The article by PY CHIN first appeared in TheSundayPost Jan 21, 2007.
CHINA IN ENVIOUS POISITION OF HAVING TOO MUCH MONEY
Each day China's coffers are ballooning with billions
of US dollars, as its foreign exchange reserves keep
piling up, without any stoppers in sight. By
end-October 2006, its reserves passed the USD1
trillion mark; and soon by end of this year, the US$2
trillion-mark will be broken with ease. The rising
reserves are having a tremendous effect on its
currency, the yuan, which has not stopped appreciating
since it was floated.
By P.Y. Chin
Email: py1818@yahoo.com
Last week, China announced three sets of statistics --
two whose figures broke the US$1 trillion (RM3.5
trillion) mark; and the third chalking up an
astonishing record.
The first statistic was that shares on the
Shanghai and Shenzhen stock exchanges were more than
tripled in value, reaching a total of US$1.01 trillion
(RM3.55 trillion) as of last Thursday's close.
With this, China is now the third-biggest stock
market in Asia by value, after Japan with USD4.8
trillion (RM17 trillion) and Hong Kong with USD2.1
trillion (RM7.4 trillion). The US stock market, at
USD17.4 trillion (RM61 trillion), is the world's
biggest.
At USD1.01 trillion, according to Bloomberg
data, China's stock market is equal to 46% of the
value of its economy, which is worth US$2.2 trillion
(RM8 trillion). Comparatively, the US stock market is
equalled to 126% of its economy while the Hong Kong
stock market is 649% of its economy.
The second statistic was announced by Beijing's
central bank earlier this wee that its reserves stood
at USD1.0663 trillion at the end of December 2006, up
more than 30% from one year earlier, making China the
first country officially to top the USD1 trillion mark
as well as the country with the world's largest forex
reserves.
The third landmark statistic was that China's trade
surplus which ballooned 74% last year to a record
USD177.5 billion (RM622bil), up from USD102bil
(RM357bil) in 2005.
All these three statistics produced an immediate
effect on China's currency, yuan -- pushing it with
ease for the first time in 13 years right through the
psychological barrier of the Hong Kong fixed peg of
HK$7.80 to the US dollar.
In forex trading rooms, the yuan was traded at
HK$7.7935 to the US dollar at the Thursday's close
last week. It had since recovered, but stayed a
whisker below the HK$7.80 mark.
There was of course loud expressions of great
consternation within the corridors of the offices of
Hong Kong's monetary authorities and forex traders'
trading rooms.
A debate began to emerge as to whether the
existing peg of the HK dollar to the US dollar would
remain, and whether the yuan would replace the HK
dollar as the official currency unit in the colony.
The HK dollar-US dollar peg has been in place
since Oct 17, 1983, after the currency plunged 48%
against the US dollar for the previous nine years as
China publicly asserted its claim to have Hong Kong
back in its fold.
The British, who was in control of Hong Kong
then, sought to boost confidence in the currency,
retained the peg during talks with China on the return
of the colony to Chinese rule targeted for 1997.
Since 1983, the HK dollar-US dollar peg had
managed to remain stable despite the 1987 Black Monday
worldwide stock market crash, and later when Hong Kong
was officially handed over to China in 1997.
During the Asian financial crisis in 1997, to
keep the peg, Hong Kong monetary authorities fought
off an attack from currency speculators on the HK
dollar by buying USD15bil (RM53bil) worth of shares on
the HK stock exchange.
In response to the yuan breaking the 23-year-old
peg, the Hong Kong Monetary Authority (HKMA), which in
essence is the colony's central bank, was quick to say
that "any change will rock investor confidence".
The HKMA added: "The government has no intention
to change the linked exchange rate system, which
continues to serve Hong Kong well."
HKMA's firm stand is understandable as it has
all along insisted that the HK dollar-US dollar peg
would not be dropped, and that there would be nothing
to be gained from any change. At the same time, for
the last three years it had tried to stop the HK
dollar's appreciation.
