China's Exchange Rate System Rtf om

Transcription

1 China's Exchange Rate System Rtf om Lessons for Macroeconomic Policy Management PAUL YIP Sau Leung Nanyang Technological University, Singapore NEW JERSEY LONDON SINGAPORE BEIJING SHANGHAI HONG KONG TAIPEI CHENNAI

2 Contents Preface About the Author Acknowledgements vii xxi xxxv Part I: China's Exchange Rate System Reform 1 Chapter 1 Macroeconomic Conditions and Debates 3 Before the Reform 1.1 Macroeconomic Conditions Before the Reform The Beginning of China's Persistent Trade Surplus The Asian Financial Crisis: The Beginning 6 of the Peg to US Dollar The Weakening US Dollar Since Early 2002: 8 Reasons and Impact Other Macroeconomic Performance Before 11 the Reform 1.2 Debate Before the Reform: Risk of Various Proposals 13 Chapter 2 Transitional and Medium-Term Designs 17 of the Reform 2.1 The Proposed Transitional Reform Gradual Appreciation, No Major or Medium Jump 17 in Exchange Rate and No Widening of Band A Basket of Currencies with Special Care to the 19 Exchange Rate Against the US Dollar at the Early Stage A Narrow Exchange Rate Band at the Early Stage 20

3 xxvi China's Exchange Rate System Reform 2.2 The Proposed Medium-Term Arrangements The Debating Process Before the Medium-Term 20 Recommendation The Medium-Term Recommendation 26 Chapter 3 Supplementary Measures Prolonged Asset Inflation and Then Economic Crisis: 31 A Major Potential Threat to China's Economic Development 3.2 Supplementary Measures Banking Reform Control of Asset Inflation Variable Wage Component Capital Control 38 Chapter 4 The Transitional Reform in The Reform Announced in July Market Response at the Early Stage Two Important Characteristics That Contribute 43 to the Initial Success 4.4 Proposed Measures to Deal with the Speculative Inflows Measures That Discourage Speculative Inflows Measures That Offset the Impacts of Speculative 46 Inflows 4.5 Further Discussions on the Offsetting Measures Importance of Maintaining Capital Control 48 at That Time The Moderate Speculative Inflows Was Still within 49 the Central Bank's Sterilization Capacity Two Other Important Sources of Inflows Some Basic Principles to Guide the Direction 50 of the Offsetting Measures Ways to Build in More Controllability 54 and Adjustability on Potential Outflows 4.6 More Following-Up Comments on the Offsetting Measures Need to Scale Up the Offsetting Measures 60 and Maintain a Trade Surplus

4 Contents xxvii An Accounting Hurdle on the Recommended 61 Sterilization 4.7 Actions Taken by the Chinese Government The Moderate Mistake Committed by China's Central Bank 65 Between Mid-2006 and Early 2008 Chapter 5 Further Proposals on Supplementary 71 Measures After the Transitional Reform 5.1 The Potential Disaster of Developing the Renminbi 71 Forward or Futures Market at That Time The Chinese Central Bank's Initial Proposal 71 to Develop the Renminbi Forward Market The Potential Damage The Central Bank's Decision to Freeze the 80 Development of the Renminbi Futures Market Hong Kong's Intention to Establish the Renminbi 80 Futures Market 5.2 Further Proposals to Increase China's Immunity 81 and Resilience Against Financial Crisis Law to Increase Speculators'Non-Economic Risk Development of the Renminbi Forward or Futures 84 Market Should Be the Last Step of the Reform 5.3 Further Proposals on the Banking Reform Non-Performing Loans in Chinese Banks Were Huge The Three-Step Injections Had Strengthened the Capital 90 Adequacy Ratio of the Chinese Banks The Keys Would Still Be Proper Internal Control, Proper 91 Lending Criteria and Proper Lending Behaviors The Strategy of Inviting Foreign Strategic Participation 92 Had Helped Avoid an Immediate Crisis Not All the Products or Services in Foreign Banks 95 Are Worth Importing Why Foreign Strategic Partners Have Strong 96 Incentives to Help Establish Internal Control within the Banks Starting the Anti-Corruption from the Banking Industry 99

