- The Washington Times - Wednesday, February 17, 2010

A series of decisions by Chinese authorities on banking standards and currency holdings is fueling speculation that Beijing may be trying to curb its overheated economy, raise the value of its currency and reduce its exposure to foreign markets.

Twice in the past five weeks, China’s central bank has jacked up reserve requirements in an effort to limit bank lending, which, after more than doubling last year, soared in January.

Late last week, the People’s Bank of China announced that big banks will have to keep 16.5 percent of their deposits, up from 16 percent, on reserve at the central bank. In January, the central bank raised the requirement from 15.5 percent.

Raising the reserve requirement on banks will reduce the funds available for them to lend and, Chinese officials hope, dampen inflationary pressures.

Meanwhile, China is coming under intensifying pressure from the United States, Europe and developing economies to let its yuan currency rise in value, thus reducing what Beijing’s trading partners charge is an unfair trade advantage. China recycles the huge trade surpluses it runs with the United States into purchases of U.S. Treasury securities, helping keep its currency fixed at an artificially low rate.

However, the U.S. Treasury Department reported Tuesday that Chinese holdings of Treasury securities plunged by $34 billion to $755 billion in December, dropping China into second place behind Japan in terms of foreign holders of U.S. debt.

Overall, the report said, foreign holdings of U.S. Treasury bills fell by $53 billion, which will put more pressure on the U.S. government to raise interest rates in order to sell the bonds — at the cost of damaging a fragile economic recovery.

“The Chinese are worried that we have unsustainable debt levels and we do not have a policy for dealing with it,” Alan Meltzer, an economics professor at Carnegie Mellon University, told the Associated Press.

The Treasury report follows speculation that China may soon allow its currency to rise in value to help reduce inflationary pressures.

Chinese officials fear that the 2009 deluge of bank loans threatens their economy with inflation and asset-price bubbles, analysts say.

Such developments eventually could undermine not only the fastest growing country in the world but the global economy itself, which is still struggling to recover from its worst collective downturn since the Great Depression. On the same day China raised its reserve requirements for the second time, for example, the eurozone countries reported that their economies expanded a paltry 0.1 percent during the fourth quarter.

China’s policy actions would strike the right balance by reining in the booming economy, but just by enough to quash inflationary pressures. Such a balance is difficult to achieve, analysts say.

“The key question is whether they will be able to keep their tight controls on lending in the coming months, without which they are likely to see inflationary pressures rising rapidly again,” Goldman Sachs economists Yu Song and Helen Qiao said in a research note.

“China has experienced a much more rapid recovery” from the global downturn than other economies, “and officials are now concerned about inflation,” said Thomas G. Rawski, an economist at the University of Pittsburgh.

The Chinese economy expanded by 10.7 percent during 2009, fueled largely by government-induced bank lending to finance massive stimulus spending. That succeeded in promoting recovery but also drove up property values, Mr. Rawski said. Property prices jumped by nearly 10 percent during the past 12 months, according to Chinese government statistics.

“The government is worried that these big increases in property prices will spill over into the rest of the economy,” Mr. Rawski said.

As much as 90 percent of last year’s economic growth could be traced to soaring commercial property sales, said Derek Scissors, a China scholar at the Heritage Foundation. He suspects property prices increased last year much faster than the government reported.

“The property market is absolutely a bubble,” said Mr. Scissors, who regards recent monetary actions to be “just a little tighter than unbelievably loose.”

Consumer price inflation over the past 12 months amounted to 1.5 percent in China, but producer prices at the factory level jumped 4.3 percent. Most analysts expect these price increases to work through the economy and raise consumer prices.

But China’s raising its reserve requirements will not have much effect on inflation, said Gordon Chang, a Washington-based China analyst.

A pessimist on China’s longer-term economic outlook, Mr. Chang argues that China missed a major opportunity during the global expansion from 2002 to 2007, when it could have restructured its economy away from its heavy dependence on exports into a more consumer-driven model.

“The only thing that can save them now — strong world economic growth — is beyond their control,” Mr. Chang said. “Stimulus-created growth in the world’s three largest national economies — the United States, Japan and China — is not sustainable.”

Once stimulus effects around the world subside, global demand will be flat and China’s export-driven economy will suffer, Mr. Chang said. “With no good options available, China will be left making adjustments in reserve requirements that are meaningless.”

China could dampen inflationary pressures and slow its economy by increasing the value of its currency, the yuan, which is pegged to the dollar at a fixed exchange rate. Most economists think the yuan would be worth 20 percent to 40 percent more if it were as freely convertible as other major world currencies. The lower value gives China a trade advantage that is widely criticized as unfair.

Increasing the yuan’s value would drive down the price of imports and limit the pricing power of China’s domestic producers, thereby relieving inflationary pressures. Revaluing the yuan also would make China’s exports more expensive, slowing its economy.

But a significant revaluation is a move that China’s leaders have been loath to take for fear of raising unemployment throughout its export-dependent economy at a time when global demand for its output is still so fragile.

Jim O’Neill, chief economist at Goldman Sachs, predicts that China may soon raise the yuan’s value by as much as 5 percent, then peg it to a variety of world currencies rather than just the U.S. dollar, and finally allow its value to fluctuate within certain limits.

“They need to do something to slow the economy down and deal with the inflation consequence,” Mr. O’Neill told Bloomberg News this week. “The more they do — and the sooner — the better.”

The last time China modified the yuan’s dollar peg, it let the currency rise by 20 percent over three years ending in July 2008, when the yuan’s exchange rate was fixed again, in response to the global economic crisis.

But a similar float over another extended period would invite its own problems, said Douglas Paal, vice president for studies at the Carnegie Endowment for International Peace.

Currency speculators anticipating continuing appreciation would flood China with “hot money” and put more upward pressure on prices, Mr. Paal said.

In the end, China’s likely refusal to revalue by 30 percent or so in one swoop probably would guarantee that the potentially destabilizing inflation it fears will eventually arrive, said Peter Morici, a business professor at the University of Maryland. He said China has been manipulating currency for years.

Raising reserve requirements will prove to be an ineffective substitute for revaluation, said Mr. Morici. “It’s an attempt by an alcoholic to avoid going on the wagon,” he said.

“All those yuan China must print to purchase dollars” in order to keep its undervalued currency pegged to the greenback “will get into the system one way or another,” Mr. Morici said. “And those yuan will be chasing assets, creating bubbles and stoking inflation.”

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