Demographic projections and trade implications

With yesterday’s bad April CPI number, the subsequent increase in minimum reserve requirements to 16.5%, and the slowing will-they-won’t-they appreciation of the RMB, it is tempting to stick to monetary topics in this and the next few blog entries, but regular readers know what I am going to say anyway. First, inflation may get a little better in the next month or two (although I wouldn’t bet on it), but by now it is pretty clear, at least to me, that this is a monetary phenomenon and, given the continued recent expansion in the domestic money supply as reserves pile on, we are going to see non-food inflation surge in the coming months.

Second, as far as the slowing of RMB appreciation is concerned, I bet this is going to be a very temporary phenomenon, and is probably largely a response to the dollar’s appreciation against the euro. But this new strategy (or revival of a failed old one) is not going to improve the worsening monetary dynamics. Reserves are going to continue to surge, driven increasingly by hot money rather than the trade surplus, and with inflation rising and still no sign of an economic slowdown it is just a question of time before the monetary authorities throw in the towel and go for the one-off appreciation.

Nothing else will work. By the way last night I had dinner with a group of Chinese academics, including a very famous and influential finance scholar (who for obvious reasons shall remain nameless), and he said there was little doubt in his mind that a one-off revaluation was the only solution left to the country’s monetary problems. Our only disagreement was that he said it should be a 10% jump, whereas I think that is too little and is only likely to encourage speculative inflows.

Interesting as all this is, however, in this blog entry I want to change the subject to something very different and with much longer-term implications. I spent the last week going thorough historical and projected population data for China by age group, and the most interesting summary of the data I have put in the table below.

The table shows the growth rate of Chinese population by decade (of course these are average annual growth rates for each decade), as well as the growth rate of subcomponents of China’s population. Given the way the data is presented I am defining “Young dependents” as anyone 19 or younger, and “Old dependents” as anyone above the age of 65. “Working population”, of course, is everyone else.

1990-00

2000-10

2010-20

2020-30

2030-40

2040-50

Total population

1.00%

0.60%

0.60%

0.21%

-0.05%

-0.21%

Working population

1.72%

1.42%

0.40%

-0.26%

-0.60%

-0.49%

Young dependents

-0.51%

-1.50%

-0.30%

-0.44%

-1.36%

-0.41%

Old dependents

3.34%

2.43%

4.30%

3.51%

3.20%

0.62%

To summarize the raw numbers, China’s population is expected to grow from 1.32 billion today to 1.46 billion in 2030, after which it will decline slowly, to around 1.42 billion in 2050. Its working population is currently around 840 million. This component of the population will rise in the next ten years to around 910 million and then will decline quite rapidly to around 790 million by 2050.

The graph below shows the composition of China’s population by age group. Needless to say the most dramatic change is the explosive growth of the over-65 population, followed by the decline in the share of the young. Another way of understanding this is to note that China’s median age basically climbs over this period from 24 to 45 (which, by the way, may have favorable consequence for long-term political stability).

image002_48.gif

The graph shows the consequence of these differential growth rates on the age composition of China’s population. Notice that the Y-axis begins at 50%, so the working population is much bigger than its share of the graph might indicate. As is nonetheless evident, the real interesting story here is in the age composition, especially in the growth of the over-65 population. In 1990 China had about 63 million people over the age of 65. Today that number has grown to around 109 million.

The rate of growth really starts to pick up in the middle of the next decade so that by the year 2050 China is expected to have about 350 million people over the age of 65 – this, for comparison sake, is more than 15% bigger than the total current population of the United States. The ratio of the elderly rises from 5% of the population in 1990, to 8% today, to an expected 25% in 2050.

The graph also indicates that, thanks to the baby boom in the 1950s and the implementation of the one-child policy beginning in the mid-1970s, China has enjoyed a huge demographic dividend beginning around 1970 or so, when people of working age comprised around 51% of the working population (one worker for every non-worker), to 2015, when they will comprise around 65% of the total population (one and one-half workers for every non-worker).

