[Vnbiz] Another article from Michael Pettis...not directly VN related but I think....

[Craig Stevenson]

that there are many commonalities to consider and broader implications to be
drawn from the nature of the discussions.

Despite what might be assumed on a surface level, the money flows discussed
in the final paragraph, and those are official, legal flows might be more a
bain then a benefit.  One thing is clear, that the official FDI that China
received from 2001 to 2005 of 381 Billion USD, was probably quite higher
than that when added illegal flows and that flows after that in the
intervening years are probably quite a bit higher leading to recent
acceleration in reserve growth.Such reserve growth has been described as a
"benefit" pointing to the growing importance of the Chinese Economy on the
world stage which might not, seems not, to have been a good thing for the
Chinese people as they seek to balance so many objectives walking a high
rope getting teughter by the minute.  Despite little disagreement as to this
being a sign of strength, even hope, whether this has been a benefit or has
serious destabilizing side effects remains to be discerned, I expect that
markets tend to overshoot as investors expectations always tend toward the
irrational.

With global pensions at 26 trillion USD in 2006 (2/3 held in US) and private
wealth at 100 trillion USD in 2006 (in value not all in USD, of course), of
which 40 trillion USD (in value) being held by individuals with more than 1
million USD in liquid assets (with 30% of that number held in US), there
seems to be quite a bit of room (and impetus) for (more) speculation in
light of a "weakening" dollar.  Anyway, many of the issues discussed here
might actually be relevant, will definitely have impact, when scaled to the
Vietnamese case.

Enjoy, where possible, another eye-opening article from Professor Pettis.  I
believe the issues related to devaluation to be considered carefully, in the
VN case. As well as policy responses (and frankly ability) of the VN
government to control what is occuring in the broader world around it.

Craig




  FRI 7
MAR
 More, or less, RMB
appreciation?<http://www.piaohaoreport.sampasite.com/blog/More-or-less-RMB-appreciation.htm>
By
Michael Pettis

Most PBoC watchers have always believed that the PBoC has been among the
most vocal supporters of a stronger currency, and has argued in the past
that an appreciating RMB is the best way to fight inflation.  Yesterday,
however, Zhou Xiaochuan, governor of the PBoC, surprised a number of people
at his NPC-related press conference.  He said, among other things, that
"faster currency appreciation helps to rein in inflation, but not a lot.  To
curb inflation, we will rely more on domestic policies. 
There is no need to
use exchange-rate reforms as a way to fight inflation."



A lot of commentators are reading this as meaning that currency appreciation
is losing its appeal as a way of attacking inflation (The *Wall Street
Journal Asia* headline was "China's Zhou Says Strong Currency May Not Be
Best Way to Fight Inflation"), while raising minimum reserve requirements
and hiking interest rate will be used more aggressively.  I am not sure I
agree, since Zhou also commented on the difficulty or using interest rates
as a tool, and admitted that the recent aggressive rate cuts in the United
States are restricting his agency's ability in raising the cost of capital.
He also said "We have to consider and measure the impact of interest rate
changes on domestic demand," which doesn't sound like he is expecting to
raise the deposit rates by a whole lot.



Zhou may have meant what he said about the currency, but it is also possible
that he was just trying to talk down hot money inflows by downplaying the
prospects of large appreciation gains.  Actually I think Zhou is partly
right about the limited efficacy of RMB appreciation in the fight against
inflation, but not perhaps for the reasons he means.  Looking at the rate of
appreciation of the RMB and the CPI inflation numbers, it is hard to draw
the conclusion that an increasing appreciation rate has reduced inflation.



In part this shouldn't be a surprise since there are inevitably going to be
lags between the currency and its impact on domestic inflation, especially
if you believe, as I do, that the inflationary pressures have been
accumulating for many years and have only just emerged.  On the other hand
it isn't much easier to see the inflation-reducing impact of raising
interest rates or minimum reserve requirements.  None of the policy measures
have worked – that is the big problem facing the authorities.



If Chinese inflation is a monetary problem, which I think it is, I it seems
clear to me that the only way to reduce inflationary pressures is to reduce
monetary growth, and that means of course reducing the net capital and
current account inflows into China.  A more rapid rise of the RMB is not
only unlikely to reduce those inflows (at least until the RMB is much more
expensive than it is now), but on the contrary it will actually
*increase*net inflows by encouraging hot money faster than it reduces
the trade
surplus (and anyway so far the trade surplus hasn't declined). This is what
seems to be happening, and a recent report by *Bloomberg*, that "China will
increase (QFII) quotas for overseas investments in yuan-denominated stocks
and bonds this year," seems unnecessarily to complicate things, unless they
are hoping that it will boost the stock market.



