sudden contraction in the
domestic money supply, which is perhaps just another name
for a domestic financial crisis.
Undermining the Balance Sheet
There is an old banker’s saying that bad loans are made
during good times. Times are as good as they can get for
Chinese banks: GDP is growing quickly, corporate
profitability seems to be rising (although at least part of this
may come from speculating on financial markets, China’s
latest corporate fad), and China and the world are flooded
with liquidity that has kept interest rates low, asset prices
high and rising, and has not yet shown up as inflation.
But it is precisely in this sort of Minsky paradise that the
financial system is likely to evolve in a direction where risks
are built up and even more bad loans are made. Loan growth
and investment growth in China have been high—in the first
quarter of 2007 loans grew by 1.4 trillion yuan, an amount
equal to nearly 28% of first-quarter GDP and more than half
of last year’s already high loan growth. The authorities have
raised minimum reserve requirements an unprecedented
seven times since April 2006, they have raised interest rates
three times during this period, and they have made
tremendous sterilization efforts, with no apparent impact on
the economy and without putting a dent in the pace of loan
growth or stock-market appreciation.
Even China’s much-vaunted administrative controls haven’t
done much. During the last three years every bout of
excessive growth was moderated, to much fanfare, by
administrative policies—but never for more than two or three
months, after which the country’s economy once again
picked up speed. Analysts often laud the use of
administrative controls as Beijing’s ultimate weapon, but the
track record seems to provide very weak evidence for their
usefulness. They seem temporarily to slow down growth in
the areas in which the authorities are most concerned, but
have no impact beyond a few months. For all the talk of
administrative controls over the past five years, GDP grew
by 11.1% in the first quarter of 2007—after its already heady
10.7% and 10.4% surges in 2006 and 2005. Administrative
controls seem mainly effective in shifting problems from
where they are noticed to where they are not.
The failure of market and administrative measures will
almost certainly increase systemic risk. There are many
problems in the country’s financial markets, but the two
greatest have to do with the banking system. The most
obvious problem, of course, is that the country’s financial
system is dominated by its banks, whose lending policies
tend to be inflexible, whose risk systems are rudimentary,
and whose ability to adjust is constrained by a rigid (and
opaque) governance structure. This means that since banks
are the primary source of financing, contractions in the
banking system are likely to be transmitted into the
underlying economy. There they can set off more
self-reinforcing processes in which banking-sector
contractions caused by rising bad loans lead to economic
contraction as the banks clumsily attempt to reduce loan
exposure, which then leads to further banking-sector
contraction as corporate defaults rise in response to bank
tightening.
The second problem is that the banking system is already in
trouble. While there have certainly been improvements in
lending practices in recent years, Chinese banks have a long
way to go before they are healthy and prudently managed. If
nonperforming loans and other assets were valued correctly,
these banks would be technically insolvent. In a November
2006 report, Fitch Ratings calculated that total unrealized
losses in the banking system exceeded total capital and
reserves by more than one-third. This figure does not include
estimates made for the rapid loan expansion of the past two
years, which most analysts believe will result in a surge in
new nonperforming loans.
The financial authorities have attempted to clean the banks
by carving out roughly $300 billion in bad loans and selling
them to asset management companies for liquidation.
Unfortunately, because the actual liquidation process has
been glacial, the cleaning up of the banks, as limited as it has
been, fails on two counts. First, liquidating bad loans is not
done simply to clean up the banks. It also permits overly
indebted companies to eliminate financial-distress costs
associated with the debt overhang and begin to operate
normally. This not-widely-understood benefit of loan
liquidations is a very important element in repairing a badly
functioning banking system, but in China it has barely taken
place.
