“Pointing the finger at hot money is an excuse. Move off the peg with the dollar”
An interview with Patrick Chovanec, American Professor at Tsinghua Univ.
If you travel by foot in the central rings of Beijing metropolitan area you saw shopping centres and rich malls where employees outnumber the clients. Even where people are busy walking around and checking prices at Zara in Wangfujing Avenue or Ikea (where it is common to see visitors sleeping on pieces of furniture), you find, surprinsingly that prices are the same or even higher than in Lisbon. You peak bananas or grapes at a street market and you find, again surprisingly that they cost more than in Lisbon – and not just for tourists, for everybody. Then you saw the titles of the English editions of Chinese newspapers, like China Daily, with full of buzzwords and sanguine titles: “hot money,” “crazy prices,” “quantitative easing fuels imported inflation,” “stifle inflation,” “consumer price index surges,” “prices go sky high.”
There’s a Chinese word, Zhàng, [漲] which indicates price rises. It was the most nominated word by netizens for the character of 2010. The complete sentence is two words in Chinese: Zhàng (to rise) Jià (price, value) – 漲價.
What all these bizarre and paradoxical facts truly mean? We interviewed professor Patrick Chovanec (程致宇), an associate professor at Tsinghua University’s School of Economics and Management in Beijing, where he teaches in the school’s International MBA Program. He holds an BA in Economics from Princeton University and an MBA in Finance and Accounting from the University of Pennsylvania’s Wharton School, where he graduated as a Palmer Scholar, in the US. He wrote an interesting article about China as a mosaic of distinct regions. It’s the product of over 20 years of business travel and personal exploration in China.
Interview by Jorge Nascimento Rodrigues, Janelanaweb.com 2010
Q: Do you think the monetary easing with Chinese “characteristics” and loan policies in China since January 2008 (64% plus in M2 until October 2010) is approaching an overstretch tipping point? What can the government do to deal with this volcano, as you qualified the situation for Bloomberg today?
A: To answer your second question first, China can move off the exchange rate peg. The primary source of new money being injected into the Chinese economy these past two years have been (1) banks drawing down on their reserves, which accumulated due to the enforced sterilization of prior year’s FX (foreign exchange) reserve purchases, and (2) non-sterilization of more recent FX reserve purchases. When China buys dollars (or other currencies) to keep the exchange rate fixed, it issues RMB in exchange. Unless it runs a constantly tightening monetary policy to compensate, the domestic money supply will increase — and for the past two years, China has been doing anything BUT running a tight monetary policy. True, China can raise the reserve requirement ratio and try to mop up some of that excess liquidity, as it did before last year’s stimulus. But in the end, that’s just a game of catch-up. It’s like trying to dry yourself off with a towel while you’re still standing underneath a running shower. You need to turn the shower off.
Q: And regarding the first part of my question?
A: To answer your first question: there are some economists, who I respect, who say a little bit of inflation is not necessarily a bad thing. I tend to think playing with inflation is like playing with fire, but I might even agree with them if the money supply was growing at a slightly higher rate than real growth. But the monetary expansion we’ve seen in China is just phenomenal, and I think the inflationary effects have been disguised by the fact that the money went into an investment boom rather than a consumption boom, initially producing asset inflation rather than consumer inflation. Asset inflation is a funny thing: when the price of bread doubles, it feels like it’s getting harder to make ends meet; when the price of high-end condos doubles, it feels like smart investors are getting rich. I think this has lulled Chinese policy-makers into a false sense of security when it comes to inflation. Right now there’s a lot of asset inflation that has yet to work its way into the general price level, and that has me very concerned.
Q: The culprit of the situation in recent months is only the hot money coming from outside?
A: Hot money shows up as an unaccountable inflow on the capital account. Yes, it adds to the imbalance in payments, and hence the FX purchases China must make to support its currency. But if China wants to counteract this, the solution is easy (at least in principle): move off the peg, and — if you want to moderate RMB appreciation — open the capital account so that Chinese companies and individuals can invest more freely abroad. Pointing the finger at hot money is an excuse.
Q: Inflation in basic food products are firing particularly in big cities. Even in certain cases we assist to a hyperinflation in last months. With common people waging between 900 yuans (€100, $135) and 5000 yuans (€560, $750) a month in cities, can we risk a social turmoil? Has the government policies to deal with this situation?
A: The Chinese government is keenly aware that it came to power in 1949 partly due to hyperinflation that wrecked the post-war Chinese economy, and nearly lost control of things in 1989 due to widespread unhappiness over inflation. So I expect it will try to move pretty aggressively. Unfortunately, the policy measures it has announced so far focus mainly on price controls, and trying to regulate supply and demand for food. They ignore the underlying problem, which is monetary inflation — more money chasing the same amount of goods. I don’t know whether they’re looking to price controls as a real solution, or using them as a way of telling the public they’re doing something, but price controls won’t solve the problem and will only create new problems.
Q: How do you appreciate the recent announced measures regarding the banking sector? Are they sufficient? Will they have real impact?
A: Raising the reserve requirement ratio is a step in the right direction because it does rein in lending and money creation by mopping up excess liquidity in the system. But it’s not very helpful if more and more liquidity keeps being poured into the system due to the peg. Essentially, the central bank has gone back to trying to sterilizing its FX purchases, but that’s not really a long-term solution.
Q: One of the striking daily scenes in the shopping malls in big cities is the fact that employees outnumber the clients in each shop. Consumerism is still a promise to fulfil?
A: Yes, you do see that a lot, don’t you. It’s something I still try to figure out. It depends a lot on where you visit. Some malls are empty, others are full. When they are full (like the Beijing Ikea) it’s not always easy to tell how many people are actually buying. Like I say, it’s something perplexing that I’m still trying to figure out.