Thursday, January 05, 2006

Speculative flows, the yuan and deflation in China

This Times article suggests that speculative currency flows into yuan have dropped off drastically as hopes of a significant near-term revaluation have faded. Particularly interesting is the claim that the inflationary forces felt recently in China were more due to "hot money" from outside rather than overheating of the economy. With growth rates in the 10% range there are few signs of inflation now.

...Hundreds of billions of dollars have flowed into China in recent years, driving the country's total reserves beyond Japan's, to $860 billion. But this fall, only half as much money flowed into China as a year earlier.

Investors in the once red-hot Shanghai property market are walking away, and currency speculators who had bet that China would sharply strengthen the yuan have pulled back as it became clear that the authorities favor a slow approach to currency appreciation.

The flow of money has diminished even with the rise in the Chinese trade surplus, which has tripled in the last year to the irritation of politicians and business executives from Washington to Brussels to Tokyo. They want Chinese officials to let the yuan rise faster to make the country's exports more expensive in foreign markets.

In July, authorities revalued the yuan only slightly after trading partners complained that its link to the dollar kept exports cheaper than they would otherwise be. That, combined with very low interest rates, damped investment enthusiasm.

The slowing of speculative investments "takes the pressure off" Chinese authorities to allow appreciation, said William Belchere, chief Asia economist at Macquarie Securities here.

The reduced speculation has brought measurable advantages as well: inflation has almost disappeared, even as the economy grew at a 9.8 percent rate last year. Economists attribute this in part to dwindling amounts of speculative money sloshing around the economy.

China has also enjoyed excellent harvests, and there has been so much investment in new factories that a recent government report estimated that three-quarters of all categories of manufactured goods suffered from oversupply.

"There's no pricing capacity for anything," said Jing Ulrich, a J. P. Morgan economist here. "Food prices are falling," she said, and those for manufactured goods "are seeing stagnation at best."

...The central bank said late Tuesday that it wanted to keep the yuan's exchange rate "basically stable at an adaptive and equilibrium level." It added that big fluctuations "will adversely affect China's economic and financial stability and undermine China's fundamental interests."

Qu Hongbin, a senior economist at HSBC, said speculators had expressed disappointment that China did not let the yuan rise more in July and was keeping short-term interest rates at half the levels in the United States. Speculative inflows have virtually disappeared as a result.

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