China Research

On November 8, the National Congress of the Communist Party with more than 2000 delegates will start its convention in Beijing and some days later select its next political leadership for – probably – the next decade – a decade that will be much more difficult to surmount than the previous one.

The powerful politburo will almost completely be replaced by new faces, and probably seven/five out of nine/seven individuals of the even much more powerful inner circle Politburo Standing Committee will have the same change, i.e. that only the – most probably – forthcoming Party  Leader  Xi Jinping and future Prime Minister Li Keqiang will keep their seats in this forum of all important decisions (currently considered as number six and seven).

A lot is currently discussed about the future political, social and economic course of Xi Jinping. But this discussion is too simple-minded since the Party Leader is not making decisions on his own. He has to find consensus himself within the Standing Committee which mostly urges for a “middle-of- the-road position”. This line can only be left in extraordinary cases,  like the opening-up policy by Deng Xiaoping almost 35 years ago. Currently, such moves cannot be seen. I still cannot see Xi as a major reformer, neither in political nor in economic terms. But nobody knows what will happen in the next, very challenging 10 years. Not many scenarios can be ruled out completely.

Political challenges

Discussions about future policy and strategic issues were not taken up in the past months  by  the leading candidates for China’s new leadership. However, it seems to be completely clear that domestic issues will have to /should dominate politics in the future. This may concern amoung other areas

–  institutions  (including the fight against corruption and more application of the rule of law)

–  transparency (also an institutional factor)

–  better environment in all respects (quality of food and water included)

–  acceptable minimum social security standards for the whole nation

–  acceptable health care for the whole nation

–  better income distribution.

All post-war leaders had so far their political legitimacy, lately particularly high economic growth and internationalization. In my feeling, the new Chinese leaders will have to look mainly for acceptable growth – which may be closer to 8-9 percent than maximum growth around 10 percent as seen in the past two decades. But such a development will assume that the above-mentioned political challenges will be taken seriously by the new leaders.

Economic challenges

Many of the future economic challenges have a nexus with politics or globalization. Some of them are mentioned below (but have been described more thoroughly by me in earlier pieces).

They are, for example (without ranking):

–  generally: more marketization and transparency (vs political control)

–  modernization of financial markets (institutions such as the stock exchanges and bond markets, instruments, products for savers, supervision, etc)

–  cleaning up the state-owned banks (and make them more transparent)

–  financial deregulation (domestically, cross-border, sequencing)

–  transparency and the creation of sustainable real total government debt (central and local)

–  modernization of monetary policy

–  modernization of exchange rate policy

–  new growth model (higher share of private consumption in relation to GDP)

–  creation of conditions for improvements of corporate productivity and industrial value chain

–  creation of improved conditions for product quality and services

–  decrease of the state-owned corporate sector

–  decline of regional disparities

–  creation of strategies for gradually worsening demographic conditions.

 

This leads us finally to three crucial questions (which cannot be elaborated in this little blog contribution):

–  Can the new Chinese leaders achieve an appropriate way of combining state intervention and marketization?

–  How sustainable are Chinese current account surpluses in the long run?

–  What happens the day when China’s yuan finally achieves the status of a convertible currency (probably not within the next decade – but serious preparations may start during Xi’s leadership)? How will the U.S. and the U.S.dollar react on such a change?

We stay here for today – predicting no  major changes of wind in the foreseeable future. Gradual and smaller steps forward, however, should continue in the next years. Political, social and institutional strategy considerations should gain political momentum in the next decade – maybe somewhat at the expense of economic growth.

 

Hubert Fromlet
Professor of International Economics
Editorial board

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Commodity price indices had been in a broad decline in real terms since mid-1800s. The falling real price for commodities was the product of ongoing global economic development and demand growth, but also a positive commodity supply response and ongoing increases in productivity and innovation in the use of resources.

Oil prices were an obvious exception in 1970s, with two sharp upward oil price shocks – but oil prices then fell back to earth in the 1980s and 1990s.

What has changed? The principal difference has been the Chinese growth miracle since early 1980s, which has added a new source of global commodity demand beyond the normal growth pattern in industrial countries. Other emerging markets also caught the policy reform wave, saw their sustainable growth rates and incomes rise, and the demand for commodities followed in tandem.

The rise of the middle class in China and a growing number of other emerging markets was thus the core driver of increased commodity demand and in real prices (that is, with the impact of inflation removed) Since the early 2000s, there has been a structural upward shift in the global prices for energy, metals, food and related key inputs like fertilizer.

Recent global economic developments have had a negative feedback effect on many commodity prices. Global turbulence due to the ongoing euro crisis, the slow US recovery, and slower related economic growth in emerging markets has placed downward pressure on commodity prices as global demand slowed. However, although commodity prices in aggregate have declined over the past 18 months, they generally remain well above the levels of a decade ago. There are, of course, differences among the various commodities – pulp, iron ore and natural gas prices are all facing their own special downward forces.

