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Wednesday, February 28, 2007

China Odds and Ends

This piece in the FT yesterday is of interest:

Chinese exports have become more profitable in the 18 months since the revaluation of its currency, the renminbi, as industry has lifted productivity and moved into a growing range of higher-value products. The rise in profits and volumes of Chinese exports comes despite an appreciation of about 6.5 per cent of the renminbi against the US dollar since mid-2005, and sharply higher prices for most raw materials.

What the FT article seems to suggest is that despite slight upward pressure on the yuan the Chinese have been able to maintain volume and profitability by moving up the value chain, and by raising productivity. As we have seen in the case of Germany and the euro rise, currency movements are by no means a one way street in terms of the impact on exports, since if there is room to increase productivity, the rising currency will only serve to make this happen sooner rather than later. Indeed there is probably more of such an effect in the tradeables sector than in the non-tradeable ones. So I found this comment revealing:

The ongoing competitiveness of China also underlines how any focus by the US in trade talks on the currency alone will not be effective in rebalancing bilateral economic ties.

and this one:

“China’s export sector is experiencing a rapid structural upgrading in areas including technology, product mix and marketing,” said Deutsche Bank economist Jun Ma. “Most visibly, many textile, machinery and auto parts companies have dramatically expanded their product categories, enhancing their pricing power and profit margins.”

So while relative currency values matter, it is important to appreciate that this is a dynamic and not a static situation. China is in the midst of a massive economic development process, and this will involve structural shifts with a secular rise in the value-added component in Chinese exports, so it will be the combination of these two components which will serve to determine the forward path of Chinese exports.

On another front, I couldn't help noticing the sharp drop in Chinese stocks yesterday:

Mainland China shares fell by nearly 9 per cent on Tuesday, the biggest one-day drop in a decade, in the latest indication of the highly volatile nature of the Shanghai market.

News of the sharp drop in US durable goods orders seems to form part of the picture, and all of this only serves to underline just how vulnerable the Chinese economy (and indeed the whole global one, given the export dependence of some of the leading members) is to any ultimate slow-down in growth in the US.


My thanks to an anonymous commentor for the following:

I don't disagree with your point in the last paragraph, but for accuracies sake, would note that the Chinese market tanked first, then the durable goods number came out.

Now, as they say in legal jargon, for the avoidance of doubt, and as the commenter says, in the interests of accuracy, I should make clear that what he says appears to be correct. However I would stress I didn't actually say that the Chinese 'correction' was a response to the US data, but mearly that the US durable goods situation forms part of the picture, although it may be important to point out that this picture is a more general Asian one, as this Bloomberg piece pointed out:

Asian stocks fell, adding to the steepest losses in eight months yesterday. Toyota Motor Corp. led exporters lower after U.S. economic reports pointed to slower growth in the world's biggest economy.

The Morgan Stanley Capital International Asia-Pacific Index fell 0.7 percent to 143.20 at 11:46 a.m. in Tokyo. It slumped 3 percent yesterday, the most since June 13, after a Feb. 27 plunge in Chinese shares triggered a worldwide selloff. More than $1 trillion of global stock market value was wiped out in two days.

The underlying point would be more to do with the validity of the so-called 'uncoupling thesis', and how all this is going to work out in practice. Certainly Nouriel Roubini was very quick off the block, but I find his underlying thesis very hard to swallow, especially since he seems to have no idea of the underlying structural drivers which are at work.

Simple demographics will put some kind of floor under the property unwind in the US (which doesn't mean the US won't have a recession this year, this is a delicate situation and is very hard to call), but the US economy must be experiencing some kind of Kuznet's cycle (which given the loss of historical memory associated with so much contemporary economic analsysis, has become an issue which has hardly surfaced in the debate).

What I am trying to get at are the underlying mechanisms which are at work here. Growth is undoubtedly slowing in the US. This will put pressure on many economies, and in particular on those who are export dependent (most noteworthy China, Japan and Germany). This pressure will be reflected in the future course of global interest rates (the ECB may raise again next week, but I wouldn't expect much more in this line, and I do expect the next move in BoJ rates to be down as the deflation problem rears its ugly head again). The only big plus on the horizon may be India, but it is hard at this point to be clear on how this can impact growth rates elsewhere, since India is still not that well integrated in the global economy.

Of course there will be feedback mechanisms, and the US economy could be negatively impacted by events elsewhere, but I certainly don't anticipate any big crash, nor do I see any real flight out of treasuries, or dollar decline, as weaknesses elsewhere make this a very difficult perspective to buy (remember the whole goldilocks recovery scenario may well be simply plain wrong), and if interest rates globally start to turn south then this may well become dollar positive at some point.

So while it is very hard to say at this point what will happen and when, it is perhaps a bit easier to say that most on the consensus (and catastrophist) analysis we are being offered is just plain wrong, and we could start here be naming the G7 and the Economist as key culprits in the confusion.


Anonymous said...

I don't disagree with your point in the last paragraph, but for accuracies sake, would note that the Chinese market tanked first, then the durable goods number came out.

Scott said...


Here are some things that I came up with today that seem to fit the title of your post:

About Recent Financial Turbulence...re sources of inflation outside the US is this quote:

"China and India are expected to continue tightening in response to inflationary pressures. Indeed, the China Economic Review says analysts expect reserve ratios in China to go as high as 11.5% in 2007. And analysts expect more hikes in India given domestic inflation of 6.5% and forecasted GDP growth of 9.2% (highest rate in 18 years)."

The author further states: "one trigger for the recent turbulence in stock markets was a stepping up of efforts to withdraw liquidity from the world economy", referring to the previous quote. Although the primary goal of the Chinese and Indian authorities is naturally to reign in their domestic inflation, it is likely that this withdrawal of liquidity will have meaningful effects in the US capital markets. For example, funds for purchase of mortgage-backed securities may shrink as a result of these actions. A document produced by Brad Setser has several interesting statements:

"Chinese deposits in international banking system are relatively small; most Chinese reserves seem to be invested in securities.
It is not just Treasuries
China holds a relatively diverse portfolio
Lots of agency bonds
Other mortgage backed securities as well
The trend has been for more purchases of agencies, corporate debt, and the dollar-denominated debt of emerging economies
China will likely set up a “government investment corporation” at some point to make more aggressive investments; PBoC manages a very significant share of China’s national wealth."

It seems to me that the PBoC is possibly going to take it in the shorts not only on its dollar reserves that it has accumulated while suppressing the value of the RMB, but on its investments made with those dollar reserves.

Scott said...

Here's a related link:
"China's launching of a 15-year plan akin to the U.S. post-Sputnik research initiative to achieve "indigenous innovation," is a laudable objective, bound for failure."