Most of this week’s very long newsletter focused on the NPC meeting in Beijing, the proposals to boost consumption (which I think will greatly disappoint), and the release of data by the National Bureau of statistics. Last week, for example, new lending numbers were released, and if it hadn’t been for rumors all the previous week that they would come it at RMB500-600 billion I think we would have all been surprised by how low they were. Here is the relevant article in Xinhua:
The People’s Bank of China (PBOC), the country’s central bank, said Monday that new yuan-denominated loans stood at 535.6 billion yuan (81.52 billion U.S. dollars) in February.
The figure was 192.9 billion yuan less than February last year, said the PBOC in a statement on its website. By the end of February, the balance of outstanding yuan-denominated loans stood at 48.89 trillion yuan, up 17.7 percent from a year earlier. The rise was 9.5 percentage points lower than the rise a year earlier.
As I discussed last week, total new lending has represented a rapidly declining share of the total lending the PBoC now monitors, so we don’t really know how much new credit the banks extended in February. The table below was released two weeks ago by the PBoC (I have summarized it), and it shows what has been happening:
| 2010 | 2009 | 2008 | 2007 | 2006 | 2005 | 2004 | 2003 | 2002 | |
| Total | 100 | 100 | 100 | 100 | 100 | 100 | 100 | 100 | 100 |
| RMB loans | 55.6 | 68.1 | 71.5 | 61.3 | 79.3 | 82.1 | 78.8 | 81.0 | 92.0 |
| Entrusted loans | 7.9 | 4.8 | 6.2 | 5.7 | 4.7 | 3.4 | 11.1 | 1.8 | 0.9 |
| Trust loans | 2.7 | 3.1 | 4.6 | 2.9 | 2.1 | ||||
| Bank acceptances | 16.3 | 3.3 | 1.6 | 11.3 | 3.8 | 0.1 | -1 | 5.9 | -3.5 |
| Corporate bonds | 8.4 | 9.2 | 8.1 | 3.9 | 2.1 | 7.0 | 1.8 | 1.6 | 1.6 |
.
The total represents all of the financing that the PBoC is now tracking, and is listed as 100%. I have broken this total lending into a few especially important categories and listed the percentage they comprise of the total. By the way I have left out several categories that I didn’t think especially useful to the discussion.
Notice that at the beginning of the decade new RMB bank lending represented virtually all new financing – 92% as far as the PBoC calculates. What is striking is how quickly it came down – in 2010 new RMB loans represented only 56% of total new lending. It didn’t decline, of course, because of any restraint in new lending. On the contrary new lending has exploded, especially in 2008, 2009 and 2010.
It came down because other categories surged. We have discussed this on my blog for several years. I have argued many, many times that limiting loan growth through administrative measures (loan quotas, for example) while keeping interests low, credit risks socialized, and maintaining pressure for investment driven growth, could not help but result in an explosion of lending outside the normal channels which the PBoC and the CBRC simply would not be able to control.
When you have excessively loose monetary and credit policy, you will automatically get a rise in risky loans. Not even Japan in the 1980s was able to violate this rule of finance (for all they dismissed it as a “western” rule), and China has not been able to do so either. The PBoC tried to regulate loan growth by putting into place a RMB quota system, but the consequence was completely predictable, and in fact was predicted by several of us.
The system adjusted so as to allow more loan growth to take place outside the regulated areas. Banks, in other words, simply created alternative forms of financing to get around the rules. Now that the PBoC is monitoring this wider range of lending activities, if they start trying to control growth in all of these areas I think it is pretty safe to assume that even newer forms of lending will develop.
I think it is also pretty safe to assume that in a month or so we are going to see a renewed expansion in credit. With controls on new lending a lot of companies are struggling for financing and I suspect growth is going to slow down by more than Beijing can bear.
The “correct” exchange rate always changes
I want to turn away from recent events in China to focus on a more technical or macro discussion. My friend Robert Kapp, President of Robert A. Kapp & Associates, Inc, recently had a question about the undervaluation if the RMB. This question is about an issue the represents a pretty common confusion in the debate over the revaluation of the RMB, so I asked him if I could reproduce his question for this newsletter:
I hope someone can help me with this. In 2003, when the currency-value flap took off, the high end of the allegations of over-valuation, if I remember correctly, was about 30%. The RMB was at 8.28 to the dollar.
Today, my handy little forex-gadget tells me that $1 is equal to RMB 6.577. My hand calculator tells me that that represents an appreciation against the dollar of about 20.56 percent.
