I was too early in 2006

by on January 26, 2016 at 2:28 pm in Current Affairs, Economics | Permalink

I wrote:

The yuan should not, as matters stand, float freely with free capital movements. Large quantities of Chinese savings, currently restricted to the domestic currency, would probably flee the country, worsening the serious solvency problems at Chinese banks. The Chinese must first clean up their banking system before they can have free capital markets. Contrary to the conventional wisdom, a market-determined value for the yuan might well be lower than today’s exchange rate, not higher.

Here is the rest of my 2006 column on China.

1 ptuomov January 26, 2016 at 2:32 pm

In financial markets, right ten years early is usually indistinguishable from wrong… 😉

2 Subotai January 26, 2016 at 2:52 pm

That we are not seeing the effects until now does not mean it was wrong at the time. Are you suggesting that the yuan should free float and the current turbulence in the Chinese economy has some other cause? Or that the benefits of a float without a clean banking system would offset the current disruption?

3 ptuomov January 26, 2016 at 4:46 pm

That was just a general comment about timing, couldn’t resist.

4 tt January 26, 2016 at 9:44 pm

The Cubs will win the pennant +- 2000 years

5 Ray Lopez January 26, 2016 at 11:03 pm

+1 to ptuomov, that’s a well-known adage as seen in the excellent movie “The Big Short”

Just back from Hong Kong after a week there, which was excellent but for me and my hot twenty-something Philippine girlfriend half my age, we spent close to $6000 USD total (I spent $1k in “Uniqlo” clothing store alone). The HK dollar is pegged to the US dollar and prices in HK are high (but the quality of goods is vastly superior to the Philippines).

6 ptuomov January 27, 2016 at 6:03 pm

Got a photo? 😉

7 ptuomov January 27, 2016 at 6:02 pm

In terms of substance, I mostly agree with the 2006 piece. I guess the only issue I have with it is that one should clearly distinguish between floating exchange rate and capital mobility. The Chinese can have a freely floating exchange rate and troubled banking system as long as the capital controls are effective.

This person here for example is advocating a floating rate with tight capital controls:

China Should Let Yuan Float to Avoid Slump, Ex-PBOC Adviser Says http://bloom.bg/1Sk9lhy

8 Brian Donohue January 26, 2016 at 2:52 pm

The Renminbi is 20% higher today versus the dollar than it was when you wrote the article on 9/7/2006.

Not sure I’m grokking your point.

9 andrew January 26, 2016 at 9:58 pm

And the dollar is generally a lot stronger than it was in 2006.

10 Brickbats and Adiabats January 26, 2016 at 3:59 pm

You were probably right then, in the sense that China’s extreme levels of financial repression would have caused Chinese capital to chase better yields overseas. Weirdly, it seems that both the US and China are now two places where capital flows are driven more by financial demand than by balancing the current account.

11 Stephan January 26, 2016 at 4:16 pm

The future ain’t what it used to be

12 Mike January 26, 2016 at 5:22 pm

I’ve managed money for Chinese hedge fund clients and their expectations for rates of return are much higher than those of Westerners. It is true that they are quite financially repressed. Ours was one of a small number of products managed by a foreign firm available to Chinese investors. We were only able to do it by working through a Chinese broker as a “consultant”. So I think that certainly there would be outflows if controls were lifted, but not because the Chinese are sour on the investment opportunities in China. Perhaps they would seek diversification, but I’m not sure that’s exactly the mindset. They are not used to the value of their investments going down. Ever.

On the other hand, there would certainly be inflows from foreigners looking to diversify their holdings into China. On net, I’m not sure what side would overwhelm.

13 Thiago Ribeiro January 27, 2016 at 5:00 am

“I’ve managed money for Chinese hedge fund clients and their expectations for rates of return are much higher than those of Westerners.”
Do you have any idea why it is so? If they are financially repressed at home, shouldn’t they be used to low rates of return? Do you have any idea of whose money was it you were managing (institutional investors,corporations, common savers)?