But in general, each time there is a drop in perceived global economic risk, energy and key metals prices (like copper) rise again, which reinforces the strength of the underlying demand for resources from China and other major emerging markets. Commodity prices in aggregate may not return to the highs of 2007 any time soon, and they may even decline a bit in real terms going forward. But they are also unlikely to return to the historic downward path. Structurally higher commodity prices are the new normal, thanks to the rise of the middle class in China and many other emerging markets.

 

 

 

 

Glen Hodgson

Chief Economist, The Conference Board of Canada

 

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Recent informal talks with business managers from both the industry and the financial sector in a number of developed countries have led me to the conclusion that general knowledge about the Chinese currency (renminbi = RMB or yuan = CNY, official) still is very limited. This is the case despite China’s great – and still growing – importance to the global economy and many globalized companies.

There are different reasons for this shortcoming. Many executive practitioners in the corporate world are not really interested in details of exchange rate policy. Furthermore – which may be an even more important reason for the lagging interest – the Chinese exchange rate policy is still extremely opaque for outsiders, i.e. for everybody outside the Chinese Communist Party leadership.

Some knowledge about Chinese exchange rate policy, however, exists. We know that China had an 8.3 RMB fixed link to the American dollar (USD) until 22 July, 2005. On this day, this fixed exchange rate regime (more or less) was abandoned and replaced by a limited floating policy which allowed for a sizeable appreciation until today all the same – the Chinese answer after many years of American complaints about an undervalued Chinese currency when considering China’s dynamically rising surpluses in foreign trade.

We also know that China is linking the RMB to a kind of currency basket that consists of about 20 different currencies. But what we do not know are the weights of these 20 different currencies in the Chinese basket despite the obvious dominance of the USD in this basket. In an interesting empirical study (“Re-pegging the renminbi to a basket: issues and implications”, Crawford School of Economics and Government, 2012, Asian Pacific Economic Literature), Heikki Oksanen from Helsinki University found that the RMB may be linked by up to 90 per cent to the USD. The consequence of this is that not very much influence is left to the other currencies – not even to the Euro – which means that predictability of the CNY vis-à-vis other currencies tends to be even more difficult.

Having said that the Chinese exchange rate policy is closely linked to the USD does not, however, rule out that China’s political leaders in recent years having been going for a cautious, but visible appreciation policy with slightly varying speed of this policy in relation to the USD (around 25 percent since July 25, 2005). Sometimes, we also have seen intermissions in this appreciation process – obviously in times when Chinese exports have been/are suffering from difficulties because of dampened global demand. This could be observed during the American subprime crisis in the latter part of the past decade and in 2012 when the European crisis was the seen as the main obstacle for Chinese exports.

Despite the fact that two thirds of the huge Chinese currency reserves are invested in USD, it would be beneficial to China to gradually decrease the weight of the USD in its currency basket which I have been pointing at before in different articles. The predominance of the USD is too strong in this respect, also from a (Chinese) risk perspective. The current Chinese foreign investment strategy makes China too dependent on financial markets’ confidence in the dollar. The U.S. economy will have major challenges in the forthcoming decade, too, and nobody can rule out that the USD may suffer from sizeable downward pressure at some point in the future.

Altogether, the composition of the Chinese currency basket should have much more hedging elements. This is another reason why China really dislikes the ongoing European crisis since only the Euro has the theoretical and practical capacity to become a real alternative to the USD for Chinese currency investors. Therefore, China is definitely not interested in a weak Euro.

However, there is only way for the Chinese exchange rate policy to get closer to the Euro, i.e. the very gradual one. Really fast moves in such a direction would cause turmoil on global currency markets at the expense of the dollar – but also when it comes to the development of the real economy of China, the U.S. and many other countries (exports, imports, GDP). China most certainly wants the survival of the Euro.

If we assume a positive outcome of the current Euro/European crisis, the Euro will gain a lot of importance in the longer run, maybe 10 years ahead or even more. This would “automatically” incline a weakening status of the USD as a reserve currency with unpredictable consequences for both the U.S. and the whole global economy. We really should hope that the U.S. will be successful in restoring fiscal stability and sustainability during this probable process.

Otherwise, the global economy will become even more unstable. China will – without doubt -have an increasing impact on this development, also by its exchange rate policy. However, the “global house” cannot be put in order during the next decade or so without major positive contributions from both Europe and the U.S. – also for the avoidance of (temporarily) chaotic conditions on global currency markets.

In the meanwhile, there should be room enough for China to make its exchange rate much more transparent and also for substantial changes in exchange rate policy. Such a change could mean a more trade-related basket in line with the Swedish model from the 1980s (which failed because of major macroeconomic imbalances in Sweden, not because of its composition of currencies) or – according to Oksanen’s second suggestion – a linkage to Special Drawing Rights (SDR, which contains USD, Euro, yen and the British Pound Sterling – a composition that has to be checked up/revised by the IMF every fifth year).

But even if these technical changes in Chinese exchange rate policy will occur in the forthcoming years, the road to a fully convertible currency will be very, very bumpy for the renminbi. It may take 10 years or even much longer to get there.

 

Hubert Fromlet
Professor of International Economics
Editorial board

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