A Penny Saved is an RMB Deflated?

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I’m pretty sure I’m just paraphrasing Ben Franklin with that one. Last week, an article on Time magazine’s website purported that the massive trade imbalance between China and the rest of the world (but specifically the United States) has caused the Chinese government to take certain measures uncharacteristic of its past in order to maintain its own balance between consumption and savings.  Up until recently, America’s savings rate was hovering around zero percent.  Since the credit crisis, we’ve closed our collective wallet, and seen our saving shoot to a whopping (by our own standards) 4.5% of GDP.  Conversely, China’s savings rate, who at the onset of the financial crisis was saving roughly 10% of GDP has fallen by a similar margin. With the RMB (Chinese currency) being undervalued between 15-25%, many global economists have wondered why China has decided not to let their currency’s value float.  Instead, they have done everything possible to keep its value as close to 7 to 1 to the dollar (where it has been historically) as they can. The most intriguing aspect of these measures is not why they are doing what they are doing, but rather what they are doing, and the greater impact that could have on their economy down the road.

In order to keep international trade imbalances modest, China has regulated exports by imposing heavy subsidies.  Worldwide demand for China’s exports has greatly diminished with the evaporation of disposible income in economies across the globe.  Rather than risk massive job losses from factories shutting down due to lack of product demand, China has helped keep these corporations alive.

More interestingly is what they have elected to do domestically in an attempt to spur consumption.  The Chinese government has practically given away money to banks, who in turn have lent money to developers and businesses who don’t really need it, for product that consumers do not want.  Real estate developers in China are already sitting on massive inventories in many major metropolises for housing product.

China is also subsidizing some consumer purchases and retail sales in China were up about 15% in the first nine months of 2009. “By transferring wealth from households to boost the profitability of producers, China’s ability to grow consumption in line with growth of the nation’s GDP is severely hampered,” says Michael Pettis, a finance professor at Peking University’s Guanghua School of Management.

Unfortunately, all of thus activity has not done much to change the economic landscape for China. Consumption as a percentage of GDP remains today about where it was a year ago: at about a third of China’s economy. If China is not careful with the way they attempt to stimulate consumption growth and the production of export goods, they could fall into a similar trap as the U.S. has. Subsidizing the private sector has its risks as well as its limitations. If you think American financial giants like AIG were too big to fail, remember that China’s population, as well as its conglomerates, are far bigger than America’s.