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Sunday, April 17, 2011 2:06 PM


Zhou Pledges More Tightening; Moody's downgrades China Property; Clouds Over Global Economy; Yuan Reserve Currency Hype


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Storm clouds are gathering over the global economy but few investors see them as bullish sentiment on equities and bearish sentiment on the US dollar mount.

The European economy is hugely imbalanced yet the ECB is tightening, the property bubble in Australia has popped, cutbacks in state budgets will hit the US, and China Raises Reserve Ratios as Zhou Pledges More Tightening in order to combat inflation an rampant property speculation.

China increased banks’ reserve requirements to lock up cash and cool inflation, and central bank Governor Zhou Xiaochuan said monetary tightening will continue for “some time.”

Reserve ratios will rise a half point from April 21, the People’s Bank of China said on its website yesterday, pushing the requirement to a record 20.5 percent for the biggest lenders. The move came less than two weeks after an interest- rate increase. Zhou sees no “absolute” limit on how high reserve requirements can go, he said April 16.

“Our monetary policy will continue to move from moderately loose to prudent,” Zhou said at a briefing in the southern Chinese province of Hainan, where he attended the Boao Forum for Asia. “The trend will continue for some time.” He said that the government will “remove the monetary factors that are related to inflation,” echoing comments made by Premier Wen Jiabao.

In China, inflation accelerated to a 5.4 percent annual pace in March, largely driven by food costs, a statistics bureau report showed three days ago.

Officials are grappling with the aftermath of a record 17.5 trillion yuan of lending over 2009 and 2010 that drove up property prices, leading to official concern at the risk of social discontent. Taming inflation is the government’s top and “urgent” priority, China’s cabinet said after meeting in Beijing to review the performance of the world’s second-biggest economy ahead of the release of the quarterly GDP numbers.

The most recent rate increase, effective April 6, took key one-year borrowing costs to 6.31 percent and the deposit rate to 3.25 percent. While higher rates can attract “hot money,” or speculative capital, the size of the Chinese economy means that such inflows are not always a problem, according to Zhou.
Moody's Downgrades Mainland China Property

China Daily reports Moody's downgrades mainland property on gloomy fundamentals
Moody's Investors Service downgraded its outlook on the mainland property sector to "negative" from "stable" on what it says are gloomy fundamentals for developers over the next 12 to 18 months.

Under a tough operating environment driven by tightening regulatory measures, rising interest rates, reduced bank lending and increasing supply, mainland developers will inevitably encounter slowing sales, shrinking profit margins and liquidity pressure, according to the rating agency.

It also anticipates that the proceeds from contracted sales of residential homes will decline by an average 25 to 30 percent in first and second-tier cities this year.



According to a Moody's liquidity stress test on 38 mainland developers, 10 of them - all of which are listed in Hong Kong including Shimao Property Holdings Ltd and Central China Real Estate Ltd - will become "vulnerable" in terms of balance sheet liquidity if their contracted sales decline 25 percent this year compared with 2010.

Du Jinsong, head of China property research at Credit Suisse, told China Daily he agrees the finding of Moody's, adding that Credit Suisse has been underweight mainland property since October 2010.

The investment bank expects mainland home prices to slide 5 to 10 percent this year with trading volume to drop 10 to 15 percent.
I expect a bloodbath, not a 5% pullback. Once sentiment changes it will likely be gone for a long while just as happened in the US.

China's Sovereign Wealth Fund Manager Sees Clouds Over Global Economy

The Wall Street Journal reports China Fund Chief Highlights Caution on Global Economy
The head of China's sovereign wealth fund, China Investment Corp., said he sees gathering clouds over the global economy, with the continuing debt crisis in Europe, no end in sight to the U.S. property slump and natural disasters that have set back a nascent recovery in Japan.

Lou Jiwei's generally pessimistic outlook for the developed world summed up a broad theme of anxiety at two high-level meetings on the Chinese tropical island of Hainan over the past week: the Boao Forum for Asia, which brings together Asian business and political elites, and a summit of the Brics economies of Brazil, Russia, India, China and South Africa.