Perhaps more importantly, the cleanup of bad loans has
consisted largely of transferring the loans from the banks’
balance sheets, where they were effectively contingent
obligations of the government, to other entities where they
are direct obligations. This wouldn’t be a problem if the
government’s credit were unassailable, but the government’s
total liabilities, including contingent liabilities, have been
rising and may well exceed 60% of GDP. It is not obvious
that the government’s credit can withstand much more
increase in contingent debts, which would probably occur if
some event were to set off an economic contraction. Because
of this shuffling of bad loans, the credit-worthiness of
Chinese banks has barely improved in the past 10
years—while the banks’ direct credit has improved, that of
their guarantor has deteriorated.
Monetary Policies
During the national People’s Congress in March, Premier
Wen Jiabao said that the economy is “unstable, unbalanced,
uncoordinated and unsustainable.” China’s feverish economy
and weak national balance sheet are largely the consequence
of the past several years’ explosive monetary growth, and as
it accelerates, it is clear that some sort of adjustment needs to
happen. Perhaps it is possible that the adjustment will take
place in a benign context and the consequences will be mild.
If China is lucky, if global growth and liquidity conditions
are maintained for at least another five to seven years, and if
the government gets serious about cleaning up the banking
system and developing alternative financial markets, China
may muddle through.
But this may be a lot to hope for. It is not clear that anyone
can count on benign conditions for so long, and it is even less
clear that the financial authorities are seriously repairing the
financial system. In retrospect the financial authorities have
made two major mistakes. The first was to have dragged their
feet on cleaning up the banks, when they should have been
strengthening and clarifying the governance framework,
carving out bad loans, liquidating them as quickly as
possible, and so limiting their current and future impact on
the country’s credit. The second mistake may have been
harder to predict at the time, but it now seems that the
financial authorities waited too long in beginning the
appreciation of the yuan. By waiting until 2005, and then
only permitting a gradual upward creep, they forced the yuan
to stay too low for too long.
As things stand now, there is little that the authorities can do
to rectify the currency problem. To continue allowing the
yuan to appreciate at its current glacial path means that the
monetary imbalances will persist, and as they do, the
combination of a further weakening in the national balance
sheet and the greater monetary pressure will make the
eventual adjustment more difficult. To allow a more rapid
appreciation of the yuan brings equally serious difficulties. It
would almost certainly cause a pick-up in hot money inflows,
which would exacerbate monetary conditions and increase
the set of problems—overinvestment, excessive loan growth,
and asset-price bubbles—that the authorities need so urgently
to fix.
None of the standard policy options seem to be
working—domestic monetary contraction via interest-rate
increases, minimum-reserve increases, and administrative
measures have proven as ineffective as faster or slower
appreciation of the currency. Another as-yet-untried option,
however, which now seems so unlikely that most economists
dismiss it out of hand, will eventually draw much wider
support—not because it is obviously good policy but rather
because it may be the only option left.
The central bank can engineer a large one-off jump in the
value of the yuan, followed by a peg, which would halt hot
money inflows and after a period of adjustment reduce the
trade surplus, to bring China’s monetary system back into
balance. If the revaluation is sufficiently high, and is
followed by a credible peg, it will cause an import-related
boost in consumption that will help bring down the trade
surplus while also reducing or even reversing capital inflows.
The slowing of reserve growth will slow investment, which
by reducing production will limit export growth.
This policy option is not without significant risks. A
too-great revaluation could hurt export industries and lead to
capital flight which, by weakening bank loans to export
companies and simultaneously creating deposit outflows,
could jeopardize the banking system and precipitate the crisis
it was designed to modify. And of course anything that
reverses the self-reinforcing process of investment and
growth may result in a rise in unemployment in the short
term.
Although the relative attractiveness of this policy option is
increasing and will continue to increase over time, there is
still great resistance because of its potential impact on the
banking sector. That is not surprising given the risks, but
what else can the financial authorities do? Monetary growth
is caught in a self-reinforcing trap whose consequence is an
ever-weakening national balance sheet. The failure of market
measures places even more emphasis on the use of
administrative measures, but administrative measures are
most powerful when least used. The threat of using them is
often more effective than the actual measures, and because of
their overuse no one now expects them to have much effect.