Their share is then expected to decline to around 56% of the population by the middle of the century. During and after the 1970s, the working population exploded as the baby boomers joined the work force, but with very few children being born, even the very rapid growth among the elderly (thanks, I assume, to significant improvements in health care) meant that China’s working population grew much faster than its total population. Even if worker productivity were constant (and it wasn’t – it rose dramatically), the consequence would be a sharp improvement in per capita income and living standards.

I don’t have the figures yet from before 1990, but looking at other sources I would guess that China’s working population grew by about 2% or more annually during the 1970s and 1980s. In the 1990s, as the table indicates, the growth rate of the working population slowed to 1.72%, declining further in the current decade to around 1.42% on average. The number of working Chinese keeps growing until around the middle of the next decade, and then begins to decline by about half a percent a year.

Actually these numbers might understate the change, since as China transitions from a largely rural society to a largely urban one I suspect that the definition of the working population becomes more rigid. In a peasant and rural societies, in other words, the definition of working population is probably a lot more flexible, and many too-young people and too-old people do the same work that the working population does. As the society becomes increasingly urban, however, young people are expected to go to school and old people to retire, so their contribution to the work force probably declines. This suggests that the real working population may have grown a little more slowly in the past decade or so and may decline a little more rapidly in the coming decades than the age numbers indicate.

All this has important implications both for nominal growth rates and per capita growth rates in the next few decades. For one thing, a country’s GDP growth rate can be expressed as a factor of the growth rate of its working population and the growth rate of average productivity per worker. As the growth rate of the working population swings from positive to negative – by a little more than 2%, depending on what periods you compare – this will have a commensurate impact on Chinese GDP growth rates, i.e. all other things being equal (which of course they are not). China’s equilibrium growth rate should be about 2% lower than the equilibrium growth rate of the past two or three decades.

The other thing worth noting is that beginning some time in the next decade, China’s working population will begin to grow more slowly (or shrink more quickly) than its total population, suggesting that the demographic dividend it has enjoyed during the past three decades will become a demographic tax. Per capita income, in other words, will grow more slowly than the growth in worker productivity.

Since total consumption is a function of the size of the total population and its income per capita, and total production is a function of the size of the working population and its productivity, the demographic relationship between total production and total consumption also will change. Remember that a country has a trade surplus if it produces more than it consumes, and a trade deficit if it consumes more than it produces.

This implies that over the last three decades China has had a demographic bias towards trade surpluses (working population, a proxy for production, grew faster than total population, a proxy for consumption), but over the next three decades it is likely to have a demographic bias towards trade deficits. This doesn’t mean, of course, that China necessarily ran trade surpluses during the last three decades (in some years it ran deficits) and will necessarily run trade deficits over the next three decades. Other factors, including most obviously changes in worker productivity and savings rates, matter too. But it does mean that since demographic conditions contribute towards the relationship between consumption and production, in China we are going to see a switch in those conditions from a bias towards trade surpluses to a bias towards trade deficits.

Three years ago I argued in a Wall Street Journal OpEd piece that because of the aging and declining populations of Europe and Japan (and to a lesser extent China and Russia), compared to the growing population and relatively stable age distribution in the US, it was not unreasonable for the former countries to run large current account surpluses with the US since they would need the accumulated claims against the US to pay for the current account deficits they would need to run to manage their demographic adjustments.

This is why I have never been terribly worried about the sustainability of the US trade deficit. In the next decade it is likely that demographic changes will create pressures to reverse those US trade deficits.

It also suggests at least one extenuating circumstance explaining the very mercantilist trade policies followed by the Chinese government. As they are probably very aware of the dramatic demographic adjustments China will need to make in the coming decades, it is reasonable for them to want to accumulate claims against the US to pay for these adjustments. Of course now, I think, their policies have caught them in a monetary trap from which it is very difficult to escape and which is causing balance sheet havoc.

Still, after their upcoming monetary adjustment, however painful, I expect them to continue favoring export oriented policies. The only certainty about their demographic future is that there will be a difficult adjustment from a rapidly growing working population to a rapidly shrinking working population.

