On Sept. 15, the Chinese government issued 2.4 billion yuan of national debt. The market reaction, however, was uncommonly cool. A mere two-thirds of the bonds were subscribed to, mostly by government-appointed underwriters. This coolness towards issued government debt highlights one of the problems with China's exchange rate and financial and monetary policies -- a problem that is a side effect of the yuan's fixed exchange-rate regime.
First, from 2001 until this June, China's foreign exchange reserves increased sharply, by US$134.3 billion. In particular, the reserves increased by US$60.1 billion during the first half of this year, including US$20 billion worth of speculative "hot money." The persistence in maintaining a fixed exchange-rate regime has forced the government to use yuan to purchase excessive amounts of foreign currency, thereby creating an extremely rapid increase in the supply of yuan.
By end July, the broad money supply, M2, had increased by 20.7 percent over the same time last year. Last month it increased even faster, by 21.6 percent, the most rapid increase since May 1997.
If such rapid issuance of money continues for a long period of time, it will cause the Chinese economy to overheat and create a bubble economy, in particular in the real estate sector. During the first seven months of this year, investment in fixed assets increased by 32.7 percent, and real estate sales value increased by 43.9 percent over the same period last year. China's very unhealthy financial system may create more non-performing loans and greater financial risk.
To slow the excessively rapid increase in the money supply and avoid inflation, late last month the Chinese government announced that it would raise the required reserve ratio by 1 percentage point on Sept. 21, from the current 6 percent to 7 percent. According to the People's Bank of China estimates, this measure will tie down 150 billion yuan in excess reserves.
By this policy, however, the government has created a shortage of capital and caused the stock market to fall sharply. This forced the People's Bank of China to pour 50 billion yuan in short-term capital into the stock market on Aug. 28. In order to decrease financial risk, the government then began tightening financial controls on the four major state-owned banks on Sept. 15, in particular by fixing items where credit was increasing more quickly.
With China's central bank tightening money supply, it creates a shortage of capital, and it may also be creating rising interest rates. Prior to announcing the increase in the required reserve ratio, for example, the interbank rates between Chinese banks varied between 2.2 percent and 2.4 percent. They now have increased to between 2.9 percent and 3 percent. Because markets worry over increasing interest rates, investor reactions have been cool towards the selling off of government debt. At the same time, rising expected interest rates will attract more "hot money" to China, leading to further pressures on the yuan to appreciate and more money to be issued.
In addition, rising interest rates will lead to a decrease in total consumption and investment, and may result in instantaneous deflation. China has suffered heavily from deflation since 1998 and has still not managed to eliminate the problem. An appreciating yuan would depress prices further and lead to more serious deflation.
In particular, M2 growth reached 20.7 percent in late July, while the consumer price index for the same month only increased by 0.5 percent.
The consumer price index for January through July increased by 0.6 percent, but that was mainly under the influence of fresh vegetable prices, which increased by 24.7 percent. If that factor is eliminated, the consumer price index for January through July fell. This shows that China is facing quite heavy deflationary pressures.
Finally, China has adopted aggressive financial policies over the past five years, to alleviate deflationary and unemployment pressures. This has led to a huge financial deficit which must be made up for by issuing national debt. Last year, China issued a total of 592.9 billion yuan of national debt. According to official Chinese estimates, this year will see the issue of 637.6 billion yuan of national debt.
However, increasing market or expected interest rates will lead to the price of national debt falling, which will be disadvantageous to the issuance of national debt to make up for huge budget deficits. This will make aggressive financial policies difficult.
To sum up, China wishes to maintain a fixed exchange rate in order to maintain export competitiveness and avoid deflation, but is doing so by creating a sharp increase in the issuance of money, which may lead to an overheated bubble economy, thereby increasing the amount of non-performing loans and financial risk.
China therefore wants to tighten money supply by slowing the rate at which money is issued and suppressing inflation. How-ever, this may in turn lead to higher interest rates and increase the cost of financial policy implementation, while at the same time possibly increasing the rate at which speculative hot money enters the country, thereby increasing the pressure on the yuan to appreciate.
Finally, higher interest rates will lead to falling overall consumption and investment, which will further aggravate China's still very serious deflationary problem. The government must therefore actively increase financial expenditure. Such is the difficult situation currently faced by the Chinese government.
Tung Chen-yuan is an associate research fellow at the Institute of International Relations at National Chengchi University.
Translated by Perry Svensson
Recently, China launched another diplomatic offensive against Taiwan, improperly linking its “one China principle” with UN General Assembly Resolution 2758 to constrain Taiwan’s diplomatic space. After Taiwan’s presidential election on Jan. 13, China persuaded Nauru to sever diplomatic ties with Taiwan. Nauru cited Resolution 2758 in its declaration of the diplomatic break. Subsequently, during the WHO Executive Board meeting that month, Beijing rallied countries including Venezuela, Zimbabwe, Belarus, Egypt, Nicaragua, Sri Lanka, Laos, Russia, Syria and Pakistan to reiterate the “one China principle” in their statements, and assert that “Resolution 2758 has settled the status of Taiwan” to hinder Taiwan’s
Singaporean Prime Minister Lee Hsien Loong’s (李顯龍) decision to step down after 19 years and hand power to his deputy, Lawrence Wong (黃循財), on May 15 was expected — though, perhaps, not so soon. Most political analysts had been eyeing an end-of-year handover, to ensure more time for Wong to study and shadow the role, ahead of general elections that must be called by November next year. Wong — who is currently both deputy prime minister and minister of finance — would need a combination of fresh ideas, wisdom and experience as he writes the nation’s next chapter. The world that
Can US dialogue and cooperation with the communist dictatorship in Beijing help avert a Taiwan Strait crisis? Or is US President Joe Biden playing into Chinese President Xi Jinping’s (習近平) hands? With America preoccupied with the wars in Europe and the Middle East, Biden is seeking better relations with Xi’s regime. The goal is to responsibly manage US-China competition and prevent unintended conflict, thereby hoping to create greater space for the two countries to work together in areas where their interests align. The existing wars have already stretched US military resources thin, and the last thing Biden wants is yet another war.
Since the Russian invasion of Ukraine in February 2022, people have been asking if Taiwan is the next Ukraine. At a G7 meeting of national leaders in January, Japanese Prime Minister Fumio Kishida warned that Taiwan “could be the next Ukraine” if Chinese aggression is not checked. NATO Secretary-General Jens Stoltenberg has said that if Russia is not defeated, then “today, it’s Ukraine, tomorrow it can be Taiwan.” China does not like this rhetoric. Its diplomats ask people to stop saying “Ukraine today, Taiwan tomorrow.” However, the rhetoric and stated ambition of Chinese President Xi Jinping (習近平) on Taiwan shows strong parallels with