The market has already been trained to buy every dip.
In April Xia Bin, director of the finance division of the
Development Research Center and advisor to senior
government officials, told members of a financial forum that
“The central bank of China’s current monetary policy is a bit
weak. In other words, money supply is a bit out of control.”
This is an admirably (and surprisingly) frank assessment, and
if true implies an uncomfortable future. China is muddling
through its monetary management and will probably continue
to muddle through for the foreseeable future, but at some
point there must be a substantial adjustment made, in which
not only does money-supply growth slow significantly but
also the previous excess money-creation is wrung out of the
economy.
The authorities have tried nearly every gradualist tool at hand
and nothing seems to work. They can’t even get the attention
of financial journalists, who relegate these moves to the back
pages of their newspapers. No one seems to care what the
authorities do. China’s latest reserve-increase announcement
(up 50 basis points, to 11%) made two days before the May 1
holidays saw the stock market respond contemptuously the
next day by surging 2.17%.
This is not surprising if the root problem is excessive
monetary growth caused by ballooning reserves, because
none of the tools have so far been able to address the root
problem. Until they do so, it is hard to see how this story can
end well. Perhaps the best thing for Chinese bankers,
investors and businesses to do now is to enjoy the party and
try not to think too much about tomorrow’s hangover. That’s
probably what the punk band NOFX would do.
Mr. Pettis is a director of Galileo Global Horizons, a New
York-based fund-managing firm.
China’s Last Option: Let the Yuan Soar
June 2007
by Michael Pettis
After their sold-out concert last month, legendary American
punk band NOFX met with Beijing’s leading musicians at
the trendy club D22. Music is moving forward as quickly as
everything else in this wildly interesting country, and as they
interacted drunkenly with the cream of Beijing’s
underground, members of NOFX expressed surprise at the
dizzying speed of change.
It is probably a safe bet that the FX in the band’s name is not
a reference to foreign exchange, and that the changes they
noted have nothing to do with the financial sector, but it turns
out that a rock band is not a bad metaphor for China’s
markets. Monetary conditions are clearly out of control, and
the country is drunk on excess money. What’s worse, there is
a hangover still to come. At some point China must make a
monetary adjustment, and with so few alternatives left among
policy options, this adjustment is increasingly likely to
involve a one-off maxirevaluation in which the financial
authorities engineer a revaluation of the currency designed to
stop capital inflows without causing a banking system
breakdown.
Why would the authorities do something they have
steadfastly and sincerely insisted they will not do? By
coincidence, the day NOFX performed in Beijing,
newspapers around the world noted with awe the huge $136
billion first-quarter increase in central bank reserves reported
the previous day. This latest number brings total reserves
held by the Chinese central bank to $1.2 trillion. First-quarter
imports amounted to $206 billion, up 18% from 2006
first-quarter numbers (exports were up 28%), so that total
central bank reserves cover nearly 18 months of
imports—well beyond the six- to nine-month coverage ratio
that most economists recommend.
A $136 billion rise in first-quarter reserves—equal to 21% of
first-quarter GDP—is by any measure an astonishing
number. For comparison, during all of 2003 China’s reserves
grew by $117 billion, to an already hefty $403 billion. At the
time there was a serious debate about the implications of this
level of reserve growth. Many commentators expressed
concern that the accompanying monetary growth—which
takes place as the People’s Bank of China, the country’s
central bank, is forced to fund the purchase of reserves by
issuing currency or central bank bills—was beyond the needs
of the economy. Such rapid monetary growth was likely to
lead to excessive loan growth at the nation’s already weak
commercial banks, to overinvestment in a number of
industries, including real estate, and perhaps eventually to
inflation, which once ignited would be hard to control.