How is it that, having risen 20.6% against the dollar since the RMB first surfaced in Washington, the RMB is now claimed variously to be anywhere from 25% to (most commonly used in political rhetoric) 40% undervalued against the dollar?
“This is not a rhetorical question,” he adds, “there has to be an economic answer.”
There is. To simplify his question, a few years ago people suggested that the RMB might be undervalued by 30%. Since then the RMB has appreciated by 20-25%. And yet today people are still arguing that the RMB may be undervalued by 30%. How is it possible that so much appreciation has not seemed to affect the estimates of undervaluation?
Before answering it is worth pointing out that there is no way that anyone can determine precisely the amount of undervaluation of the RMB, or any other currency, and so any estimate can be nothing more than that – an estimate based on many moving parts. There are plausible reasons for arguing that a currency is undervalued or overvalued, but there is absolutely no way to determine with any precision by how much.
This difficulty is compounded by the fact that many analysts are simply getting the math wrong. So for example when people say the RMB is undervalued by 30%, they often mean that the dollar is overvalued by 30%. These two claims may sound like the same, but of course they aren’t. If the RMB is undervalued by 30%, it means that the dollar is overvalued by 43%, not 30%. I have seen so much confusion on this issue that I pretty much give up on trying to understand what people mean when they discuss currency changes without seeing their actual numbers.
So for example if the RMB went from 8.26 to 6.58, as Kapp argues, the RMB actually appreciated by 25.9%, and not by the 20.6% he calculated. It was in fact the dollar that depreciated by 20.6%. What’s more if we assume that the RMB was indeed initially undervalued by 30%, the subsequent appreciation of the currency by 25.9%, all other things being equal, leaves it still undervalued by 3.3%,
Price differences matter
But that still leaves the underlying question unanswered. Why do people still insist on saying that the RMB is undervalued by roughly the same amount as it was several years ago after it has already appreciated so much during that time?
It turns out that there are many reasons. The “correct” exchange rate is never correct except at a single point in time. Six years later, as in this case, the new correct level will be different because of several factors.
The most obvious factor that can change the relative valuation of the nominal exchange rate is the inflation differential in the tradable goods sector of each country. If Chinese inflation were say 2% lower than US inflation, it would imply that in real terms the RMB depreciated over six years by a further 11%, roughly.
Many people take a shortcut and just assume that what matters is the difference in CPI inflation between the two countries, but this is a mistake, and one I wrote about in my newsletter a couple of months ago. So analysts argue, incorrectly, that because in the past year the RMB has appreciated nominally by 4%, and in addition there has been a 3% inflation differential between China and the US, the RMB has actually appreciated in real terms by 7%.
It hasn’t. What matters is not CPI inflation but rather the inflation in the cost of inputs in the tradable good sector. I don’t have the numbers in front of me, but over the past few years most inflation in China has been in the food sector, and not in the tradable goods sector. If the relevant US inflation exceeded the relevant Chinese inflation during the past six years, the inflation differential argument might explain part of the reason for the continued high estimates of RMB undervaluation. There would have been a real depreciation of the RMB during these years that would have moved against the direction of its nominal appreciation.
The second obvious factor is the productivity growth differential between two countries, or perhaps more accurately, the US/China differential in the domestic differential between wage growth and productivity growth. If workers in one country become more productive at a faster rate than workers in another country, and that difference isn’t neutralized in the form of higher wages, it effectively lowers the real vale of the exchange rate.
So if Chinese worker productivity grew faster than US worker productivity by 3% annually, and if wages failed to keep up, the RMB would over a six year period depreciate in real terms by roughly 16% (again, the actual nominal numbers matter if you want greater precision, as does of course the wage/productivity differential in the tradable goods sector, not the country as a whole).
The third obvious factor in countries like China is the cost of capital in the tradable goods sector. If the cost of capital is heavily subsidized in China (which it is) and not in the US (which it isn’t, except recently at very short maturities, which is not too relevant for producers anyway), this counts as an effective depreciation of the RMB. The cost of capital is of course an important input in the production of tradable goods, and to subsidize its cost is no different than putting into place import tariffs and export subsidies. In both cases you reduce the real exchange value of the currency.
Any subsidy matters
The amount of undervaluation caused by artificially low interest rates is much harder to calculate than in the other cases, but the sheer amount of interest-rate repression in China (at least 400-600 basis points, by my calculation), suggests that this may be the biggest single reason for arguing that the RMB is still significantly undervalued in spite of the 26% appreciation in the past six years.
Finally, as all of the above factors imply, any other differential in the growth rate of subsidies, including taxes, will imply real appreciation or depreciation in a currency. If Chinese manufacturers get subsidized land, or subsidized energy, this has the same impact on the trade balance as lowering the nominal exchange rate.