For anyone who might be interested, I am including a graph below of total population during the past two decades and projected forward over the next four decades.

image004_32.gif

17 Responses to "Demographic projections and trade implications"

  1. Vitoria Saddi   May 13, 2008 at 8:58 am

    Michael,What is the change in demographic required to decrease substantially the US trade deficit?ThanksVitoria

  2. Rachel   May 13, 2008 at 9:22 am

    great post – especially the data. How much do you think China’s surplus or rather its savings rate will be effected by its demographic shifts? ie how much will savings be eaten away by pensions and health costs. Will this be the forced rebalancing? I also wanted to say – I really enjoy your blog and am thrilled to see you writing here also.

  3. Victor Shih   May 13, 2008 at 9:38 pm

    Hi Michael, interesting indeed. I would just note that the regional distribution of pension burden will be different. My student just completed a very interesting thesis projecting the pension burden of Shanghai versus Guizhou. Essentially, if you assume current fertility and migration pattern, Shanghai will end up with more young workers in 20 years time, even though more young people are being born in Guizhou. Of course, the story is that young people are moving to Shanghai and out of Guizhou. So, divergence continues!

  4. Michael Pettis   May 14, 2008 at 3:10 am

    Vitoria and Rachel, your questions should be addressed to someone a lot smarter than me. There is so little precedence for a demographic change of this magnitude that we don’t have much empirical evidence to guide our thinking.Victor, I am sure someone can spend a whole career just mapping out the demographic changes taking place within and across China, and when one-fifth of the world’s population undergoes such dramatic social, economic and demographic chnage, the consequences have to be historical.

  5. Anonymous   May 14, 2008 at 6:30 pm

    Prof. Pettis: excellent post! Any chance China will do a one step revaluation of the RMB?

  6. Anonymous   May 14, 2008 at 6:31 pm

    The graphs with this post are missing? Can you repost them? Thanks!

  7. Guest   May 15, 2008 at 2:47 am

    Hi, I am currently a PS master student at NUS.I did some research on why China made cautious movement in revaluating its currency. Can I share with you some of my view point? I argue that China is unlikely to afford any radical, one-step currency reform at this point. At least, since 2005 till today, we observe that the currency reform steps are very prudent. This I believe is an outcome of Chinese govt’s deep worries over what a large appreciation will bring to its own economy, such as political instability, rampant unemployment, speculative activities and already vulnerable banking system and financial sector. China’s recent CPI rise made “radical revaluation’ a particularly risky move as the speculative action is large believed by the govet to be responsible for the excessive issuance of RMB, partly leading to the inflation problem. Zhou xiao chuan announced many times that “revaluation’ is not a cure and inflation is the overriding policy objective for the recent period.While the external pressure mainly comes from certain congresspersons connected with domestic manufacturing and labor’s union, the executive branch appears a lot more moderate due to its concerns over its trade relation & future cooperation with China and many MNCS operating in China. As the three US-China strategic economic dialogues show in 2006 and 2008, the Bush administration is more interested in cooperating with China in a wide range of realm such as energy, aviation ,etc….And I found that today the US govt is a lot more pragmatic than ever. The most obvious sign is that the government rejected numerous times the congressional pressure to pass retaliation law to punish China’s slow progress in RMB appreciation. .This gave China a wider margin of liberty in pursuing its own agenda. China’s revaluation policy is always " go slow’. Bo XIlai, Wuyi and many high-ranking officials on various occasions have made this point explicitly. In addition the Chinese government also believes a “moderate revaluation” is necessary for its own reason…I feel the revaluation is part of the government’s large scheme of upgrading at the cost of certain small scale labor intensive and environmental-unfriendly industries. While a large revaluation is believed by the government to be unaffordable (their statements and facts show), a small and gradual revaluation is always favored. Therefore, I believe a “one step” revaluation is very unlikely to happen to the extent hitherto facts shows.