Since then, reserve growth, and with it the growth in money
supply, has accelerated. In 2004, reserves were up $207
billion to $610 billion. In 2005 they increased by another
$209 billion to $819 billion. In 2006 reserves climbed $247
billion to just over $1 trillion, comfortably ensconcing China
in the position of holding the world’s largest hoard of
central-bank reserves. Add to this the first-quarter growth of
2007, and it becomes clear that growth in reserves is out of
control, and with it, growth in the nation’s money supply.
What explains this first-quarter jump, which surprised most
China-watchers long inured to surprising numbers? Part of it
of course comes from China’s rising trade surplus, which hit
$46 billion in the first-quarter of 2007, double last year’s $23
billion first quarter surplus. China also received $16 billion
in foreign direct investment during the period. Although the
composition of the central bank’s reserves is a secret, Brad
Setser, senior economist at Roubini Global Economics,
estimates that currency appreciation, mainly of the euro, may
have added $5 billion, which when aggregated to another $10
billion to represent returns on investment, still leaves nearly
$60 billion unaccounted for.
In order to head off concern that this might represent a
resurgence of hot money inflows, Chinese authorities took
the unusual step of trying to explain the first-quarter surge.
Three days after the news was released, Wu Xiaoling, a
deputy governor of the People’s Bank of China, speaking at a
seminar in Guangzhou, said that the unwinding of swap
agreements between the central bank and Chinese
commercial lenders had resulted in foreign exchange coming
back onto the PBoC’s books during the first quarter. In
addition some of the funds raised in offshore initial public
offerings by Chinese banks and other enterprises had also
been brought back onshore, driven by the desire to take
advantage of the rising yuan.
Wu Xiaoling’s comments eased market concerns somewhat.
However they gave no information on the actual size of other
inflows (although these were probably still small), and they
didn’t address the fundamental problem that these first
quarter inflows, which included capital inflows that were a
postponement of inflows generated in 2006, will still have an
adverse monetary impact. Excessive monetary expansion is
as much a stock problem as it is a flow problem, and the fact
that reserves are growing rapidly is much more important
than the precise timing of the initial cause of the growth.
The Money Trap
What the first quarter numbers did highlight is that for the
past several years China has been caught in a money trap,
and it is not at all obvious how it can escape. The trap
consists of self-reinforcing structures in which cause and
effect are intertwined. At the heart of this is the trade surplus.
China’s trade surplus means, by definition, that it produces
more than it consumes. If it produces substantially more than
it consumes, as it currently does, the Chinese economy is
forced to run a substantial trade surplus.
This trade surplus is self-reinforcing because it generates
too-rapid growth in reserves as dollars pour into the country
through the export account. As the People’s Bank of China is
forced to buy the incoming dollars, it expands the domestic
money supply, either by creating money or by issuing a close
substitute for money, short-term central bank bills. The
money creation itself forces further expansion in investment,
either directly or through the banking system, which results
in ever-greater production and with it ever-greater trade
surpluses.
The result can be seen in the numbers. For all the attempts to
manage the process over the past five years, including
administrative controls, yuan appreciation, numerous
increases in minimum reserve requirements, and several
interest rate rises, industrial production continues to soar,
along with the trade surplus and the money supply. M2 was
up 17.3% in the first quarter of 2007, against a target of 16%.
Industrial production was up 18.3% over the same period last
year, a 10-year record (versus an already high 16.7% for first
quarter 2006). With this level of growth in industrial
production, it is unrealistic to expect a narrowing of the trade
surplus any time soon, and if the trade surplus doesn’t
narrow, neither money growth, loan growth, nor investment
is likely to slow down. As they continue to surge, they will
put more upward pressure on China’s exports.
The Chinese Academy of Sciences recently forecast this
year’s trade surplus to be 43% higher than last year’s $178
billion. China, it seems, is stuck in what once seemed like a
virtuous cycle but is increasingly a vicious one. As in Japan
in the 1980s, trade surpluses create the conditions for more
trade surpluses. Unless authorities can somehow force down
the surplus—perhaps by going on a massive (and probably
inefficient) international buying spree—it is hard to see what
can reverse this self-reinforcing process, short of a sudden
appreciation in the currency or a sudden contraction in the
domestic money supply, which is perhaps just another name
for a domestic financial crisis.
