My knowledge of what's happening in China is very slight. But from what I've been reading over the last few months (like this today), it sounds worrying.
Others may have noticed this parallel, but just in case you missed it, I'm going to make it.
Compare China vs the US to Spain or Ireland vs Germany, with a lag of about 3 years. The China/US game is about 3 years behind the Eurozone game.
China has a (roughly) fixed exchange rate with the US, just as Spain and Ireland have an (exactly) fixed exchange rate with Germany. The monetary policy that was roughly right (well, not really right at all, but definitely not too loose) for the US was too loose for China. Before the recession, 3 years ago, the monetary policy that was roughly right for Germany was too loose for Spain and Ireland. So China, Spain, and Ireland had a credit boom and rising asset prices, especially house prices.
It all ended badly in Spain and Ireland. It now looks like it might end the same way in China, with a 3 year lag. Fixed exchange rates seem to do this sort of thing. Spain and Ireland used to wish they could revalue their currencies against Germany. They now wish they could devalue their currencies against Germany. China failed to revalue its currency against the US, when it should have done. I wonder if it will soon want to devalue its currency against the US?
Per capita income is way lower in China than Ireland or Spain. My own feeling is that China has more booming to do before the Adjustment Boogeyman comes calling.
China is also trying to do something domestically with increased regulations and reserve requirements.
Wow...I sound way more pro-China than I am...
Posted by: Mark | October 18, 2011 at 10:09 AM
Mark: funny you mention reserve requirements. I was just thinking the other day. A lot of people say it's so old-fashioned to teach required reserve ratios in macro. But China has been using them actively recently. And China matters. Plus, a lot of my students come from China. The whole point of universities is not just to teach about the here and now. It's to teach about what was, and is elsewhere, and what might be.
Posted by: Nick Rowe | October 18, 2011 at 10:26 AM
Nick, agreed.
Really, really good point.
Posted by: Adam P | October 18, 2011 at 10:59 AM
Adam: thanks! Now, several months back you wrote an extremely short and cryptic blog post saying (IIRC) that this was the beginning of China's decline. It's stuck in my mind, though you never explained why you said that. You are looking more right now, than when you said it. But you never explained.
Posted by: Nick Rowe | October 18, 2011 at 11:05 AM
Looking at China's GDP make-up it's (I think) about 45% investment, which has increased dramatically since 2007 and before, has falling consumption share of GDP, and exports are about 6% of GDP (down from 11% in 2007). I'm not convinced that the fixed exchange rate per se is the penultimate problem facing China, it's more, IMO, that it has a problem where its investment loans are nonperforming on a grandiose scale. It's a matter of time to when these loans are called, but could be several years off still.
Another point: China has a huge current account surplus, Spain has a huge current account deficit. So I think the relation is backwards: China :: US as Germany :: Spain.
Posted by: jesse | October 18, 2011 at 12:24 PM
Pboc is really fascinating. They aren't just stuck in the past; they use some very current ideas like sterilizing bond sales. The result is that China is different. They use flows to peg the dollar (they create dollar demand) and they use reserve ratios and sterilizing bonds to freeze out the stock of money they are creating.
In that sense, I don't agree with your parallel. Spain does not do these things. Still china is in a bind now. They have to make large interest payments on the sterilization bonds but their assets are ninety percent USD dominated. This is why they cannot appreciate.
Posted by: Jon | October 18, 2011 at 12:30 PM
How do you get from fixed exchange rates to the debt panics mentioned in the article you linked to?
Posted by: JP Koning | October 18, 2011 at 12:33 PM
Let put it another way: Stress is piling up everywhere, then, what will be the first thing to give (the famous first domino)?
Posted by: Marc Labbé | October 18, 2011 at 12:55 PM
jesse: "Another point: China has a huge current account surplus, Spain has a huge current account deficit."
Hmmm. Good point.
Jon: "They have to make large interest payments on the sterilization bonds but their assets are ninety percent USD dominated. This is why they cannot appreciate."
Sort of like the carry trade, only in reverse, and the government's doing it?
JP: that's what I want to know. Simple theory says you should just get a rise in the price level, to get the same real appreciation as if you revalued, but otherwise monetary neutrality. Maybe sticky prices and/or negative real interest rates? But there ought to be some sort of parallel in the flexible exchange rate case, or even closed economy, if the central bank screwed up in the right way.
Marc: dunno.
Posted by: Nick Rowe | October 18, 2011 at 01:20 PM
The PBOC regulates deposit rates, they are at 3.5%. These are set far below inflation, so you definitely have negative real interest rates.
Posted by: JP Koning | October 18, 2011 at 01:46 PM
Good point Nick "Chuck" Rowe;-)
The difference is however that China has an option to devalue it this is in the interest of the country. And guess what the market is now pricing in that the appreciation of the yuan has come to an end. So once again the market is faster than us economists. The market is not pricing in a Chinese devaluation, but if the disappointments continue in terms of economic data then that could soon be the case.
Posted by: Lars Christensen | October 18, 2011 at 01:57 PM
Jon said "Pboc is really fascinating. They aren't just stuck in the past; they use some very current ideas like sterilizing bond sales. The result is that China is different. They use flows to peg the dollar (they create dollar demand) and they use reserve ratios and sterilizing bonds to freeze out the stock of money they are creating"
Is this unique? I always thought most big-gish emerging market economies would do something similar.
In India, for example, the currency floats (more or less) but the Reserve Bank uses flows to reduce volatility and big swings in the prices.
Reserve ratios and sterilization bonds are used to 'freeze out the stock of money' or maintain the target interest rate.
And yes, as Nick points out, this is more or less like a reverse carry trade. This is even more true for India where the dominant foreign capital inflow is institutional 'hot money' aimed at the equities market rather than FDI. The Reserve Bank of India basically has a position that is short Indian equities and long USD/Treasuries. This is an amazingly profitable trade in a crisis.
Posted by: Ritwik | October 18, 2011 at 01:57 PM
I thought that the US was the borrower and China the lender, thus the US is Spain and China is Germany. It seems clear to me that when the US doesn't want to borrow anymore from China or reduce its debt to China, it will do so by increased inflation. If China maintains the peg it will be taken along for the ride. If it wants off the ride it will let the Yuan appreciate against the Dollar.
Posted by: Determinant | October 18, 2011 at 04:59 PM
INflation is indeed the key for the current crisis but the ride will be anything but smoot
Posted by: Marc Labbé | October 18, 2011 at 07:47 PM
roller coaster anyone?
Posted by: Marc Labbé | October 18, 2011 at 07:49 PM
When Nick and Adam P both agree that the world is coming to end, I start to freak out.
Off to buy bottled water and ammunition.
Posted by: Patrick | October 18, 2011 at 09:50 PM
I prefer a lever-action rifle. I'm a sucker for tradition. ;)
Posted by: Determinant | October 18, 2011 at 10:32 PM