14 ptuomov January 27, 2016 at 6:09 pm

In my (limited) experience, the “expected” rates of return by third-world individuals is very high. I don’t know why that is, but I speculate it’s because the growth and interest rates have been very high there in the recent decades, because these individuals have been very lucky and extrapolate their personal investment experience, and because they assume some probability of a sudden total loss due to expropriation or fraud for any investment.

15 Thiago Ribeiro February 1, 2016 at 5:46 am

I see. Thanks.

16 Tom T. January 26, 2016 at 5:27 pm

Isn’t the currency peg helping to shield them from having to clean up their banking system?

17 ptuomov January 27, 2016 at 6:10 pm

Currency peg or capital controls? They are not the same thing.

18 Mark Thorson January 26, 2016 at 7:32 pm

If they really want to get the RMB cleaned up enough to be an international reserve currency, they should pursue a currency union with Taiwan. If they could achieve that, it would be a major vote of confidence, and it would be a great stimulus to cross-strait trade. Tourism is a major industry in Taiwan, and this would greatly simplify mainland tourist spending, so there is big benefit for Taiwan here.

19 Benjamin Cole January 26, 2016 at 9:19 pm

I have reading for at least 10 years that China’s banking system “needs to clean up its act.” However, the Chinese bank reserve requirement ratio is close to 20%, roughly double that of United States banks. Tyler Cowen, what percent of Chinese bank loans are sour? And of that percent, what percent would not be sour if real estate values reflate, as they typically do in all economies.

Additonally, just as with the US Federal Reserve Board, China has the People’s Bank of China, which can print money and inject it into the banks. As China is now far below its inflation target, they have plenty of room for this form of quantitative easing. The Reserve Bank of India conducts such operations, under the name of the “liquidity injections.” Yes, with University of Chicago scholar Raghuram Rajan in charge. No one seems to think the Reserve Bank of India is doing anything wrong, at least in western circles.

What China is suffering from today is a lack of demand, in fact a global problem. The world’s central banks should forget about fighting inflation for several years, and instead concentrate on boosting aggregate demand.

And I think Chinese banks are a strong as can be, they cannot fail under such a system. Actually, it is US banks that appear only marginally less flimsy than 10 years ago…

PS—-I prefer free markets. But we are discussing specific banking systems…

20 ptuomov January 27, 2016 at 6:12 pm

Have you read the book “Red Capitalism”? Not that it would prove you wrong or right — I just think you’d find it very interesting if you haven’t already read it.

21 Ray Lopez January 26, 2016 at 11:10 pm

TC’s 2006 article contains this howler, which I suspect is a blunder–it assumes the Chinese are innovative. Does anybody have evidence of this? “The climb of the Chinese economy out of Communism and into prosperity has brought the world, and the United States, a free lunch. Consumer goods of many kinds are cheaper and the Chinese are likely to generate many scientific and technical innovations .”

22 ptuomov January 27, 2016 at 6:17 pm

In my experience, the Chinese who have worked with me are just as innovative as are the Americans, Dutch, etc. In my opinion, there’s no difference in the innate ability that I can detect. The system in China may discourage some kind of innovation, but as a counterweight to that effect high and fluctuating economic growth seems to be generally conducive to innovation and invention.

Just some random first reactions to your provocative question.

23 TallDave January 27, 2016 at 10:21 am

The yuan might have been undervalued in 2006, and overvalued today. It looks like they’ve been creating a lot of yuan to feed their investment binge. That was a sustainable strategy coming on the heels of basket-case Maoism, where basically anything they built probably added a lot of value, and the productivity growth offset the monetary expansion, but now China’s a middle-income country and a lot of that investment now appears to be malinvestment, based on the debt and profit figures.

The official inflation numbers allow them to hide the money creation, but a floating currency would probably end the charade pretty quickly, with potentially dire consequences for the leadership if they don’t handle things properly.

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