(12/29/11) What Is China's Next Step?

Currency specialist and author Andrew Busch discusses his outlook for the Chinese currency, as well as some of the other challenges facing the Chinese economy.

Every year it seems we hear about the Chinese perhaps floating their currency at some point in the future. Is that ever going to happen? What’s going on with their currency?

Our guest today is Andy Busch to talk about that. Andy, so what’s going on with the Chinese currency?

Tim, I would love to see the Chinese currency floated. All currency traders want to see another major currency pair out there. I think that’s still about five years away from now.

But what they’ve done is over the years they’ve let it appreciate a little bit more and more every year—5% to 7%, depending on how they feel about their economy and it’s been doing that recently. They’re opening up certain parts of their capital account to aid in the transition from a managed currency to a more open, traded currency, so that’s a good thing.

Alright. What about this idea that the Chinese own all of our debt and that it's going to cause problems for us if it’s not already? What are your thoughts?

I wish they owned all of our debt—then we could default and then we’d just say forget it. No. They don’t own all of our debt. They own some of it.

They have $3.3 trillion in US dollar reserves. That’s a chunk, and I believe they’re up to about $1.3 or maybe $1.5 trillion worth of US debt. That’s still a tiny amount to some extent. I mean, we're at $14 trillion of debt, so you know, it’s one-fourteenth of it.

It’s not insignificant, obviously, but no, I don’t think the Chinese can really necessarily drive US deficit talks or tell us what to do, because I don’t think anybody would listen to them at this point. But they’re certainly important players in that they want to encourage the United States to manage their economy a little bit better and manage their finances so they don’t get burned on the debt they do own.

Alright. What’s it going to take for them to float their currency? What’s in it for them to do it? What’s it going to finally take for them to see the advantage of them to do it for themselves?

Right. They have to view it as something positive domestically for the Chinese.

In the transition—and they’re trying to make this transition from a totally export-driven market to one that’s more domestically focused—and obviously when they do that, they’ll want to have their currency be able to aid their consumers. And you do that by allowing it to strengthen. That’s what really will drive it.

The other thing too, obviously, is inflation. Inflation is pretty high in that country, running at, you know, 6.1% CPI per month. A stronger currency obviously helps with that. So it’s kind of the combination of those two things that will continue to drive the Chinese to let their currency strengthen.

And do they concern themselves with the strength of the dollar because they’re worried about losing manufacturing the things that they have? Do they worry a lot about the US dollar strength because of that part of their business?

They do, but one of the aspects of it is they’re driving their wages higher. Their wages and labor costs are going up about 20% per year, and have done so over the last three years. By doing that, they actually price themselves out of manufacturing.

Guangzhou is one city that’s had some major problems in China, and has shut down quite a bit of manufacturing as those costs have gone up, as the cheap supply of money domestically has dried up a little bit too, due to the tight monetary policy, and as jobs have moved to cheaper places like Vietnam. Yes, they are definitely concerned about it.