China And Asset-Bubble Management As Monetary Policy

China is still lending its way towards its 8% growth target for the year. Third-quarter growth has come in at 8.9%, with the National Bureau of Statistics (via Xinhua) pointing up strong fixed-asset investment and rising domestic demand offsetting the drop in exports. The economy expanded by 7.7% over the first nine months. M2, the broadest measure of money supply, rose 29.3%  in the first nine months. The banking system has turned on a fire hose of new loans, a record 8.65 trillion yuan ($1.3 trillion), which has pushed up fixed-asset investment by 33.4% in the first three quarters. A lot of that liquidity has flowed into stock, property and commodity markets. How measured the People’s Bank of China is in turning down its fire hose will determine how smooth an exit the economy makes from its stimulus program. As for all central banks, finding an acceptable mix of financial stability, growth and inflation as the global economy recovers from recession depends, in essence, on managing asset bubbles.

China, Japan, South Korea FTA Could Be Kernel Of Something Bigger

There have been previous attempts to unite the nations of north-east Asia, some more ill-starred than others, of course. Some Japanese officials, and let’s go back no further than the 1980s, envisioned Asia’s economies flying like a skein of geese with their own country the lead bird. Regional economic cooperation has always been easier than political cooperation, as ASEAN attests, though even economic cooperation has been a hard slog for a set of economies of such varying size and stages of political and economic development. But Japan, China and South Korea, already tied closely by trade and investment as well as geographical proximity are talking seriously about creating a free trade pact.

The issue was discussed again this weekend at a meeting of Prime Minister Wen Jiabao, new Japanese prime minister Yukio Hatoyama and South Korea’s President Lee Myung-bak. It is still a long way from an Asian equivalent of the European Union, as some envision, but as the three countries are the regions three largest economies, collectively accounting for 16% of world GDP, they would anyway form the core. much as France, Germany and Benelux were the founding kernel of the EU. And in the interim, uniting China, Japan and South Korea under a free trade regime would be a considerable step towards expanding an alternative export market for Asian counties to the U.S. and an engine of global growth if U.S. consumers are going, as seems likely, to have a lengthy period of recovery from their recent excesses.

Oiling The Decline Of The Dollar As The World’s Reserve Currency

More on the dollar and its growing role as the fault line of the China-U.S. relationship: China, Russia, Brazil, France and the Gulf States are plotting to switch global oil trading out of dollars, according to Robert Fisk writing in The Independent. Instead they would price oil against a basket of currencies and gold. Secret meetings of finance ministers and central bankers to this end have been held, Fisk says.

What is no secret is that less of the world’s oil trade is priced in dollars than was once the case as buyers and sellers have sought to dampen the volatility that the dollar has exhibited in recent years. The mechanics of pricing oil against a basket of currencies and commodities would be a nightmare, unless the IMF’s special drawing rights (SDRs) or some close facsimile become a widely accepted currency, which this Bytander doubts will happen anytime soon. And what constitutes a secret meeting when it comes to finance ministers and central bankers getting together is another thing of definitional fuzziness.

Saudi central bank governor Muhammad al-Jasser has flatly denied The Indie’s report, saying there have been no such discussions secret or otherwise. Japan’s finance minister Hirohisa Fujii said much the same. But it is certainly no secret that China, along with some other leading developing economies, is steadily chipping away at the notion that the dollar should be the world’s sole reserve currency, and with it the U.S. sway over the world economy.

The Dollar And The Yuan, Not A Turkish Delight

The finance ministers’ meetings in Istanbul over the weekend revealed a deep crack in the veneer of harmony over the global financial crisis that the world’s leading economies have been seeking to present to the world. Ministers from the seven largest rich nations urged China to take steps to strengthen the yuan, a move Beijing has resolutely declined to undertake since the crisis broke. Yi Gang, a Peoples Bank of China vice governor, who was also in Istanbul for one of the plethora of finance-related meetings, made it clear that wasn’t going to change anytime soon: Beijing’s policy would continue to emphasize stability for now, for all the intention it says it eventually has to free up the yuan, which its critics now hold is undervalued.

This now sets up an interesting confrontation in the foreign-exchange markets. The U.S. dollar has fallen by 15% on a trade-weighted basis over the past six months. The G7 has as good as said it will not intervene to prevent it continuing to decline. China is not going to let that happen, at least not against its own currency:  This commentary on Xinhua about what it calls the “G7’s RMB complex” gives a flavor of its mood. Beijing can manage holding the line (the dollar/yuan rate has barely budged since the crisis began) but it will have to deal with the consequent hot money and inflation implications even as it faces down the forex traders.

Long-term Washington wants and needs a strong dollar, especially if inflation becomes not just a clear but also a present danger as the economy recovers. For now, at least, it is in the U.S.’s interest, to keep its currency low to shore up exports, particularly those of its beleaguered manufacturers, and to lower the value of the debt that the U.S. Treasury is piling up. Similarly, it is in China’s near-term interest to keep its currency stable (for which read low)  to shore up exports, particularly from its beleaguered manufacturers, and to protect the value of the U.S. Treasury debt it is piling up. Though, of course, neither would admit it.

