stratfor.com
Chinese Insistence on Supporting the Yuan Masks Deeper Problems
As the Russian financial system crumbles, the focus of international attention must remain on
China. With Russia's economic future fairly clear, the remaining major question in the global
economy is whether and how long the Chinese will manage to hold the line. The pivotal
question has become the future of the yuan. With the collapse of the rest of Asia's currency
structure, it would have seemed inevitable that China would be forced to devalue its currency
as well, in order to maintain a rough competitiveness in the price of its exports. However, the
Chinese government has not only refused to devalue the yuan, but has made the currency's
defense a fundamental policy objective. Thus far, they appear to have succeeded.
Appearances can, of course be deceiving. The yuan has already declined. According to the
Hong Kong newspaper "Ming Pao," the black market price in of the yuan has fallen to 8.9 to
the dollar, as compared to the official rate of 8.6. This represents a decline of about 3.5
percent. Since the Yuan is a controlled currency, there is a normal discount between the street
price and the official rate. But the rates began to gap last week, amid rumors that the Chinese
government would devalue the yuan in relation to its coal exports. This rumor helped create
the gap, since a partial devaluation is hardly sustainable. The gap continued to widen, clearly
alarming the Chinese government.
In response to this, Beijing kicked off a vigorous campaign to stabilize the yuan, issuing strong
warnings to speculators. Officials reminded them of the strength of the Chinese economy and
of the willingness of the Chinese government to defend the yuan. Liu Mingkang, deputy
governor of the People's Bank of China, warned speculators not to "bet" against China, which
he said still holds $140 billion in foreign exchange reserves. Hong Kong's financial secretary
warned that speculators attacking the Hong Kong dollar would be similarly smashed, noting
that the mainland's currency reserves will defend the HK dollar. The Chinese ambassador to
Tokyo took up the cry as well. This warning was urgently repeated by other officials and in
the Chinese media in an orchestrated campaign.
One interesting question is who this warning was directed at. The yuan is not traded on highly
liquid markets, so arbitrage masters like George Soros are hardly going to raid it. The
mechanisms for a major move simply aren't there. The real targets for this barrage of
reassurances was not foreign speculators but domestic Chinese, who have been scrambling to
buy hard currencies in anticipation of devaluation. Earlier this month, new regulations were put
into effect which stated that Chinese financial institutions would have their operations
suspended if they permitted customers to illegally purchase foreign currency. Chinese citizens
need government issued permission to purchase and hold foreign currency.
The mystery here is: Why is the Chinese government waging an international campaign to
convince its own citizenry not to dump the yuan for dollars? Given control mechanisms,
foreign speculators can't force the yuan down without the government's agreement.
Speculators are not the major force in the black market. So issuing statements in Tokyo is
fairly pointless. Vigorous enforcement of currency laws should be enough. Yet, facing a
domestic problem, the Chinese government is conducting an international campaign.
Explaining this strange behavior requires us to consider a broader oddity. What is the big deal
in devaluing the currency? With the rest of Asia's currencies slashed, devaluing the yuan
would seem a logical and prudent move. After all, China is an export oriented economy and
the artificial inflation of its currency relative to its competitors' and markets' currencies places
China at a disadvantage. Indeed, the Bank of China vowed last week to increase its support
of exports with favorable financing arrangements, because China needed foreign trade to
grow this year by 10 percent. Now, if that is the goal, then refusing to devalue seems not only
strange, but counterproductive. Again, what is the big deal? Chinese explanations, including
fear of inflation and a fear of weakening the rest of Asia simply don't explain the refusal for
even a modest readjustment in currency levels.
So, we have two facts. First, the Chinese government is doing everything it can to convince
non-Chinese that China is not going to permit the yuan to decline, in spite of the fact that
foreigners have relatively little influence over that decision. Second, the Chinese unwillingness
to devalue runs counter to the export obsessed Chinese economic strategy. Why defend an
arbitrary value for your currency when it will undermine your core economic strategy? And
why is China trying to convince foreigners that it will not change a clearly counterproductive
policy.
At the core of their argument is a key assertion, made over and over again, that they hold
$140 billion in foreign currency. It is this claim that convinces the world that China will float
above the Asian disaster. It is this assertion that encourages U.S. companies to continue
investments in China; to continue to finance Chinese commercial paper that is dollar
denominated; that allows non-Chinese to do dollar denominated business with China. If that
claim is false, then the infrastructure of Chinese export trade will begin to evaporate.
China is desperately trying to convince outsiders of its reserve level, not because of its
currency concerns, but to persuade them to continue carrying out dollar denominated trade.
The current campaign has little to do with the yuan and everything to do with the claim of
massive reserves. Yet reports in the past two days report the Chinese selling yen fairly
intensively, in spite of its depressed price. We think this has less to do with the Chinese
evaluation of the yen and more to do with the need to sell foreign currencies in order to cover
debts.
In other words, we are not at all convinced that China has reserves of $140 million. We do
not know the true level of Chinese reserves, but we do know that the universal characteristic
of the Asian crisis is that government claims on currency reserves, on banking liquidity and on
bad loans and so on, have in every case proven to be false. We see no reason to believe that
China is the exception. Indeed, China is perhaps the least transparent and least regulated
banking system. We don't think that the Chinese have anywhere near $140 million in reserves.
If they did, they would ignore speculators, they would carry out a modest devaluation, and
they wouldn't give it a second thought.
We are becoming convinced that the Chinese are attempting to convince foreigners that they
are in better shape than is actually the case in order to maintain the trade facilities they
desperately need to maintain their economy's stability. Bellicose threats, inflexible currency
policies, unrealistic growth targets, and obsession with exports even at losses, do not add up
to the image China is trying to project. Countries with $140 billion in hard currency reserves
don't behave inflexibly. Countries in financial trouble, trying to convince outsiders that there
are no problems, do behave this way. That's why they are cracking down on every citizen
holding foreign currency. Not because they are rolling in money, but because they are running
out. |
