Global Journal: What is the main concern of the Chinese monetary policy makers today?

Dr Li Daokui: The main challenge to monetary policy makers in China is to strike a balance between controlling China’s inflation and not attracting hot money from international capital flow. That’s our main concern. If you look at the inflow of foreign currencies into China, it is significantly higher than our trade surplus. In a typical month, trade surplus accounts for 60 to 70 % of our inflow of foreign flow in China. The rest is for the purpose of investment. That can be called hot money or cold money depending on the perceived condition of the Chinese economy. If the Chinese economy continues to be perceived as good, then a lot of hot money that originally plans to stay for a short period of time can become cold money and may stay in the Chinese economy for a much longer period of time. Conversely, if the economy is perceived to be slowing down, the so-called cold money may become hot and exit. This is a very fluid and tricky situation. If something changes the external perception of the Chinese economy, that’s immediately very challenging. That is why we don’t even know how much of our extra capital inflow is hot money or cold money. It all depends on the external perception.

Why did you say recently that an alien from outer space would find the current international monetary system very bizarre and unreasonable? Does this have anything to do with the very latest move to issue the Chinese renminbi and allow it to be used outside China ?

 If you think of the international monetary system today from a detached perspective, it is indeed very strange. Why? Because, in today’s world, there is a large chunk of the world economy which is very dynamic, including the Chinese economy. However these economies cannot and do not issue their financial obligations internationally in their local currency. Instead they’re issuing these financial instruments in the US dollar or in the euro. Meanwhile the issuing economies of the US dollar and euro are encountering quite significant economic troubles. We have an asymmetry here, where dynamic economies can’t use their currency outside their borders, while economies in deep trouble are still enjoying the benefits of being the dominant players in the international monetary system. Therefore, is it highly suitable for economies such as China to encourage the financial markets to issue financial obligations in their own currencies. In doing so there are a lot of advantages. One advantage for the issuers is to be able to raise renminbi and to use the raised renminbi either to buy Chinese goods or to invest in China more easily than issuing in other currencies. In addition, the buyers of the financial obligations in renminbi can also avoid potential financial losses associated with renminbi appreciation against the US dollar or euro. So it makes sense for financial participants to issue financial instruments in renminbi. In a very general sense, this is also happening because of the restructuring of the worldwide economy.

Is this good news from the Us point ofview?

I truly believe that having currencies like the renminbi more widely used than they used to be, is fundamentally also good for the US economy. From the US point of view, having the US dollar as the most important and dominant international currency is potentially destabilizing for the US economy. When the US dollar is so widely circulated and used outside the US economy, the world demand for the US dollar necessarily fluctuates much more than the US economy’s own demand for the US dollar. Therefore, the US monetary policy has to take into account the status of the global economy. In the long run, global economic conditions will heavily affect the US economy in ways that are beyond the US’ best economic interests. Therefore, having the US dollar as the heavily dominant international currency is certainly not desirable even from the US perspective. After all, the US economy is unlikely to stay as dominant as it was before the global financial crisis.

This is quite a surprising answer from an advisor of Chinese monetary policy. is it a way of evading the exchange rate debate that is raging between the Us and Chinese governments?

 Not at all. The exchange rate debate is a totally different issue. I think there is a tremendous misunderstanding among the policy makers in the US and in other countries. They tend to believe that the exchange rate ought to be the most important tool to help an economy to strike an external balance. This is wrong because in reality, especially in a fast-growing, developing economy like China, there are other very important, and perhaps even more important, variables than the exchange rate to help economies rebalance. For example, in China, there are domestic policies to encourage investments in inland areas, which are importing regions, as opposed to exporting regions in our coastal area. Also, policies have been put in place to cut consumption taxes, in order to boost consumption. The end result is that imports are growing much faster than exports. Overall in the Chinese economy we see tremendous efforts and initiatives to help our economy to rebalance and to reduce our trade surplus. In 2010, the Chinese trade surplus will probably come down to 3.5% of GDP, while it used to be at 8% before the global financial crisis. My forecast for next year is that our trade surplus will come down to 3% or even less. My point is that only looking at the exchange rate is misleading. It is important only to the extent that a gradual adjustment or realignment of exchange rates is helpful. Anything beyond that, like a drastic appreciation of the renminbi, would only cause prices and inflation to rise in the US and some Chinese exporting firms to close down. In today’s US economy, the last thing they want is a sudden surge of the price of goods imported from China, since most Chinese goods are daily consumption products for middle income families. I think that a gradual appreciation of the renminbi, combined with domestic policies in China pushing for economic restructuring, is the best policy combination we can expect for both China and the US.

Could you tell us about the situation with regard to domestic demand in China?

We saw very encouraging progress in structural change in the Chinese economy in 2010. By my estimation, for the first time in 16 years, household consumption is becoming almost the biggest driving force for GDP growth, which is forecast to be around 10.3%. Trade surplus in 2010 did not increase from the previous year, contributing nothing to growth. That is, growth comes entirely from domestic demand, of which household consumption is almost as significant as domestic investment. Thus, 2010 was a very important year of structural change in the Chinese economy. How has the economy been able to achieve such progress? Two things are very important to mention. Firstly, there are important domestic market forces pushing economic structure changes: for example, wage rates are increasing faster than GDP growth and inflation, due to a simple market mechanism, that is, surplus labor in the countryside has almost been exhausted. Therefore workers in the exporting sector in China are now able to ask for higher wages. These workers are pressing for structural changes through their demand for higher and higher wages. Secondly, for the past two years, popular politics in China, for good or for bad, have been driving higher domestic demand and growth in investment. For example, there are useful tax cuts on clean tech car purchase and investment in green technologies.

As director of the Center for China in the World economy (CCWe), you promote new ideas in economics. For example, you advocate that macro policies should proactively deal with ‘market sentiments’. Do you plan to introduce these ideas in connection with monitoring the Chinese monetary policy?

 Sure. The idea stems from my academic research. I would like to push for new monetary policy thinking. In my view, monetary policy should take into account market sentiments, especially the sentiments of the stakeholders in financial markets. Market sentiments are important for all economies. Market sentiments are critical factors for asset prices, which are important for the welfare of the population. Nowadays, populations are not only concerned by inflation but also by fluctuations of the asset markets, since household income, expenditure, and wealth are also linked to asset markets. So my idea is that monetary policy should function as a stabilizer against market sentiments. One natural question is: how can policy makers correctly and accurately judge the ‘sentiments’ of asset markets? We’re not in exact science here. But policy makers should use a rough estimate to measure this ‘market sentiment’. This would be much better than doing nothing. That’s my general idea. I am an outrider in this regard, but I hope that before long many people will support my view.

One last question, this next year, in 2011, where will you travel in the world?

The year will begin immediately with many trips within China. Then Davos for the Annual Meeting and then Abu Dhabi for the Global Redesign Initiative (GRI) of the WEF. Singapore, New York and then again Abu Dhabi. It is going to be a busy year for traveling.


by Jean-Christophe Nothias