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Published on Taipei Times
http://www.taipeitim...5/22/2003361991
The Chinese bubble holds a lesson
By Tung Chen-yuan 童振源
Tuesday, May 22, 2007, Page 8
The People's Bank of China announced on May 18 three policies it hopes will help cool down the economy and the stock market: the required reserve ratio was increased 0.5 percent, the interest rate on one-year fixed savings deposits was increased 0.27 percent and the benchmark one-year lending rate was increased 0.18 percent. In addition, the yuan's exchange fluctuation with the US dollar grew from .003 percent to .005 percent.
China's measures come just at the right time to prove that the macro-economic control policy that has been implemented for three years has failed, being unable to lessen the growing economic inbalance and the emerging economic bubble.
At the same time, it has been unable to decrease the growing inbalance in China's foreign economic relations, which increasing international political pressure has done nothing to change.
In the last 11 months, China has gradually increased the required reserve ratio eight times, from 7.5 percent to 11.5 percent. Last year it also increased the benchmark one-year lending rate 0.54 percentage points. Yet one macro-economic control measure after another has failed to suppress the strong drive for growth.
Last year the economy grew an estimated 10.7 percent, while in the first quarter of this year the economic growth rate was 11.1 percent. In the last few years the investment rate in China has reached new highs. Last year it was already over 45 percent, higher than the 43.5 percent it reached in 1993 when the Chinese economy seriously overheated.
The local-government-regulated fixed asset investment ratio went from 76.5 percent in 2001 to 90.3 percent in the first quarter of this year. But these investments are quite often irrational investments or redundant construction and they can easily become default accounts for banks later on.
But this very high investment rate has not brought about the same frightening two-figure inflation rate as in 1993: the inflation in the first quarter of this year was only 2.7 percent. The real problem China faces is the financial risk brought about by economic unbalance and the possibility that the bubble will break.
China's economy is still in the realm of inflation reduction. In the second half of last year, supply exceeded demand for 70 percent of products. Real estate price growth dropped from its peak of 10.8 percent in the fourth quarter of 2004 to 5.3 percent in the fourth quarter of last year. But it is still much higher than before 2004 and in the first quarter of this year the price increase rate went up again to 5.6 percent.
Although the Chinese government has already taken appropriate measures to suppress real estate prices, a large amount of the available money is immediately put into the stock market for speculation.
Almost 300,000 people join the Chinese stock market every day. Beginning this year, the Chinese stock market has grown at an soaring 84 percent. The value of the stock market is 17.4 trillion yuan (US$2.2 trillion) -- more than the collective savings of the entire population of China -- and within a month it will be another 2 trillion yuan, constituting a severe risk of the bubble bursting.
The crux of China's growing economic imbalance and financial risk problems is that the yuan exchange rate system hasn't been appropriately modified. This has caused overcirculation and it's spread as a "hot money" internationally.
From 2002 to 2004, the yuan's nominal effective exchange rate has depreciated almost 17 percent. This undervaluing has caused its use internationally to skyrocket every year, from US$22.4 billion in 2000 to US$259.9 billion last year. This has caused China's foreign reserves to rapidly inflate from US$286.4 billion in 2002 to US$1.2 trillion in the first quarter of this year.
China's accumulation of foreign reserves, which grew US$779.8 billion from 2003 to last year, led to 6.4 trillion yuan being issued.
Even though the Chinese government tried hard to charge off 2.3 billion yuan, it still led to the currency supply growing by 4.1 trillion yuan. But during that same time, China's entire monetary base only grew 3.3 trillion yuan. This shows that China's monetary policy has completely lost its autonomy and is now controlled by currency issued because of increases in foreign reserves, which causes a bubble in assets. This is an accurate portrayal of China's real estate and stock markets today.
International political pressure has forced the Chinese government to face an even more prickly problem and has strengthened expectations on international exchange markets that the yuan will appreciate. Last year the US' trade deficit with China reached US$232.5 billion, the highest deficit with any single country in US history. In the past two months Chinese exports to the US still grew 20.5 percent. The US Congress and executive have therefore been putting more pressure on the Chinese government and calling for stricter trade measures with China. This has posed a serious threat to Chinese exports, on which its economic growth relies.
During the year following China's exchange rate system reform on July 21, 2005, exchange markets expected that the yuan's exchange rate with the US dollar would rise an average of 4.8 percent in one year. Since reforms to the exchange rate system began, the yuan's exchange rate has risen more than 7 percent. Foreign exchange markets, however, still expect the yuan to strengthen another 5.8 percent against the US dollar in one year. In the first quarter this year, foreign reserves grew US$135.7 billion, an explosion of 141 percent.
Clearly, past adjustments to the exchange system and macroeconomic control policies completely failed to cool market expectations of appreciation of the yuan. As China moves further into a market economy, it will be important to figure out how to resolve expectations of yuan appreciation on exchange markets. It looks like China still has a lot to learn.
Tung Chen-yuan is vice chairman of the Mainland Affairs Council.
Translated by Anna Stiggelbout and Marc Langer
Edited by Insider, 22 May 2007 - 11:15 AM.
