China’s Soybean Importers Threaten More Defaults

CHINA’S SOYBEAN IMPORTERS are hardening their line on defaulting on contracted shipments in an attempt to force down prices in face of burgeoning stockpiles and slowing demand. China is the world’s biggest buyer of soybeans, accounting for three-ffiths of global imports. The main use for the beans is to be crushed into meal to make poultry feed. Demand for feed has fallen by an estimated 15% following last year’s outbreaks of bird ‘flu.

Since late February Chinese importers have cancelled 1 million metric tons of orders from the U.S. and South America, particularly from Brazil, though to put that in context, China imports 70 million metric tons a year. In the Chicago commodities futures markets, soybean prices have risen by more than 14% this year.

Trading firms mostly clustered in Shandong province have refused to make payments for about 20 shipments, Shao Guorui, general manager of Shandong Sunrise Group, reportedly says. Chinese buyers face losses of as much as $7 million dollars on each shipment, he adds. The crushing companies they sell onto are suffering, too, with around half the industry’s capacity idle because of over-expansion. 

Sunrise accounts for one-eighth of China’s soybean imports. It is part of Shandong Chenxi Group Co., run by Shao’s multi-millionaire brother Zhongyi.

The issue could flare up into a trade dispute with Japan.  Shandong buyers have 80 to 100 cargoes booked for delivery from the Japanese trading giant, Marubeni, through July. Marubeni accounts for a quarter of China’s soybean imports. “Marubeni is deluded in thinking that payments will come once the cargoes have sailed,” an unidentified industry executive based in Shandong was quoted as saying.

 

Yuan Rising: How Much Is Enough?

There is a steady drumbeat coming out of Beijing: the yuan is approaching equilibrium with the U.S. dollar. Prime Minister Wen Jiabao got it going earlier this year. Scores of Chinese officials and economists have picked it up. It is starting to reverberate among economists and analysts at the foreign banks and securities houses that have enjoyed a one-way bet on the Chinese currency for years. On cue, the yuan has reversed course in recent weeks, falling to its lowest level since mid-March. The sound is more incessant than ever.

Does it deafen to deceive?

The numbers show that since the peg with the U.S. dollar was broken in July, 2005 the yuan has risen by 30% against its American counterpart. The chart to the right shows how many dollars a yuan has bought over the past eight years. Were it expressed as the yuan a dollar buys, it would show the Chinese currency appreciating from its 2005 peg price of 8.2765 to the 6.3043 it averaged in April. There was a period in the aftermath of the 2008 global financial crisis when a peg was temporarily restored. Once loosened, the yuan resumed its rise. Adjusted for inflation, and particularly the relative changes in Chinese and American labour costs, the yuan’s rise against the dollar is as much as 50% since the 2005 peg was broken.

This upward revaluation of the currency has not stilled the voices in America complaining that China keeps its currency undervalued in order to support its exporters. During his recent visit for the bilateral security and economic talks, U.S. Treasury Secretary Timothy Geithner said that the currency should move higher against the greenback to allow for more flexible policy. It was a more nuanced call for a further rise in the yuan than he has voiced previously. That may reflect a better understanding on Geithner’s part than that of American trade protectionists of the reasons that China needs to let the yuan appreciate to help force the rebalancing of its economy. Yet it also recognizes the reality of the change in the exchange rate that has occurred, not popularly acknowledged in the U.S., while simultaneously giving a necessary nod to domestic political realities in a U.S. election year.

Not even the most obdurate American China-basher can gainsay that the yuan is now closer to its equilibrium rate with the dollar than it was when it was pegged. Yet how much further, if at all, does it have to go? Not an easy question to answer. It takes two to make an exchange rate. Not being fully convertible, the yuan doesn’t have a free market where its equilibrium price is readily discoverable.

China’s central bank determines the rate by restricting the currency to floating in a narrow margin around a fixed base rate determined in reference to a trade-weighted basket of currencies. The bank doubled the permitted daily trading band in mid-April to 1%, a small step in a long journey to fuller convertibility of the currency. It was said then that current conditions–slowing economic growth, weak export markets and investment outflows in the wake of looser currency controls–would be more likely to push the yuan down than up. So it has proved, an outcome welcome to policymakers, who can point to the market, not them, manipulating the direction of the currency in a way that happens to favor the country’s hard-hit exporters. We’ll overlook the conveniently woolly confusion of the outflow of funds on the capital account with a trade imbalance on the current account.

A plateauing of the yuan’s upward revaluation may indicate that equilibrium is near, but it is not a confirmation of it. Economists commonly use two methods to estimate equilibrium exchange rates. One set uses purchasing power parity, which assumes that exchange rates will come to equilibrium at the rate that aligns prices between countries. The second approach is to look for the exchange rate that would allow for an equilibrium balance of payments.

Much of the case for the yuan approaching equilibrium turns on applying the second approach. China’s current account surplus has fallen from 10% of GDP in the mid-2000s to somewhere likely to be between 2% and 3% this year. Next year it may fall to 1.5%. In macroeconomic terms, that is as near to an equilibrium balance of payments as makes no difference.

Yet beating the drum for that approach doesn’t necessarily make it so. Joshua Lipman of the Wharton School of the University of Pennsylvania, in a paper published last year, calculated that the equilibrium rate using purchasing power parities was around 4 yuan to the dollar. He also reckoned that using the equilibrium balance of payments approach, the figure should be and somewhere between that and 5 yuan. He did his sums when the current account surplus to GDP ratio was higher. A recalculation today should push the figure towards or past the higher number. Using either method, however, implies the currency is still undervalued, if by an ever decreasing amount.

Lipman notes, and the chart above shows, an important point: the central bank has managed the appreciation of the yuan by letting it rise steadily, an average of 6.4% a year since the peg was first broken. If that rate were to continue, the yuan would take until mid-2015 to reach five to the dollar and a further three years to reach four to the dollar, the range of Lipman’s computed equilibrium rate.

By letting the exchange rate move only within a narrow daily band, China has managed to avoid the shock to its economy from a rapidly rising exchange rate that Japan endured after the Plaza Accord in 1985. Intended to end the undervaluation of the Japanese currency against those of its main trading partners, the accord led to the yen doubling against the dollar in two years (see chart above). That triggered the endaka recession and then the monetary expansion to counter it that inflated a property and debt bubble that was followed by Japan’s so-called Lost Decade. