About China blogosphere, travel, and entrepreneurship

I just returned a few days ago from a 10-day trip to Shanghai and Beijing. I’ve got a lot to blog about but I’ve been busy catching up on my work at Kango these last few days. And I’m still fighting jetlag and insomnia. One night, instead of doing any real work, I picked at my Google Reader feeds and via Micah Sittig’s blog, discovered James Fallows’ analysis about the Chinese government’s $1.4 trillion buildup of US dollar reserves. This has been a personal topic of fascination since I have seen my own spending power in RMB terms drop from about an 8:1 RMB:USD exchange rate in late 2006 to today’s 7.14:1 ratio (which is continuing to fall). I responded to this depreciation by transferring the maximum of USD 50,000 into RMB in a China Merchants Bank account but still don’t feel fully hedged against USD depreciation, and I have to wait a full year before I can make any further transfers.

Fallows frames the situation as follows:

Through the quarter-century in which China has been opening to world trade, Chinese leaders have deliberately held down living standards for their own people and propped them up in the United States. This is the real meaning of the vast trade surplus-$1.4 trillion and counting, going up by about $1 billion per day-that the Chinese government has mostly parked in U.S. Treasury notes. In effect, every person in the (rich) United States has over the past 10 years or so borrowed about $4,000 from someone in the (poor) People’s Republic of China.

In Fallows’ understanding of the situation, starting in the 1990s when the current buildup of USD reserves began, the Chinese government made a policy decision to maintain a lower value for the RMB than would have otherwise occurred if the currency were allowed to float. By maintaining an artificially low-valued RMB, a higher level of export-oriented manufacturing and employment resulted. To maintain this currency level, banks in China who receive USD must “surrender” it to the People’s Bank of China (PBOC) who in turn delivers it to the State Administration for Foreign Exchange (SAFE) who then invests an estimated 70%-75% of the money in USD, and the remainder in Euros and Yen. In the beginning, this strategy made sense as China was able to build up a war-chest of foreign reserves to protect itself from the kind of currency crisis experienced by countries like Thailand during the Asian financial crisis in the late 90s.

But today, China holds far more foreign reserves than necessary to protect its currency. And yet China cannot afford to revalue the RMB to its likely market value because of two reasons. First, a higher-valued RMB would cause dislocation from “expensive” areas of China like Shanghai to lower -cost areas in China, and even to lower-cost countries like Vietnam and Cambodia. Second, a higher-valued RMB would increase consumption as everything from cars, cosmetics, and San Francisco family vacations become less expensive. This would further accentuate the rich-poor split that is already evident everywhere in China.

So neither country has an interest in a currency shock, that would create significant social pressures on both sides of the Pacific. And yet it seems unlikely that the situation can continue indefinitely. Even if you can argue that the first $1 trillion of foreign reserves is OK, it gets increasingly harder to argue that the second trillion makes sense let alone the third! But that is the direction we are heading. Meanwhile, Chinese consumers are getting a raw deal because their buying power is artificially held down in order to minimize the perception of rich-poor split and to maximize the creation of export-oriented manufacturing jobs.

The implication on a personal level is the need to diversify away from USD denominated assets. This is easier said than done because so much money is required to purchase and own residential real estate in Silicon Valley, and that is just where we happen to live. Also, there are limited ways to invest directly in RMB denominated assets, and plenty of ways to lose your money on unwise “China” plays. So I will just live with a certain degree of nervousness that our USD valued assets will not plummet because it is not in the interests of any government to see that this happens. Does anyone have any advice on this?