“China's Economy in 2010 Forum” Snapshot (2)

January 12, 2010

The first session of the second part of “China's Economy in 2010 Forum” is hosted by Professor Wu Ho-Mou.

The first speaker is Professor Lu Feng from CCER. His speech includes two parts: an introduction of China Economic Observer(CEO) to the audience and a prediction of China's long term performance as compared to the US. The China Center for Economic Research organizes a quarterly event of China Economic Observer (CEO), which is a symposium inviting all this cutting-edge economist to give their opinions on hotly debated issues regarding China's economic performance. The CEO started from 2005 under the leadership of Professor Justin Y.F. Lin. Guoqing Song, Qiren Zhou, Yang Yao, Geng Xiao, Yiping Huang are all regular participants of this event. The coming symposium will be held late next month. Apart from that, the CEO also coordinates a macroeconomic projection program called LangRun Forecast, which is a projection on China's economic performance on a quarterly basis with usually nine macroeconomic predicted indicators released at the CEO as well as CCER's official website. The third quarter's LangRun Projection of GDP is exactly the same as the real data. Before CCER group came here, Lu Feng has consulted and collected data from some of the participants at CEO on the projection of next year's economic performance. It shows that China's growth in 2010 would be around 10%. Then, Lu Feng extended his analysis to a much longer perspective. It is well known that Goldman Sachs produced a famous report in which “Bricks” will finally take over the six biggest economies, and China will surpass the US at 2041. Lu Feng argued empirically that China is very likely to finish the task in terms of total economic size before 2025, much earlier than GS's prediction. China's current economic growth rate is 8.7 and 12.2 percent higher than the US during 2003 and 2008 in real and nominal terms respectively. If changes in RMB/Dollar exchange rate are allowed, China's convergent rate toward the US is around 16%. China's current GDP size is about 34 trillion RMB by the end of last year, which converts into almost 5 trillion US dollars, something like 35.6 of total size of the US. In other words, the economic size of the US is about 2.8 times as large as China, so if China continues 16% of annual convergent rate in the next 10 years, the current ratio of China's economy to the US's will more than quadrupled. In this assumed case, China's economic size will surpass the US in 7 years. However, the convergent rate is not an appropriate assumption for China's future catch-up. If a much smaller convergent rate, for instance, 10%, is assumed, China's economic size would surpass the US by 2021 or 2022. In conclusion, China will surpass the economic size of the US by 2025. However, itt should be noted that even that day comes; China is still a poor country in terms of GDP per capita. Lu Feng fully agrees professor Lin and Dr. Qin's discussion of China's economic reform, but he wanted to highlight the reform of RMB exchange rate and interest rate policy, which is crucial to the improvement of macroeconomic management system. China may not need or lack domestic demand, which seems to be very strong in terms of 2003 to 2008. Moreover, China does not need large trade surplus to assure the desired aggregate demand, and a more flexible exchange rate is appropriate.

Dr. Wang Jianye is the second speaker. He talked about China's risk and opportunities facing foreign capital inflows. China's economy has rebounded faster compared to other major economies. The major reasons of it lies on prudent management of cooperate finance and policies that are highly open to foreign investment. High degree of openness brings efficiency gains on global competition, but capital flows can also be volatile and detrimental. Available data indicates that China's inflows declined rapidly from 2008 to 2009. According to the inflow data on the central bank's foreign asset, China's base money fell over 40% in 12 months from Sep 2008 to Sep 2009. China monetary policy was not expansionary in the March of 2009. However, things have changed since the bankruptcy of Lehman Brothers when money supplies increases sharply. It's not because that central bank increases base money, but because of the extension of commercial banks' loans. This is in contrast to the US, where the Federal Reserve's balance sheet extended before 2008. Dr. Wang believes the expansionary behavior of China's commercial banks can explain the quick recovery of China's economy. China's large foreign exchange reserve also raised a question of the impact of capital flow. When most of currencies in the emerging markets devalued, China's RMB keeps stable during the crisis just as in the Asian Crisis. Now is the challenge of surging capital inflow. There are clear indications of the capital flows to China again. As base money grows fast, trade surplus and recorded long-term capital flows do not fully account for all the changes in central banks' net foreign position. Short-term capital also flows despite of capital controls. Will this trend intensified in the coming years? Jianye believes so. The reasons are twofold: China's market for consumer and investment goods are huge and expanding rapidly, which attracts international long-term capital. In addition, the G-3 monetary policies are still in extraordinary expansionary process. If unchecked, these inflows will put a pressure on China's money supply. In his view, China and other emerging markets will face the risks of asset bubble over inflation. Finally, he talked about financial policy in China. In his opinion, just continuing bank lending is not enough, China should mange capital inflows more effectively and increases the share of FDI. Capital outflow is also a useful means of maintaining domestic financial stability. Potential regulations are also very important for preventing systemic risks. As to the exchange rate, real effective appreciation of RMB is unavoidable. But orderly adjustment of the exchange rate by developing country is very hard when all reserve currencies are in a super-expansionary mode and capital flows are unpredictable. Capital flows will be a major challenge to China's policy makers. But judging from its performance during the crisis, China will be on a strong and sustainable path.

