Page 2 of 4 CHINA'S DOLLAR MILLSTONE, Part 1 Breaking free from dollar hegemony
By Henry C K Liu
In a world order of sovereign nation states, the supranational nature of
central banking will render it inoperative, as it can be and has been used as
an all-controlling device for the world's rich nation to neutralize the
sovereign rights of financially weak nations. In a democratic world order,
central banking is also inoperative within national borders, as it can be used
by a nation's rich as a device to deny the working poor of their economic
rights. Central banking, in its support of dollar hegemony, operates
internationally in opposition to the economic interests of sovereign nation
states and domestically in opposition to the economic rights of the working
poor by discrediting enlightened economic
nationalism as undesirable protectionism.
To preserve dollar hegemony, exporting economies that accumulate large dollar
reserves through trade surpluses are forced by the US to revalue their
currencies upward, not to redress the trade imbalance, which is the result of
dysfunctional terms of trade rather than inoperative exchange rates, but to
reduce the value, in foreign local currency terms, of US debt assumed at
previously stronger dollar exchange rates. When commodities prices rise, it
reflects a defacement of all fiat currencies led by the dollar as a benchmark.
When the currency of another nation rises against the dollar, it does not mean
that currency can buy more; it only means the dollar can buy less than what the
appreciating currency can buy. This is why commodities prices have been rising
in all currencies, albeit at different rates.
The bursting of the latest dollar-denominated debt bubble created a global
credit crisis in August 2007 that is beginning to cause globalized trade to
contract. Exporting economies around the world are now forced to reconsider
their dysfunctional strategy of seeking growth through exports for fiat dollars
that are pushing the world economy towards hyperinflation, leading all other
fiat currencies in a depreciation race to the bottom.
China's high trade dependency
At the top of the list of exporting economies is China's. The country in 2006
registered an unwholesome trade-to-GDP (gross domestic product) ratio of 69%,
with a per capita trade value of US$1,645. In 2007, China's nominal GDP was
24.66 trillion yuan, or $3.38 trillion at then exchange rate of 7.3 yuan to a
dollar. The 2007 per capita GDP for the population of 1.32 billion was 18,655
yuan, or $2,556, translating to $9,711 on purchasing power parity (PPP) ratio
of 3.8. If China's exports were to be redirected towards the domestic market,
the country's 2007 per capita GDP on a PPP basis would have increased by $5,384
to $15,095, even not counting any stimulant multiplying effect. Chinese
household consumption remains at a record low of 37% of GDP, the smallest ratio
in all of Asia, due to low Chinese wages.
China's trade surplus fell 20% year-on-year in June 2008 to $21.3 billion
because of a drop in export growth. In Chinese currency terms the drop is more
due to a rise in its exchange rate against the dollar. Still, it was the
biggest surplus since December 2007, which totaled $22.7 billion. Export value
in June was $121.5 billion, 18.2% more than a year earlier but the growth rate
was nearly 10 percentage points down from the May figure. Imports totaled
$100.1 billion, up 23.7% from a year earlier. China's trade surplus with the US
in June totaled $14.7 billion, 5% higher than 2007. The surplus with the EU,
its biggest export market, was worth $13.2 billion, up 21.2% from 2007.
Chinese exports are slowing because of reduced global growth caused by a
developing US recession, while imports are rising on the back of rising
commodity prices. These figures are not inflation adjusted. However, they
reflect the rising exchange value of the yuan. In other words, exports have
been falling more in yuan terms. The fall in exports is expected to accelerate
as no market analyst of worth is projecting any quick or sharp recovery in the
US economy.
Going forward, the ratio of nominal-GDP to PPP-GDP can be expected to fall as
China's domestic inflation rate continues to exceed the US inflation rate. This
trend will gain momentum as China attempts to use its trade surplus denominated
in dollars for domestic development, which requires it to issue more yuan into
the Chinese money supply. And market pressure can be expected to push the yuan
down against the dollar until the Chinese inflation rate is at parity with the
US inflation rate.
But a falling exchange rate causes more domestic inflation from imports
denominated in dollars; and rising domestic inflation adds pressure to a
falling exchange rate in a downward spiral, preventing the yuan from rising
against the dollar from market forces. That is the dysfunctionality of the
yuan-dollar exchange rate regime in relation to the inflation rate
differentials between the two economies, when the exchange rate is set by trade
imbalance denominated in dollars. This dysfunctionality is cause by the flawed
attempt to use exchange rates to compensate for dysfunctional terms of trade,
which has been mostly caused by wage disparity.