  8. CHEN jiyao   May 15, 2008 at 3:02 am

    Dear Prof Shih, Prof Michael Pettis, Rachel and Vitoria Saddi, forgot to leave my name in my above comments.:)). My name is CHEN jiyao and I am glad to find your blog where I found so many amazing and enlightening articles.

  9. Michael Pettis   May 15, 2008 at 6:25 am

    Chen Jiyao, it is widely known that the government prefers a gradual appreciation policy to avoid potential destabilization, but I don’t think we should limit our discussion to what their preference is. After all they also prefer no inflation, an end to massive hot money inflows, a reduction in FAI, and less speculative stock markets, but they haven’t been able to acheive any of those things. I would argue that their failures on these fronts are caused precisely because their monetary policy has been so loose (and I characterize their monetary policies to date as excessive, rather than prudent — making tiny adjustments over the past four years when much larger ones were required is not prudent, I think). At any rate, crises never occur because governments choose to enter into crisis. They occur because unsustainable imbalances continue for so long that at some point an adjustment is forced onto the system. I am worried that if they don’t adjsut the cyurrency quickly, they will find themselves in such a crisis. I think many people in the government, especially at the PBoC, understand that, but the power groups that are less familar with monetary policy and more worried about unemployment are still — just barely, I think — in control.

  10. CHEN jiyao   May 16, 2008 at 1:40 am

    Dear Prof Pettis,Thank you for you reply.’Chen Jiyao, it is widely known that the government prefers a gradual appreciation policy to avoid potential destabilization, but I don’t think we should limit our discussion to what their preference is. After all they also prefer no inflation, an end to massive hot money inflows, a reduction in FAI, and less speculative stock markets, but they haven’t been able to acheive any of those things.’ Yes, apparently all government statement points out its consistent preference to a gradual appreciation policy. But I think the issue of why the government can afford to stick to a gradual appreciation is worth inquiry as it helps understand the larger international& domestic political economy and institutional context that allows Chinese government to foster a slow appreciation. For instance, the US government is in fact an implicit proponent of China’s slow move in its currency for various reasons. This makes China’s slow-move preference based on its own concerns Possible. Therefore, it is not simply about a preference due to certain reasons; it is also about why this preference can become possible. This is relevant and can be the starting point of our further discussion as to “should the government abandon its current preference and follow instead a “go-quick” approach.” ‘I characterize their monetary policies to date as excessive, rather than prudent — making tiny adjustments over the past four years when much larger ones were required is not prudent, I think’ Yes, I agree with that and obviously the massive hot money due to the expectation on RMB appreciation contributes most to the subsequent loose money supply. However, I only intended to say that China’s revaluating movement is small and cautious. I never meant that China’s monetary policies in the past few years are prudent—-of course they are not and this problem is even more serious when the government corruption and bank officials’ collaboration with the real estate sector had a significant role in accelerating its money supply. Dear Prof. Pettis, I completely agree with your contention that Beijin’s reluctance to adopt a “once and for all” approach to revaluing Yuan is responsible for the continuously deteriorating price stability and indeed the core decision-makers in power now are more concerned about the social stability issue than the seemingly less immediate issue of rampant inflation due to the constant inflow of foreign exchange—I did not mean the inflation is less immediate, it is an urgent issue, I mean instead that Beijin’s worries over the social instability are also not illegitimate and and it does the decision-maker slightly injustice when their decision to avoid a quick appreciation of Yuan against the U.S dollar is questioned on the ground that they are less familiar with monetary policy. I totally accept your view that “because their monetary policy has been so loose”; however, at this point, both strategies- either a one-off revaluation or a very slow and gradual appreciation—carry certain inherent risks. While the one-off approach is bound to lead to the widespread bankrupt of many export-oriented companies, (although you argued before that a carefully chosen timing can cause much less repercussion, it is still hard to implement; more importantly, China cannot afford to chose the wrong times even once since a radical one time revaluation of Yuan can also damage if hot money massively flees. ), a slow and gradual appreciation will also help stock expectation to bet on yuan to rise even further, thus leading to subsequent inflation. I think this is a dilemma facing the decision-makers and most likely it is not because that those in power are less familiar with monetary policies, but because that either way they have to make a choice, either choice A or choice B. The ultimate choice must be an outcome of a painstakingly done trade-off. Anyway, I believe the government is at least on a right track, if not an optimal one since at least the choice is between revaluating slowly or quickly, instead of continuing the peg-to-dollar policy. In fact, the government had relied on various means except the ‘one time appreciation’ to buffer the inflow of foreign capital, especially the speculative funds including reducing the incentives of the foreign investments by cancelling the preferential tax policy, etc, tightening monetary policies such as raising the reserve rate (though those policies have limited effects compared to the “loose” issuance of RMB in the past few years. e) but it turns out that they come out with very little effects. But importantly, those efforts, at a minimum, shows that while the government fears the unemployment problem likely to be caused by radically revaluing Yuan, it knew that something else has to be done in association with the “go slow” RMB approach. Now, when their quest for a safe way fails to materialize the PBoC quickly started to consider employing a quick and large revaluation as an alternative candidate strategy to deal with the inflation. Also it takes time for those decision-makers to realize what a better way is and evidence shows their efforts of trying to patch up what the loose money supply brings for the last few years. I notice that a very good development recently in this line is PBOC’s realization yesterday on 15th of May, 2008: RMB exchange rate can also serve to alleviate the hypertension on the domestic price level. I clearly remember that Zhou Xiaochuan claimed otherwise last year: while he insists the overriding importance of curbing the surging CPI, he refuted the role that a radical RMB revaluation can play in combating the recent hiking CPI. But PBOC’s changing stance to RMB reform yesterday illustrated their recognition that a quicker RMB appreciation can also be a candidate alternative to curb the inflation.

