In Peter Schiffs latest youtube video he makes the case that China raising interest rates will only make inflation worse in China until it allows its currency to appreciate against the dollar. His logic is essentially this:
China raises rates which makes Chinese deposits more attractive. This leads the Chinese to increase the money supply even faster to buy up dollars to hold thier peg to the dollar thus leading to higher inflation in China through the increase in the money supply.
It’s a pretty simple concept so if this is a valid point then surely the Chinese have recognized it too. But then again many others whether Austrian or not have wondered why the Fed does what it does and why they didn’t see or even express concern of the possibility of THIS or THAT happening until it was too late
I know some people here have been critical of Schiff , so I would like your take on his view of Chinese monetary policy as of late.
I don’t know enough about international economics to really judge this argument, especially since much of what I’ve learned does not apply to the Chinese economy and currency, which is not freely exchanged in open markets. Usually, a higher interest rate will lead to carry trades where individuals sell dollars, buy Yuan, and invest in China, yielding Yuan currency appreciation. Additionally, how does China raise interest rates? Typically, a nation has to reduce the supply of reserves in order to do so, which yields currency appreciation (deflation or disinflation). I also don’t understand why higher Chinese interest rates puts pressure on its peg.
I’ll conclude by saying that if China really has to buy additional dollars in order to maintain its peg, and if it’s forced to create more Yuan in order to do so, than a higher rate of inflation does makes sense. But again, I would like a clearer presentation of Peter’s argument.
I think the argument is that China doesn’t want to let their currency float freely (rise) because that will force them to transition from an export economy to a more consumption at home based economy. And even though that would greatly benefit the people longterm (with lower prices and more buying power) it would cause short term pain while the country transforms. Probably a deep recession. (Who knows - maybe they are worried about unrest if that happens) So the gov’t just wants to continue as is - and hope the dollar doesn’t plummet too fast.
Plus the gov’t has a big stake in the export businesses so they don’t want to jeopardize those trade surpluses.
In the end, it won’t matter - the United States will continue to debase the dollar - probably too fast for the Chinese to peg with - but that could still be decade or more away.
Esuric, we should be careful using conventional economics when talking about China, because interest rates in China are purely a notional artifice.
Banks in China are state-controlled, and only lend to those to whom they are asked to lend. Essentially, the interest rates here become just an arbitrary figure, because the government decides where the giant pool of capital goes, irrespective of issues of moral hazard, adverse selection, and the ability to attract depositors. It does not even matter whether the companies to whom they lend can pay back since they are mostly state-controlled too, and are told what plants they have to build, how much size it has to occupy, from where they must buy materials, and to where they can sell those materials. All that happens here is that a government is deciding where all resources are allocated and instruments typical of capitalist economies like prices, interest rates, and wages are used just as notional calculating devices. Because there are capitalist economies outside China, the Chinese can get a slightly better idea of what those prices, interest rates, and wages should be, and they keep those three devices so as to find a way to barter with countries where those figures do mean something. They don’t have to worry about lack of capital, since everybody can be ordered by the state to do transactions through a bank account.
China does not have to reduce supply of reserves to raise interest rates; it can do that simply by ordering banks to lend at higher rates.
Now that would be correct if China were a pure socialist common wealth. Since it is obviously not, then the interest rate cannot be a “purely notional artifice”, but again, a price that is highly distorted by government intervention. That’s what China effectively really is: An interventionist/hampered market economy, only more so relative to more Western States. As long as Chinese consumers have some (even limited) freedom in deciding how to set their personal consumption-savings rate (and there is such freedom), and as long as there is international trade (and there is), interest rates are distorted and tampered with. This is why the Chinese are worried about their own real-estate “bubble”.
Boom/bust cycles cannot occur when interest rate is a “purely notional artifice”. Malinvestment then becomes a permanent state of affairs.
The People’s Bank of China short term strategy is twofold. First: increase interest rates and slow down money supply increase. Second: allow the yuan to increase its value to the dollar and other currencies.
The reason for this move is very simple (at least as explained by financial newspapers). Beijing has finally realized the housing bubble is getting out of control and wants to reel it in as quickly as possible. Chinese authorities are perfectly aware this move will probably cause slightly decreased economic growth in the immediate future but are willing (not being democratically elected) to take some short term pain for increased gains in the future. Beijing will also probably implement other measures to deal with massive industrial overproduction in some sectors, most notably cement, glass and steel.
The Chinese are also betting on the fact the world needs them. They have become the world’s factory. Even if the yuan goes up, say, 10% against the dollar and the euro in a year, Westerners will still be forced to buy their goods from China because they have no short term alternatives. They’ll buy less but they’ll keep on buying. This may lead to decreased industrial output in China but, again, that’s what their government is aiming to. There’s also the strong possibility that increased rates may lead to even higher saving rates and, by return, increased domestic consumption.
Another possible intended side consequence of this revised monetary policy is that it will make US bonds less palatable to Chinese and, perhaps, other Asian investors. The People’s Bank of China itself may continue its purchases (though they have slowed down noticeably in the past two years) but domestic investors will look at the bottom line and see that keeping their money home may yield better returns. This could be a devastating blow to struggling US local governments whose bonds are mostly held by Chinese investors other than the People’s Bank.
