By Jonathan Galaviz
Managing Director and Chief Economist - January 18, 2011 (US)
CHINA'S EXPORTING OF INFLATION
Over the last few weeks there has been an acceleration in news coming out of China regarding its effort to contain the national inflation rate. Inflation is one of the most highly avoided dynamics of any national economy. We believe that China is starting the process of an 'exporting of inflation' strategy by encouraging the use of the Yuan as a global reserve currency in order to assist in the containment of its inflation.
In many respects, China is taking a page from America's playbook. The U.S. dollar has been used as the world's reserve currency for most of the last several decades, mostly due to political stability rather than because of economic fundamentals.
The U.S. has benefitted by exporting its U.S. dollars abroad. This has allowed the U.S. to print more dollars without increasing inflation. The printing of those dollars went to other countries for them to hold as reserves rather than being used in America's own economy, thereby allowing America to get a 'free-pass' on inflation. We believe China sees this same approach as a credible strategy to contain its own inflation.
One of the emerging novel strategies of China to counter the increasing risk of major economic dislocation is for China to encourage the world to hold the Yuan as a global reserve currency. This last week, China announced the Bank of China (not to be confused with the central bank) would allow U.S. citizens to open Yuan denominated bank accounts. This move supports our view, in an anecdotal way.
CHINA'S FIAT CURRENCY SYSTEM
China, like the United States, operates a fiat currency system which allows the unlimited printing of paper-money based on policies generated by a central bank. This monetary system tends to be perilous on several fronts, but the highest impact is on money supply, the amount of paper money (or even electronic money) that is 'printed' and used in the economic system.
Many people don't know this, but China was the first country in the world to use a true fiat paper money currency system during the Yuan Dynasty from 1271-1368. The name of this currency was called the Chao. Eventually, the Chao collapsed due to excessive inflation and rampant printing of money. China's current money-supply is of deep concern to many, even its own economic advisers, who often must comment with a limited amount of negativity regarding their own economy.
When most of the world moved away from what was left of the gold-standard in the early 1970's, China followed along for all intents and purposes. This also left China with the task of creating a true fiat currency system that essentially prints money at the direction of the central bank.
CHINA'S CENTRAL BANK AND SYSTEMIC RISKS
It may be suprising to some, but China's central bank has been one of its most stable political institutions since its establishment in 1948. Its formal name is the People's Bank of China (PBC). The PBC holds of the most financial assets of any bank in the history of the world and manages most of the economic news that comes out of China.
As China's economy continues to heat-up, we believe that systemic risks in China's economic system are accelerating. There continues to be significant malinvestment in the economy and investment in non-productive assets such as vacant condos and empty manufacturing plants.
We believe that true national long-term wealth is created by the productive deployment of capital rather than just asset accumulation - a distinct but important point. However, we also see China's central bank as not doing much to reign in credit extension, i.e. money printing. The best evidence of this news is that China will maintain a target loan growth rate of an astonishing 14%.
CONCLUSIONS AND MOVING FORWARD
In our view, China's economy is more likely now, than ever, to experience a major economic downturn at some point in the multi-year future (we will not estimate time-frame). We believe that China's central bankers also see this ever increasing risk, but do not publicly state so. The longer an inflationary monetary policy dominates in China, the worse any economic calamity will be for all of Asia.
This major downturn would be the realization that much of China's economy is based on asset accumulation rather than the productive use of those assets. The core source of the problem would ultimately be China's inflationary monetary policy for over two decades.
Our hope is that China does not experience such an economic downturn. It would put the entire global economic system at risk in way that would make the financial crisis of 2008 look like a relative cake-walk.
Simply put, if China could no longer buy U.S. debt due to a major economic crisis in its own economy, who will?
ABOUT GALAVIZ & COMPANY
Galaviz & Company is a boutique economic research and strategy consulting firm that serves global Fortune 1000 companies to understand Asia from a strategic, political and economic perspective. The firm has its roots in the analysis of the global travel and leisure sector (hotels, casinos, and airlines). Galaviz & Company prepares feasibility reports and provides strategy consulting for clients worldwide, including private equity funds, investment banks, and real estate firms. The firm was founded in 2010 and is proudly based in Las Vegas, Nevada.
|
