Mixed Signals

Mixed Signals

The Chinese and the U.S. central banks are sending out two completely different messages to the global market. China, with looming in fl ation, is raising interest rates and the reserve requirement ratio to curb runaway consumer prices. The United States, on the other hand,is pumping money into the market, attempting to overcome mounting economic challenges. Li Daokui, a member of the central bank’s Monetary Policy Committee and a finance professor at Tsinghua University, said high liquidity and high currency stocks could lead to economic instability in an interview with China Central Television.Edited excerpts of the interview follow:

Li Daokui

It is time for the central bank to adjust its monetary policy from moderately accommodative to moderately cautious. And the central bank needs to take a string of measures such as interest rate hikes to reduce the liquidity. Luckily, the Chinese central bank has already done so by raising the benchmark interest rate by 25 basis points and the reserve requirement ratio fi ve times this year,which has sent a clear signal to the market that stringent money supply can be expected and that it might not be a good idea to take out bank savings to invest in the stock market.

China’s economic growth is stabilized.Therefore, if we have to choose between securing growth and controlling in fl ation, the latter becomes the primary issue and needs to be addressed appropriately. The government,however, should stabilize citizens’ expectation for in fl ation by measures like raising the interest rate to such a level that it can beat in fl ation growth.

The Chinese capital market is running healthily with investors becoming more rational and the price per earnings ratio maintained at a reasonable level. Institutional, or professional, investors now account for half of all investors in the stock market, which is a stable force in the volatile market.

The dollar nightmare

At the G20 summit in Seoul, South Korea, in November, the U.S. quantitative easing policy was criticized by many countries.

In the U.S. camp, the influence of the U.S. quantitative easing policy, aimed at expanding investment and production, might be very limited on stimulating economic recovery. It is because the old and inherent economic problems in the U.S. fi nancial system have not been resolved and continue to thwart the goodwill policy.

U.S. banks are now plagued with heavy debts and toxic assets and they are supercautious in lending and investing. At present,even though they are loaded with money thanks to the government’s generosity, they are still reluctant to lend, as they believe lending is a risky game in the United States.Then that money is taken by investment funds or hedge funds out of the United States and put into other markets. In other words,the money injected by the U.S. Government does not stay in the United States, but works its way into markets with high yields. It is a core problem clogging the U.S. economic development.

In the short term, the massive greenback injection will push up asset prices, but the effect will soon fade away. Both the United States and European countries are at economic dead ends since they cannot come up with any better idea than printing more money. More money means higher prices, as reflected in the surging raw material prices in the international commodity market. It will deal a heavy blow to emerging industrial countries like China, as we need those commodities for production. The developed Western countries, however, have already industrialized and urbanized with little demand for raw materials. So naturally, this is something we are worrying about.

The large injection of greenbacks will undoubtedly lead to a curtailing of China’s foreign reserves, as most of our reserves are denominated in U.S. dollars. As such, the U.S. Government should consider compensating holders of U.S. Treasury securities.

The yuan issue

China is like the 16-year-old version of NBA player Yao Ming. It was pushed onto the global arena at a young age, but was not ready for so much attention and popularity.

After the outbreak of the fi nancial crisis,the United States repeatedly attacked China’s currency out of pure political concerns.China should not play the currency game with the United States.

The Obama administration has a huge misunderstanding of the U.S. and Chinese currencies. They tend to believe if the Chinese yuan appreciated to 4 yuan per U.S.dollar from 6.8 yuan per dollar, China’s exports to the United States would drop significantly, thus reducing the U.S. trade de fi cit. The logic is totally wrong.

The yuan appreciation is a zero sum game for both China and the United States.

Let’s assume the Chinese yuan appreciates to 4 yuan per dollar. This could result in losses of export companies. But I believe most of the owners will hold on to their factories as they have invested a lot in their factory facilities and hired a number of employees. They must continue production even though they are losing money. The United States, on the other hand, cannot fi nd a replacement of Chinese manufacturers in one or two years, and it is also impossible for U.S. entrepreneurs to set up factories in Malaysia or Indonesia on such short notice.Therefore, the only way out for the Chinese exporters is to raise their prices and transfer the currency appreciation to U.S. consumers.The United States will therefore continue to have a huge trade de fi cit with China, and rising prices of imported goods will ultimately lead to rising in fl ation pressure in the United States. Therefore, the yuan appreciation will do no good to either China or the United States, as the unemployed and poor families who depend highly on low-priced Chinese products will fi nd their lives even more diffi cult.

At present, China’s trade surplus with the United States has been greatly reduced thanks to China’s efforts in economic restructuring and upgrading to its industrial production. I expect the 2010 trade surplus will decline to $180 billion—accounting for less than 4 percent of the country’s GDP rather than 9 percent of the pre-crisis level.This means the Chinese exporters are changing their business pattern and are selling more products in the domestic market, and they are making a contribution to the world trade balance.

The U.S. Government, for sure, knows this, but they are reluctant to talk about it,as U.S. citizens do not have the patience to listen to any explanation on political issues.What they are willing to hear is a 30-second pep talk about how Chinese exporters steal U.S. jobs and make their lives miserable.

I had a face-to-face talk with former U.S.President Bill Clinton a few days ago. He said the United States itself was the culprit for the financial crisis and it should not make China the scapegoat. He said since he no longer had to campaign for any position in the government,he could now speak out the truth. But how can Barack Obama, who is now the U.S. President,talk to his citizens like that?

Therefore, China must stick to its own principles and should not tolerate any attempts to appreciate its currency. A moderate and controllable yuan appreciation in line with China’s own economic targets is what we need and we should not subject to any outside pressure.