Now that Singapore has done it, the big question for the global investment community is whether China will follow suit. Responding to rising commodity prices — especially the intolerable surge in the cost of imported food — the Monetary Authority of Singapore last week signalled its preference for a stronger home currency. What the Monetary Authority said it would do is to reset the middle point of the (undisclosed) band in which the Singapore dollar is allowed to fluctuate against a basket of (unnamed) trading partners’ currencies.
The new centre, which market participants can and do fairly accurately guess, would be the current level of Singapore’s nominal effective exchange rate. “It amounts to a de facto revaluation,” V. Anantha Nageswaran, head of investment research at Bank Julius Baer and Co. Ltd, wrote in a note to clients. (Revaluation causes the currency to gain buying power against other currencies.)
Singapore’s anti-inflation stance is for the good of its 4.6 million residents and its status as a financial centre; were China to do something similar, it would be for its own benefit as well as in the interest of the world community. Can China use a stronger currency to tame the 23% pace at which its food prices rose in February from a year ago? It can, but only if the appreciation in the yuan takes the form of a large, one-off revaluation.
The current regime of fairly rapid appreciation is counterproductive because it “will only encourage hot money flows”, Michael Pettis, a Peking University professor of finance, says on his Web log.
A revaluation in the Chinese currency could provide an opportunity for other countries in the region to tame inflation. With export competitiveness as less of a constraint, Asian nations would rather let their currencies appreciate than raise interest rates. Of course, anything like, say, a 20% revaluation in the yuan could badly spook already jittery financial markets. So, perhaps the best time to announce it would be just after the Olympics — as a kind of return gift to the participating nations. By then, of course, there’s a chance that it may not even be needed.
According to several analysts, there’s already enough slowdown in the world to deflate the commodities bubble.
“Commodity prices are going the wrong way,” says Simon Johnson, the chief economist at the International Monetary Fund (IMF), which estimated the likelihood of a global recession — led by a slowdown in the US economy — at 1-in-4.
“A slowdown in OECD (Organisation for Economic Co-operation and Development ) energy demand — 60% of the total — is clearly already under way and likely has further to go in 2008,” says Fitch Ratings. “A weakening US economy, coupled with the forecast slowdown in Chinese GDP growth to 9.7% from 11.4% in 2007, the slowest in six years, is likely to take a further toll on metals demand.”
Fitch wrote that report before China last week raised its estimate for last year’s growth to 11.9%. That prompted Goldman Sachs Group Inc. to say the Chinese economy will grow faster than 10% in 2008.
That may be too high to cause an appreciable slump in China’s hunger for commodities.
A halt to the rapid build-up of fixed asset investments in China, which accounted for 90% of the increase in the consumption of four key base metals from 2005 to 2007, is an imperative.
It isn’t a certainty, though — the opposite might happen.
“Beijing will respond to a slowing external economy by boosting the domestic economy, especially fixed asset investment,” Citigroup Inc.’s commodities analysts Alan Heap and Alex Tonks wrote in a report this month. “There is still a lot of infrastructure to be built.”
What about food?
Fitch says food supplies can get scaled up more quickly in the short run than, say, oil or metals. “This points to the likelihood that high food price inflation will prove less protracted than oil and metals inflation,” the ratings firm says.
That forecast may well come true.
For the moment, though, it looks like agricultural commodity prices will remain uncomfortably elevated, unless there’s a large deceleration in biofuel demand or an end to the growing hunger for protein in China and India.
No return gift?
What if the global recession fails to materialize, or is too shallow to produce a large disinflationary shock? In that case, will China revalue the yuan to cool its economy and curb inflation?
If China fails to “import” a soft landing through a “US-led global downturn”, it may seek to induce one through a “large revaluation of the exchange rate”, says Morgan Stanley economist Qing Wang. “This is the most likely alternative scenario,” Wang wrote in a 27 March note to clients.
Ultimately, China won’t do anything drastic, unless its domestic inflation—already at an 11-year high of 8.7% in February—continues to worsen.
As for the Olympic spirit of universal brotherhood, China can always point to the bad behaviour of its guests — who are suddenly getting all worked up over Tibet — to deny them a return gift.
Respond to this column at firstname.lastname@example.org