Tag Archives: China

Did China’s regulators exacerbate its recent stock market bubble?

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The plunge of China’s stock market that has taken place since June 2015 has received a lot of attention.  All the commentary says not only that the Chinese authorities have taken a variety of artificial measures to try to boost the market on the way down but also that they did the same during the huge run-up in stock prices between mid-2014 and mid-2015, when the Shanghai stock exchange composite index more than doubled.  The finger-wagging implications are that the Chinese authorities, particularly the stock market regulator, have not learned how to let the market operate and that they had only themselves to blame for the bubble in the first place.

There is unquestionably a lot of truth to this overall story.  But am I the only one to notice that the Chinese authorities repeatedly tightened margin requirements during the bubble, in January and April 2015?   And that in fact the event which apparently in the end “pricked” the bubble was the June 12 announcement by the China Securities Regulatory Commission of plans to limit the amount brokerages can lend for stock trading?

It seems pretty clear that the extraordinary run-up in stock market prices from June 2014 to June 2015 was indeed fueled  by an excessive increase in margin borrowing.  Reasons for the increase in margin borrowing include its original legalization in 2010-11; easing of monetary policy by the People’s Bank of China since November 2014 (in response to slowing growth and inflation); and the eagerness of an increasing number of Chinese  to take advantage of the ability to buy stocks on credit.   Nevertheless, it appears that the stock market regulator responded by leaning in the opposite direction.

This is the sort of counter-cyclical macroprudential regulatory policy that we economists often call for, but less often see in practice.  (I survey some of the research  in the 2015#2 issue of the NBER Reporter.   A recent study by Federico, Végh, and Vuletin, for example, found that China and a majority of other developing countries also adjust bank reserve requirements counter-cyclically.)

Someone could criticize the Chinese increases in margin requirements by saying either, on the one hand, that their effects on the stock market did not last long (January and April, 2015) or, on the other hand, that they caused the recent crash (June).  But at least the moves were in the right direction, which is not a trivial point.

[Comments can be posted at Econbrowser.]

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Asia Games: Not Zero-Sum

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Two hostesses are rivals in a popularity contest throughout the social season.  When they hold soirees on the same night invitees must choose which one to go to.  The hostesses guard their social ranking jealously, and may even punish a guest who goes to the rival’s party by withholding an invitation next time.

To read about the roles of China and the US over the last month, one would think that Asia/Pacific relations are a zero-sum game like that of these two hostesses in some fictional time and place.   Are countries signing up for China’s Asian Infrastructure Investment Bank?  Or for America’s Trans Pacific Partnership?  Will China’s currency be admitted to the SDR club, or will it be kept humiliatingly waiting at the entrance?  Is the United States still number one globally in economic size, or did China pass it in 2014?

To phrase interesting economic questions in this way — “who’s on top?” — is a very strong temptation.  But it is the wrong way to think about them.  There is no reason, for example, why some countries should not join both China’s AIIB and America’s TPP; nor why the membership overlaps should not expand over time; nor, indeed, why the hostesses should not eventually attend each other’s parties.  The more the merrier. Let’s run through the list of current issues.  Apologies in advance: my score-card lacks the satisfying simplicity of declaring who is up and who is down.