This means the peg will continue to remain for
some time to come. HKMA chief Joseph Yam was quoted to
have said months before the breakthrough that "the
yuan reaching 7.80 is just a psychological level that
will not play a role in setting Hong Kong's currency
policy."
Indeed, official policy of the HKMA prevents its
currency from trading more than 5 HK cents either side
of HK$7.80 to the US dollar.
Despite the firm commitment of the HKMA, many
currency traders are expecting the peg to end next
year, according to a Bloomberg survey of 10 currency
strategists in Hong Kong recently. The strategists had
also forecast a rate of HK$7.20 to the US dollar by
2010 after the peg is removed.
But what's significant was that last week, China
allowed for the first time, yuan-denominated bonds
outside China, which HKMA's Jospeh Yam commented:
"This is the first step for the yuan moving towards
the international stage." Others see it as a first
step towards the yuan's full convertibility.
With the yuan now slightly more expensive than
the HK dollar (the exchange rate was 1.0004 yuan to
the HK dollar last Thursday), the first to benefit are
the mainland tourists in the colony. Already,
retailers in Hong Kong had last week started to accept
the yuan for payment in addition to the Hong Kong
dollar from mainland Chinese.
The rise in the value of the yuan is also
reversing a trend where Hong Kong people have been
used to travelling across to mainland China for cheap
goods and services. Now, mainland Chinese may find it
cheaper to buy goods and services in the colony.
One other point: The rising value of the yuan
could in due course stoke the fires of inflation in
the colony as the bulk of Hong Kong's basic food items
are imported from mainland China. With a more costly
yuan, the prices of these foodstuffs could go up.
The rise in the value of the yuan is not
unprecedented. Nor has the rise been unexpected.
In the last few years China's economy has been
growing at unprecedented rate of an average of 9 to
10% a year. The US and European governments have
consistently maintained their stand that the yuan is
under-valued. They have kept pressing China to make
its exchange rate of the yuan more flexible to reflect
such an economic scenario.
China continued resisting the external
pressures, until the middle of 2005, when the intense
debate over China's currency and foreign exchange
policies reached its height. Finally, on July 21,
2005, the People's Bank of China, which in essence is
China's central bank, abolished the peg and allowed
the yuan to float against a basket of currencies.
For decades the yuan was pegged at a fixed rate
to the US dollar. Now, the float resulted in a virtual
revaluation of the yuan by 2.1% to 8.11 yuan to the US
dollar.
But that was not enough. A 3% appreciation of
the yuan followed over the following year. And 18
months from the day of the float, the yuan had
strengthened a total of 5.6% against the US dollar.
Even that was not enough. The yuan continued its
strong advance, and by last week when it broke through
the HK$7.80 to the US dollar barrier, it had gone up a
further 6.2% on the top of the 2.1% virtual rise at
the time it was floated.
According to a study, the yuan is still on its
climb with much room upwards. This year, the study
estimates, the yuan will add a further 3 to 4% against
the US dollar, taking it to a rate of 7.5 yuan to the
US dollar at the end of this year from the present
7.8.
This prompted a foreign currency trader
operating in China to comment: "The gains reflect a
fast and amazing assimilation of capitalist culture."
Despite the additional increase, the US and
European governments still insist that the yuan is
"still cheap and under-valued", and that there should
be a greater revaluation as well as greater
flexibility in the exchange rate mechanism.
At present the yuan is not easily convertible
into US dollar or any other foreign currencies. The
People's Bank of China has also very tightly
controlled the margin of flexibility with regards to
the yuan's peg. In effect, what China did was to
implement "a regulated, managed exchange floating rate
system based on market supply and demand".
The issue of revaluation of the yuan has been
sticking out like a sore thumb at every economic
meeting between China and the United States; the last
meeting was in the middle of last month when US
Treasury Secretary Hank Paulson flew to Beijing.