  11. Michael Pettis   May 16, 2008 at 3:38 am

    These are all good points, Chen Jiyao, and this debate, the way I see it, is ultimately about two things: first, is the admittedly risky one-off-reval the only policy that can protect China from the dangers of a ballooning of its money base, or are there workable alternatives, and second, if the former, at what point will the government recognize this? The ultimate concern, I suspect, and as you point out, is social stability. A maxi-revaluation migh be destabilizing, but it is still worth pursuing if and when the government believes the alternatives are worse. The only further point I would add to our debate is that I believe that if it does indeed turn out to be the best policy, the longer we wait to implement it the worse the damage will be.

  12. CHEN jiyao   May 16, 2008 at 12:47 pm

    Yes, indeed. Finding alternatives is a technical thing, while getting the government making the right choice requires institutional reforms i think, but still it is not impossible to happen. The key part is the government’s perception about it. Fortunately, they seem also open to changes in those key issue areas that concerns the stability of China’s entire economy. At any rate, the recent PBOC’s explicit stance to using Revaluation as a policy aparatus gives much hope.

  13. Rob   May 16, 2008 at 2:08 pm

    Wont a slowdown in consumer spending in the US cause a dramatic slowdown in inflation in China?I dont understand why more emphasis is not placed on this fact in discussions of Chinese inflation. And couldnt the Chinese have enormous influence on US consumer spending by forcing higher US interest rates through fewer purchases of Treasuries?It seems to me that the Chinese could reduce their inflation problems anytime they want by reducing their purchase of Treasuries if they are willing to put the brakes on their export driven economy. At the present time though they are unwilling to tackle inflation at the cost of slower growth.