Stagflation danger
Li Yining, a leading Chinese economist, former president of Guanghua School of
Management at Beijing University and member of the Standing Committee of the
11th National Committee of the Chinese People's Political Conference, the
country's political advisory body, opined in the Second Meeting of the Standing
Committee on July 4, 2008, that China is facing a pressing challenge in
preventing inflation from turning into stagflation - the dual evils of high
unemployment along with high inflation - if market expectation concludes that
Chinese policymakers will fail to insulate the economy from the developing
global slowdown that is expected to deepen next year with no prospect of a
quick recovery.
Overwrought anti-inflation macroeconomic measures by Chinese policymakers may
cause investors to dump shares of companies in the export sector, putting these
companies in financial distress and causing foreign capital to exit the Chinese
economy to cause unemployment to rise in China. As China is unhealthily trade
dependent, this will hurt domestic development and curb consumer spending.
Li argues that China should decelerate the pace of capital and foreign exchange
decontrol within the context of an oncoming, protracted global economic
slowdown to preserve the value of its huge foreign exchange reserves in yuan
terms. He wants the government to avoid being misguided by the static concept
of a fixed low inflation rate target of 3%. Rather, an inflation rate up to 60%
of the economic growth rate should be permissible, meaning to allow an
inflation rate at around 6% for a 10% growth rate.
China's inflation rate hit an 11-year high of 8.7% in February 2008 and eased
to 7.7% in May, still high above the government-set goal of 3% annualized. Li
points out that incoming economic data show that the Chinese economy is on a
sound footing despite new challenges from abroad and at home, including the May
12 Sichuan earthquake and serious floods in the south. However, Li warned the
government to avoid risks of stagflation in formulating macro policies going
forward.
Li's advice is sensible. It serves no useful purpose to cause a collapse of the
economy to fight inflation, as Paul Volcker did in the US in the1980s, making
the cure worse than the disease. Still, Volcker was facing a 20% inflation rate
in 1980, which might have justified drastic action. Yet Li should realize that
under dollar hegemony, Chinese central bankers must try to keep the Chinese
inflation rate target below 3% to stay on par with the dollar inflation rate
target set by the US Federal Reserve, the head of the world's central bank
snake. A 6% inflation rate in China would be more than triple the current
inflation rate target set by the US central bank, the defender of dollar
hegemony even as it allows the dollar's exchange rate to fall.
A Chinese inflation rate of 6%, as proposed by Li, would cause market forces to
push the yuan down against the dollar, further exacerbating US-China trade
tension and reviving protectionist pressure in the US. As China is being
pressured relentlessly by the US to further revalue the yuan upward against the
dollar, yuan interest rates must rise above Chinese inflation rates. At 6%
interest rate for the yuan, the disparity with the dollar interest rate would
cause hot money denominated in dollars to rush into China through "carry trade"
to profit from interest rate arbitrage, betting on continuing Chinese
government intervention to keep the yuan from falling against the dollar
despite higher Chinese inflation.
With a 6% inflation rate, China will be forced to pay currency traders massive
sums to defend an overvalued yuan dictated by US trade policy in contradiction
of US Treasury policy of a strong dollar. That was how the Bank of England
allowed itself to be broken by George Soros on Black Wednesday, September 16,
1992, when the British central bank attempted in vain to defend an overvalued
pound sterling out of sync with its interest rate regime. It was also how the
Hong Kong government was forced to execute its "incursion" into the equity
market in August 1998 to defend the Hong Kong dollar's peg to the US dollar
against market fundamentals.
China has been forced to take steps to offset the impact of the US Fed's easy
money policy on the Chinese economy. The US Fed has cut the Fed funds rate
target eight times since September 18, 2007 from 5.75% to 2% on April 30, and
the discount rate nine times since August 17, 20007 from 6.25% to 2.25% on
April 30. Although China's central bank has issued notes to absorb excess
liquidity, market pressure still exists for the central bank to put more
currency into circulation to add to already excessive liquidity. China's
central bank has increased interest rates six times and the bank reserve ratio
15 times since 2007, but Shanghai interbank rates have increased only slightly,
signaling major resistance to monetary policy.
LIBOR and SHIBOR
Assistant governor Yi Gang of the People's Bank of China (PBoC), the central
bank, in a speech in the 2008Y SHIBOR (Shanghai inter-bank borrowing rate) Work
Conference on January 11, 2008, outlined the role of SHIBOR, introduced a year
ago as a benchmark rate for money market participants. At the initial stage of
the index's launching, central bank promotion is deemed
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