William Pesek Jr. is a columnist for Bloomberg News. The opinions expressed are his own.
China May Be a Prisoner of Greenspan's Fed: William Pesek Jr.
May 28 (Bloomberg) -- Your move, Alan.
That seems to be the thought foremost on the minds of Asian policy makers, particularly China's. As they mull their own outlooks, it's impossible not to factor in what Federal Reserve Chairman Alan Greenspan will do with U.S. interest rates.
It's hard to exaggerate the Fed's influence here in Asia. The U.S. economy is by far the largest and its central bank affects global rate trends everywhere. Take China, whose currency is pegged at 8.3 to the U.S. dollar; it essentially makes China's monetary policy a prisoner of the Fed.
It's an important point that's often missed by investors. That China is experiencing irrational exuberance, mainland style, is well known and economists the world over are calling for higher rates there. Far less well known, though, is the extent to which China's hands are tied by the Fed's actions -- or lack thereof.
Boosting borrowing costs for the first time in nine years would help China cool an economy that grew 9.1 percent in 2003. Trouble is, doing so would attract deposits in Chinese yuan, forcing the government to spend even more money selling the currency to prevent it from gaining against the dollar.
Fed Will Lead
``If China were to raise its rates today, then they will be generating more pressure on the yuan,'' Hong Kong Financial Secretary Henry Tang said in an interview. That's why ``it will be the Federal Reserve leading'' Chinese authorities.
Tang, who has close contact with officials in Beijing, has more than a passing interest in all this; the Hong Kong dollar is pegged at 7.8 to the U.S. one. And Tang expects a U.S. rate increase to happen ``pretty quick.'' Surging job growth and rising goods and services prices are fueling talk of a move when Fed officials meet on June 29-30.
China is already behind the inflation curve. And the aggressive monetary tightening it has needed for some time seems at least a month away. Many investors fear China already is overheating, and Asia's No. 2 economy may become even hotter in the interim.
So far, efforts to regain control of China's economy have focused on clamping down on credit growth. With money supply growing in the vicinity of 20 percent, though, officials in Beijing need far more drastic measures.
Gradualist Approach
Here, the Fed's gradualist approach may be a problem for China. Even if the U.S. central bank moves next month, it's only expected to raise its overnight lending rate to 1.25 percent from 1 percent. China needs to tighten considerably more than that.
All this gets at one of the most convincing arguments for China to scrap its dollar peg. Only when its exchange rate isn't pegged can the People's Bank of China run an independent monetary policy. Yet only when China's economy matures and its banking system is sound will that be possible.
In the meantime, China's economy-slowing options are limited by Greenspan's reluctance to step on the brakes more forcefully. It's ironic when you consider the Fed's easy money policies probably played a role in China's economic bubble.
Keeping U.S. rates so low for so long fueled speculation in high-risk assets. One of the byproducts was an investment boom in China fueled by cheap capital. Some of it invariably reflected so- called ``dollar-carry trades,'' in which investors borrow cheaply on dollars and put the money in riskier markets.
Two Possible Outcomes
Such speculation will most likely end in one of two ways: By the Fed reversing its policies or a financial meltdown caused by the leverage building up in higher-risk assets.
A Fed reversal seems the more likely -- and desirable -- scenario. Yet that's hardly comforting people here in Asia who remember the events of 1994. It was then that the Fed boosted short-term rates from 3 percent to 6 percent within 12 months.
The actions precipitated meltdowns in U.S. bonds and emerging- market debt around the globe. Markets eventually calmed down, but not before the fallout helped sink Mexico's economy, Orange County, California and venerable Wall Street firm Kidder Peabody & Co.
At issue here in Asia is what the most powerful central bank does this time around. A few moderate Fed rate increases this year may be just fine by this region's booming economies; a repeat of 1994 would be anything but.
``Three hundred basis points by the Fed would be quite a shock,'' Tang admitted.
Fixated on Greenspan
While few think Greenspan will make that mistake again on rates, it can't be ruled out with the Journal of Commerce Industrial Commodity Price Index up 33 percent over the last 12 months and U.S. growth bouncing back.
That explains why Asian markets are fixated on the Fed. The currency-market environment, for example, is ``more volatile than I've seen it in many years,'' William Ryback, deputy chief executive of Hong Kong Monetary Authority, said in an interview.
Asia is far more connected with the global economy than a decade ago, and it is increasingly relying on a stable China. Japan's recovery also owes much to China. This region could be in bad shape if the Greenspan Fed makes the wrong moves on rates. |