  14. CHEN jiyao   May 16, 2008 at 5:34 pm

    “I dont understand why more emphasis is not placed on this fact in discussions of Chinese inflation. And couldnt the Chinese have enormous influence on US consumer spending by forcing higher US interest rates through fewer purchases of Treasuries?”Dear Rob, You seem to argue that purchasing fewer treasuries can force the U.S to raise its interest rates. Lets assume China faces no barrier to reducing its treasuries holding( this I will address in the later part) and suddenly converted its treasuries into the dollar CASH which earns nothing. Suppose this happens, I do not think the U.S. plagued by the sub-prime mortgage, will be willing to raising its interest rates even when China ceased to offer low interest loans. Secondly, since lots of the consumption by the American people are daily necessary goods imported from cheap sources such as China, I do not think a rise in the interest rates will significantly affect their consumption pattern. Subsequently, you said that if the consumers in the U.S tend to consume less, then China’s inflation will be automatically corrected. I am very curious about this cause-effect relation. Do inform me of that. “It seems to me that the Chinese could reduce their inflation problems anytime they want by reducing their purchase of Treasuries if they are willing to put the brakes on their export driven economy. At the present timethough they are unwilling to tackle inflation at the cost of slower growth.”I doubt so. Policy making is not about whether the government has the capability or not, it is more about balancing various interests and trade-off. I am afraid putting the brakes on the export driven economy will lead to far more than just “slower growth”. I think the social stability issue such as rampant unemployment due to the bankrupt of export-oriented is what the CCP is concerned about primarily. In their various public presentations, this is a major focus. So definitely this concern is a major barrier towards China’s being able to tackle the inflation problem at any time. With these major constraints, the CCP cannot do it anytime they want. By the way, I do not follow the logic why reducing the purchase of Treasuries will necessarily leads to China’s inflation being solved. And I wonder why this is related to ‘Putting brakes on their export driven economy”. I only know that reducing the treasury can be a result of China’s intentional bringing down the export momentum through certain policies such as terminating the export tax rebate incentives, etc. this in theory can result in the less inflow of u.s dollar, thus leading to China’s less purchase of the treasury. However, in reality, I feel there are three principle obstacles. Firstly, the hot money still continues to flow in if the expectation on a rising RMB still exists, so it does not matter if China attempt to reduce the trade growth or not. As long as China does not use a one-off revaluation, the inflation caused by hot money still will be here to stay. Secondly, unilaterally selling off the treasuries without securing a commensurate alternative of managing the funds is too expensive an action to do because holding the treasuries earns profits and due to China’s huge foreign reserve, the opportunity cost will be horrifyingly big if China decides to sell the treasuries and the reserve ends up earning nothing. Thirdly, China’s holding of the treasury is a big favor CCP does to the U.S and China certainly benefits in many other ways. So this is a tacit agreement between the two government. China is unlikely to change the status quo for no reason. But it will be very interesting if China can figure out a better alternative to managing its huge foreign reserve other than buying the U.S treasuries. I guess only when that alternative is possible, this proposition can be of value.

  15. Rob   May 16, 2008 at 11:58 pm

    “You seem to argue that purchasing fewer treasuries can force the U.S to raise its interest rates. Lets assume China faces no barrier to reducing its treasuries holding( this I will address in the later part) and suddenly converted its treasuries into the dollar CASH which earns nothing. Suppose this happens, I do not think the U.S. plagued by the sub-prime mortgage, will be willing to raising its interest rates even when China ceased to offer low interest loans. Secondly, since lots of the consumption by the American people are daily necessary goods imported from cheap sources such as China, I do not think a rise in the interest rates will significantly affect their consumption pattern.”“Subsequently, you said that if the consumers in the U.S tend to consume less, then China’s inflation will be automatically corrected. I am very curious about this cause-effect relation. Do inform me of that.”Dear Chen, Rather than just hold CASH, couldn’t the Chinese invest significantly more in dollar denominated equities and assets as well as equities and assets in currencies pegged to the dollar? Even if they overpay for them they still would be much less vulnerable to US inflation than Treasuries, and investments in the US which would be unaffected by import tarrifs could act as a hedge against potential future US protectionist policies. Many of these investments could also be in products which China will become more and more dependent upon (i.e., agriculture, farm land, food production, water, oil, alternative energy etc.).As for whether or not the Federal Reserve would raise interest rates in the midst of an economic slowdown I am unsure. But with a weaker dollar, rising energy costs, enormous deficits and an aging population the inflationary pressures in the US are enormous. Just as the World Bank and IMF recommended very bitter medicine for other countries during economic slowdowns the US will be forced to pay for its profligate ways sooner or later. I believe the FED will have no choice but to raise short term rates while long term rates will rise regardless of their actions.Also although it is true that some of our imports from China are for daily necessities, much of what we import is just to maintain lifestyles we cannot afford. A rise in interest rates should slow the US economy and by extension have a dramatic effect on slowing down the Chinese economy. Although the Chinese government is starting to allow their people to invest abroad, aren’t most dollars converted to Yuan and add to the money supply in China? As the US imports less, the money supply should tighten, the Chinese economy should slow down and inflation should decrease. As you point out, too much of a slowdown could lead to political instability, which is exactly why the Chinese government is not acting more quickly to target their inflation.