Undermining the Balance Sheet
There is an old banker’s saying that bad loans are made
during good times. Times are as good as they can get for
Chinese banks: GDP is growing quickly, corporate
profitability seems to be rising (although at least part of this
may come from speculating on financial markets, China’s
latest corporate fad), and China and the world are flooded
with liquidity that has kept interest rates low, asset prices
high and rising, and has not yet shown up as inflation.
But it is precisely in this sort of Minsky paradise that the
financial system is likely to evolve in a direction where risks
are built up and even more bad loans are made. Loan growth
and investment growth in China have been high—in the first
quarter of 2007 loans grew by 1.4 trillion yuan, an amount
equal to nearly 28% of first-quarter GDP and more than half
of last year’s already high loan growth. The authorities have
raised minimum reserve requirements an unprecedented
seven times since April 2006, they have raised interest rates
three times during this period, and they have made
tremendous sterilization efforts, with no apparent impact on
the economy and without putting a dent in the pace of loan
growth or stock-market appreciation.
Even China’s much-vaunted administrative controls haven’t
done much. During the last three years every bout of
excessive growth was moderated, to much fanfare, by
administrative policies—but never for more than two or three
months, after which the country’s economy once again
picked up speed. Analysts often laud the use of
administrative controls as Beijing’s ultimate weapon, but the
track record seems to provide very weak evidence for their
usefulness. They seem temporarily to slow down growth in
the areas in which the authorities are most concerned, but
have no impact beyond a few months. For all the talk of
administrative controls over the past five years, GDP grew
by 11.1% in the first quarter of 2007—after its already heady
10.7% and 10.4% surges in 2006 and 2005. Administrative
controls seem mainly effective in shifting problems from
where they are noticed to where they are not.
The failure of market and administrative measures will
almost certainly increase systemic risk. There are many
problems in the country’s financial markets, but the two
greatest have to do with the banking system. The most
obvious problem, of course, is that the country’s financial
system is dominated by its banks, whose lending policies
tend to be inflexible, whose risk systems are rudimentary,
and whose ability to adjust is constrained by a rigid (and
opaque) governance structure. This means that since banks
are the primary source of financing, contractions in the
banking system are likely to be transmitted into the
underlying economy. There they can set off more
self-reinforcing processes in which banking-sector
contractions caused by rising bad loans lead to economic
contraction as the banks clumsily attempt to reduce loan
exposure, which then leads to further banking-sector
contraction as corporate defaults rise in response to bank
tightening.
The second problem is that the banking system is already in
trouble. While there have certainly been improvements in
lending practices in recent years, Chinese banks have a long
way to go before they are healthy and prudently managed. If
nonperforming loans and other assets were valued correctly,
these banks would be technically insolvent. In a November
2006 report, Fitch Ratings calculated that total unrealized
losses in the banking system exceeded total capital and
reserves by more than one-third. This figure does not include
estimates made for the rapid loan expansion of the past two
years, which most analysts believe will result in a surge in
new nonperforming loans.
The financial authorities have attempted to clean the banks
by carving out roughly $300 billion in bad loans and selling
them to asset management companies for liquidation.
Unfortunately, because the actual liquidation process has
been glacial, the cleaning up of the banks, as limited as it has
been, fails on two counts. First, liquidating bad loans is not
done simply to clean up the banks. It also permits overly
indebted companies to eliminate financial-distress costs
associated with the debt overhang and begin to operate
normally. This not-widely-understood benefit of loan
liquidations is a very important element in repairing a badly
functioning banking system, but in China it has barely taken
place.