Differences Still Divide G-20 Finance Ministers

You don’t have to peel back a very thick layer of agreement at this weekend’s prep meeting in London of finance ministers for the G-20 Pittsburgh summit to see how much difference remains between the U.S., Europe and China. Set aside for the moment the more-or-less consensus on regulation of the banking industry (which will get frayed once national regulators start implementing it in detail). It is in the short- and long-term management of the global economy that the true differences lie.

The U.S., as the recovery laggard, wants stimulus programs to continue worldwide. Europe and China see much of that part of the work of economic recovery done, and are much more ready than the U.S. to talk about how to unwind it. The U.S. also needs the two big export-led economies, China and Germany, to reorient towards domestic consumption and to take on the role America has long played of being the export market of last resort. That will happen neither quickly nor easily.

This weekend’s meeting also ducked the thorny question of how to give China and other developing nations, notably its fellow BRICs, Brazil, Russia and India, greater say in the management of the world economy. April’s G-20 meeting set the start of 2011 as the deadline for proposals to this end. Here the U.S. and China can make common cause: to reduce European nations’ voting power at the International Monetary Fund, suggesting 5% and 7% cuts respectively. Somehow typically, even here they disagree.

A Map Of U.S. Bank Failures, 2009

A map showing the location of banks closed by the FDIC in 2009.

China Announces Broad Range Of Measures To Finance Domestic Demand Expansion

China’s State Council has announced a broad range of measures to make sure that there is plenty of liquidity in the economy next year and that consumers, companies and infrastructure projects get the loans they need so their spending can boost domestic economic activity.

Among the 30-point mandate (in Chinese):

• a 17% target increase in money supply in 2009, a substantial increase from the 15% annual rate in November (M2: bank and cash deposits);
• a suspension of government issuance of three year bills and fewer one-year and three month bills, which were used to sop up liquidity when inflation was the problem;
• a loosening of bank lending rules;
• more state directed lending to projects that fall into the 4 trillion yuan stimulus package;
• keeping the yuan stable;
• new steel and grain futures markets, an expanded corporate bond market and a Nasdaq-like market for start-ups.

China, Having Slowed Yuan’s Appreciation, Takes Foot Off Brake

The yuan’s recent little run of depreciation against the dollar seems to be done. Last week, the central bank allowed the biggest decline in China’s currency since ending its fixed exchange rate against the dollar in 2005. That confirmed a view forming since October among investors that Beijing was weakening the currency to help the country’s beleaguered exporters. But in the last couple of days the yuan has strengthened again and 12-month forward contracts have also risen.

Officials told visiting U.S. Treasury secretary Hank Paulson last week that the yuan will be kept stable and academic economists are being trotted out to say that government plans to spur domestic demand mean that a weak yuan policy is unlikely. Despite the recent decline the yuan is still 20% stronger than when the peg was dropped. The currency has gained more than 6% this year, but less than 0.1% in the second half.  The charitable view would be that the recent devaluation was a tap on the brakes rather than a policy U-turn.

China To U.S.: Look After Our U.S. Investments. Unsaid: Or Else?

A curious turn of phrase from Vice-Premier Wang Qishan during his opening speech at the latest bilateral strategic economic talks with his American counterpart U.S. Treasury Secretary Hank Paulson:

”I hope the United States will take all necessary measures to stabilize its economy and financial markets as soon as possible and to ensure the security of Chinese investments and interests in the United States.”  (fuller reports from Xinhua here).

The first half of that is straightforward enough and could have come from any recent meeting of international leaders from the G-7 up. But to what does the second half refer? Investments by state agencies such as China Investment Corp. and state-controlled banks and other enterprises which have been battered by the fall in global equity markets? We noted yesterday that CIC had lost $6 billion on its stakes in two U.S. financial firms, Morgan Stanley and the Blackstone Group.

Or was Wang referring to the 60% of China’s $2 trillion of reserves that are held in dollar assets? A substantial share of those are U.S. Treasury bonds and debt issued by troubled U.S. mortgage lenders Freddie Mac and Fannie Mae, both now effectively under U.S. government control.

It is no secret that some top officials have been worried for a while that the dollar’s decline was eroding the value of those holdings and questioning whether it made sense for China to continue to increase them. Not that the dabbling in equity markets by way of diversification and to juice yields to offset that has necessarily turned out well in the circumstances (see CIC above).

However, with the U.S. having to fund an expensive bailout, and China being one of the primary surplus countries that will have to provide the cash, the internal debate about growing China’s dollar-denominated reserves will continue. China has little choice but to continue to fund America’s deficits if it wants to avoid global recession, but it also wants to avoid throwing good money after bad.

One sign of its willingness to get tougher with the U.S. over this is its willingness to let the yuan depreciate against the dollar over recent weeks, a move that helps China’s exporters even though it reverses Beijing’s compliance with the U.S.’s long standing pressure to get the yuan to rise against the dollar and to stop being what its American critics, including President-elect Barack Obama, have called a currency manipulator.

China Makes Big Cut In Rates

China’s newly announced cut in interest rates is the fourth cut since mid-September and biggest since the Asian financial crisis in 1997. The People’s Bank of China lowered its benchmark one year rate to 5.58% from 6.66%, to take effect on Thursday. The central bank also lowered the reserve requirements it imposes on banks, by 1% point for big banks and 2% points for smaller banks.

None of this is a surprise, though the size of the rate cut has been to some. That in itself is another signal that the economy is slowing faster than desired, and how seriously Beijing is taking remedying that.