  • When Britain, Germany, Korea and Australia and others unexpectedly decided in March to join the Chinese-led Asian Infrastructure Investment Bank (AIIB), it was widely reported as a mass defection of US allies to a rival party.   That it came across this way did indeed represent a misstep of Obama Administration foreign policy.  But there is in fact nothing wrong with this development.  Asia does need more help with infrastructure investment than the World Bank and Asian Development Bank can provide; China can play a useful leadership role; and the participation of the UK and other countries with high governance standards can assist in avoiding the sort of cronyism, corruption, and environmental damage to which road-building and other infrastructure projects are sometimes prone.
  • The Obama Administration is finally making some progress getting authorization from Congress to pursue the Trans Pacific Partnership.  Negotiations for TPP are sometimes characterized as a US attempt to isolate China.   But high volumes of trade in Asia and the Pacific and a dense set of regional trading arrangements running in every direction show that neither China nor anyone else is about to be isolated.  It would be best if trade negotiations could make progress through the World Trade Organization, so that everybody can participate, without the dangers of inefficient trade-diversion or the messy complications of rules of origin.   But WTO negotiations have been stalled for years.  In the meantime, TPP and other regional initiatives like APEC and various intra-Asia free trade areas are better than nothing.
  • On April 9, the US Treasury released the bi-annual report mandated by Congress to point the finger at countries engaging in “currency manipulation.”  Neither China nor anyone else was found guilty this time.  But, as in every administration, the Treasury feels it has to keep up the pressure, or else Congress may follow through on threats to pass currency manipulation legislation and so derail TPP and other trade agreements.
  • Every five years the IMF re-considers the composition of the SDR, its special currency unit, currently defined in terms of the dollar, euro, yen and pound.  We are told that China wants its currency, the renminbi, included in the basket this year, as a matter of prestige.  I don’t think this will happen now.  The renminbi does not yet qualify, because it is not “freely usable.”   (Maybe next time.)   This would be reported as a defeat for China.  It should not be.  The issue is of very little importance.
  • It might seem that lack of clarity regarding the proper role of country rankings in international politics could be shrugged off as a harmless media spectator sport.   But it can do real damage, as a barrier to sensible policy.  Such is the case with the stalled IMF quota reform, an issue where the rankings in fact are of some importance — but not in a zero-sum way.  By any measure of their economic importance, China and other big Emerging Market economies have long since merited much larger quota shares at the IMF, implying greater financial contributions and commensurately greater voting weights.   Their increases in shares do not need to come at the expense of the US. It is the European countries that are greatly over-represented.  Despite European reluctance to cede ground, President Obama succeeded in brokering such a reallocation of IMF quota shares at the G20 summit in Seoul in November 2010.  Five years later, however the US Congress is still holding up IMF quota reform – not because it would imply a loss of power or a cost to the taxpayer, but rather because many members view it as a matter of principle not to give the President anything he asks for.

Thirty years ago, we wanted nothing better than for China to become a capitalist economy.  It has done so, with spectacular success.   The rules of the game now require that it be given a bigger share in the governance of the international institutions.   That does not hurt the rest of us, not in the only “game” that matters most, which is world peace and prosperity.  If the Congress does not pass the IMF quota reform, we can hardly blame the Chinese for undertaking initiatives such as the AIIB on their own. We often hear about hard power (military) and soft power (the attractiveness of a country’s idea, culture, economic system, etc.).  But there is another kind of power.  Ever since Bretton Woods, the United States has had the power of global leadership.  The symphony needs a conductor.

Americans had been unprepared during the interwar period to assume the mantle, but learned the cost of that in World War II and so rose to the challenge in 1944. Seventy years later, even after the foreign policy mistakes we have made, even after the erosion of soft power, even after the Chinese economy has supposedly caught up with the US in size of GDP (evaluated at PPP, that is), the world is still ready to be led by the United States, in ways such as brokering IMF reform.  If we refuse to lead, then we abdicate power willfully.

[An earlier version of this post appeared at Project Syndicate.  Comments can be posted there.]

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If China Stops Manipulating, Its Currency Will Depreciate

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A rare issue on which the two parties in the US Congress agree is the problem of “currency manipulation,” especially on the part of China.   Perhaps spurred by the 2014 appreciation of the dollar and the first signs of a resulting loss of American net exports, Congress is once again considering legislation to attack currencies that are seen as unfairly undervalued.  The proposed measures include the threat of countervailing duties against imports from offending countries, although that would be inconsistent with international trading rules.

Even if one accepts the possibility of identifying a currency that is manipulated, however, China no longer qualifies.  Under recent conditions, if China allowed its currency to float freely, without intervention, the renminbi would more likely depreciate against the dollar than appreciate.  US producers would then find it harder to compete on international markets, not easier.

The concepts of manipulation or unfair undervaluation are exceedingly hard to pin down from an economic viewpoint.   That China’s renminbi depreciated slightly against the dollar in 2014 [2%] is not evidence:   Many other currencies, most notably the yen and euro, depreciated by far more last year.  As a result the overall value of the renminbi was actually up slightly on an average basis during 2014 [3%], reaching an all-time high.

The sine qua non of manipulation criteria is intervention in the foreign exchange market: selling the domestic currency, in this case, the renminbi, and buying foreign currencies, the dollar, so as keep the foreign exchange value of the domestic currency lower than it would otherwise be.   To be sure, the People’s Bank of China did a lot of this over the preceding ten years.   Capital inflows on top of trade surpluses contributed to a huge balance of payments surplus.  The authorities bought the dollars needed to make up the difference, the excess supply of dollars.  The result was an all-time record level of foreign exchange reserves, reaching $3.99 trillion by July 2014.

The situation has recently changed, however.  In 2014, net capital inflows into China reversed and turned to substantial net capital outflows.  As a result, the overall balance of payments turned negative in the second half of the year, which constitutes an excess demand for dollars or excess supply of renminbi.  The People’s Bank of China actually intervened to dampen the depreciation of its currency against the dollar, the opposite of its actions over the preceding decade.  As a result, foreign exchange reserves fell to $3.84 trillion by January 2015.

