As this issue of China Economic Review goes to print, the volatility in global markets caused by ratings agency Standard & Poor’s downgrade of US debt has yet to abate. After a gut-wrenching week in which US market indexes moved up and down by over 4% over four consecutive days, the trading floors in New York paused, recovered, then dove down 4% again.
This wild ride has shaken confidence. Some economists are now saying the chances of a “double-dip” recession in the US are 50-50, and this has unleashed another wave of Chinese criticism of US policy, which would be more understandable if China wasn’t still buying US debt.
Many Chinese citizens, not all of them economically naive, are questioning why their country continues to buy dollar assets. Didn’t China just spend US$586 billion to lower its dependence on fat Americans and their credit cards? Wasn’t the Chinese consumer supposed to have grabbed the reins of the country’s economy by now?
Chinese domestic demand has picked up, of course, as import figures show. But much of this demand appears to have been the product of political creationism, spent on prestige projects. Other metrics remain negative. Chinese individual savings rates – a negative confidence indicator – have been on a steady climb since the reform period began, even as personal consumption as a percentage of GDP has declined. The same holds true for labor’s share of GDP. Wages are rising rapidly, but it’s difficult to assess whether any significant reversal of these trends is underway yet.
At the same time, China’s trade surplus is up again, climbing to US$31.5 billion in July, its highest level in two years. A lot of money is still being produced by the same old export sector, and this sector continues to lobby Beijing to keep the renminbi weak, i.e. buy dollars. The fact that respected academic economists and retired regulators are moving their tents further into the liberalization camp changes no part of this equation.
Nevertheless, some observers argue that recent upticks in the renminbi-dollar exchange rate, combined with publicly trumpeted pilot programs in the offshore renminbi market in Hong Kong, indicate Beijing is finally ready to make a radical readjustment. This is wishful thinking.
For one, the renminbi’s rise against the dollar is mostly due to the dollar’s loss in value: Over the course of the last year the renminbi has actually declined 4.5% against a trade-weighted basket of currencies, including those of competing export centers like Brazil. If the US economy does contract again, the pace of renminbi appreciation is likely to slow, not accelerate. Weaker US demand will push down margins in China’s export sector, and Chinese exporters will howl if the renminbi springs upward.
Diminishing US demand would also weaken one central argument for appreciation, namely that a stronger renminbi is necessary to ease inflation. Another American recession would knock a chunk out of global commodity prices (especially oil), reducing the imported components of inflation without any action on China’s part.
Currency appreciation is not a cure-all, nor is it risk free. Japan paid a big price for prematurely allowing the yen to appreciate – namely a horrific asset-price bubble – and China is not about to repeat that mistake. Allowing convertibility is even less likely. Many foreigners have moved money into the country on the assumption that currency is artificially undervalued by 20%. To this crowd, liberalization and appreciation are the same thing. But this ignores Chinese perceptions of the renminbi. Patriotism tends to weaken as it approaches the pocketbook, and China’s leaders may fear that opening the current account would release a wave of Chinese money fleeing the country – providing a far more accurate referendum on Beijing’s performance than official statistics. If the rush to acquire foreign passports by Chinese elites is any indicator, China’s confidence in its model may weaker be than its rhetoric suggests.
China does not have to liberalize the currency to offset a second downturn in the US anyway; there are plenty of other available policy tools in the finance system. But they will likely be less effective this time around, and they certainly will serve as validation of the last three years of policy. If nothing else, the recent crisis shows the dangers of procrastination. China needs more real consumption and less investment-driven nonsense, and it needs it yesterday.