The Chinese Bubble

Submitted by Beppe Grillo  – The Beppe Grillo Blog

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The devaluation of the currency decided by China’s Central Bank has surprised financial markets. After anchoring the yuan to the dollar within a minimum margin of oscillation, after the Lehman crisis, the Chinese authorities have progressively broadened the oscillation zone and in 2014, they altered it from 1% to 2%. The decision in August to disconnect the yuan from the dollar has made it possible for the market to stabilise fluctuations in the currency and China did not intervene to correct the oscillation in the value of the yuan and thus it allowed the currency to devalue. Why?

Reasons for the devaluation

An initial response can be found in the 8% annual fall in Chinese exports reported in the month of July. Connecting the yuan to the dollar after the crisis in 2008, eliminated the exchange rate risk and it facilitated the flow of foreign investments but it also brought about a devaluation of the yuan that penalised the balance of trade. In fact the real Chinese exchange rate increased by 30% between 2008 and 2014, most of which was in that last year following on from expectations of the rise in USA interest rates and the relative increase in the value of the dollar. The result saw a decline in exports to such an extent that it now needs explaining – now at no more than 20% of China’s GDP as compared to 40% a few years ago. Devalue to maintain growth is thus the first and most obvious way of looking at this new mercantilist spirit on the part of the Chinese monetary authorities.

The Chinese property bubble

2008 was the start of the Chinese property bubble.

The de facto regime of fixed exchange rates with the dollar and the enormous reserves in foreign currencies have guaranteed the convertibility of the yuan and this has facilitated the flow of capital and the disproportionate expansion of credit to families. Since 2008, all the advanced economies have entered a phase of credit contraction (deleverage), whereas China has been moving in the opposite direction: from 2008 to 2014 private debt in China as a percentage of GDP, has gone from 100% to 180% (of this, corporate debt as a percentage of GDP has gone from 85% to 140% and for families it has gone up by a bit less than a multiple of three: – from 15% in 2008 to 40% today). This means that the ratio of private debt to GDP in China reached and went beyond the levels that Japan and the United States recorded in a 17 year period: from 1993 to 2010.