Addressing the Boao Forum on Sunday, Mr. Lou said that measures to combat inflation in emerging countries will likely lead to a slowdown in their growth. China's economic growth is widely expected to slow to around 9.5% this year, below last year's 10.3% expansion.

Mr. Lou said emerging markets would carry the global economy along this year, but the momentum could slow in 2012. That could threaten growth in Europe in particular, he said, because it is increasingly reliant on exports to emerging markets even as it grapples with a sovereign debt crisis.

The difficulties would be exacerbated if the U.S. started to withdraw its fiscal stimulus at the same time, Mr. Lou said. In Japan, there is a growing chance of a "major slowdown," he said.

Meanwhile, divergent views on the potential role of the Chinese yuan as a reserve currency emerged at Boao.

Mr. Dai, chairman of China's National Social Security Fund and former chief of its central bank, said on the panel that China will likely need at least 15 years to make the yuan a fully internationalized currency, with full convertibility and other attributes of current reserve currencies such as the dollar.

"The yuan's internationalization is a long-term process," he said. "My estimate is not conservative."

Officials including from France and the U.S. have proposed that the yuan become a component of the special drawing rights, an artificial reserve currency created by the International Monetary Fund. The SDR is now made up of the dollar, the euro, the yen and the British pound. But officials have differed on what changes to China's exchange-rate system that would require.

China's government, while promoting the internationalization of the yuan, has shied away from the idea because of concerns that it may involve bigger, faster changes than Beijing wants to make.

However, Chinese central bank Gov. Zhou Xiaochuan on Friday hinted at support for the idea. "If someone suggests that the RMB should be in the SDR, I welcome this kind of opinion," Mr. Zhou told a panel discussion, using another common term for the yuan.

Former U.S. Treasury Secretary Henry Paulson on Friday dismissed the idea that the yuan could become a reserve currency anytime soon, or even a component of the SDR. He said such moves would require significant further liberalization of the yuan, which is now tightly controlled.

"To me a reserve currency has got to be one that is liquid and is convertible and whose value is determined by the markets, not by governments," Mr. Paulson said.
Reserve Currency Hype

In spite of all the hype everywhere about the Yuan as a reserve currency, the idea is complete nonsense given issues regarding convertibility, property rights, civil rights, and the nature of China's command economy in general.

Moreover, given China's massive property bubble and unwarranted infrastructure build-out, the Chinese banking system is as bad a shape if not worse than other major countries. It is not even clear the Yuan is undervalued.

Paulson has this correct.

SDRs are nothing but hype as well. No one trades in SDRs. Moreover, any country that wants to keep reserves in a basket of currencies is free to do so now. Baskets of currencies will not fix any structural problems anywhere.

Thus, all these little arrangements where China trades in the Yuan with its neighbors are essentially irrelevant.

Articles like China "Attacks The Dollar" - Moves To Further Cement Renminbi Reserve Currency Status are complete silliness.

Countries Like to Bitch

The BRICs are bitching, with a legitimate reason. Countries like Brazil are mainly bitching about global currency debasement, led by the US and ironically by China. However, bitching will not solve any structural problems, nor will SDRs. In fact, if baskets do not resemble actual trading patterns, they would exacerbate the problems.

Gold's Enforcement Mechanism

Gold had an enforcement mechanism that paper currencies and baskets of paper currencies lack. That enforcement mechanism is easy to explain: Countries that run trade imbalances long enough and fiscal deficits deep enough, eventually run out of gold.

When Nixon closed the gold window, the last set of controls on reckless monetary expansion went out the window. Neither SDRs nor the Yuan is any part of a reasonable solution, nor is the Yuan likely to be any kind of reserve currency any time soon for reasons explained.

Nonetheless, expect the hype to continue because global imbalances are still large and growing, and also because people like to hype.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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