Premier Wen Jiabao made stabilizing prices China’s top economic priority for 2011. Amid the surge in world energy costs, this story didn’t make the front page. However, Chinese policymakers did take their time spent out of the limelight to allow the Chinese yuan to appreciate roughly 0.3% against the US dollar.
Chinese inflation is elevated and near 5% (4.9% is the official rate as of January 2011). I understand that China’s growth adjustment will take time; but if you’ve got unwanted inflation, then domestic policy is too loose (fiscal or monetary). And in this case, it’s the monetary policy that’s too loose – that goes for both currency and rates policies.
On the rates front: there’s a very frothy feel in domestic asset markets, specifically the property market. Low rates and easy money have sparked a(nother) property boom in China, one that policymakers are trying to tamp down. From the Economist:The Chinese government has unveiled a series of measures since April 2010 to mute house-price inflation. They include raising the minimum downpayment for first-time buyers to 30% of a home’s value, up from 20% before, and a stop on mortgages for people buying a third or subsequent home. These measures have had some success. The year-on-year price rise has slowed down: in December it was 6.4%, not that much higher than the overall inflation rate.
Even so, the market continues to look extremely buoyant on many measures. Total property loans outstanding last year rose by 27.5%, which at least was slower than in 2009. Policymakers lean towards further tightening. A property tax was announced in Shanghai and Chongqing at the start of this year, causing a rush to seal deals before it takes effect. Transactions in Shanghai in the first half of January reportedly jumped by more than a third year-on-year, according to local estate agents. Wen Jiabao, China’s prime minister, has said he wants to see the residential market return to a “reasonable level” before his term of office ends in 2013.
But it’s going to take much, much more than raising down payments and reserve requirements to shore up demand for risk assets. I mean, it really doesn’t take a genious to see that real rates are entirely too low. What’s the investment strategy here: nominal GDP is expected to grow at a 11% in 2011 (according to Economi Intelligence Unit, no linke), while the lending rate is just 6.8%. There’s no rocket science here: money’s entirely too easy and inflationary pressures are there.
Furthermore, deposit rates are likely low and tabs on domestic demand. Rates need to rise.
On the currency front. Although there’s been a little recent appreciation in the nominal rate of the Chinese yuan (see chart below), the Chinese have only recently allowed their currency to fluctuate at all (again) on an annual basis: October 2010, to be specific. Without nominal appreciation, there’s inflation, since the central bank doesn’t fully sterilize the inflows of foreign currency from export sales.
Inflation is rising, a fact that is driving up the Chinese real exchange rate. The real exchange rate, which takes into account the nominal rate plus shifts in the ability to buy foreign goods as measured by relative price fluctuations, is appreciating at a 4% annual pace, according to JP Morgan’s real trade weighted yuan index.
You’ll notice that the nominal exchange rate is now gaining traction on an annual basis, since the Chinese government halted its movement against the USD in 2009. I suspect that the Chinese will allow the nominal momentum to continue and slowly allow its currency to fluctuate upward in order to temper just some of the inflationary impetus coming from outside its borders (like Fed policy). But as I said, it’s not just the Fed policy, it’s Chinese policy that’s too loose at home.
The problem is, that Chinese policymakers want to rein in accommodative policy without raising rates too much because they don’t want the currency to appreciate markedly and are unable to fully sterilize all the flows, so inflation results.
If China’s policy makers really want to make controlling price inflation the top economic priority, it seems the answer to this self-induced problem is pretty easy: raise rates and allow the currency to appreciate.