Chinese money

by Prof. Thomas Velk and Dov Zigler

On June 19^th China’s central bank, called The People’s Bank of China, announced that it will “increase the renminbi’s “exchange-rate flexibility”, meaning that the U.S. dollar cost of buying Chinese money (also termed “Yuan”) might go up.  And so everything that the West buys from China, ranging from computer parts, TVs, heavy machinery and plastic toys to edamame (the Chinese supplied “Japanese” soy beans you eat in Asian restaurants) and London Cabs (the firm is owned by China’s Geeley company) may cost a bit more.

US Senator Charles Schumer along with other China bashers will claim success in their long effort to blunt China’s "unfair" currency-driven competitive advantage over Western (especially American) companies.  The assembling G 20 countries may well express concerns over China's effect on their economies,  Wrong focus.  China’s domestic stock markets and moreover its real estate bubble are the real reasons that China may be compelled to make it more expensive to buy Chinese money.

Bear with us for a bit of economics. China’s central bank holds two trillion US dollars worth of foreign exchange (foreign money of all kinds), including approximately one trillion in US Treasury Bonds.  How does the money get there?  The Edamame Bean grower gets dollars from the Western restaurant buyer.  Mr. Bean takes those dollars to his Chinese bank, exchanging them for Chinese money used to pay his workers and buy seed.   The Chinese bank has many such customers, thus it builds up, every month, a surplus of dollars from export proceeds and a need for renminbi to use for domestic loans. That’s where the central bank steps in, buying those dollars for inflated quantities of Yuan – 6.826 per dollar as of this writing.

Encouraged by the favorable exchange rate, Chinese banks swap (“turn in”) nearly US$200 Billion in exchange for Yuan on monthly contracts.  What do they do with this enormous inflow of Chinese money?  They lend it out to Chinese borrowers.  2009 was the biggest year ever for Chinese bank lending.  Many loans are made to more or less ordinary Chinese folks to use in their more or less private economic lives, but especially for their purchases of housing. Larger loans are made to China’s mega quasi-state companies, which, in the absence of a robust global export market have parked the cash either in investment accounts or in deals for empty land. 

The fire-hose quantity of in-flooding money is too great for even the growing needs of China’s growing economy.  On the one hand, China’s domestic consumer prices have not risen much since, after all, many Chinese people have great unmet wants for basic consumer goods. In addition, China’s export markets have declined with the ‘great recession,’ so there are a lot of surplus goods hanging around China. Hence China's inflation as measured by its official 'Consumer Price Index' is 3.1% - higher than desirable but still acceptable.

So where does the excess money and excess domestic Chinese bank lending go?  A lot of it went into the local stock market, which has corrected by 20% so far this year.  The real estate market is something else entirely.   Prices there are bubble strong, and bubble dangerous.

That danger, and not the posturing of American Senators, tariffs on Chinese auto tires, or pressures from Western financial centers, is the motive for the Bank of China’s move. That, and the fact that China’s Agricultural Bank is issuing the largest IPO in world history this week - $28 billion – and a 0.5% appreciation of China’s currency could make the stock hundreds of millions of dollars more expensive in Yuan terms. You decide.

Of course, North America, the West and China are all best served by stability in their terms of trade, with volatility of any sort bringing with it changes that at least we would be loathe to try and prognosticate. Investment flows in particular become hard to figure out. These kinds of uncertainties however are coming to seem normal during periods as turbulent as the last three years have been for the global economy.

What was it that the Chinese proverb is supposed to say about ‘interesting times’?