Perhaps more importantly, the cleanup of bad loans has
consisted largely of transferring the loans from the banks’
balance sheets, where they were effectively contingent
obligations of the government, to other entities where they
are direct obligations. This wouldn’t be a problem if the
government’s credit were unassailable, but the government’s
total liabilities, including contingent liabilities, have been
rising and may well exceed 60% of GDP. It is not obvious
that the government’s credit can withstand much more
increase in contingent debts, which would probably occur if
some event were to set off an economic contraction. Because
of this shuffling of bad loans, the credit-worthiness of
Chinese banks has barely improved in the past 10
years—while the banks’ direct credit has improved, that of
their guarantor has deteriorated.
Monetary Policies
During the national People’s Congress in March, Premier
Wen Jiabao said that the economy is “unstable, unbalanced,
uncoordinated and unsustainable.” China’s feverish economy
and weak national balance sheet are largely the consequence
of the past several years’ explosive monetary growth, and as
it accelerates, it is clear that some sort of adjustment needs to
happen. Perhaps it is possible that the adjustment will take
place in a benign context and the consequences will be mild.
If China is lucky, if global growth and liquidity conditions
are maintained for at least another five to seven years, and if
the government gets serious about cleaning up the banking
system and developing alternative financial markets, China
may muddle through.
But this may be a lot to hope for. It is not clear that anyone
can count on benign conditions for so long, and it is even less
clear that the financial authorities are seriously repairing the
financial system. In retrospect the financial authorities have
made two major mistakes. The first was to have dragged their
feet on cleaning up the banks, when they should have been
strengthening and clarifying the governance framework,
carving out bad loans, liquidating them as quickly as
possible, and so limiting their current and future impact on
the country’s credit. The second mistake may have been
harder to predict at the time, but it now seems that the
financial authorities waited too long in beginning the
appreciation of the yuan. By waiting until 2005, and then
only permitting a gradual upward creep, they forced the yuan
to stay too low for too long.
As things stand now, there is little that the authorities can do
to rectify the currency problem. To continue allowing the
yuan to appreciate at its current glacial path means that the
monetary imbalances will persist, and as they do, the
combination of a further weakening in the national balance
sheet and the greater monetary pressure will make the
eventual adjustment more difficult. To allow a more rapid
appreciation of the yuan brings equally serious difficulties. It
would almost certainly cause a pick-up in hot money inflows,
which would exacerbate monetary conditions and increase
the set of problems—overinvestment, excessive loan growth,
and asset-price bubbles—that the authorities need so urgently
to fix.
None of the standard policy options seem to be
working—domestic monetary contraction via interest-rate
increases, minimum-reserve increases, and administrative
measures have proven as ineffective as faster or slower
appreciation of the currency. Another as-yet-untried option,
however, which now seems so unlikely that most economists
dismiss it out of hand, will eventually draw much wider
support—not because it is obviously good policy but rather
because it may be the only option left.
The central bank can engineer a large one-off jump in the
value of the yuan, followed by a peg, which would halt hot
money inflows and after a period of adjustment reduce the
trade surplus, to bring China’s monetary system back into
balance. If the revaluation is sufficiently high, and is
followed by a credible peg, it will cause an import-related
boost in consumption that will help bring down the trade
surplus while also reducing or even reversing capital inflows.
The slowing of reserve growth will slow investment, which
by reducing production will limit export growth.
This policy option is not without significant risks. A
too-great revaluation could hurt export industries and lead to
capital flight which, by weakening bank loans to export
companies and simultaneously creating deposit outflows,
could jeopardize the banking system and precipitate the crisis
it was designed to modify. And of course anything that
reverses the self-reinforcing process of investment and
growth may result in a rise in unemployment in the short
term.
Although the relative attractiveness of this policy option is
increasing and will continue to increase over time, there is
still great resistance because of its potential impact on the
banking sector. That is not surprising given the risks, but
what else can the financial authorities do? Monetary growth
is caught in a self-reinforcing trap whose consequence is an
ever-weakening national balance sheet. The failure of market
measures places even more emphasis on the use of
administrative measures, but administrative measures are
most powerful when least used. The threat of using them is
often more effective than the actual measures, and because of
their overuse no one now expects them to have much effect.
