Xinjiang Is more Important than a New International Moneary System for China's Hu Jintao

The drama at the G-8 meeting in Italy came when China's Hu Jintao deserted the conference before it began.

Richard McGregor and Kathrin Hille explain Mr. "Hu, the president and communist party head, convened an emergency meeting of the leadership, the nine-member inner-circle of the Politburo, hours after arriving home on Wednesday from his truncated G8 trip to Italy.

The management of the crisis is a high-profile test for Mr Hu, who must satisfy the demands of hardliners within the party for a tough response, with an eye on the sensitivities of Muslim countries offshore.

China has blamed Sunday’s violence in Urumqi, which left 156 people dead and more than a thousand injured, on Xinjiang’s indigenous Muslim population, the Uighurs."

Thus it was Mr. Hu's surrogate that delivered China's call for a less dollar dependent international monetary system.

As George Parker, Guy Dinmore, Krishna Guha, and Justine Lau tell it "China attacks dollar’s dominance:" (FT: July 9 2009)

"China has launched its highest-profile criticism of the dominant role of the US dollar as a global reserve currency at a meeting of the world’s biggest economies.

"Dai Bingguo, Chinese state councillor, raised the issue on Thursday when he joined the leaders of four other emerging economies for talks with the leaders of the Group of Eight industrialised nations – including US President Barack Obama."

China has already taken concrete moves toward a reduced reliance on the greenback:

"China moves to cut reliance on dollar"

By Richard McGregor in the Financial Times, July 3 2009, Page 19


China has taken another step towards internationalising its currency and reducing reliance on the US dollar with the announcement of new rules to allow select companies to invoice and settle trade transactions in renminbi.

The regulations released by the People's Bank of China, the country's central bank, will allow approved companies to settle transactions through financial institutions in Shanghai and other cities in southern China.

Offshore, the trial scheme will allow transactions to be settled in renminbi in Hong Kong and Macao, the two self-governing territories on China's southern borders, and later in a limited fashion in south-east Asia as well.

Importers and exporters will be able to place orders with authorised Chinese companies, and settle payment for them, in renminbi.

Although it has no short-term implications for the full convertibility of the renminbi, the announcement adds to the volley of political signals Beijing has sent recently over its dissatisfaction with the US dollar.

"To many minds in China the US dollar's time is almost up, the eurozone suffers from political paralysis and a too-conservative central bank, while two decades of economic stagnation and a shrinking population do the yen no favours," said Stephen Green, of Standard Chartered, in Shanghai.

"For them, the renminbi is an obvious, and imminent, replacement."

Far from being a replacement for the dollar as a freely-traded reserve currency, the move has been justified by the PBoC initially as assisting exporters buffeted by the greenback's fluctuating value.

"Companies in China and neighbouring countries are facing relatively large risks of exchange-rate fluctuations because of big swings in the US dollar, the euro and other major currencies used for settlements," the PBoC statement said.

The rules have also been expressly drafted to ensure that the new regime is not used to circumvent China's capital controls, by requiring supporting documentation for transactions.

"Domestic settlement banks should take effective measures to know the nature and purpose of their clients' trading," the central bank said.

The announcement of an offshore role for the renminbi chimes with China's call earlier this year for a new reserve currency.

He Yafei, a vice-foreign minister, said in Beijing yesterday that China supported reserve currency diversification in the future and that it would be "normal" for the issue to be raised at the G8 talks.

The volume of trade conducted under the new rules is expected to be small initially, but over time it should increase demand for the renminbi.


Copyright The Financial Times Limited 2009

It's Abut Time Someone Did: Asian Officials Push Back Against Savings Glut Theory

On July 3rd, Andrew Batson at the Wall Street Journal reported: "Asian officials and scholars are pushing back against the notion that their countries' high savings helped cause the financial crisis by flooding the world with money, arguing that lax U.S. financial regulation bears the brunt of the blame."

Alan Greenspan and then Governor Bernanke made these arguments when the Fed was keeping the federal funds rate negative.

European Air Traffic Down

The Wall Street Journal's Kaveri Niththyananthan reports, "Several European carriers Tuesday reported falls in traffic for June, historically the month when travel starts to pick for the peak summer months."

Making Sense out of the Economic News: Not As Bad As The Dow Took It.

We have just had a great deal of economic news come out.

