Thursday, October 28, 2004

Just what the doctor ordered. At least, what Stephen Roach ordered.
The People's Bank of China lifted its one-year rate on bank deposits by 0.27 percent to 2.25 percent, AFX News reported from Beijing. It also lifted their six-month deposit and three-year and five-year deposit rates as well.

"This round of macro-control measures, including economic, legislative and necessary administrative measures, has achieved good results and the overall macro-economic and financial operation continues to move towards its targeted direction," the bank said in a statement.

"But to address recent conflicts and problems still existing in the financial and economic operations and to further consolidate the results achieved, the People's Bank of China has gained the approval of the State Council (cabinet) to raise benchmark interest rates."
Roach has been saying for some time that global rebalancing is essential to save the global economy from ruin. An essential part of that rebalancing is a new relationship between the dollar and the renminbi, one to which the Chinese have been the most resistant. On September 27 Roach opined,
I have been a diehard optimist on China for over seven years. But now I am worried that China is at risk of making a series of major policy blunders that are tied directly to its role in leading the new Asian way. It was one thing to maintain the RMB peg in the face of mounting world pressures to do otherwise in recent years. I still feel this was the right thing to do on a stop-gap basis -- in effect, providing China�s undeveloped financial system with an anchor during a critical phase of its integration into the global economy and world financial markets.

But now China is digging in its heels on interest rate policy -- refusing to deploy the conventional policy instrument that is widely accepted as the principal means to restrain an overheated economy. China, instead, prefers to use the administrative edicts of its central planning heritage -- controlling the quantity of credit and project finance rather than its price. The combination of these two policy rigidities is especially worrisome. China�s central bank must keep creating RMB in order to recycle its foreign exchange reserves back into dollars; this runs the grave risk of undermining China�s ability to control its domestic money supply. But now, by holding its interest rates down, China is encouraging the very excesses that are driving its overheated economy -- a massive investment overhang and mounting property bubbles in several important coastal markets, especially Shanghai. By freezing the currency and its interest rates, China is, in effect, forcing its own imbalances to be vented in increasingly dangerous ways. This is not sustainable.
Conventional wisdom says that this rate hike takes more steam out of the near-runaway Chinese locomotive, and especially its property and investment bubbles. Combined with more US tightening, the boil might just come off smoothly.


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