Thursday, June 03, 2010

A Real Revaluation?

As the US Commerce Department appears to be "seriously considering" an investigation into US industry claims that China's piss-taking in the FX market represent a subsidy to its exporters (well, duhhhh...), it is interesting that today Beijing increased the minimum wage by 20%. Obviously, that is only one city and a small part of China's output, but there have been increases in other manufacturing provinces as well, and this is suggestive of similar moves in other urban areas. People tend to have an aversion to nominal increases/decreases, but Economics 101 says there are two ways to bring FX rates to "fair value" (whatever that is...): you can let the market move to offset imbalances, or you can try to remove the imbalances directly. A 20% increase in domestic labour costs (or 5% or whatever it ends up being) would go some ways in pushing up China's Real Effective Exchange Rate (REER) and move the "fair value" for CNY. Is this a way for the more economically liberal-minded policymakers to pursue currency policy without risking the wrath of the "appalling old waxworks" of the Communist Party? Or is it just part of the "master plan" to stop speculators from making any money out of the inevitable CNY reval?

The People's Republic of Europe certainly seems to be of the latter view, led by Finance Minister Schauble and his short-selling ban. Having said that, the relative silence from European policymakers the last few days has probably helped risky assets stabilise somewhat. You can't help but suspect that Geithner's chat with the Germans went something along the lines of "Just shut the fuck up, OK?!". On the European front, it is something of a surprise that Moody's confirmed the standalone bank financial strength ratings of seven Portuguese banks, while keeping them on review for a possible downgrade of LT-debt, rather than just downgrading them. Hmm...

Back to China. The below chart shows USD/CNY (brown), the CNY's Nominal Effective Exchange Rate (green), and the ratio of the USD's REER to the CNY's REER (white). A 20% increase in domestic wages would put the Real Reminbi at its strongest relative to the USD since 1989 - no small thing. But what about other side-effects? You have to think that with inflation at 3.7%, wages at 20% and the structural supply-side constraints of a Communist Chinese Capitalist system that there is a serious risk of inflation getting out of the bag, and with it a hard-landing for China as policy is tightened hard. But in the short-term this might work out to the advantage of the West - especially Europe - as inflation leaks abroad, offsetting the deflationary neck-tie of PIGS debt.


So it seems that Voldemort has chosen a very visible single hand over Adam Smith in order to correct global imbalances....

6 comments:

melki said...

this is very interesting development.

i would say though that there is no way a 20% increase in wages translates to 20% increase in prices. a proportion of it will certainly eat into profits and the rate (breathtaking, i'm sure) at which china is creating m(b?)illionares slows down.

am i wrong? for instance i have heard it said elsewhere that chinese export geared firms (massive generalisation approaching) aren't actually that profitable.

cpmppi said...

Nope, realistically, the wage-price pass-through will be much smaller than 20%. I just thought this was interesting, especially given that we are seeing news of increasing numbers of strikes etc. Pressures are building...

I guess it doesn't really matter whether they are profitable or not provided the management have the right political connections...

Lars said...

What is the blp ticker for the cny reer and usd reer?

Игры рынка said...

How about this? Minimum wage increase will bankrupt the weakest companies because this is no margin they can use. So the result of this wage increase will be lower demand and not higher demand.

cpmppi said...

CNY : JBXRCNY Index
USD : JBXRUSD Index

Chetan said...

i would say though that there is no way a 20% increase in wages translates to 20% increase in prices.

Quite right its more than 20% once it starts to feed into the system. Nore sure big this really is but if china can manage to export some price inflation then the west has decent chance of inflation all this while we have been importing everything on the cheap