John Greenwood, chief economist at Invesco and the man who in 1983 proposed the currency board system used to control the Hong Kong dollar to this day, spoke at the FCC in Hong Kong yesterday. He gave his views on the state of the global economy and the prospects for Asia.
On Asia and its export dependency:
Balance sheets in Asia were both less stretched and contained far fewer unpleasant surprises than those in the West so the region entered the global recession in comparatively better shape, Greenwood noted. However, Asia’s export dependency is a millstone around its neck – as soon as the West started struggling, consumers stopped buying manufactured goods. Asia has taken a hit and the question is to what extent can it recover while the West is busy going through the painful balance sheet repair process? Greenwood’s answer is it can’t. "There is a two-tier growth process in Asia. When the West is booming and Asian economies are exporting very successfully then we see maximum potential growth. When the West is in recession, Asia grows rather slowly… [This] will persist until growth in the West picks up."
Greenwood argues that Japan is the only economy that has successfully decoupled from the West and this was in the second oil crisis (1979-81). A floating exchange rate – which acted as a buffer between Japan and the difficulties elsewhere – and strong monetary policy were the keys to Tokyo’s survival. "There was stability in the economy and the floating exchange rate meant it could ride through the crisis. That is not the situation we have today. Asia is much more dependent on the West in terms of exports and very few countries have a floating exchange rate."
On whether China’s economic recovery is sustainable:
"In order to generate the current revival they have had a huge fiscal boost and money and credit growth has exploded. This is fine for the short term but it is highly questionable whether this can be sustained without strong inflation. We have seen how quickly inflation in China can rise with overheated credit conditions… Unless we see some winding back of the credit expansion in China then there are going to be significant risks to the country in the mid-term."
On the effects of renminbi controls:
Greenwood argues that China’s recovery must be seen in the context of its fixed exchange rate system, which he believes distorts the economy. At the heart of this is the large current account surplus – a by-product of the country’s massive exports and an imbalance that would be righted if the renminbi was able to move more freely. (The currency appreciates; Chinese goods become relatively more expensive; purchases of these goods fall; the current account surplus falls due to smaller export revenues… and so on.) Instead, Beijing deals with the issue through massive sterilizations. "At one point about 25% of the bank assets were held with the central bank – that’s the sum of the reserve requirement that China needs to mop up the foreign exchange reserves plus the bonds it issues to mop up surplus liquidity. This delays the development of China’s domestic financial markets and promotes excessive investment in export-related sectors."
On Hong Kong’s strong capital inflows:
This is a consequence of economists’ general consensus that growth in Asia can continue irrespective of the downturn in the world at large. Given that much of the money is coming from foreign parties looking to capitalize on this growth, Greenwood believes that feet will grow cold as easily as sentiment became hot. Any sign of a price bubble and the capital will flow out. The random factor is Beijing’s monetary policy. If the credit explosion is not stemmed and price bubbles form in the mainland, Hong Kong can expect to see bubbles of its own. "If China continues with its current rate of money and credit growth then there is an inflationary danger. It starts with money and credit then goes to asset prices and then to general economic activity and the CPI (consumer price index)."