Remember that an undervalued exchange rate is nothing more than a consumption tax on imports, the proceeds of which are used to subsidize manufacturers in the tradable good sector. It reduces household consumption by reducing real household income, and it increases production by subsidizing manufacturing. By putting upward pressure on the gap between the two, it puts upward pressure on the trade surplus.
There are many other ways of doing the same thing. Any time household consumers are explicitly or implicitly taxed, and the proceeds used directly or indirectly to subsidize manufacturers in the tradable goods sector, for example by forcing household depositors to lend money to manufacturers at artificially low rates, it is the same thing as devaluing the exchange rate. In either case it forces an artificial split between production growth and consumption growth, and this shows up as trade intervention.
The reasons above, and the confusion they create, is why I worry when people focus too narrowly on the currency in terms of pricing equivalence as the source of trade imbalances. The correct way to look at the causes of trade imbalances, in my opinion, is to look at policies that force up or down the savings rate, or the consumption rate (which is more or less the same thing since total savings is simply total production minus total consumption).
In that sense anything that reduces consumption and increases production forces up the savings rate, and unless there is an equivalent increase in investment, it also forces up the trade surplus. Undervalued currencies (like repressed interest rates or low wage growth relative to productivity growth) are a kind of tax on households and so reduce consumption, and they are a subsidy for manufacturers and so increase production. This is what forces up the savings rate and so forces up the trade surplus. If China were to raise the value of the RMB and simultaneously lower real interest rates, which is has done in the past year, you could have the seeming paradox of a rising RMB and even greater RMB undervaluation.
This is an abbreviated version of the newsletter that went out Tuesday. Academics, journalists, and government and NGO officials who want to subscribe to the newsletter should write to me at chinfinpettis@yahoo.com, stating your affiliation, please. Investors who are clients of Shenyin Wanguo Securities will already receive the newsletter. Investors who are not clients but who want to buy a subscription should write to me. also at that address.
Prof Pettis,
It seems that there are more forces pushing the yuan up rather than down, is this right or wrong?
We hear of 100% or 200% debt to GDP being the “point of no return” but at what debt ratio do you think that the Unites States can comfortably tolerate without some sort of major debt restructuring?
Michael:
See this one:
http://www.roubini.com/emergingmarkets-monitor/260705/the_chinese_state_takes__but_never_gives
Few Questions
Relationship of Banks SOE’s to Central Huijin, where some of the banks act as the Chinese Treasury, printing RMB, and others as the Fed, holding assets (Forex)??? Any thoughts on the Nature?
Where such a complex array of cross-relationships exist, what is the potential for double dipping as far as assets, with assets held showing up on multiple balance sheets.
Do bank dividends feed into the national budget, or only into the complex relationship between Central Huijin and the Chinese SWF’s? Dividends would be payed in RMB, SWF’s and Chinese Central Bank hold FOREX, another Bank, BOC, prints RMB….. How does this all feed into national budgets, or growth in Chinese SWF’s.
One more question, what is your guess toward the further spin-off of SOE’s. Which I believe many are under CH, or am I wrong. I am sure this pace has slowed, the downturn and 2012, wonder your guestimates as to when it will pick up.
Dear Michael,
When I read this:
“The correct way to look at the causes of trade imbalances, in my opinion, is to look at policies that force up or down the savings rate, or the consumption rate (which is more or less the same thing since total savings is simply total production minus total consumption).”
I inmediately thougth abot german “kurzarbeit” wihich in my opinion is a subsidy for producers/exporters at the expense of the rest of the economy (private or public services), although the subsidy has been “sold” as a wage subsidy. As I see this some manufacturers have an subsidised rise in workforce productivity.
The reciprocal issue confuses everyone.
1.25 and .8 are reciprocals. If you take 100 and multiply by 1.25 and then .8 you will be back at 100. But even people who need to know this to earn their living often get it wrong.
I suppose that’s the plan, by letting the RMB trend up, they can slow down their overheating economy, and by requiring banks to hold more actual cash (reserve requirements) they can pull off the ‘soft landing’ on this little real estate bubble.
I’d rather be trying to land a high flying plane, than trying to get a busted one off the ground.
csteven,
CH is the vehicle that was created to recapitalize the banks after trafsferreing (most of??) the NPLs to AMCs (Asset Management Companies). After most of the gvt owned banks’ liting, CH became the state’s single vehicle (one exception) for holding the remaning stakes (all of them controlling ones) in the big banks and most of the other financial services companies. For reasons about which there appears to be no consensus, CH was made a subsidiary of the newly created China Investment Corp, ususally considered China’s SWF (although the FX arm of the PoBC, SAFE, is a much bigger international investor and also in investments other than short term cash instruments). CIC appears to be the result of a compromise between the MoF and the PoBC over several contentious issues that have arisen in the development of China’s peculiar brand of state capitalism.