Back home, Paulson is under pressure from the
Democrats, who now control both Houses of Congress and
Representives, are exerting pressures on the
Republican President George W. Bush's Administration
to push China into resolving the revaluation of the
yuan.
The strong rise in the value of the yuan is in
essence a reflection of the strength of China's
economy which has grown 10-fold since the late Chinese
leader Deng Xiaping opened the whole country to
international investments in 1978.
More specifically, the strength of the yuan lies
basically in the heavy trade surplus now building up
in China's favour vis-a-vis its major trading
partners, especially the United States. At the same
time, the building up of foreign exchange reserves has
also helped strengthen the yuan considerably.
China's foreign trade last year was a record at
USD1.76 trillion (RM6.2 trillion) with the trade
surplus widening also to a record of USD177.5bil last
year.
External trade is expected to grow even bigger,
as China's products keep overwhelming the world.
Already, China's Ministry of Commerce has predicted
last month that the country's trade volume would grow
by 15% to US$2 trillion (RM7 trillion) this year.
Although export growth has slowed, import growth
has slowed even more sharply. This trend according to
some reflects a longer-term structural shift in
imports as more industries in China produce more parts
and assembled more products, substituting present
imports.
If China's trade surplus is growing bigger, the
trade deficit between China and the United States is
expanding even faster -- reaching a record USD214bil
(RM750bil) by November 2006 in China's favour. (This
is according to US' standard of measurement, which
classifies exports from Hong Kong to US as coming from
China).
This widening gap in trade between China and US
is already putting heavy pressures on Paulson to deal
more firmly with China, especially on the issue of the
revaluation of the yuan.
In assessing the situation of the China-US trade
deficit, many tend to miss the point that it is the US
consumers that are to be blamed. So long as US
consumers keep spending more than they save, and keep
demanding for China goods, the trade deficit is
unlikely to disappear soon.
Thus, if the Democrat-controlled Congress is
getting very impatient and plans to introduce
legislations this year that will hit hard at China,
then the Americans may have been misdirected in their
actions. China-bashing may not help to lessen the
problem of the trade deficit; neither will China
revaluing its yuan do any good to the present dilemma.
China's State Council, similar to the Cabinet, is
scheduled to meet this month to decide on setting up
"an oversight body" to co-ordinate policies among the
various economic management and financial regulatory
groups. This would include managing the forex
reserves. The China Daily newspaper reported that this
new framework would be in place "no later than March
next year".
Presently the bulk of the forex reserves are
channelled into US treasury bills which generate low
yields and low returns, which also means China is
holding its forex reserves mainly in US dollars.
In buying more and more US treasury bills, China
is really in a financial sense helping US to finance
its imports. Thus, some have argued that for a country
as poor as China, it certainly makes no rational sense
to "bankroll the world's richest economy".
In view of the huge holdings of US dollars,
China is therefore sensitive to any weakening in the
value of the US dollar, simply because China would be
forced to incur losses in its central bank's balance
sheet that contains the forex reserves. This is
certainly not acceptable in whatever way, even
politically.
However, China has announced last month that it
would consider seriously moves to diversify the
composition of its forex reserves, investing some in
financial instruments with higher yields and returns.
Already, market traders are seeing not a
diversification, but more of China buying less US
treasury bills when making new investments with its
forex reserves.
Meanwhile, China's Vice-Premier Zeng Peiyan has
suggested using part of the forex reserves to help
build up strategic mineral resource. The China Daily
newspaper commented: "It looks like a stone with which
China can kill two birds -- the growing imbalance in
its international payments and its need for key
resources like oil and minerals."
Even with this idea of buying mineral resources,
China has to tread cautiously, as a tiny part of its
forex reserves could make the world commodity markets
tremble, and make every trader nervous. It has been
reported that only a year of China's imports of iron
ore, soybeans, copper, alumina and nickel would cost
about USD40bil (RM140bil).
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