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One of the problems with learning more about the Chinese economy every day, is that occasionally you find yourself disagreeing more and more with people whose opinions you respect and that you very much enjoy reading. Andy Xie, a former Morgan Stanley economist who prints monthly editorials in China International Business, despite being a thrill to read, mostly because of his grotesque use of metaphors and his insistance that everything is a massive bubble, is beginning to unfortunately fall in that category. I'm going to go through last months column and spend some time discussing why.
The basic gist of his argument this month is that the appreciation of the Chinese currency will cause hot money inflows that will fuel the already crazy property boom. On the other hand an Interest rate hike would just make mortgages more expensive and savings less expensive - China has negative interest rates, so saving actually costs money - thus is a better policy move.
But acting on the currency first, especially in small steps, would further inflate China's property bubble and inflation, potentially leading to a major economic crisis in two years. For China to achieve a soft landing from the current property bubble – if this is at all possible – interest rates must steadily increase by 2 percentage points in 2010, another 3 points in 2011, and further in 2012. Such a trajectory for interest rates would not burst the bubble, but it would prevent real estate interest rates from further declining in an atmosphere of rising inflation.
At some point, real estate interest rates will start inching up and slowly rein in speculation. Stopping real estate interest rates from declining further would prevent inflation expectations from accelerating, which in turn could halt inflation's accelerating pace.
He's right about the fact that hot money inflows help fuel the property boom, but I think he's miss representing the source of hot money inflows.
It's lasted for so long because financial markets have few stories to stir fry, and an appreciation of a pegged currency is a free lunch. Nothing gets financial markets more excited than a free lunch.
The intensity and persistence of yuan appreciation expectations point to support for China's vast property bubble. These expectations have increased the concentration of hot money in China, which in turn has caused excess liquidity and speculation, fueling the property bubble.
The numbers that are being thrown around regarding the "imminent appreciation of the RMB" is nothing to write home about. 5% at most this year. 3% is more likely. Sure if you're investing billions of dollars 3% is quite a lot, but you can get better returns elsewhere. It's also really difficult to get billions of dollars around China's currency controls. What's really drawing hot money into China is the property boom, where on average you can get around a 11% return, and in certain places you can get a 100% return a year (different stat sources say different things). This also is in a sector more open to micro-investing than "banned forex trades," in other words an overseas Chinese businessman can easily get money into the country to buy a flat, and has plenty of incentives to, Goldman Sachs cannot easily get a billion dollars into China.
This would all be academic, as the extra 3-5% on the RMB is rather delicious icing on the cake (a 15% return is quite a lot), and thus obviously driving some hot money flows, but it plays into the fundamental flaw in his argument, that the property boom is ALL speculative:
By all measures (stock value to GDP ratios, inventory value to GDP ratios, new property sales to GDP ratios, price to income ratios, rental yields, and vacancy rates) China's property market is one of the biggest bubbles ever. It's probably much bigger than the U.S. property bubble relative to GDP.
He forgot one measure: Price to upper-middle class wages, who are the primary purchasers of houses. According to this measurement housing prices are merely "expensive" and no where near the range of the Tokyo bubble (USD 200,000 for a flat in central Beijing is a lot less than USD 1,000,000 per square foot in Central Tokyo in the late 80s). Add to that the fact that the middle and upper-middle class are growing quite quickly, urban wages have in each of the past 10 years except for 2004 and 2009 grown faster than real estate prices, and that urbanization will continue probably through the second half of the century, and I don't think we yet have to worry about a "the biggest bubble ever," except as far as prices make people really really angry (renters rights don't yet exist in China), and there is a lack of housing options for lower classes (not saying they should purchase, but some solution needs to be provided that doesn't involve harassment by rental agencies). Still, investment in real estate isn't as dumb as he likes to make it seem.
He also seems to completely misunderstand why the RMB is thought of as undervalued:
Whenever a country successfully industrializes, its currency value should appreciate. This appreciation can come in the form of a higher exchange rate or inflation. What worries me is that inflation has already happened. China's real exchange rate may have appreciated greatly in the past three years. Even though China's reported inflation rate has been relatively low, prices that one encounters in daily life appear to have risen enormously. Foreigners who visit China are often surprised by prices, which are even higher than in many developed countries. Even China-made retail products are more expensive in China than in other countries.
I wonder what foreigners he is talking about? The prices one encounters in most people's daily life, at least most people who don't get banker's bonuses, are exceptionally low. The only things that are really expensive compared to the GDP-per-capita are property prices and import prices (he earlier argues that Chinese domestically made cars are the most expensive in the world, which makes me think he's never been to the US). High import prices are pretty much par for the course in the developing world, where a combination of tariffs and a "status effect" jack up prices to levels much higher than those in the developed world. Oh, also, an undervalued currency might contribute something to import costs... just maybe.
Most domestic goods are dirt cheap. Food prices in China are about 20-30% developed world prices, as are rental prices (My "decent" two-bedroom flat in a prime part of town goes for about USD 550 a month, which I of course split with my girlfriend. In the states it'd go for 3-4 times that).
I think there are plenty of arguments that can be made for keeping the RMB relatively low, and a 3-5% appreciation is a much smaller amount than what people were talking about 2 years ago, when 15-20-30% was been bandied around. But Andy isn't making the right argument to make his case.