The contradictory relationship between the currency regime and currency
inflows forces the authorities back into the policy gridlock I have
discussed so many times before.  China must adjust the RMB to regain control
of its careening monetary policy, but the very process of adjustment is
likely to make things much worse before they can get better, and it is not
clear to me that China has room for things to get much worse.  That is why I
think ultimately they must be forced into a much more abrupt currency
adjustment.



And they are certainly going to have to do something about inflation.  During
Premier Wen's speech he announced that the inflation target for 2008 will be
4.8%, equal to 2007's CPI inflation (the 2007 target of course was under
3%).  I haven't found a single person, Chinese or foreign, who doesn't
believe that this target is more about reining in expectations and letting
the Chinese people know that the government is fighting inflation than it is
a serious forecast.  Everyone I have spoken to thinks inflation will come in
much higher for 2008, and there are some pessimists (including me) who
expect it to average above 7%, perhaps well above 7%.



So far, of course, the pessimists are right.  I have mentioned in previous
posts that CPI inflation for February is widely expected to come in at no
less than 7.8% and perhaps even exceed 8% (we will know Tuesday – January
CPI inflation was 7.1%).  A very interesting report by my friend Paul Cavey
at Australian investment bank Macquarie is a whole lot grimmer. He writes:



Inflation definitely is a big worry. According to the Ministry of
Agriculture's wholesale price index, food prices were about 30% higher than
in the same month a year earlier. This index tends to be quite a good
predictor of food CPI, suggesting overall inflation in China could make
double-digits in February. Statistical quirks could bring the published
number lower, but it is still likely to be high enough to be scary.



Paul also argues, based on China's two previous bouts with inflation in the
late 1980s and the early mid 1990s, that the policy responses are going to
less vigorous than we might have expected because "Contrary to the popular
perception of a Communist Party seeing inflation as a life or death issue
for the regime, Beijing's response to inflation has usually been late and
indecisive. The reason of course is that as much as the government is
worried about the social consequences of rising prices, it is also concerned
about the dissatisfaction that an inflation-tackling slowdown would cause."



Unemployment, in other words, will trump inflation as a cause of concern.  Of
course we might get both.  Premier Wen predicted that GDP growth for 2008
will be 8%.  That might seem shockingly low after the last year's GDP growth
of 11.4%, but remember that most years (including last year) the government
projects next year's GDP growth at 8%.  This is not really a target but a
base case.  In fact I would define 8% growth as stagnation, since for me
stagnation in the Chinese context means GDP growth that isn't great enough
to prevent a rise in urban unemployment.  On this topic Xinxin Li at
Observatory Group has some useful reminders:



The 8% GDP growth rate is only a bottom line growth rate, and the real
target of Beijing's policymakers is around 10%.  Note that Wen also
announced an annual target of new urban job creation at 10mn.  That won't
happen without stronger economic growth.  (Forget the unemployment rate
target of 4.5%, as the real number could be much higher, too.)  In the past
three years, China created 9.7 million, 11.8 million and 12.0 million new
urban jobs respectively, but its annual GDP growth was steadily high at 9.9%,
11.1% and 11.4%.  In other words, 10% is viewed as a minimum growth rate for
Beijing to reach its employment target.



If China can't keep its GDP growth rate above 10%, it will have great
difficulty in maintaining the necessary employment growth, and with
unemployment rising among the young (and among university graduates) there
is a lot of pressure to keep growth effervescent.  China's conundrum is that
it has too many economic policy objectives not only which are contradictory
but also for which they seem to have no very efficient tools.  Last year
around this time Premier Wen shocked everyone by saying that the Chinese was
on a clearly unsustainable path.  One year later the country is still
racing, faster than ever, down the same path.



Leaving China briefly and turning to the rest of the world I saw the
following in today's *Financial Times*:



Capital flows to emerging markets reached record levels last year as
investors fled the US and other developed economies in search of higher
yields and faster rates of economic growth, the Institute of International
Finance said on Thursday.  The IIF said total flows to emerging markets
reached an estimated $782.4bn in 2007, a sharp rise from $568.2bn in 2006
and $521bn in 2005.



I am not surprised that during this time of developed-world crisis so much
money is flowing to emerging markets.  There is plenty of risk-loving
liquidity looking for a home (see Brad Setser's latest blog entry), and I do
not believe we are at the end of the latest globalization cycle, in which
rising international trade and investment flows and the always coincident
"next stage" in the industrial revolution are always underpinned by a sharp
rise in global liquidity.



Still, the developing-country financial historian in me finds this
worrisome.  In the past, massive capital flows into developing countries
with their weak financial systems and inverted balance sheets often created
serious imbalances in sovereign and banking capital structures.  These were
only resolved by financial crises that were often deep and long lasting.  The
"lost decade" of the 1980s was merely the most recent such period.
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