The Global Credit Crisis and China s Exchange Rate

Transcription

1 The Global Credit Crisis and China s Exchange Rate Ronald McKinnon Brian Lee Yi David Wang Bond University Sydney, Australia April 9, 2010

2 Advantages of Stabilizing Yuan/Dollar Rate A Potted History 1995 to 2004 fixed rate nominal anchor: 8.28 Y/$ [McKinnon & Schnabl, Jan 2009] July 2005 to July 2008, one-way bet on RMB appreciation: hot money inflows, buildup of official exchange reserves, loss of monetary control, disrupt forward exchange market [Wang 2009] July 2008 to Nov. 2008, unwinding of dollar carry trade with sharp apprec.of $ effective ex rate, (Lee 2009), Y/$ rate reset at 6.83 through to present. monetary control regained with a massive expansion of bank credit to support fiscal stimulus for offsetting sharp fall in exports After March 2009, fall of dollar (and RMB) with zero U.S. interest rates again stokes hot money inflows

3 U.S. Mercantile Pressure. China Bashing: 2000 to? -China surpasses Japan in 2000 as having the biggest bilateral trade surplus with the U.S -Unlike Japan, export surge is across the board in low value added manufactures. Focus is primarily on appreciating the Renminbi: -Schumer-Graham bill of March 2005 for a 27.5% tariff on U.S. imports from China unless RMB appreciates (withdrawn October 2006, but new threat in 2007) -Section 3004 of U.S. Public Law : U.S. Secretary of Treasury must report twice a year on whether countries with trade surpluses are manipulating their currencies. Timothy Geitner s congressional testimony January 2009 RMB rises by 2.1% on July , and begins slow upward crawl

4 Source: Federal Reserve Economic Data Figure 1: China s monetary policy and the yuan/dollar rate ( ) Yuan/Dollar Fixed exchange rate anchor: monetary stability One-way bet on yuan appreciation: loss of monetary control, inflation "Accidental" stabilization: regain monetary control? /Jun 96/Jun 04/Jun 05/Jun 06/Jun 07/Jun 08/Jun 09/Jun

5 One way bet: RMB appreciation July 2005 to July 2008 Hot money flows into China No private capital outflows to finance China s huge trade surplus (McK & Sch 2009) Huge buildup of official exchange reserves: government sole international intermediary Massive sterilization: sale of central bank bonds, increases in reserve requirements of com banks Direct restraints on domestic bank credit Still loss of monetary control with domestic inflationary pressure added to foreign Restrictions on capital inflows and disruption of forward exchange market

6 Renminbi and Dollar Exchange Rate Movements ( ) Nominal Rate:Dollar/Yuan 90 Effective Rate of the Renminbi 85 Effective Rate of the U.S. Dollar Sep Source: BIS and Federal Reserve Economic Data

7 Source: State Administration of Foreign Exchange

8 Figure 3: China s Consumer Price Indices (Growth rate: % yoy) Source: EIU

9 Figure 4: Renminbi and Dollar Exchange Rate Movements ( ) 120 Unwinding of Carry Trades July Source: IFS and BIS Nominal Rate Dollar Yuan Effective Rate of the Renminbi Effective Rate of the U.S. dollar

10 Figure 5: Commodity Price Indices (Jan 2002 =100) The Economist Commodity-Price Index West Texas Intermediate /05 Source: globalfinancialdata.com

11 Figure 8: Unwinding the yen and dollar carry trades (effective exchange rates, 2006=100) July United States Japan Source: BIS

12 Table 1: Returns on carry trades ( ) Funding Interest rates Returns from Returns of Unwinding in 2008: Currency Funding Investment Appreciation Carry trades Trough to Peak Appreciations c US Dollar a 1.1 a 7.9 a 19% Japanese Yen b 5.2 b 10.7 b 44% Source: Brian Lee (2009) Note: (a) For funding in dollars, the return is the average for Brazil, Mexico, and Canada. (b) For funding in yen, the return is the average for Australia, Korea, and New Zealand. (c) Trough to peak for the yen s effective multilateral exchange rate. Caution: The unwinding of the carry trades in 2008 may not fully explain these exchange rate appreciations.

13 Dollar carry trade unwinds and accidental stabilization of the RMB since July 2008 Credit crunch summer and fall of 2008 dries up short-term finance for dollar, yen, and commodity carry trades Surprise dollar appreciation, July to Nov 2008, of approx 20% against all currencies except the Japanese yen with a general fall in commodity prices. PBC stops gradual (and predictable) appreciation of RMB, and stabilizes at 6.83 yuan/dollar. Hot money inflows stop, some private outflows, minimal increases in official exchange reserves. PBC regains monetary control Massive domestic credit expansion: cuts in reserves required of commercial banks while lifting credit ceilings, reductions in deposit and loan interest rates Domestic spending largely offsets collapse in exports

14 125 Figure 2. The U.S. Dollar s Exchange Rate Movements (Effective rate, Jan 2000=100) Dollar Carry Trade Credit Crunch China begins slow appreciation New Dollar Carry Trade? (Hot money inflows to China restart) China resets 6.83 yuan/dollar Dec Source: Federal Reserve Economic Data

