The strains of monetary policy

michael pettis

Wednesday’s South China Morning Post reports that Cheng Siwei, vice-chairman of the Chinese People’s Political Consultative Conference, parliament’s top advisory body, said that Beijing needed to dampen international expectations that the RMB would keep rising.  As many of you will remember, in the same speech he caused a global stir when he said that China should “balance” its reserves between the euro and the dollar.  Cheng does not really have any control over financial policy and it is obvious that he doesn't understand what are the economic implications for China if they were to "balance" dollars and euros  (for one thing, exports to the US would collpase), but I am more interested in his comments on RMB appreciaition because they indicate what at least some people in the leadership may be thinking. 

According to Cheng, this “mindset” – international expectations that the RMB would keep rising – was more dangerous than a stronger RMB itself.  I think I understand why he is saying it, but I also think he underestimates how serious the RMB problem really is (and he can’t seem to resist the Chinese temptation to explain a domestic problem as somehow being caused by the “international” community).   

To the extent that his is a common perception within the government, I think the outlook for policy isn’t good.  If they believe that the “problem” of the RMB is not the impact of the currency regime on monetary policy but rather that China will be subject to damaging speculative inflows because of “international” perceptions that the RMB must rise, this may lead authorities to focus more on changing those perceptions by introducing volatility to the RMB’s appreciation, rather than adjusting the currency regime.   

By the way his comments make me skeptical of claims by some analysts that speculative inflows caused by faster appreciation are not a serious problem. 

According to another article in Wednesday’s South China Morning Post: 

Premier Wen Jiabao has mounted a rare public defense of his macroeconomic policies, which have been criticised both within the Communist Party and overseas. In an uncharacteristically assertive manner, Mr Wen arranged an interview with a group of Hong Kong reporters yesterday during his visit to Russia.  The premier said the criticism directed at his economic policies was ill-founded - the strong and stable growth vindicated those policies.  

"Everybody agrees that China's economy has been doing pretty well for the past five years and actually it's one bright spot [in the global economy]," said Mr Wen, who has been in charge of the economy since 2003. "If that's the case, then to label [our] macroeconomic controls as ‘toothless’ contradicts both fact and logic."  Mr Wen's management of the world's fourth-largest economy has been a subject of heated debate. Overseas media and analysts have said his macroeconomic controls have been ineffective in cooling the sizzling economy and run the risk of damaging the mainland's long-term growth 

I have a lot of sympathy for Wen and think overall he has done a great job on a number of fronts, but I think managing the competing interests affected by economic and monetary policy isn’t easy and he is going to be criticized no matter what he does.  The options facing China are pretty limited and not terribly enticing.  Still, it is very interesting that he felt the need to defend himself while in the middle of his Russia visit.  It suggests to me that there must be real nasty debate and even some internal strains, reaching all the way into Zhongnanhai, the leadership compound in Beijing.