Floyd Norris of the New York Times outlines (in two parts) the US/Chinese Dilemma:
November 12, 2010, 12:00 PM
My column this morning mentions how upset the Chinese are with the Federal Reserve, but it does not discuss one very good reason they have to be upset:Ben Bernanke’s monetary policy is not what China needs these days. It needs to tighten, as is shown by rising inflation there.
So what? China can adopt its own monetary policy, can’t it?
Actually, that is not so easy. Having decided to tie its currency to the dollar, China has effectively allowed the Fed to set monetary policy there as well. But the Fed’s mandate does not extend to protecting the Chinese economy.
The impact of that is muted to some extent by the fact China’s economy is far from open. You and I cannot invest there as easily as we can in, say, Germany. If we could, there would be a surge of capital into China, driving up the value of the Chinese currency. But there is not an impenetrable wall between China and the West, and money does get in. China’s money supply has been rising rapidly. And that is likely to continue as long as it insists on ridiculous undervaluation of the currency.
In the long run, China may have to choose. Its currency can become more reasonably valued by rising against the dollar (and the euro, and the yen, andthe pound, and the won and so on and on) or it can become more reasonably valued through inflation and rising costs that reduce China’s competitiveness.
and
Who's in Charge of Determining U.S. Interest Rates? It May Be Beijing
May 19, 2005 | May 13, 2005
IN Washington these days, complaining about China has become standard operating procedure. The Bush administration calls on China to allow its currency to rise and Congress talks of punishment if China does not do so.
Be careful what you wish for.
As speeches of low-level Chinese bureaucrats are read with care for hints as to just when China will allow its currency to rise, perhaps it would be better for Americans to ponder the impact of China's current policies. Some might wonder just why the American politicians are upset. The way things work now, China sells to the world most everything the world wants and then buys United States Treasury securities. That helps hold down interest rates and stimulates consumer spending.
You can understand why China might not like to keep doing that forever. Those Treasury securities do not pay much interest, and they are sure to decline in value, measured in Chinese yuan, when that currency rises. But the largest vendor financing program ever has stimulated both the Chinese and American economies. In Washington, the theory is that China's keeping the yuan low increases America's trade deficit. But the benefits to United States exporters from a modest rise in the Chinese currency would most likely be small, while the effect of higher interest rates could be larger if China cut back on its purchases, particularly if other Asian central banks decided that they, too, wanted to sell dollars.
If that were to happen, the impact could be acute in the housing market. Investors in housing stocks have been nervous for some time, happy to see ever-higher profits but worried that the good times must end someday and fearful that they could be left holding the bag when that happens. One stock where those conflicting emotions have played out is Pulte Homes, a home builder active in 27 states. Last fall, its share price fell when it reported problems in Las Vegas, which was perhaps the most overheated market in America. But price cuts there got homes selling again, and the stock has resumed its ascent. Pulte filed its quarterly report with the Securities and Exchange Commission last week, disclosing that its inventory of land continues to grow. Some of that land is owned, while the rest is controlled via purchase options that give Pulte the right to walk away – forfeiting what it paid for the option – if home sales soften.
Kathleen Shanley, a bond analyst at Gimme Credit, points out that Pulte's inventory of land is concentrated in areas where home prices have been rising rapidly and that the company's cash flow is negative, even as profits soar, because of all the land it is buying. Pulte has been borrowing money even as it buys back stock at high prices. When things were at their worst in Las Vegas, Pulte was seeing cancellations of home purchases that amounted to 75 percent of new sales. "The risk of similar, and perhaps more prolonged, regional downturns should not be ignored," Ms. Shanley wrote in a note to clients. Rising interest rates could be a cause of such downturns. Homeowners with fixed-rate mortgages would be relatively immune, although they could find it harder to sell if they needed to, and the flow of cash from mortgage refinancings would dry up.
But many buyers, particularly in some of the hottest markets, have resorted to floating-rate mortgages, some of them paying only interest. Alan Greenspan, the Federal Reserve chairman, has less power over interest rates than he once did. Perhaps the real decision maker will be Hu Jintao, the Chinese president, as he weighs the pressures to free his currency and stop accumulating Treasury securities. In the words of Robert J. Barbera, the chief economist of ITG/Hoenig, "Hu's in charge here."
