Greenspeak: one more reason for the house of cards to fall.
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Greenspan warned that if China were to let its currency float immediately, it could threaten the world economy. 7:45 p.m.
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Greenspan Warns About Yuan Float
Fed Chief Says Removing
Currency's Peg to Dollar
May Hurt China's Banks
By GREG IP
Staff Reporter of THE WALL STREET JOURNAL
WASHINGTON -- Federal Reserve Chairman Alan Greenspan warned that if China were to let its currency float immediately, as many in the U.S. want, it could weaken that country's banking system and threaten the world economy.
As much as 50% of Chinese bank loans are nonperforming, Mr. Greenspan said in a letter to Senate Banking Committee Chairman Richard Shelby (R., Ala.). The banking system can operate that way only if depositors don't pull out their money, he said. Many in China fear that lifting capital controls, necessary for a floating currency, "could cause an outflow of deposits from Chinese banks, destabilizing the system," which would "present a risk to the global economic outlook."
China pegs the value of its currency, the yuan, to the dollar via strict controls on the ability of local and foreign investors to exchange yuan for dollars. As imports from China have surged, U.S. companies complain that that peg has kept the yuan artificially cheap and given Chinese companies an unfair advantage in the U.S. market.
The Bush administration, led by Treasury Secretary John Snow, has steadily ratcheted up pressure on China to float its exchange rate, but so far without success. Last week, Mr. Snow acknowledged, "It's going to take some time." Treasury officials visited Beijing last week to advise on technical aspects of making the move.
Mr. Greenspan's letter, released by Mr. Shelby's office, responded to follow-up questions stemming from his recent appearances before Congress. Mr. Shelby had asked Mr. Greenspan to elaborate on a speech he made in Dallas in December. In it, he said China's pegged exchange rate ran the risk of fueling inflation and eventually triggering recession in that country.
His latest remarks suggested there were also risks in the other direction, and that before floating its exchange rate China should fix its banking system.
China, he said, needs to strengthen bank accounting and regulation, inject more government capital into the banks so that bad loans can be reserved against, and "eliminate state interference in bank lending decisions." To do this, bank managers "need to be given training, incentives and authority" to evaluate credit risk and make loans accordingly. He noted the Chinese government appears to be moving in this direction.
Meanwhile, China's central bank in recent weeks has quietly broadened the scope of a nearly one-year-old program designed to keep the rigid exchange-rate system from overheating the economy. Other cooling efforts have been aimed at cutting loan growth.
This year, the central bank has redoubled efforts to soak up, or "sterilize," record amounts of money supply. Data from the central bank and market participants suggest that in January and February it had already absorbed yuan valued at a net $13.9 billion from the banking system, more than it did in all of 2003, when around a net $9.1 billion was absorbed.
Mr. Greenspan also reiterated recent comments that the dollar's decline so far "has been gradual," and has had no noticeable impact either on stock and bond markets or on inflation.
But he said because the U.S. current-account deficit with the rest of the world is so large, foreigners may become reluctant to purchase U.S. stocks and bonds to finance it. Reducing the U.S. budget deficit would limit the risk that such a withdrawal of foreign investment "could severely crimp" business investment in the U.S.
He that noted while import prices in the U.S. are now rising instead of declining for several years, the "turnaround to date has been mild." Eventually, he said, depreciation would "help to contain our current account deficit" as foreigners export less to the U.S. and the U.S. exports more.
Write to Greg Ip at greg.ip@wsj.com
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