  16. CHEN jiyao   May 17, 2008 at 2:14 am

    Dear Rob, ‘Rather than just hold CASH, couldn’t the Chinese invest significantly more in dollar denominated equities and assets as well as equities and assets in currencies pegged to the dollar?’this is a good point. I tend to agree that CHina should try to diversify the management of its foreign reserve and figure out a better way of capitalizing on its dollar reserve rather than merely purchasing the treasuries. ‘As the US imports less, the money supply should tighten, the Chinese economy should slow down and inflation should decrease’Why the U.S imports less, as you mentioned, what you import from China is either daily necessiries or what you cannot afford otherwise; in that case, the U.S imports , at least these two parts, will not shrink at all.Seondly, how will the reduciton in imports on the part of the U.S leads to meaningful decrease in China’s monetary policy? CHina’s loose monetary supply, as i mentioned before, comes more from the hot money betting on RMB to rise, rather than so much the export profits; and also it is unclear whether China’s export to U.S will shrink. You said that if China’s monetary policy tigthenes, economy will slow down and inflation will automatically disappear. First, i want to say that there are lots of cases where the recession comes hand by hand with inflation. So it is highly likely these two things happening simultaneously, rather than one being the cure for the other. Secondly, now the situation is that CHina’s monetary policy IS tightening and the issue is that Tightening the monetary policy is not enough to curb the inflation after its being too loose for four years. So I wonder we do not need to bother using Purchasing less treasuries, forcing the interest rate to rise, then cutting down the u.S imports from China, then causing China to apply tighening monetray policy….Tightening policy IS what we are doing now and the reason why wer are concerned is because that it is losing force. And our dilemma is not about how to enforce tightening monetary policy, but about how to choose btwn a one-off revaluation and continuing applying only tight monetary policy.

  17. Rob   May 17, 2008 at 10:48 am

    Dear Chen,‘how will the reduciton in imports on the part of the U.S leads to meaningful decrease in China’s monetary policy? CHina’s loose monetary supply, as i mentioned before, comes more from the hot money betting on RMB to rise, rather than so much the export profits; and also it is unclear whether China’s export to U.S will shrink.’I was assuming that the majority of dollars flowing into China were from exports. If you are right that most of the dollars going into China, being converted to Yuan and adding to the money supply are from hot money, then I agree that China will have no alternative but to allow large revaluation of the Yuan. But if most of the dollars are not resulting from exports to the US, and the Chinese economy can sustain itself from domestic consumption and exports other than from the US, then why keep the Yuan pegged to the dollar at all? There would be no reason not to let it appreciate against the dollar.I think that China recognizes that up until the fall of the US real estate market, the US economy was running off of equity withdrawals from rising housing prices. And now, the US consumer will go back to living off their credit cards. That too cannot go on much longer and the US economy is going to have a deeper recession than many predict. Albeit maybe after a short period of growth from all of the current stimulus.China believes that this will moderate the rise in their inflation, but can also lead to more unrest. China is trying to bide its time, by propping up the US economy long enough to ween itself off of dependence on the US. The trick is to navigate between higher inflation and slower growth. I think China will adjust their currency appreciation and treasury purchases dependent on how quickly and deeply the US economy slows.You are right that rather than letting the Yuan appreciate, or decrease their treasury purchases, China has been using tight monetary policy at home such as raising the reserve requirements on banks. I believe this is a temporary, more direct tightening mechanism while they wait to see what happens with the US economy.