China: A review
Since China was in the news this week, I thought it might be fun to take a look back at what people were writing about China many years ago. Clearly a lot has changed over the past fifteen years... but much remains the same. Here's a nice little piece from The Economist, dated July 4, 1992, that sounds at the same time a bit strange and rather familiar:
China: Return to goThese are heady days for China's economy: reformers are winning, business is booming and foreigners are scrambling to invest. The cautious, however, will recall that when China was last like this, only four years ago, the economy went out of control and inflation reached an annualized rate of 80%. The government responded with a tight squeeze on credit and imports. Economic growth fell from 11.5% in 1988 to 4% in 1989 (a decline sharpened by Western sanctions after the Tiananmen Square killings). Will it happen again?Most people are too thrilled with recent events to waste time on such morbid speculation. In the first five months of 1992, China's real GDP was 11% bigger than in the same period last year; industrial output was 18% higher; real income per person in the cities 16% higher. In the southern Guangdong province industrial output was up by 26% and exports by 32%.Meanwhile, the reformist directives multiply at bewildering speed. In mid-June it was suggested that five cities along the Yangzi River would be given the latitude to attract foreign investment; this week the government announced that the Yangzi's open cities would actually number 28.Still more significant was the formal announcement on June 25th that service businesses such as retailing, transport and banking will be opened to foreign investors. This part of China's economy offers wider scope than any other for improved efficiency, growth and profits -- and the government seems unperturbed by the social implications of allowing foreigners to shape a consumer culture in China.The foreigners are eager to begin. In the first five months of 1992 the government approved 8,900 foreign-investment projects, with a value of $ 10.5 billion, around three times the comparable figures last year. Overseas Chinese from Hong Kong, Taiwan and South-East Asia are showing especially keen interest. They know China better than other foreigners, and as they get involved will have a farther-reaching influence.Li Ka-shing, Hong Kong's biggest businessman, has for the first time taken a share of big property deals in northern China (in Shanghai and Beijing). He is also committed to taking stakes in bridge and highway projects in Guangdong. Robert Kuok, a Malaysian tycoon who is a partner of Mr. Li's in the Beijing and Shanghai projects, recently made three Chinese Property deals in four days. Over the weekend of June 27th-28th, Shanghai signed a total of 20 property-development agreements with foreigners.The worry, however, is that such developments will help the economy overheat -- as it did in 1980, 1985 and 1988 -- and the government will then cool it by the same painful methods as before.Danger signs are already plentiful. Consumer prices in the first five months of 1992 were 11% higher in the cities than in the same period last year. The government's budget deficit last year, by IMF rather than Chinese arithmetic (which includes foreign loans as revenue), was 78 billion Yuan ($ 14.6 billion) -- around 20% of government spending and 3% of GNP. This year spending continues to grow faster than revenue.The culprits, as usual, are the loss-making state enterprises. Despite government exhortations to improve their performance, the biggest state companies lost 8.2 billion Yuan in the fist five months of the year, 20% more than in the same period last year. Although the central bank has increased banks' reserve requirements, rumor -- supported by a weakening of the Yuan on the free market -- has it that money supply grew at its fastest-ever rate during the first five months of this year.Optimists are undismayed. They say things have changed since 1988: more of the economy is in private hands and there are fewer of the rigidities that stopped supply from responding to price movements in 1988. True enough. But even if an economy is efficient, which China's is not, it will inflate predictably in response to the kind of pressure China is under. Go-go could all too easily become stop-go.
Turns out that the astonishing estimates of China’s economic growth, which I showed you below
China's Economy Probably Grew 10.4 Percent as Exports Boomed on Bloomberg, Apr 17 -- China's economy, the world's fourth largest, probably grew more than 10 percent for the fifth straight quarter on booming exports and an investment rebound.Gross domestic product expanded 10.4 percent from a year earlier, according to the median estimate of 24 economists surveyed by Bloomberg News, the same pace as in the fourth quarter. The statistics bureau released first-quarter figures in Beijing on April 19.China's foreign-exchange reserves grow by $1 million a minute, flooding the economy with cash and fueling investment and inflation. ...China's economy has more than doubled in size since the end of 2000 and last year's 10.7 percent expansion was the biggest since 1995. Growth for each of the past four years was at least 10 percent....Urban investment in factories and real estate probably climbed 23 percent in the first three months from a year earlier, the survey showed. That compares with 13.8 percent in December and 24.5 percent for all of last year.