The Employment Report: The unemployment rate is up slightly to 9.5 percent (compared to 9.4 percent in May.) This was as expected. The payroll survey showed a bigger than expect drop: 467,000 jobs in June. The latter became the headline news. Wall Street opened a hundred and fifty points lower and continued to fall. London and European stock markets accelerated their early morning declines in response to the news. A closer look at the data shows a curious divergence in the trends measured by the household and establishment surveys. Over the last three months, the establishment survey shows employment falling by an average of 436 thousand jobs a month, while the household survey shows a monthly fall in employment almost half that (230 thousand.) This is significant because in the last recession household employment growth turned positive well over a year before payroll jobs turned up. Corrected for base biases, it may be a better cyclical indicator.

Aerospace appears to have lost another five thousand jobs in June for a two month total of 12-13,000. BLS does not break these data out, so I have to estimate them from the published data.

Consumer confidence was down. German and Australian retail sales were up and beat expectations. U.S. durable goods orders were up in May.

Non defense aircraft and parts orders were up as well. Although orders were half May, 2008, they reached the highest level since October. Order backlogs for the industry fell from 39.2 months to 33.4 months.

Car sales are up and appear to have bottomed out in February. They are way from May, 2008.

Turn in Thursday for News

Thursday will bring two big releases of national economic data with significant implications for the Wichita economy.

9:00 A.M. Central Daylight Savings Time: The Bureau of Economic Analysis (of the Commerce Department) will issue data for May manufacturing orders, shipments, backlogs, etc. While total new orders are an important cyclical indicator, we in Wichita will be particularly interested in the new and unfilled orders for the aerospace industry. This will not include the impact of Quantas' recent cancellation of orders for 15 Dreamliners.

7:30 A.M. Central Daylight Savings Time: The June employment report. Normally this would be issued Friday, but the Bureau of Labor Statistics is moving it up a day for the Independence Day holiday. The consensus of forecasts is that it will show a loss of 350,000 jobs on nonfarm payrolls and the unemployment rate up to 9.6 percent.

What to look for: A better showing on job losses would support our thesis that the economy has bottomed out. Even without a significant surprise from the payroll data, the report may better expectations on the unemployment rate which is based on the notoriously noisy household survey. The household survey also gives an alternative measure of employment. Analysts tend to ignore this measure for techical reasons, however I have found a careful analysis of these data gives better signals at turning points. By this metric the decline in employment has moderated even more than manefested on the establishment survey. Look for further confirmation of bottoming out. The non aerospace component of Wichita's economy needs to see a pickup in activity in the national economy.

The Bank of China Has Elevated Zhou Xiaochuan's Call for International Monetary Reform

Mr. Zhou Xiaochuan, is the People's Bank of China's Governor and Chairman of the Monetary Policy Committee. He published a paper on March 23, 2009 calling for increased use of the SDR as a reserve currency. Read Governor Zhou Xiaochuan's call to "Reform the International Monetary System" on the Bank's web site.

Robert Flint in the Wall Street Journal tells us, "In its 2009 financial-stability report on Friday, the People's Bank of China elevated the status of earlier suggestions for a new international currency. The ideas put forward in March in an essay by central bank governor Zhou Xiaochuan have now become part of the official view.

"The report is essentially a reiteration of the call in Mr. Zhou's essay for expanded use of Special Drawing Rights, a basket of currencies used by the International Monetary Fund. There is nothing in the stability report that hasn't been stated before.

"The central bank took a big step when it published Mr. Zhou's essay in English on its Web site in March. But to make his views a central-bank-backed position puts more authority behind the call for a new reserve currency.

"The central bank is an arm of the Chinese government and ultimately answers to the State Council, the country's highest governing body."

China to Be Long On Gold & Real Estate and Short on the Dollar

Zhou Xin and Alan Wheatley report in the Guardian, "Li Lianzhong, who heads the economic department of the Party's policy research office, said China should use more of its $1.95 trillion in foreign exchange reserves to buy energy and natural resource assets.

"Speaking at a foreign exchange and gold forum, Li also said that buying land in the United States was a better option for China than buying U.S. Treasury securities.

"'Should we buy gold or U.S. Treasuries?' Li asked. 'The U.S. is printing dollars on a massive scale, and in view of that trend, according to the laws of economics, there is no doubt that the dollar will fall. So gold should be a better choice.'"

China has 1,054 metric tonnes which, with gold selling at $941/oz, is worth $35 billion compared to America's 8,133.5 metric tonnes worth $270 billion.

