China was never likely to receive much sympathy by complaining about other countries engaging in so-called currency wars.
If there is a modern mercantilist blueprint Beijing surely wrote it — its longstanding dollar peg saw it rack up decades of double-digit export growth and the world’s largest pile of foreign reserves.
And on cue, February’s expectations-beating 22% surge in exports suggests China’s exporters are still winning any trade skirmish.
On the surface, this makes repeated saber-rattling comments about currency wars by Chinese officials appear unnecessary, if not somewhat odd.
On Friday, Commerce Minister Chen Deming was the latest to raise concerns about competitive currency depreciation and the effects of excessive money-printing by central banks.
The head of China’s sovereign-wealth fund was less diplomatic, reportedly warning Japan against “treating their neighbors as your garbage bin and starting a currency war.”
There were some clues, however, as to what lies behind this escalation in rhetoric in economic reports out this weekend.
While China’s exports impressed, its economy is showing some disturbing trends: cooling industrial output, weakening retail-sales growth and a spike in inflation. Read: China inflation climbs; other indicators soften
Specifically, February’s consumer price index hit a 10-month high inflation rate of 3.2%, beating expectations, while industrial output in January and February expanded just 9.9% from a year earlier, below expectations. Retail sales growth, meanwhile, fell to 12.3% year-on-year in the January-February period, down from 15.2% in December.
One familiar area where activity is picking-up is in property and infrastructure. Investment in fixed assets accelerated to 21.2%, with real-estate investment growing at an even faster 22.8%.
The property market is showing renewed signs of overheating. Sales have been soaring, rising 77.6% from last year’s levels in value terms over the first two months of 2013.
The snapshot suggests China’s recent economic recovery is far from assured. The massive lending figures seen at the beginning of the year appear to be generating more inflation than growth. To concerns about property bubbles, some might add looming stagflation.
Clearly the last thing China needs just now is a surge in hot-money flows through quantitative easing (QE).
We are familiar with Chinese officials in the past protesting QE by U.S. Federal Reserve Chairman Ben Bernanke. With a large part of China’s $3 trillion foreign reserves held in U.S. dollars, Beijing has a keen interest in any greenback debasement.
There was at least a silver lining, however — as the U.S. dollar slid, so too did the yuan, which tended to give an extra boost to China’s exports.
This time, however, it is Japan in the firing line, following its recent adoption of ultra-loose monetary policy. It is also harder to see China’s silver lining.
Losing export competiveness against the yen is unlikely to be a big concern for China as the countries are rarely direct competitors. But Japan’s quest to raise inflation will worry Beijing if it also succeeds in chasing up prices in China.
Since the middle of last November, the yen has fallen close to 18% against the dollar. This is likely to prompt capital flows into a hard currency, and here the yuan stands out in Asia as attractive, with its managed float against the relatively robust-looking greenback.
While China officially operates a closed capital account, it is also the world’s largest trading nation, so keeping its borders sealed to money flows will inevitably be a challenge.
The latest figures showed a surge of money heading into China. Last week, China’s central bank reported that companies and individuals changed 684 billion yuan ($109 billion) worth of foreign currency in January. This was a record for a single month, and the data point is often used as a proxy for hot money flows.
For China, currency wars appears less about export competitiveness and more about fears of further fanning domestic inflation and property bubbles. With a fixed exchange rate and porous capital controls, China risks losing control of its own monetary policy.
This also presents a policy dilemma.
If China were to hike interest rates to curb inflation, the risk is this will only attract more capital as the interest differential with the yen or dollar widens.
But if Japan and other countries continue with QE, China may find it harder to keep speculative capital out.
One option would be for China to try to seal its capital account, yet that goes against its reform agenda to internationalize the yuan.
Perhaps the real reason behind the amplified currency war rhetoric is that China has been pushed into a tight spot. The end game could be floating its currency much sooner than it would have wanted.
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