The market has already been trained to buy every dip.
In April Xia Bin, director of the finance division of the
Development Research Center and advisor to senior
government officials, told members of a financial forum that
“The central bank of China’s current monetary policy is a bit
weak. In other words, money supply is a bit out of control.”
This is an admirably (and surprisingly) frank assessment, and
if true implies an uncomfortable future. China is muddling
through its monetary management and will probably continue
to muddle through for the foreseeable future, but at some
point there must be a substantial adjustment made, in which
not only does money-supply growth slow significantly but
also the previous excess money-creation is wrung out of the
economy.
The authorities have tried nearly every gradualist tool at hand
and nothing seems to work. They can’t even get the attention
of financial journalists, who relegate these moves to the back
pages of their newspapers. No one seems to care what the
authorities do. China’s latest reserve-increase announcement
(up 50 basis points, to 11%) made two days before the May 1
holidays saw the stock market respond contemptuously the
next day by surging 2.17%.
This is not surprising if the root problem is excessive
monetary growth caused by ballooning reserves, because
none of the tools have so far been able to address the root
problem. Until they do so, it is hard to see how this story can
end well. Perhaps the best thing for Chinese bankers,
investors and businesses to do now is to enjoy the party and
try not to think too much about tomorrow’s hangover. That’s
probably what the punk band NOFX would do.
Mr. Pettis is a director of Galileo Global Horizons, a New
York-based fund-managing firm.
Sunday, August 26, 2007
Wednesday, August 8, 2007
Beautiful Dark Skin
Aesthetics can be objective but concepts of physical beauty are influenced by the development of human society. During the pinnacle of ancient Chinese culture plump women with light skin were considered more attractive than skinny ones with dark skin. the same is true of Renaissance Europe, when lily white women with love handles were objects of desire. This notion, of course, has changed in the east and west in the 21st century where being overweight is no longer associated with wealth. Skin, though, is a different matter.
Lily white skin is no longer considered beautiful in western countries anymore. White people consider a golden brown tan to be the most attractive hue for their skin. Most see this as objectively the most beautiful color, even Asian. However, Chinese see light skin as the most attractive color too, as if this were just as objective. Perhaps part of the reason for this discrepancy is that beauty is often tied tho the notion of wealth. A nice tan in the west signifies a life of leisure and money. Dark skin tin the east is associated with working in the fields, the life of an impoverished farmer. Who wants to be perceived this way?
My black friend described the color of her skin to me as coffee with a bit of milk stirred in, which is much darker than any Chinese farmer. It is a beautiful shade of brown but every time she sees a cosmetics commercial in china she is reminded that people here do not agree. People have even given her unsolicited advice on how to lighten her skin. She finds this quite frustrating because in American this would be considered a racist comment. Perhaps the concept of "white Chinese" will change as the society develops just as being overweight has gone out of fashion.
Lily white skin is no longer considered beautiful in western countries anymore. White people consider a golden brown tan to be the most attractive hue for their skin. Most see this as objectively the most beautiful color, even Asian. However, Chinese see light skin as the most attractive color too, as if this were just as objective. Perhaps part of the reason for this discrepancy is that beauty is often tied tho the notion of wealth. A nice tan in the west signifies a life of leisure and money. Dark skin tin the east is associated with working in the fields, the life of an impoverished farmer. Who wants to be perceived this way?
My black friend described the color of her skin to me as coffee with a bit of milk stirred in, which is much darker than any Chinese farmer. It is a beautiful shade of brown but every time she sees a cosmetics commercial in china she is reminded that people here do not agree. People have even given her unsolicited advice on how to lighten her skin. She finds this quite frustrating because in American this would be considered a racist comment. Perhaps the concept of "white Chinese" will change as the society develops just as being overweight has gone out of fashion.
Tuesday, July 3, 2007
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