Enjoy these nice articles and have a good weekend.The establish wisdom of big gurus that 'convertibility' is nirvana is finally breaking-
Markets lack means to bet against the Chinese currency
because it isn't freely convertible
By Peter Passell
RIEFING reporters before US President Bill Clinton's arrival
in China, US Treasury Secretary Robert Rubin explained
that the Chinese economy was "an island of stability" -- the
only Asian power that was still growing, the only one whose
currency had not taken a dive since the troubles swept the region last
summer.
What he didn't explain is that
China's economy is
fundamentally in no better
shape than, say, Indonesia's.
Or that the primary reason the
Chinese yuan hasn't budged is
that currency markets lack the
mechanism to topple it: Unlike
most Asian economies, China
does not allow anyone to
exchange its currency for
dollars or yen without
government permission.
Does that mean the hordes of economists who counselled developing
economies to adopt convertible currencies as quickly as possible
were wrong?
"Frankly," said Fred Bergsten, the director of the Institute for
International Economics in Washington, "the answer is 'yes'."
With hindsight, it is easy enough to do a Dorian Gray-style analysis
of the Asian economic miracle. Vast domestic savings and sheer
hard work effectively masked the fragility and lack of sophistication
of institutions that support modernisation in a capitalist economy.
As a result, Asia was able to grow rapidly through the 1980s and
'90s, even though far too much money went into grandiose,
ill-advised investments and too many banks and businesses took
open-ended risks by borrowing heavily in foreign currency.
But the often-corrupt, top-down capitalism that weakened the
economies of Thailand, Malaysia, South Korea and Indonesia
describes China equally well.
Indeed, Indonesia had a more solid institutional base on which to
grow. Indonesia's private banks, largely left alone by former
president Suharto's family and friends, flourished. Moreover, unlike
China, Indonesia carried far less baggage in the form of inefficient
state-owned industries with debts that could not possibly be repaid.
However, when currency panic spread from Thailand and Malaysia
in the second half of last year, Indonesia proved extremely
vulnerable.
For one thing, it was easy to bet against the Indonesian rupiah
because it had long been legal to exchange rupiah for other
currencies. For another, Indonesian banks and industries owed
billions of US dollars to banks and bondholders that were callable on
a few months' notice.
In China, by contrast, there was no easy way to make a currency bet
in which you win if the yuan were devalued. To buy dollars with local
currency requires permission from the Chinese central bank, which is
not forthcoming unless it serves government policy.
Moreover, Chinese banks and corporations have very little
short-term dollar debt because Beijing won't co<->operate. Lenders
won't lend dollars because they can't be repaid unless the
government agrees.
Most foreign investments in China are thus in the form of equity in
Chinese subsidiaries of foreign corporations or in long-term loans to
Chinese corporations that are tied to machinery imports such as
aircraft.
While hindsight has not been kind, there was method to the seeming
madness of all those economists who pressed developing countries
to allow free convertibility of currencies.
Among other things, convertibility attracted foreign capital by
reassuring investors that they could always repatriate their profits. It
gave local importers and exporters a means of hedging their currency
commitments. It reduced incentives for government corruption.
But George Perry, an economist at the Brookings Institution, notes
that the exceptionally high domestic savings rates in Asia (in contrast
to Latin America) minimised the advantages of free convertibility.
"What Asia needs is foreign technology and business organisation,
which comes with direct foreign investment, not dollar loans," he
said.
While an inconvertible currency creates inefficiency since government
bureaucrats ultimately decide who has access to foreign cash, the
cowboy capitalist ethic of financial markets in developing countries
creates equally important inefficiencies.
After all, private lenders in most of Asia were plainly out for the
quick profits that came with borrowing in foreign currency -- and
thus apt to ignore their exposure to currency fluctuations.
With a convertible currency, "you're betting the farm on the vagaries
of the international markets", said Jagdish Bhagwati, an economist at
Columbia University.
China is not entirely immune to the Asian currency flu. As Beijing has
publicly acknowledged recently, China will eventually feel compelled
to devalue the yuan to insure that its exports remain competitive. But
devaluation is probably months or years off, both because Hongkong
would be adversely affected and because China is enjoying the
prestige derived from currency stability.
But the Chinese focus on stability is the exception in a global
economy full of opportunistic borrowers and pathologically optimistic
lenders.
