China Research

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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China’s housing market is turning the corner. Sales have risen, inventories are coming down, and prices have firmed slightly in many cities. Slow new house-building will remain a drag on the economy for some time yet, but should begin to add to GDP growth in 2013. The key drivers of the turnaround are greater affordability and an easing of financing constraints.

Divining the state of China’s housing market is not easy. China has 16 cities or conurbations with a population over 5mn and a further 20 with populations over 3mn, and conditions vary. What is happening in Shanghai and Beijing in the luxury sector does not necessarily represent what is happening elsewhere. Official data on housing is improving, but remains limited and, as with all China’s data, sometimes misleading.

To supplement the available data, at Standard Chartered we have conducted a regular survey of thirty developers in eight Tier 2 and Tier 3 cities, with populations from 3-8mn. Our most recent survey confirmed official data suggesting that the market is improving. Developers are seeing more sales and are beginning to plan increased construction.

Owning property is a powerful ambition in China. For many men it is a pre-requisite for finding a wife given the gender disparity and cultural expectations for a dowry from the male side. And despite the building boom, the vast majority of people in China have still not made the move to a modern apartment block, but would dearly love to. There is a huge underlying demand that is rising with continued urbanisation, and is set to remain rapid for a few more years before levelling off.

China’s housing market is also widely used for investment. Opportunities to earn higher returns on savings have improved for wealthy investors in recent years, with the rapid growth of trust companies. But the stock market is languishing at low levels, so property is the preferred asset class for many.

New apartments in China are typically sold unfinished, with internal walls and electric outlets, but not doors, floor coverings, kitchens or bathrooms. Investors generally leave them unfinished. Buyers in China have a strong preference for new apartments and any chosen kitchen or bathroom might be unfashionable a few years later.

This is a key reason for the frequent observation of empty apartments; usually they are sold, but just left empty. These apartments are effectively treated like a land investment, rather than as an income-generating asset. One implication is that a property investment boom in China does not necessarily reduce rents as it might in the West, which slows any natural rebalancing.

Large investor holdings could be a problem if everyone tried to sell at the same time. But there has been limited distress among owners in this housing cycle because loan-to-value ratios are generally low and many investors have no mortgage at all. They can afford to wait it out.

The spurt in home completions in late 2011 on projects started during the post-2009 bubble phase is slowing, while the amount of floor-space under construction is deep in negative territory. Meanwhile our survey finds buyers returning, attracted by lower prices and local easing in financing conditions. Over time these trends will bring down unsold inventories, which are still high.

I say “local” because the central government has resisted easing up on the housing sector. It is afraid of a sudden return to bubble conditions, particularly given the easing in monetary policy generally to combat the economic downturn. Some cities that tried to loosen regulations too much have apparently been over-ruled. But overall, the evidence is that it has become somewhat easier to get finance than a year ago, at least for owner-occupiers.

Prices seem to have fallen in the range of 5-20%, with a greater fall in new-build than in the secondary market, as is typical after a boom. This may not sound like much, but wages are growing 15-20% in many cities. Encouraging wage growth is a deliberate part of the government’s strategy for boosting consumption, but it also means that housing affordability has considerably improved over the last two years.

Price is the key issue. While prices in Shanghai and Beijing often look breath-takingly high, arguably this reflects their “world city” status. In ordinary cities, prices were also becoming high relative to earnings a couple of years ago, sparking social discontent. The signs are that the slowdown over the last couple of years has corrected this, to some degree. But it would not take much to open up a gap again. Hence the government focus on restricting investors, by limiting people to one property only, while encouraging first-time buyers. As the market recovers, expect an increased focus on ways to prevent prices rising too fast, including property taxes and financing restrictions.

John Calverley
Head of Macroeconomic Research, Standard Chartered Bank, Toronto

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