Dow Jones reported that gold was up during the day's trading: "The initial rise occurred on a day when the U.S. dollar weakened partly in response to comments from the People's Bank of China saying it will push for reform of the international currency system to make it more diversified and reduce over-reliance on the current reserve currencies, primarily the dollar. This particularly caught the eye of gold traders a day after a senior economic researcher in the Communist Party expressed concern about the dollar and said gold could be a better alternative.

"'The People's Bank of China's call for a new global reserve currency or super-sovereign currency will likely lead to further pressure on the dollar and gold buying,' said Mark O'Byrne, director of bullion dealer GoldCore. "


The BRIC countries have called for the creation of a new reserve currency or at least a reduced dependence on the dollar.

According to Zhou Xin and Alan Wheatley, "China disclosed on April 24 that it had increased its holdings of gold to 1,054 tonnes from 600 tonnes since 2003.

"However, China's foreign exchange reserves have grown so fast over the same period that gold's share of the stockpile, the largest in the world, has shrunk.

"Li cited the high share of gold in the foreign exchange reserves of the United States, Italy, Germany and France, to argue that China's gold holdings, which account for about 1.6 percent of its reserves, are too small.

REFORMING THE SDR

"China does not disclose the composition of its currency reserves, but bankers assume around 70 percent of it is held in dollar assets.

"China is the largest single holder of U.S. Treasuries, with $763.5 billion at the end of April, according to U.S. Treasury data. [ID:nTRU000389].

"Analysts say this data set understates the true number as it does not capture paper bought through dealers in London or elsewhere.

"Li said a second reason for buying more gold would be in anticipation of the yuan one day becoming a reserve currency.

"The yuan is not convertible on the capital account, meaning it cannot be freely traded for other currencies for financial transactions that are not related to trade.

"This rules out the yuan's use as an international reserve currency, for central banks would not be able to convert it quickly if necessary.

"But, in a very preliminary step towards that goal, China is paving the way for greater use of the yuan beyond its borders.

"
The People's Bank of China has arranged currency swap deals with six countries since December totaling 650 billion yuan ($95 billion) so that trade and investment with China can be conducted in yuan, not dollars.

"And China will soon allow selected firms in the southern province of Guangdong that trade with Hong Kong to settle their transactions in yuan, or renminbi.

"'If the yuan should go international or become a reserve currency, China needs more gold to back that,' Li said.

"When the yuan does become an international currency, which Li acknowledged was a long way off, he said the composition of the SDR should be reformed to include the Chinese currency.

Ideally, in the long term, the SDR would be made up of the dollar, euro, sterling and yen and yuan, each with a weighting of 20 percent, Li said.

"The SDR is currently made up of the dollar (with a weighting of 44 percent), the euro (34 percent), the yen (11 percent) and sterling (11 percent)

"The four currencies in the SDR, which must be convertible, are those issued by Fund members with the largest share of global trade. The weights assigned by the IMF are based on the value of exports and the amount of reserves denominated in those currencies.

"The composition of the basket is reviewed every five years. the next review is due in 2010."

Is Immunizing the U.S. Economy Against the Dutch Disease So Bad?

I have written that "Plain Vanilla Banks Must Wax and Wall Street Must Wane." The Wall Street Journal's David Weidner seems to think that is a bad idea, especially to the extent it is a policy goal of the Obama administration. In today's "The Perils of a Smaller Wall Street: Reforms Seek Smaller Pockets of Risk, but Globally, Big Firms Still Dominate," he notes there are now only two U.S. banks in the world's top ten (JPMorgan and Citi) and they are near the bottom.

How bad is it that we are no longer the Masters of the Universe? It is not that long ago that Japan had eight of the ten spots on that list. The result? The next ten years were a lost decade for the Japanese economy. Is this just another example of post hoc, ergo propter hoc (the logical fallacy of "after this, therefore because of this)? Japan had a bubble because of a huge overexpansion in credit, foreign financed after financial deregulation. Inflated capital led to overexpansion of banks and a monster bubble. Bubbles burst. Bubbles distort incentives and misallocate resources. Like inflation, bubbles are bad and are caused by bad policy.

The United States has suffered from a virulent form of the Dutch disease these last twenty years. As Wall Street has sucked in capital from all over the world, manufacturing has been hollowed out. As value added in the financial sector grew, our competitiveness waned.

The White House White Paper is largely ratifying reality. (See below and today's Eagle: "New financial rules explained.") The more prudent banks (JPMorgan, Intrust) will prosper. The others have been shrunk in true capitalist fashion. If the financial sector shrinks, so be it.