The Group of Twenty (G-20) ministerial meeting ended in the early hours of the weekend. One of the most tangible and important outcomes of the confabulation was the reduction in European quota and seats at the International Monetary Fund (IMF), and an increase in the quota for developing countries. China moves up to the third most powerful position in IMF and India to the eighth spot from the 11th spot before. Europe gives up two seats on the IMF executive board. So far, so good.
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But on the all-important question of economic rebalancing there was no agreement—though host South Korea, news agencies and cheerleaders in the financial market put a brave spin on the outcome. China and Germany lectured the US on its competitive devaluation of the dollar by stealth; while Japan claimed that it thwarted the proposal to set caps on current account surpluses, with the aid of some emerging nations. In the final analysis, we have a set of homilies in the text of the joint statement. What would they amount to in practice remains to be seen. The safe guess is to assume that US dollar weakness would resume.
That countries would mostly pursue unilateral policies with varying speeds was evident in the decision taken last week by China to raise interest rates. It raised the one-year deposit and lending rates by 0.25 % point to 2.5% and 5.56%, respectively. The deposit rate remains, in real terms, negative. That would ensure continued availability of funds for speculative investments, as investors avoid bank deposits. In other words, the rate hikes might preserve banks’ lending margins on paper, but they do little to curb speculative overheating in the economy and in China’s asset markets. The fact that, 10 months into the year, China is still coming up with administrative measures, hikes in reserve requirements and then rate hikes is telling. It is a reasonable conclusion that they are yet to come to grips with the economy and that it is still growing too fast—with inflationary pressures now more imminent than distant. China’s money supply growth rate and the rate of increase in food prices suggest that the rate of consumer price inflation would cross 4% from the current 3.6%.
Patrick Chovanec, professor at Tsinghua University’s School of Economics and Management, claims that, in the case of China, the interest rate hike is not so much an attempt to rein in inflation, as it is an attempt to let deposit rates catch up with inflation. Otherwise, banks are running up against their reserve requirement ceiling and cannot extend loans without additional deposits.
Nevertheless, China is battling domestic asset price inflation, consumer price inflation and is attempting to rein in domestic demand. Otherwise, they would not have boosted the lending rate too. This is in contrast to the demand of the West on China to ratchet up domestic demand. To be sure, China too claims to want to move in that direction. But the message is that China would do it at its own pace rather than accelerate its reforms for the sake of the US. Further, the more China tightens on the domestic policy front, the less likely it is to allow the renminbi to appreciate faster, at least in the near term.
On its part, the US, too, would pursue unilateral goals. It has no choice but to continue with its policy of competitive devaluation of the US dollar by stealth. Treasury secretary Timothy Geithner tried to throw some sand into the wheels of the dollar downhill bandwagon by suggesting that the US dollar has weakened enough against the euro and the Japanese yen. It is unlikely that this would have anything more than a momentary impact on the trend of the US dollar against these currencies unless their central banks become more productive at the printing press than the Americans are.
The reason the US has no choice but to continue with dollar devaluation is that the domestic economic picture is blighted. It is downright baffling to see some economists actually revising up their estimates for US economic growth in 2011 on the back of the additional money that the US is yet to print. First, that is in response to the pronounced loss of momentum in the economy and, second, the foreclosure and mortgage bonds crises are yet to make a real impact on the economy. That is because, knowing its potential to cause immense damage to the economy, the government has opted not to lean hard on banks for failing to disclose information that they possessed on the quality of the securitized mortgage loan pools and for prematurely foreclosing on defaulting mortgages without adequate and proper documentation.
Within two years, banks are back to being parsimonious with the truth, their analysts and strategists generous with optimism, while the government is both pusillanimous in its pursuit of the guilty and furious in inflating asset bubbles. Investors and readers shrug their shoulders at Bare Talk. What is new?
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views. Your comments are welcome at email@example.com