The Titillating And Terrifying Collapse Of The US Dollar. Again. by Michael Pettis – China Financial Markets
Foreign perceptions about the Chinese economy are far more volatile than the economy itself, and are spread across a fantastic array of forecasts. On one extreme there are still many who hold the view that overwhelmingly dominated the consensus just four of five years ago, with a book by Martin Jacques, When China Rules the World, titillating or terrifying many with a subtitle that promised the end of the Western world and the birth of a new global order. Although few within this camp still believe in their earlier forecasts of 8-9 percent annual growth for another one or two decades, many among them still think China will manage to double its GDP in ten to twelve years.
On the other extreme are those who expect the economy to collapse well before the end of the decade. Although he himself does not expect an economic collapse but rather a political one, among the deeply pessimistic is George Washington University’s David Shambaugh, who published an article in the Wall Street Journal last year about “The Coming Chinese Crackup”. His article set off an intense debate among China watchers that still continues and indeed has been made more intense by a number of recent measures that seem aimed at limiting economic discussion and analysis.
Shambaugh warns that Beijing’s policies, aimed at staving off imminent political collapse, are instead “bringing it closer to a breaking point.” This seemed to mark a sharp change from his earlier views, all the more noteworthy given that his credentials as a knowledgeable and sympathetic observer of China had been reinforced just two months earlier when the prestigious China Foreign Affairs University, “the only institution of higher learning under the guidance of the Ministry of Foreign Affairs”, according to its website, named him the second-most influential China expert in the United States.
While political whispering and gossip about political instability have undoubtedly surged during the past year, I have no ability to judge China’s complex power struggle and its mysterious political maneuverings. No one I know, even the most plugged-in of my friends and former students, seems to have much sense of the political direction in which we are going, and the only thing with which everyone agrees is that they are all a lot less certain than they used to be.
In my opinion, however, there is no question that the days of rapid growth, which powered the inexorable economic rise on which Jacques relies for the future described in his book, are well and truly over. There is no way that growth won’t drop to below 2-3% well before the end of this decade, although if it manages the adjustment well and doesn’t put off too much longer an intelligent plant to resolve its debt burden, Beijing could keep the annual growth in household income from dropping much below 5% during this period.
This doesn’t mean that I think China is likely to experience an economic or financial crisis, let alone political collapse, however, although historical precedents make it very clear that as a country’s balance sheet becomes increasingly fragile, it takes a smaller and smaller adverse shock to set off a financial unraveling. There is nonetheless absolutely no question in my mind that its GDP growth rate will continue to drop sharply – either by 1-2 percentage points a year, or a lot more steeply after two or three years in which it maintains growth rates above 6 percent.
But titillation and terror continue in various forms. For many analysts who don’t understand why continued rapid slowdown is inevitable and why, therefore, it makes sense to tone down some of the rhetoric, recent statements made by Zhou Xiaochuan, Governor of the People’s Bank of China (PBoC), set off some very loud alarm bells. In his statement on April 16 to the IMF’s International Monetary and Financial Committee meeting in Washington, D.C., the head of China’s central bank closed with two sentences that caught the eyes of a number of analysts:
Starting from this April, China has released foreign exchange reserve data denominated in the SDR in addition to the USD. We will also explore issuing SDR-denominated bonds in the domestic market.
A concurrent release by the central bank on the PBoC website emphasized the first of these two statements: “starting from April 2016, the People’s Bank of China is releasing foreign exchange reserve data denominated in the SDR, in addition to the USD currently used.”
A little bit of context is in order here. Every month the PBoC announces the value of its foreign currency reserves in renminbi and in US dollars. Beginning in April, it plans also to announce the value of the PBoC’s reserves in Special Drawing Rights (SDRs).
The PBoC correctly points out that because the SDR is necessarily less volatile than any of the constituent currencies – US dollar, euro, the Japanese yen, pound sterling, and, in October of this year, the renminbi – using the SDR “would help reduce valuation changes caused by frequent and volatile fluctuations of major currencies.” We saw how this works Sunday, in an article in the South China Morning Post that opened with this:
China’s foreign exchange reserves rose, albeit marginally, for a second consecutive month in April, indicating easing in capital outflows, according to data released by the People’s Bank of China on Saturday. The US$7.1 billion rise beat the market forecast of a drop and took outstanding forex reserves to US$3.22 trillion at the end of last month. In March, the reserves rose US$10.2 billion, ending a five-month decline.
At the bottom of the article, the SCMP gave us the SDR figures released by the PBoC:
In terms of SDR, the country’s foreign exchange reserves were 2.27 trillion at the end of last month, down from 2.28 trillion at the end of March.
A $7.1 billion increase in reserves when quoted in US dollars turned into a SDR 0.1 decrease when quoted in SDRs. The US dollar declined against most major currencies in April and this weakness showed up in the form of an increase in the dollar value of the PBoC’s non-dollar reserves. Because the US dollar share of PBoC reserves is around 1.5 times its share of SDR, this same weakness showed up in the form of a decline in the SDR value.
Aside from reducing volatility, the PBoC also claims that using the SDR to report foreign exchange reserve data will help “provide a more objective measurement of the overall value of the reserve”. Here the PBoC is mistaken; there is no additional information in the new number. Indeed anyone who preferred to keep track of the SDR value of PBoC reserves could have done so all along simply by converting each monthly US dollar value into SDRs – or euros, yen, sterling, or any other currency for that matter – at the then-prevailing exchange rate. There is no special trick here.
Undermining dollar hegemony
It was the last sentence in the PBoC release that raised eyebrows among many analysts, and this is where the titillation and terror come in. Reporting the value of foreign exchange reserves in SDRs, according to the PBoC