Tuesday, June 3, 2008

RMB Appreciation

Another chapter in the on-going saga called let-your-currency-float. I actually can't think of even a single situation where a currency peg hasn't eventually ended in disaster. It may take a long-time to happen, and the benefits may look fantastic in the meantime, but the dam always seems to break with tremendous destructive force when it does.
China, in other words, is in a nasty fix. Speculative capital is coming in through so many channels that even if the authorities were to impose capital controls, the impact would be limited at best. And the magnitude of the funds flows is eyepopping (note Pettis does go into some detail before reaching his conclusion):
Headline reserve growth for the first four months of this year was a breathtaking $228 billion.....A plausible guess, then, is that hot money inflows are greater than the headline reserve growth, or at least not a whole lot less.

So the net effect is that China has lost control of its monetary policy. It cannot sterilize this volume of inbound funds flows, so it stokes inflation, and inflation is already running at a level that is politically problematic:

Since the PBoC must monetize these inflows – either by issuing currency or by issuing central bank bills – these inflows end up adding to the country’s money base. With the largest part of the inflows probably consisting of speculative money, that is what I mean by saying that Chinese monetary policy is now driven primarily by RMB speculation.

Unfortunately I don’t think we are likely to see much improvement in the next few months, and remember anyway that even if there is a reduction in speculative inflows, it would have to be a massive reduction to mean anything. As money continues to pour into the country, the problems of inflation and overinvestment are going to persist and get worse. As they do, it will become all the more obvious that China is facing serious appreciation pressure, and the talk of a maxi-revaluation will simply increase. Needless to say, this can only increase speculative inflows.
After reading about the commodities futures markets, and these rigged exchange rate markets, and the looming disaster in the CDS and ABS markets, feel like the lesson is obvious: if you want to avoid speculative disruptions, build free, fair, and transparent markets to begin with. Such markets will not be perfect or perfectly efficient. They will be beset by usual behavioral irregularities of the East African Plains Ape. They will still be vastly better than the alternative of giving one ape (systematically bred to be a pathological bullshitter -- ie. politician) the ability to sustain these irregularities until they reach the level of a "system", at which point you are fucked, to put it succinctly. Nobody ever seems to see this line of reasoning though, and when the controls inevitably don't work, everybody asks for better controls. This is like believing an alcoholic when he says that really, this is his very-last-drink-ever.

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