There is no reason to think that this recent trend will necessarily reverse in the near future.  The downward market pressure on the renminbi relative to the dollar is easily explained by the current pattern of a relatively strong economic recovery in the US, prompting the end of a period of American monetary easing, together with a weakening of economic growth in China, prompting the start of a new period of monetary stimulus there.

Similar economic fundamentals are now at work in other countries, particularly Japan and euroland.    When the American congressmen propose to insert currency provisions into the Trans-Pacific Partnership, even though it is currently in its final stages of negotiations, they are presumably targeting Japan.  (China is not included in this trade agreement.)   They may also want to target the Eurozone in coming negotiations for the Transatlantic Trade and Investment Partnership.   Both the yen and euro have depreciated sharply against the dollar over the last year.

But, unlike China, it has been years since the Bank of Japan and the European Central Bank intervened in the foreign exchange market.   They accepted a proposal by the US Treasury to refrain from unilateral foreign exchange intervention, in an unheralded G7 ministers’ agreement two years ago.

Then what do those who charge Japan or the Eurozone with pursuing currency wars by pushing down the values of their currencies have in mind?   They have in mind the renewed monetary stimulus of recent quantitative easing programs by those central banks.   But, as the US government knows well, countries with a deficiency of demand can’t be asked to refrain from increasing the money supply or decreasing interest rates just because the likely effects include a depreciation of the currency.   One cannot even say that the likely effects include a “beggar-thy-neighbor” rise in the trade balance, because the exchange rate effect is counteracted by an income effect that boosts imports.

Indeed in 2010 it was the US that had to explain to the world that money creation is not currency manipulation.  At the time, it was the country undertaking quantitative easing and was accused by Guido Mantega, the Brazilian Finance Minister who coined the “currency wars” phrase, of being the prime aggressor.   The US hasn’t intervened in the foreign exchange market to sell dollars in a major way since the 1985 coordinated interventions associated with the Plaza Accord, which began precisely 30 years ago this month.  (There was also a smaller intervention to sell dollars in 2000, to help the euro.)

There are other criteria besides foreign exchange intervention that are used to ascertain whether a currency is undervalued or even  “manipulated” for “unfair competitive advantage,” language that is in the IMF Articles of Agreement.  One criterion is an inappropriately large surplus in its trade balance or current account balance, relative to GDP.   Another is an inappropriately low foreign exchange value for the currency, in real terms.   Many countries have large trade surpluses or low currencies.  Sometimes they are appropriate, sometimes not.  Usually it is difficult to say for sure.

China’s currency 10 years ago was unusual in that it did seem to meet all the criteria for undervaluation.  The real value of the renminbi was estimated to be about 30% below equilibrium in 2005.  The Chinese trade surplus reached 7% of GDP in 2007 and the current account surplus reached 10%.  But things have changed.   The currency appreciated about 30% in real terms between 2006 and 2013, enough that the most recent purchasing power statistics (for 2011), show it in an area that is normal for a country with real income per capita around $10,000.  The surpluses as a share of GDP came down too.  (The trade surplus is back up again over the last six months due to a fall in China’s import spending, particularly in the energy import bill.)

The criteria that US congressmen focus on is one that has no relevance for economists or for the IMF rules:  the bilateral trade balance between China and the US.   It is true that China runs a bilateral surplus with the US that is as big as ever.  At the same time, however, it runs bilateral deficits with Saudi Arabia, Australia and other exporters of oil and minerals.  And with South Korea, from whom it imports components that go into its manufactured exports.  Roughly 95% of the value of a “Chinese” smart phone exported to the US is represented by imported inputs; only 5% is Chinese value added.   The point isn’t that the trade statistics need to be corrected.  The point is, rather, that bilateral trade balances have little meaning.

If I insisted that in return for a haircut my barber must listen to me give an economics lecture, he or she would be unlikely to consider that acceptable payment.  I pay my barber in cash, and am in turn paid by Harvard University for my economics lecture.  My bilateral balances are not of concern.

Congress requires by law that the US Treasury report to it twice a year whether countries are guilty of manipulation, with the bilateral balance specified as one of the criteria.  It would be ironic if China agreed to US demands to allow the exchange rate to be determined freely in the market place and the result were a depreciation of its currency and a gain in the international competitiveness of its exporters.

[A shorter version of this column appeared at Project Syndicate.  Comments can be posted there.]

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