Current Fallacies About the Chinese Economy Part I
I rarely address the work of others on China because typically any disagreements I have are more technical or nuanced, the arguments or conclusions too ridiculous to take seriously, or simply that I don’t have the time. However, a number have gained popularity recently that range from the not really true or accurate to the downright false
The RMB has failed to become a major international currency because the RMB fell against the USD. Apologists both inside and outside China have come up with increasingly elaborate reasons why the RMB has failed to gain traction on international markets. Benn Steil at the Council on Foreign Relations lists three specific reasons. “First, the dollar-value of the RMB has been falling steadily….Second, China has tapped out its export potential….Finally, globalization broadly has headed into reverse.” All three points are entirely true and entirely irrelevant to whether the RMB became a global currency. As Steil notes, the RMB has fallen by a grand total of 12.8% from 2014 to 2016 for an average annual decline of 4.1%. Quite frankly, by major currency movements this is irrelevant. Let me give you two facts to put this in perspective. First, since the beginning of 2014 the RMB against the USD has enjoyed the smallest within year peak to trough movement compared to other major currency pairs. Here I am including the USD against the JPY, EUR, GBP, CAD, AUD, and CHF. In other words, this supposed extreme movement is actually quite small compared to other currency shifts.
Second, of the currency pairs considered, the RMB was actually the third smallest declining currency against the USD from January 1, 2014 to December 31, 2016. The RMB is only slightly worse than the JPY and the CHF by 3.1% and 1.4% respectively. This however is far better than the declines in value of the EUR, GBP, CAD, and AUD falling 23.1%, 24.8%, 26.0%, and 19.1% respectively. In short, the idea that investors were scared off a declining RMB or some type of volatility is factually wrong.
Nor does the argument that the RMB failed to become a global currency due to flat or declining international trade levels stand up to scrutiny. While the factual point is accurate that China has experienced flat or declining trade growth, this has no bearing on whether the RMB could have become a major global currency. Let me give you three points to consider. First, China is the largest trading nation on the planet but somehow Steil believes them to be helpless to trade in their own currency. Where else could anyone make a remotely credible argument that the player with the largest market share has no influence over a market? Think about writing with a straight face that Microsoft has no impact on the operating systems market or that Apple cannot influence the smartphone market. To argue that the largest trading nation has no influence on the currency it trades in is simply not credible.
Second, walk through a quick thought experiment that will demonstrate the trade slowdown is irrelevant to the analysis. A) Assume that Chinese trade expands 20% every year during this period but it still decides to impose strict capital controls with drawing offshore RMB to control the USD/RMB exchange rate OR B) Assume that Chinese trade is what we have seen the past few years and China decides instead to push traders to invoice in RMB, let RMB flow into offshore markets, and allow global markets to set the RMB/USD price. Will scenario A or scenario B result in a more globalized RMB? Clearly scenario B.
There are two key points at play here. First, fundamentally trade growth is irrelevant to whether the RMB becomes a global currency. As noted China is already the largest trading nation in the world which effectively limits to some error rate around the global average. It simply cannot grow in much in excess of the global average. For the future, China will never be able to globalize the RMB if it needs as a pre-condition double digits growth rates in trade. Second, it remains entirely a policy decision of the Chinese government not an exogenous variable foisted upon the RMB or Beijing whether the RMB becomes a global currency.
Finally, the argument that RMB globalization will grow in correlation with trade growth is not borne out factually. The facts presents a much more complex picture. If we go back to January 2012, both RMB deposits and Hong Kong and the rolling 12 month level of imports are at nearly the same level today as they were in January 2012. However, during that time while Chinese imports rose as much as high as 115 from a 100 base and dropping as low as 91, RMB deposits soared as high as high as 174 and currently sit at 89 dropping quickly every month.
The general directionality is somewhat similar with a correlation coefficient, as a simple measure of .49, but the RMB deposits proving highly elastic. Furthermore, what is notable is that in recent history, they have been negatively correlated. Since August 2016, imports growth has mostly been moderately to robustly positive with only two months experiencing YoY negative growth. However, during that same time RMB de-globalization has continued apace. Using our figures where January 2012 equals 100, July 2016 imports were equal to 91.59 and March reported a 96.92. During that same time, using the base 100 scale, RMB deposits in Hong Kong dropped from 115.82 to 88.79 in February the last month we have data for. In other words, just on the simple empirics of the assertion that RMB globalization stopped due to trade weakness, the evidence contradicts this argument.
It may be argued that China opted not to liberalize the RMB in what was effectively a down market. While it may be argued that Beijing opted for this policy course based upon the weak growth in trade, since they did not opt to globalize the RMB when trade was strong, it is difficult to give this argument serious credence for a few specific reasons. First, markets do not always give specific participants the outcomes they want, they give the market the outcome the markets wants. Beijing withdrawing its support for a global RMB when the price declines is simply evidence that Beijing does not want a global market priced RMB but a price and flow dictated by Beijing. They will be happy to let it be “market based” when it does what they want but kill the market when it does not behave according to their plans.
Second, and this is the crux of the entire problem, the RMB will never be a global currency absent totally free price setting and flow mechanisms. By definition, a global market place will set the price for a global currency. Chinese apologists talk about the RMB but can never explain how a currency becomes a global if that currency is a) not diffused throughout the world or b) is diffused throughout the has a price set by an administrative body in Beijing. Simple fact of the matter, as Beijing discovered, even a relatively small amount of RMB in Hong Kong created a “market” price that Beijing did not like and it has moved relatively quickly but very forcefully to quash.
The idea that China has solved the flow problem is simply due to the fact that China has imposed near draconian capital controls which even impact basic trade payments. The idea that Beijing is somehow swept along unable to control due to the whimsy of global trade whether the RMB becomes a global currency is simply false. It is not borne out by the either the data or basic economics. Beijing can choose not to globalize the currency and that is their right but it is important to note that is their choice.
Note: I will continue this series because there are many fallacies being circulated about the Chinese economy. I also will finish the rebalancing series