5 xxviii China's Exchange Rate System Reform Appendix 5.1 The Speculative Attack on Hong Kong's Financial 101 Markets in Step 1: Preparation 103 Step 2: Formal Attack 105 Step 3: Profit Taking 106 Appendix 5.2 Impacts of the Speculative Attack, the Proposed 107 Solutions and the HKMA's Stock Market Intervention A5.2.1 The Immediate Impacts of the Speculative Attack 107 A5.2.2 Source of the Problem: Interest Rate Hike and 109 Absence of Covered Interest Arbitrage A5.2.3 The HKMA's Stock Market Intervention and the 111 Subsequent Currency Board Reform A5.2.4 Which Measure Had Saved Hong Kong from the 112 Speculative Attack: The Stock Market Intervention or the Revitalization of Covered Interest Arbitrage? Appendix 5.3 Summary of Proposals to Deal With the 117 Speculative Attack Chapter 6 The Second-Stage Transitional Reform and 123 Potential Choices on the Long-Term System 6.1 The First Following-Up Article on the Second Stage 123 of the Transitional Reform The Monitoring Target Should Be the NEER 124 Instead of the Renminbi-US Dollar Rate Complete the Reform on the NEER Before Shifting 125 the Market Attention from the Renminbi-US Dollar Rate to the NEER Still Need to Monitor the Renminbi-US Dollar Rate Better to Complete the Reform on the NEER and 127 Then Shift the Market Attention Before Any Major Nominal Swing in the US Dollar The Appropriate Arrangement in the Subsequent 128 Years: Add a Bit Fluctuations Along a Gradually Appreciating Path

6 Contents xxix A Possible Arrangement in the Case of Diplomatic 129 Need China's Choice of No Widening of Exchange 130 Rate Band at That Time 6.2 The Second Following-Up Article No More "Unanticipated" Revaluation Alternative Ways of Making Concession to the US China's Announcement of No More "Unanticipated" 134 Revaluation 6.3 The Third Set of Policy Articles No Speeding Up of Appreciation Further Suggestions on the Details of the Second- 137 Stage Reform Proper Control on Monetary Growth Was Crucial to 141 the Success of the Exchange Rate System Reform 6.4 Direction of the Reform in the Long Term Further Discussions on the Medium-Term 146 Exchange Rate Arrangements Two Possible Long-Term Arrangements 147 Part II: Macroeconomic Policies, the Stock Market 151 and the Property Market Chapter 7 China's Foreign Reserves, Trade Surplus, 153 Outward Investments and Overseas Assets 7.1 Foreign Reserves and Holdings of Foreign Assets: 153 Some Misconceptions and Policy Implications 7.2 Increasing Domestic Demand to Attain Trade Balance: 157 A Misleading Proposal The External Balance Curve The Internal Balance Curve The Swan Diagram and Its Policy Implications 159 in Another Application for the Case in Limitation of the Swan Diagram: A Static Analysis 165

7 xxx China's Exchange Rate System Reform Chapter 8 China's Stock Market Bubble and Lessons 167 from the Bubble Squeezing Strategy 8.1 Excessive Asset Inflation: The More Likely Cause 167 of a Failed Reform 8.2 The Formation of a Stock Market Bubble in The Sharp Rise of Share Prices in The Moderate Corrections in Early The Sharp Rise in March-May The Correction in May-June The Surge Since July The Economic and Political Risks of a Bursting of 182 Asset Bubble: China's Last Chance to Gradually Squeeze the Bubble? The Risk of Being Kidnapped by the High Share 182 Price Two Types of Bubble Bursting The Curbing Measures Engineered by the 186 Party Leader 8.4 The Gradual Bubble Squeezing Strategy Early 2008: Low Risk of Second Type of Bubble 188 Bursting, But Still High Risk of First Type of Bursting The Strategy: Squeeze Only Part of the Bubble Stock Price in Early 2008 Was Still Substantially 189 Over-Valued The Danger of Selective Listening and Unrealistic 193 Trusting-To-Luck The Need to Squeeze Another Part of the Bubble The Correction in 2008: From Bubble Squeezing 196 to Avoidance of Over-Correction Further Corrections in 2008Q1 to a Less Vulnerable 196 Level The Shift from Bubble Squeezing to Avoidance 197 of Over-Correction The Global Recession and Further Plunges 200 in Share Price in 2008H2

8 Contents xxxi The Stabilization and Then Gradual Recovery 201 of the Stock Market Since November 2008 Chapter 9 China's Property Inflation I: Root Causes 203 and Consequences 9.1 Movements of Property Price in Recent Years: The Rapid 204 Rise Since Microeconomic Reasons: Why It Could Be Disastrous to 206 Let "Free" Market Force to Guide China's Property Market High Income Inequality Huge Barriers of Entry High Fixed Development Cost and Hoarding 211 of Lands The Market Structure Problem: Asymmetries 212 Between Buyers and Sellers, No Supply Curve in China's Property Market Speculative and Panic Demand Other Undesirable Effects Implications of the Above Analysis Macroeconomic Costs and Systemic Risk Excessive Rise in Property Price Macroeconomic Consequences of the Excessive 231 Property Inflation 9.4 Lessons From Hong Kong Summary on the Costs and Risk of Letting "Free" 237 Market Force to Guide China's Property Market Under the Imperfect Settings Chapter 10 China's Property Inflation II: Recommended 239 Solution 10.1 The Recommended Solution The Basic Structure of the Proposal How "Substantial" Is Sufficient? What Price Should the Government Choose? Why It Has to Be Profitable to the Government? 245

