Asia Centre

These measures did mean that the crash was avoided, but not that the Chinese economy slowed down. The problems  could not but recur. On 11 September last, the National Bureau of Statistics announced that the consumer price index for August had increased by 6.5%, a ten year high. In July, the cost of foodstuffs climbed by 15% and that of pork by 90%. Earlier, during the spring and summer, people had started to talk about an oversupply of liquid assets  (流动性过剩), a new expression that took the place of the "overheating" of three years ago.

The article in Zhongguo Guoqing Guoli offers a very pessimistic report on this "objective" situation (一个客观事实). For its writer, the only way to resolve the problem of this oversupply of liquidity is to reevaluate the yuan, a diagnostic shared by many Chinese. At the present time, China has deposits of 35 000 billion yuan (that is, an increase of 1 875 billion yuan over the previous year), 15 000 billion yuan worth of A shares, and, on average,  600 billion new investments in cities every year. According to estimates, the June excess went from 1100 to 3600 billion yuan (3 000 billion according to Zhang)[1]. The relation monetary mass M2/GDP amounted to 165% in 2006 (209 000 billion yuan of GDP, 346 000 billion of M2), compared with 55% in the United States.

Chinese monetary aggregates at the end of March 2007

Where do these surpluses come from?

For Zhang, the surplus liquidity is not related to policies broadening the monetary base, but to the exchange rates. The "double surpluses" in the trade sector (双顺差, – 46 billion dollars in the first semester, that is, over 23 billion more than the previous year – and exchange reserves of 1200 billion dollars[3]) admittedly bring China important foreign exchange reserves, but also potentially create unprecedented surpluses in liquid assets. The exchange rate is thought to be responsible for 70% of currency creation. Furhtermore, the savings/investment ratio is imbalanced. Savings continue to increase and currently represent 44% of GDP, which is well above the international average. The Chinese economy is characterised by an important current account surplus, which reinforces the surplus in liquid assets.

These structural imbalances are China’s illness, and one that rsisk getting worse with the excess in liquid assets. Besides the foreign exchange imbalance, there is also an imbalance in the investment/consumption ratio. For Zhang, the problem does not come, as one often reads, from low consumption by the Chinese, but from a too rapid increase in China’s investments. Thus, in the first semester of 2007, retail sales shot up by 14.9%. Over the same period, investments increased by 23.7%, such that the investment/consumption ratio now exceeds 70%, a ratio that is clearly not sustainable. In 2006, overall investments reached 1000 billion yuan, which represents an increase of 8.7%. Zhang estimates that of these 1000 billion, 80 billion are due to surplus liquidity. However, 92% of this liquidity surplus has gone into real estate. In the first semester of this year, fixed investments amounted to 1 752 billion yuan, of which 354 billion were in real estate, that is, 20.22% of the total.

Furthermore, the surplus in liquid assets exposes the financail sector to very significant risks. For trading banks, the abundant supply of capital runs the risk of causing a flood of loans, which will force banks to lower the requirements for the obtention of a loan. Zhang suggested that at the time of writing his article the number of loans had grown by 16.3% since the start of the year, and M2 had climbed by 17.3%, that is to say, beyond the 16% target. In terms of the stock market, the indices keep on breaking all records, and then of course there is the real estate bubble.

Monetary policy:  both inflexible and vague

The Central Bank has used quite a few levers to try to stem the flow of these liquid surpluses by issuing bonds, opening up the market, increasing mandatory reserves, adjusting interest rates, etc. But no measure has turned out to be adequate; nor has any been carried through to its logical conclusion. The issuing of bonds is not enough, and the scope of this measure remains far too   narrow in relation to the reserves of foreign currency. The gradual opening up of operations has been restricted to Treasury bonds. The Central Bank has lifted the level of mandatory reserves sevenfold over the past year. If one thinks that these measures have involved about 160 billion yuan each time, then overall it becomes apparent that there is now an unprecedented freeze of 1 120 billion yuan. We should note that implementing decisions of this kind is no easy matter, as they imply that banks will reduce their profits.

But the principal problem comes from the fact that the increase in mandatory reserves does not allow the two main causes of the surplus to be addressed. These are the rate of savings, which is too high, and the exchange rate. Nor, paradoxically, according to Zhang, does it allow for any settling of the problems associated with the increase in credit, over-investment or the real estate bubble.

In addition to these measures, the Central Bank has increased the interest rates of trading banks on five occasions within a year[4]. The lifting of rates allows an increase in the the cost of investments and should therefore see a reduction of them. At the present time, Chinese savings and bank deposits are at quite a high level. Lifting rates therefore contributes to increasing the burden borne by trading banks. In addition, rate increases runs the risk of attracting speculative capital from aborad, which has been a major fear of the Chinese since the Asian financial crisis ten years ago.

A change in economic strategy has therefore become a matter of urgency. Firstly, there needs to be less of a dependence on foreign trade. Chinese growth must be based on three strengths (三力): investments, consumption and exports. Furthermore, a social security system (i.e. improving access to health care, education and public services through greater investment in these areas) needs to be set up. This is the only way of seeing a drop in the level of savings and over-investment – and at the same time being a means of kick starting consumption.

Zhang is also encouraging further deregulation, particularly of the exchange market and in the yuan market. The best solution would be to increase by 3% thez alue of the yuan in relation to the dollar.

Disagreements

Zhang’s viewpoint is not shared by everyone. To begin with, the reevaluation of the yuan would not necessarily produce the desired effects.

The former Morgan Stanley economist, Andy Xie, cites the examples of Japan, Korea and Taiwan in the 1980s, countries which reevaluated their currencies by 30% to 50%, yet without succeeding in reducing inflation.  Any reevaluation would have only a temporary effect[5]. For Albert Keirdel, of the Carnegie Endowment for International Peace, it would have the consequence of making Chinese goods more expensive internationally, which, coupled with high inflation, would risk truning a surplus into a trade deficit[6].

What then is to be done? For Xie, as for Keirdel, the authorities have no choice but to introduce a sharp rise in interest rates as a way of showing their willingness to fight against inflation. Keirdel fears a rise in social tension. These social questions are of less concern to Xie who is calling for very tight measures to be taken, of the type adopted by Paul Volker in the United States in the 1980s. These recommendations run counter to Zhang’s proposals which aim at reinvesting in social services any surpluses in liquidity.