Twofish's Blog

February 9, 2009

Notes on Chinese money

Filed under: china, finance — twofish @ 3:21 am

http://blogs.cfr.org/setser/2009/02/08/is-complaining-about-others%e2%80%99-protectionism-protectionist/

bsetser: But it doesn’t mean that the US shouldn’t be talking to China about whether China’s peg to the dollar creates the basis for a stable global monetary architecture

In the near term (for the next one to three months), I think it’s pretty clear that China pegging to the US is a good thing. The dollar is appreciating, and a peg prevents the world from getting into a system of competitive devaluations. Right now, both the US and China have their hands full with crises, and currency isn’t high on the list of fires burning.

What happens in the longer term (and by longer term I mean 3+ months) depends on how the US and Chinese economies react to their respective stimulus packages. If the Chinese economy starts booming while the US economy stays stagnant, there will be huge calls for currency revaluation, whereas if the US economy starts booming while the Chinese economy stays stagnant, people will be asking China to keep the peg as an alternative to devaluation. Alternatively it could be that the US and China end up with lock step recoveries, although I think this is rather unlikely.

bsetser: No country really has a comparative advantage “as consumers.”

I disagree with this. Rich countries with large amounts of immigration that keeps the workforce young do have comparative advantages as consumers.

bsetser: But the combination of a rising dollar-RMB and China’s own slowdown has led to a dramatic increase in capital outflows from China.

It’s hard to figure out cause and effect from this. I’d argue that it was the reverse. That the near-collapse of the US financial system caused people to pull money out of China and this led to devaluation pressures. We can look at the timelines, but I strongly suspect that you’ll see that the capital outflows started before the the devaluation pressures, and probably started the day after Lehman went under.

One of my strong suspicions is that money from Western investment banks was actually at the core of the informal financing system in southern China. People would borrow money from Western banks and then lend RMB. When Lehman collapsed, the Western banks called in their loans, which led to a massive capital outflow and also caused factories in Southern China to close their doors as their financing was cut. So what you ended up with was a credit crisis rather than a demand shock.

Something that is still something of a mystery is who are what was responsible for the “hot money” and I think it was Western investment banks financing Chinese export industries through Hong Kong.

bsetser: But it doesn’t mean that the US shouldn’t be talking to China about whether China’s peg to the dollar creates the basis for a stable global monetary architecture …

The US and China need to be talking on a dozen topics. Currency being one of them. Personally, I’d put banking regulation and capital mobility as a higher agenda item than currency.

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