China’s delicate currency balance – and how it affects Australia: Gottliebsen

An avalanche of figures from China this week enables us to understand more clearly what is happening in the second largest economy in the world and sheds more light on its reluctance to increase the value of its currency.

The prices China pays for raw materials such as iron ore, copper and coal are rising and labour and power costs are also up.

We know what has happened to the copper price and the higher iron ore prices are flowing through.

But even more importantly, Chinese labour is becoming more expensive, which will cause groups relying on low-cost Chinese labour to review their strategies. And the cost of power in China is being boosted not only by coal prices but also by low-carbon power generation.

This rise in Chinese costs will boost western inflation, but that’s down the track.

You would normally expect that the higher costs and prices would affect demand. But, no. Although export demand is flat or lower, local demand is rising strongly and that’s pushing up manufacturing output sharply. This is good news for all in the region, including Australia. Remember that the Australian dollar is closely linked to Chinese electricity production, so this rise in Chinese manufacturing helps explain why the rise in the Australian dollar was greater than the fall in the US currency.

HSBC chief economist, China, Hongbin Qu, says the rise in the HSBC China Manufacturing Purchasing Managers’ Index (PMI) in October was one of the largest month-on-month rises in the PMI since the start of the series in April 2004.

He says that latest increase, which extends the current period of expansion to three months, suggests the strong growth momentum in domestic demand will warrant around 9 per cent GDP growth in the fourth quarter, despite the still-soft increase in new export orders. The jump in output prices reflects higher input costs amid strong demand, which also heralds a higher Chinese CPI, likely to reach its cyclical peak in October.

The rise in wages and the general feeling of prosperity appears to be boosting China’s local consumption – exactly what the world has been demanding for a long time.

But China faces a dilemma. If it were to allow its currency to rise, already very sluggish exports would rise further in price and, almost certainly, export volumes would fall sharply. This would create unemployment and might snuff out the rise in local consumption.

But China has a property bubble and a looming boost in inflation which it wants to curtail without stymieing overall rises in domestic demand. This will not be easy and efforts to date have not been successful.

If America’s QE2 stimulus is as large as is mooted then it will put further downward pressure on the US dollar and see the Chinese currency falling most of the way with it. In time the Chinese will be forced to lift their currency but they will ensure it is as slow as possible to give local demand a chance to grow.

Meanwhile, the sloshing global liquidity is boosting Chinese shares as speculators look for ways to benefit from an inevitable rise in the Chinese currency.

But usually these things take longer than you expect.

This article first appeared on Business Spectator