15 160 Figure 9: China s Nominal Trade (in billions of U.S. dollar, monthly) 140 Exports Imports Source: China Customs Statistics Information /04

16 Source: UBS Figure 10: China s interest rates (%)

17 Figure 12: China s M2 and Bank Lending (Growth rate: % yoy) Source: UBS

18 Source: Wall Street Journal Loans for 15 large U.S. banks 2Q 2009 in billions Change from 1Q Comerica % Marshall & Ilsley % Wells Fargo % Fifth Third % SunTrust % Regions % Citigroup % Bank of America % US Bancorp % PNC % BB&T % KeyCorp % J.P. Morgan Chase % Amercian Express % Capital One % Total for 15 banks 4, %

19 Loans and leases of U.S. commercial banks, Interbank Loans, Base Money and M2 (2006 Jan = 100) Loans and leases Base Money M Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Sep Source: FRED Note: The account of Loans and leases comprises of commercial and industrial loans, real estate loans, consumer loans and other loans but does not include securities

20 Source: SCB M2 growth around the world

21 Source: Direction of Trade, IMF

22

23 Change in GDP of selected economies Source: Wall Street Journal

24 Countering the Global Downturn: The Key Role of China U.S. fiscal stimulus is problematic: weak domestic financial institutions, and trade deficit would increase U.S. monetary policy euthanasia from zero interest trap. Bank credit continues to decline. China now a big actor on the world stage with stronger public finances and much stronger banking system To stimulate the U.S. and world economies, the primary fiscalmonetary stimulus should be in China and other surplus Asian economies and possibly Germany. Nov 2008, China announces a half trillion dollar fiscal stimulus Massive bank credit expansion within China. Expands domestic demand and attracts imports, particularly from Asia. With a stable exchange rate, China is the engine of global economic recovery.

25 Caveat: Stabilize exchange rate (Mundell-Fleming) Reducing China s net Saving (Trade) Surplus Increase share of household disposable income in GDP in order to increase private consumption reduce personal income and sales taxes increase government transfer payments increase dividend payouts from enterprises Increase government social expenditures. Stimulate household spending increase consumer credit abolish one-child policy? Objectives (1) Reduce China s trade surplus (2) Counter cyclical downturn in China and rest of the world

26 Source: CEIC, GS Global ECS Research. China s Savings by source % of GDP 25 Household Corporate 5 Government 0

27 60 Figure 16: Investment, Savings and Current Account of China (as a percent of GDP) Investment 50 Savings Current Account Surplus Source: EIU

28 % of GDP Corporate Household Government Latest Total Loan Note: For Asia countries, corporate loan does not include bonds in capital markets. End 2008 or latest data for all countries.

29 Table 2: China s Economic Positions in 1997 and 2007 Source: UBS Note: The NPL ratio is 2.8% for four largest commercial banks, Dec 2008.

30 Euro/Dollar and Yuan/Dollar Exchange Rates (Jul 2008-Oct 2009) Weak dollar and resurgence of hot money inflows into China China resets exchange rate at 6.83 yuan/dollar Euro/Dollar:LHS Yuan/Dollar:RHS Jan Apr Jul Oct Jan Apr Jul Oct / Source: Federal Reserve Economic Data

31 Source: Federal Reserve Economic Data and globalfinancialdata.com U.S. Short-term Interest Rates (%) Fed Funds Rate 1-month LIBOR 1-month Treasury Bill Jan 2006 Jul 2006 Jan 2007 Jul 2007 Jan 2008 Jul 2008 Jan 2009 Jul 2009

32 Source: Federal Reserve Economic Data Loans and Leases of U.S. commercial banks, Base Money and M2 (2006 Jan = 100) Loans and leases Base Money M Jan 2006 Jul 2006 Jan 2007 Jul 2007 Jan 2008 Jul 2008 Jan 2009 Jul 2009

33 Foreign Reserves and Trade Balance of China (in billions of dollars) Growth in Foreign Reserves Trade Balance June Source: The People s Bank of China and China Customs Statistics Information

34 China s Trap, April 2010 Ultra low U.S. interest rates again induce hot money inflows into China and other emerging markets. Resumption of carry trade, weak dollar RMB fall with dollar inducing widespread complaints of Chinese under valuation Hot money inflows into China increase from expected RMB appreciation PBC is trapped unless Fed relaxes policy of zero interest rates, which would be in the U.S. own best interests (McK, Nov 09)

35 Springing the Trap by a Sino-U.S. Agreement? China agrees to 1. A one-off modest appreciation to say 6.5 yuan/$ 2. Work toward reducing saving (trade) surplus by increasing consumption The United States agrees to 1. Stop China bashing on the exchange rate 2. Raise interest rate on Fed Funds to, say, 2% 3. Work toward reducing its saving deficiency Both sides agree to remove (threatened) tariffs and other restrictions on mutual trade flows