9 xxxii China's Exchange Rate System Reform Use the Substantial Public Housing Construction 248 to Offset the Soon Arriving Recession Impacts of the Proposal The Proposal in September The Warning and More Detailed Proposals in March A Summary on the Undesirable Consequences of 252 Just Relying on Market Force to Do the Allocation Job in China's Property Market Adding the Necessary Competition into China's 253 Property Market Containing the Potential Correction of Private 255 Property Price: More Classes of Public Flats With Price as the Hard Target Risk of Just Relying on Standard Tightening 259 Measures 10.4 The Tightening Measures Since April 2010 and the 260 Subsequent Developments The Tightening Measures in April The Dangerous Counter-Proposal in July The Proper Policy Mix Other Dimensions of the Proposal Further Comments in August The Administrative Restriction on Flat Purchase Remarks on the Administrative Restrictions Continuing the Anti-Corruption Strategy From the 272 Housing Sector The Strategy of Cleaning Corruption 272 Sector-by-Sector The Strategy of Cleaning-and-Consolidation Followed 273 by Another Cleaning-and-Consolidation Why the Banking Sector and Then the Housing 273 Sector Importance of Proper Implementation and 275 Counter-Checking

10 Contents xxxiii The Most Capable General Is the One Who Could 276 Make His Army Grow Chapter 11 Fiscal and Monetary Policies During the 277 Global Financial Tsunami 11.1 Signs of an Economic Slowdown in 2007H2 and Early Potential Consequences of the Anticipated Plunge 285 in US Property Prices Somebody Had to Absorb the Loss No Painless Solution to the Bursting of Property 288 Bubble The Global Economy Was Still at the Beginning 291 and Deepening Stage of the Great Recession 11.3 The Debate With the Central Bank in 2008Q2-Q The Ultra Expansionary Fiscal Policies Tax Rebate Instead of Tax Reduction Substantial Public Housing Constructions Huge Infrastructural Constructions The Four-Trillion-Yuan Fiscal Expansion The Interest Rate Policy Better to Start the Interest Rate Cuts 314 Before the Slowdown China's Failure to Cut the Interest Rate 316 Before the Slowdown First Interest Rate Cuts and Fiscal Expansion, 316 Then Quantity Easing 11.6 The Substantial Quantity Easing in Credit 319 and Money Supply Time for Substantial Quantity Easing Some Preliminary Points Before the Discussion Why Necessary to Use Ultra Expansionary 323 Fiscal and Monetary Policies?

11 xxxiv China's Exchange Rate System Reform Chapter 12 Macroeconomic Outlook: Risk of Severe 331 Asset and CPI Inflation, Exchange Rate Cycle and Then a Crisis Outside the US After the Recovery 12.1 US's QE1 Helped Avoid a Great Depression, But Raised the 331 Risk of Subsequent Global Asset Inflation and Exchange Rate Cycle The US's QE1 Had Helped the Global Economy 332 Avoid a Great Depression Similar to That in the 1930s The Risk of a Severe Global Asset Inflation 336 and Then CPI Inflation The Possibility of a Huge Exchange Rate Cycle The Global Stock Market During and After the Financial 339 Tsunami The Plunge and Then the Rebound: Some Lessons 341 for Share Investments Why It Could be Judged in March-April 2009 That 358 the Global Financial Market Had Probably Passed Its Worst Time Recession but No Great Depression in the Global 360 Economy The US Dollar Carry Trade and Early Signs 361 of Asset Inflation in Some Asian Economies 12.3 The US's QE2 and Its Potential Impacts The Debate on the Effect of QE2 on US's Output 363 and Inflation Misconceptions Related to the Liquidity Trap Monetary Policy Has Many Other Transmission 373 Channels Potential Impacts of QE2 on US Inflation The Risk of a Bubble and Then a Crisis in Economies Outside 379 the US During the Overheated Phase of the Recovery 12.5 The Likelihood of a Huge Property Bubble and Then 382 a Crisis in Singapore, Hong Kong and China References 391 Index 395