Geng Xiao is the third speaker. His focus was on uncertainties of major macroeconomic variables. The uncertainties are related to three facts: cheap emission, cheap money and cheap labor. These are three unsustainable, distortive and inefficient facts, which he thought were also the cause of global imbalances. Nobody cared about emission problem a hundred year ago because all countries were under the process of agricultural civilization. For instance, the major input of China is population, which is reproductive with no emission. Problems aroused when the west invented steam engine, which uses coal. Later on, a bunch of fancy stuffs were also created using energies. Now, nearly all of our countries are in the process of modernization, and of course, use steam engines and have emissions. More important, emission is not priced. That's why making products in China so cheap. There is also another problem. We are far away from gold standard or silver standard, and money is so cheap. Cheap money generates bubbles, which finances the US's consumption. But cheap money also finances huge over-capacity in Asia, esp. in China. All those three facts are going to change rapidly. Emission is going to be expensive, money is going to be expensive in fear of another big bubble, and wages keep rising. Those were uncertainties China face. Then, Xiao Geng talked about the exchange rate problem. Nick Lardy is here, and he has the view, which represents the typical West's view, that exchange rate is the major instrumental variable to change trade surplus. But there's an alternative view he holds that exchange rate is also a benchmark or anchor for price level. This is particularly true for developing economies, like China. If China fixes exchange rate, the only other way to raise wage and raise price levels in China is through inflation. This inflation is basically a relative price adjustment among different countries. However, this phenomenon is not very understood by most of us. We tend to see inflation as bad, but in fact, convergence of wage across the world is good, so if we agree inflation is inevitable like what happened in Japan, Korea, Hong Kong, Taiwan, etc, then we have to find how to live in a wage growth or inflationary environment in the emerging market. That is, we have to tolerate an amount of inflation. In his opinion, an inflation rate of 5% is quite normal when GDP growth rate is around 8%. If we tolerate inflation, there comes another question: How should interest rate be set? With such an inflation rate, if nominal interest rate is low, it's quite easy to get negative real interest rate, which mainly leads to bubbles, like what happened in China's stock market at 2007 and 2008. Suppose the Chinese government increases interest rate, it is compatible with the inflation in the future and makes the real interest rate positive. What would happen about China's huge amount of inflows? Capital returns in China is much higher than that of the US, Japan and Europe. This is the fact and all of us understand. This means China is facing huge challenges to deal with capital inflows. The question is not that capital inflows are bad; on the contrary, capital inflows are good if they are channeled to efficient and productive investment, which is willing to increase China's consumption in the future. Many people blames that China saves a lot, but saving is actually another word for future consumption. There's no problem with saving itself. The problem is that we don't know what Chinese like to consume in the future. This means that the macroeconomic policy faces great challenges. He thinks China should tolerate high investment, because it is basically future consumption. High investment is critical to reduce China's current balance surplus and to rebalance the global economy. If the world helps China to invest efficiently, China could consumes more in the future. That's why He believes China should raise interest rate. If not, Chinese depositors continue to lose money. It is time for Chinese government to gives over-depositors a positive rate of real interest rate and let the lending rate to go up, and forces more efficient investment in China. We need to focus on the efficiency of investment in China and in the world. If so, we can avoid trade protectionism wave which would come if we pay too much attention to exchange rate issues.