China's Economy Surges at Faster-Than-Forecast 11.1% on Bloomberg, Apr 19 -- China's economy grew at a faster- than-forecast 11.1 percent pace in the first quarter from a year earlier; raising the likelihood the government will increase interest rates to curb the risk of overheating.Growth accelerated from 10.4 percent in the previous quarter, the statistics bureau said in Beijing today. China's benchmark stock index fell 4.7 percent before the release, triggering declines in Asian and European shares, on speculation borrowing costs will rise.Premier Wen Jiabao said the government will take steps to curb lending and investment in factories and property and rein in the record trade surplus. Inflation accelerated to 3.3 percent, the fastest pace in more than two years, and breached the central bank's 3 percent target for the year."Growth has been driven by continuing strength in investment and continuing strength in politically sensitive exports," said Glenn Maguire, chief Asia economist at Societe Generale in Hong Kong. "China needs to cool profits and the easiest way to do that would be to allow the Yuan to appreciate at a faster rate."
Red hot? Yellow hot? White hot? I'm not sure exactly what the appropriate temperature description for China's economy is, but it's clear that it is growing really, really fast, and even for China. The potential implications for China's monetary policy are clear. And the fear that China's central bank might have to take steps to cool down the economy provoked a continent-wide selloff in stocks today, as Reuter’s reports:
SINGAPORE (Reuters) -- Asian shares fell sharply on Thursday as investors worried that Chinese economic data could show an overheating economy and prompt Beijing to announce more interest-rate hikes or other growth-cooling measures....China stocks fell 3.3 percent in Shanghai as investors worried that strong data could lead to more government measures to reign in the booming economy.
Yes, there can be too much of a good thing...
China's central bank takes more steps to try to cool down the Chinese economy (China's Monetary Policy):
China Raises Banks' Reserves Sixth Time in 10 Months on Bloomberg, Apr 05 -- China ordered banks to set aside more money as reserves for the sixth time in less than a year to slow inflation and investment in the fastest-growing major economy.The reserve ratio will increase by 0.5 percentage points to 10.5 percent starting April 16, the People's Bank of China said today in a statement on its Web site.Central bank Governor Zhou Xiao chuan is concerned that cash from a record $177.5 billion trade surplus is stoking excess investment in an economy that expanded 10.7 percent last year, the fastest in more than a decade. The central last month raised interest rates for the third time since April 2006 to help reduce the risk of accelerating inflation and asset bubbles."Chinese authorities have a significant liquidity problem on their hands," said Tim Condon, an economist at ING Bank NV in Singapore. "The government's probably acting in response to the very buoyant loans growth we saw in January and February. They're going to keep watching this."
While the PBoC has also raised interest rates recently (a little), it seems that they are still primarily trying to use quantity tools (controlling how much lending banks can do) rather than price tools (at what interest rates can banks lend) to manage the economy.The Chinese central bank's historical use of quantity tools instead of price tools is quite consistent with China's history as a centrally-planned economy. After all, the whole idea behind central planning is to have a planner dictate quantities produced, rather than allowing price signals to tell firms how much of what to produce. Managing the money supply through quantity controls is simply an application of the same principles.But there are good arguments that suggest that the PBoC should shift toward using interest rate management more and quantity tools less - see for example "China: Strengthening Monetary Policy Implementation," by Bernard Laurens and Rodolfo Maino of the IMF. While such a shift would probably a very good idea for an economy that is no longer centrally-planned, that change does not seem to be happening yet. It's also worth wondering how much Chinese interest rates would have to go up in order to effectively cool down the Chinese economy. The answer might be quite a bit. Furthermore, raising interest rates brings with it some complications that the PBoC may be trying to avoid. Specifically, if China does indeed raise interest rates significantly, this could put a lot of additional pressure on the Chinese authorities to allow the Yuan to appreciate. If they raised interest rates without allowing the exchange rate to change significantly, the PBoC could end up accumulating dollars even faster than they already are.So it seems unlikely to me that we'll see any significant increase in interest rates in China until the PBoC is willing to allow faster Yuan appreciation. Which brings us to one last point: as Menzie Chinn reminded us recently, the Chinese authorities could also cool down the economy very effectively by allowing the Yuan to appreciate against the dollar. They haven't used the exchange rate tool much in their efforts to slow down overly-rapid economic growth... but if they start finding that their quantity-management tools aren't as effective as they used to be, they might. And in combination with higher interest rates, a change in the exchange rate could very effectively sprinkle some cooling water on the red-hot Chinese economy.
Sources:
http://www.bloomberg.com
http://www.imf.org/external/pubs/ft/wp/2007/wp0714.pdf
