OF CHINA, FINANCE, AND TRADE

"I think that China ..., financially speaking, is the world's biggest problem."

James Grant

Recent headlines have highlighted China's intervention in currency markets - not to weaken their currency, the yuan or renminbi (RMB), but to strengthen it. On Monday, January 3, The Wall Street Journal ran a story under the headline, "China Inc.'s Large Dollar Debts fuel Beijing's Effort to Curb Yuan Plunge." The essence of that piece was that the large foreign debts of Chinese companies are a lot harder to pay off with a cheaper yuan, leading Chinese companies "to try to get out of yuan." A few days earlier, on December 30, there was a voice of America story telling us that "China Sells Off Stock of U.S. Treasury Securities to Protect Yuan."

There is some irony here - maybe less than meets the eye but some - because for some time we have been hearing from Congressional leaders that China has been working to keep its currency undervalued in order to keep exports high. And, to state the obvious, that concern and the need to address it was a prominent feature of the Trump campaign and could be a policy initiative of the incoming Trump Administration, which will take office on January 20. 

 
Admittedly, this first TTALK entry for 2017 is not really about the debate over China's efforts to manipulate the value of the yuan except in this very tangential, almost serendipitous sense. It was the web browsing in search of information on the exchange rate issue that led us to a first-rate discussion on the global economy held last summer - two days before the Brexit vote in fact -- at the Council on Foreign Relations in New York. 

Sebastian Mallaby of the Council was the moderator and James Grant, the founder of G rant's Interest Rate Observer, was one of the panelists. Near the end of the event, Mr. Mallaby asked Mr. Grant a question about China. Today's featured quote was part of his response. Here is his answer in full: 

"And I think that China, financially speaking, is the world's biggest problem. And I suggest to you that one day we'll wake up and hear or read that there has been a collapse in the wealth management products of the Chinese shadow banking and banking systems. These wealth management products are closed-end, indeed, blind pools. One doesn't know what's in them. They principally invest in credit instruments, bonds and the like--$3.6 trillion worth in a $10.5 trillion economy. These things are growing at $4 or $500 billion dollars a year.

 
"The principal technique for the redemption of wealth management products is the issuance of new wealth management products, and the word "Ponzi" was, in fact, applied to this phenomenon by a leading Chinese banker a couple of years ago. 

 
"A couple of years ago means that it has been going on and kept going on and defying the bears, who see in it, as do I, I am certainly bearish on this as the world's greatest financial risk. 

"So, sir, [to a member of the audience] you asked what the Chinese want. I think they want to remain in power. The rulers want to remain in power. They are interested in manipulating information to that end. They are interested in the manipulation of markets to that end. And I think that what is going within China, financially, is very, very worrying. "

Our impression is that there is no real argument about whether China has intervened to affect the value of yuan or is doing so now. Nor does there seem to be much of a debate over the fact that the goals of that intervention change over time, sometimes favoring a weaker yuan, sometimes a stronger. Given all of that, we were not surprised that there was no mention of naming China a currency manipulator in the message President-elect Trump delivered on November 21. That doesn't mean the issue has gone away. Almost certainly it has not, but, for now at least, it is issue that can wait for a while. We assume it will come up at the Senate hearings on the nominee to be the next Secretary of the Treasury, presumably Steven Mnuchin. We'll pick up the thread then if not before, especially the tie-in to the growing trade tension between the United States and China. 

There are two points that should be made here, however. 

One is a thought we have expressed before. Countries do try to influence the value of their currencies - both to prop it up and to keep it down. Sometimes they are seeking to make their exports more competitive, but currencies serve many functions and that is rarely the whole story. In any case, this is one area where the fix - especially trade sanctions - is likely to make things worse, perhaps much worse. 

 
Second, if you are inclined to see them, there are clear links between China's current efforts to prop up the yuan and some of the concerns expressed by James Grant last June. 

 
In talking about Brexit at the June 21 CFR event, Mr. Grant described the future as "a closed book," and so he wasn't prepared accept as gospel all of the dire warnings about the devastating consequences that would follow a UK vote to leave the EU. 

 
The phrase and the idea that the future is unknowable is much broader than Brexit.  In the China context, it seems unlikely that the Chinese officials who have been pushing so hard for so long to make the RMB a truly international currency fully anticipated the current "urgent movement of funds out of China." Doubtless, China's exporters have gotten significant benefits from having a relatively cheap yuan over the years, but now there are other concerns. 

In the Voice of America story, Jacob Kirkegaard of the Peterson Institute for International Economics explains China's problem this way: 

"Beijing is desperate to avoid a rapid decline in the RMB, as it would signal a loss of control over the economy. ... Such a signal is likely to cause confidence in the currency, as well as the Communist government, among Chinese savers to drop dramatically."

That may be a different worry than the worries James Grant expressed about China's wealth management products, but one link is the same - namely the perceived threat to the government, that is, the Communist Party.