Final comment: this could be really interesting and I bet someone in New York and Washington will be sweating profundly.
That’s an interesting question. In China, the state still has enormous sway in its domestic banking sector, and due to state influence, it’s hard to gauge whether or not the rates being set are indeed commensurate with an alternative private system. I’m not terribly knowledgeable about banking, so there may be some indicators suggesting there is indeed a housing bubble, but considering the circumstances, who knows?
False: http://www.msnbc.msn.com/id/30229507/from/ET/. Also, the Chinese needs the world to buy their products, but the world does not need China. There are plenty of under-developed economies that could theoretically pick up the slack. Would losing the Chinese market hurt? In the short-term, yes, but in the long-term, everything would readjust.
Public officials should have begun sweating profoundly every time they increased the deficit.
DD5, Hitler and Mussolini ran an economic system from Berlin and Rome where the degree of intervention was high enough for those regions to accurately not be considered market economies. United States under the New Deal was an interventionist market economy, but Hitler and Mussolini had bureaucrats to arbitrate everything from who, what, where, and for whom to produce and unlike Americans, they did not worry about government running out of money and halting certain programs, because government decided the price of everything and where resources would go. Governments in interventionist market economies like America were stuck with a budget and had to bid along with domestic buyers for the same goods at their prices.
Germany and Italy were market economies only to the extent that they had to buy inputs or goods from abroad, and allowed domestic consumers to use their money as they wished, and it would be impossible for a totalitarian economic system to be purely totalitarian. But it was the very existence of foreign markets and some domestic market that allowed them to closely observe how a capitalist system works, and then integrate them into the totalitarian system. As such, the market in such countries was a purely experimental tool for information and calculation for the otherwise totalitarian economic system.
When you say, “Boom/bust cycles cannot occur when interest rate is a “purely notional artifice”. Malinvestment then becomes a permanent state of affairs” you are right, and that was why Germany and Italy were considered successful economies by some foreigners.
China functions closely to such “state capitalist systems” that existed in Germany and Italy, and also doesn’t worry about boom and bust when it controls banks and can malinvest to no end. China, like Germany and Italy, is also considered a success because it does not have boom and bust. And unlike Germany and Italy, China is a large country with many resources located domestically, allowing the totalitarian system to work less with markets than Germany and Italy did.
Agamentus, the world needs other goods besides airplanes and mainframes. According to the same source (CIA World Factbook), China is the second exporter in the world, with $ 1.204 trillion worth of exports in 2009. The US is by far the largest customer, buying more than 20% of this. By contrast imports from the US make up about 7% of the grand total. What are these goods? Mostly consumers’ products: flat screen TV’s, microwave ovens, trousers, cooking implements… but there are also critical components, like rare-earth magnets used in high tech applications.
You should also remember that very few “underdeveloped” countries offer the same level of political stability and infrastuctural development as China. Africa is hopeless and South America is rightly seen with suspicion: you never know when a demagogue will take power and “nationalize” your assets. The rest of Asia offers better possibilities. India has immense capabilities but needs to properly solve her internal problems and I am extremely positive about South East Asia (especially Thailand, Malaysia and Indonesia in that order) but you simply cannot have these countries taking China’s place overnight.
And the world needs other goods besides tainted pet food and cheap consumer products that break every 6 months. Are you trying to say that the stuff China makes can only be made in China? I understand the law of comparative advantage, but nothing is set in stone.
This still doesn’t prove the world needs the U.S., China, or anyone else. Many things that China once made were made in the U.S. and elsewhere, and many things that the U.S. makes can be made elsewhere given the proper circumstances.
China’s politically stable? Its domestic banks are still nationalized, its citizens have virtually no political freedom, and the disparity of wealth between the coast and mainland is causing a lot of unrest. China has plenty of its own problems. Also, the Chinese “miracle” is only a recent phenomena - say over the past 30-40 years. Who are you to say that similar markets couldn’t appear elsewhere over another two generations?
I already said that China can not be replaced overnight. But it can be replaced if necessary. The modern economy is fluid and adaptable to adjust to developing and shrinking markets around the world. A lot has changed over the past few generations, and the pace of change will be even quicker as time passes.
Agamentus, the issue is this. Sure, China can be replaced, but not “on the go”, we both agree to that. But the sheer manufacturing capability China now sports (if I remember correctly it employs over 25% of their workforce and accounts for over 45% of their GDP, a monster number by any standards) makes it extremely hard to replace in a short time. That’s why I say the world needs China. Where would the West buy the flat screen TV’s, the designer clothes, even the car parts it needs to keep up its standards of living in face of decades of economic mistakes? Factories can be set up in India or Thailand but they would take time to get into full operation. Also the Indian and Thai governments may prove less enthusiastic than China about currency manipulation, making exports more expensive nonetheless. The West has no patience: they want their cheap consumers’ goods and they want them damn right now. The final nail in coffin of the DDR was not the vast network of police informants, the secret tribunals or the Berlin Wall but the inability to keep stores stocked with goods at prices everybody could afford. Materialistic and surely much less noble than the struggle for freedom but that’s how it went.