The best hope now, suggests Mr Perry, is that "we will finally
respond to the alarm bell that rang three years ago in the Mexican
peso crisis". The movers and shakers of international finance, he
argues, have to make clear that freely convertible currencies are
accidents waiting to happen. -- NYT
By Quak Hiang
Whai
22 Jun 1998
Flaws in yuan
devaluation theory
Move would jeopardise China's most ambitious
economic reforms ever
OR weeks, the markets have been hit by the somewhat flawed
speculation that China could soon be forced to devalue its currency.
The argument is that the weakening yen is pushing back recovery in
Asia and undermining the already diminished foreign capital flows into the
mainland.
A dip of 1.5 per cent in Chinese exports in May and rhetoric by Chinese
officials have reinforced the devaluation argument. As South-east Asian
currencies have suffered major devaluations which make their exports more
competitive, the suggestion is that China must weaken its currency to protect
its market share. If the yuan is devalued, the Hongkong dollar peg will
collapse, the argument goes.
Hedged funds and speculators can pick any theme they like if they choose to
sell down a market to make money. But by all accounts, a devaluation really
does not benefit China. If anything, it may be disastrous for a country which is
embarking on its most ambitious economic reforms ever -- the results of which
could determine the mandate of the leaders and the survival of the Communist
Party.
The first flaw in the devaluation theory is that China is in deep economic
trouble because of its strong currency. True, the strong yuan has eroded some
of its competitiveness. But the country is far from any economic catastrophe.
China still has some of the cheapest land and labour costs in the region despite
the asset deflation elsewhere in Asia.
To a large extent, the economic slowdown has also been a result of the more
selective policies by the government as it picks foreign investments which add
value to the economy rather than non-productive ones such as property
developments in the overbuilt economic zones. But really, one should first ask
if the Chinese economy is in such a gloomy state as to warrant a devaluation.
As Sassoon Securities pointed out recently, China has continued to boost its
exports despite the "more competitive" regional currencies. While the dip in
the May trade figures looked worrying, other South-east Asian countries may
have suffered even harder falls in May.
The second flaw in the devaluation talk is that manipulating the currency was
the only way out. Those who still remember their economics textbooks would
know devaluation is but one of the ways to boost exports and the economy.
Most governments see it as a last resort, since it risks triggering massive
capital flight and shattering public confidence. Reports in the last few months
suggest China is about to embark on its largest public expenditure ever
especially in infrastructure development and domestic housing.
As Sassoon also argued, China's deflationary problem lies not with exports
which make up only 15-20 per cent of gross domestic product but with the
other 80-85 per cent tied to the domestic sector. Other policy options include
fiscal incentives such as public infrastructure spending and attractive rebates to
foreign investors and exporters.
Besides, many also overlooked the fact that China has a newly installed
government headed by Prime Minister Zhu Rongji. Would such a new team
still looking to consolidate its position back away easily from a pledge it made
so frequently and openly to its people? Devaluation supporters should also
ask -- can China and Hongkong possibly devalue themselves into competitive
positions given the jittery currency situation in the region? Any devaluation by
China would surely trigger another wave of speculative attacks on other
regional currencies to level the score with the yuan. Worse, in such uncertain
times, monetary stability is probably the only thing going for China and
Hongkong, and its loss would trigger capital flight and freeze new investments.
In recent weeks, the speculation about a break or repegging of the Hongkong
dollar has picked up steam. Again, one cannot see how this could aid
Hongkong. For one, it is almost certain that interest rates would not go down
even after the peg is removed. If so, then what's the use of removing the peg?
Financial guru Marc Faber argued last week that hard pressed tycoons could
swap their holdings into US dollar assets and force the government to break
its peg. That is easier said than done. Who are they going to sell to? If
everyone is selling, who is going to buy from them? And at what price? In any
case, it is almost impossible for the tycoons to fully hedge their Hongkong
assets without incurring huge hedging costs.
Much has also been said about how the Hongkong peg would go should the
yuan be devalued. But Hongkong survived the Chinese devaluation in 1994
and went on to enjoy its biggest economic boom thereafter. As John
Greenwood, the architect of the Hongkong peg, pointed out, Hongkong has
survived a depreciation of some 70 per cent in the yuan in the last decade.
All said, the current economic turmoil really has to do with market confidence
and not currency competitiveness. Tinkering with one's currency does not
boost international confidence in one's economy. In fact, it is almost certain to
have the opposite effect.
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