Central SOEs (there are provincial ones too) tend to be “under” SASAC ( more or less similar to CH, but for non-financial firms) while in the old days they used to be under industry ministries, a practice borrowed from Soviet economic management.
When looking at links within the Chinese system ons should look at three or even four types of links, all existing at the same type and often contentiously: (1) formal adminsitrative authority (like CH vs the banks: the ownership role) (2) “market” relationships , for instance client-patron relationships (depend on whether the supplier or the client holds the bargaining power) or investor relationships (especially relevant wrt joint ventures involving Taiwanese/HK JVs) (3) regulatory relationships (the ones this blog tends to pay a lot of attention to, for instance PoBC credit growth policy (4) Party relationships where Mr X though having a junior formal position and not much market power may still be able to influence others to the extent that the others take his preferences into account.
Much of this is unobservable, volatile and operating in the interstices of China’s lacunous legal and regulatory systems. That is why reading China blogs is so entertaining and yet so unproductive..
I think efforts to slow the money supply growth are going to have a real impact. Chinese companies depends far more on its banks for liquidity far more than western firms, which have a more diversified offering of funding. In addition, Chinese banks lend almost exclusively short term, commercially, and so there is great risk especially to the SMEs who need to have these loans renewed. Companies are leveraged and a huge proportion of their debt is 1 year or less. Lastly, many firms have continued to expand operations even after the financial downturn, investing in new capacity. This new capacity must be profitably used to repay the debt for these highly leveraged firms. Losing liquidity now is a big problem.
In esence, China replaced demand lost from its export markets with investment in infrastructure and productive capacity. In doing so, many firms became highly indebted. Now the debt will begin to need to be paid back, the cash flow is not there and banks are tightening down on lending as a result of lending quotas. Big problems coming in selected industries.
Also, since the registration of personal property as collateral is ineffective in China, most commercial loans are at least in part, secured by real property. It will be interesting to see what happens if commercial foreclosures start to happen and the property ends up on the market.
Cinda, Huarong and Great Wall, get ready, here comes another batch of problems.
Seems like the fall in deposits at the start of the year and the liquidity squeeze were merely transient events.
Actually I looked back a few years in PBC statistics and it seems like deposits always fell in January. The liquidity squeeze was not unlike the one in 2008Q1 or earlier monetary tightening cycles.
RS, I wrote about this a few months ago, but since I am traveling I can’t tell you which entry. Basically I pay almost no attention to debt-to-GDP ratios. They are a terrible predictor of future financial distress. What matters just as much as the level of debt is the structure of the debt, the correlation between debt payments and the underlying economy, how diversified and volatile the economy is, and other factors specific to the borrower. I know from time to time the market likes to get itself worked up over the imminent that of a USG default, but I think we are extremely far away from that event.
CSteven, I don’t think there is much monetary impact of the Central Huijin holdings. As Rien points out this is more the consequence of internal politics than of any monetary plan of the PBoC. As for the spin-off of SOEs, if it is merely a question of reassigning ownership within and among government entities, I think this will reflect political considerations about which I can say very little. If you mean privatizing, I would respond that for now there is very little serious interest in privatizing, but I would guess that this will be a very hot topic in three to four years.
Ignacio, I think there are a lot of distortions that explain the large trade surplus in Germany. We prefer to think of trade imbalances as reflecting moral virtue, or the lack of it, but of course they are mainly the intended or unintended consequences of institutions and policies, such as the “kurzarbeit
Lemiwinks, I am not sure I agree. Typically it is household deposits that fall in January and February, because of the lunar New Year festival, not corporate deposits. This year they both fell.
Michael,
What do you think of this copper “finance” business? http://ftalphaville.ft.com/blog/2011/03/29/530461/chinese-copper-financing-got-even-more-popular-this-month/#comments
A desperate search for non-punitive loans for people without good enough connections with the PBOC or some other money spewing entity?
Prof. Pettis,
I have to disagree. According to PBC stats enterprise deposits fell in 2010-01 and 2010-02 as well as in 2009-01. Savings deposits kept on increasing all these months.
Seems like the fall in corporate deposits at year start is some periodic event. maybe related to statistics, maybe to the scheduling of loan remittances.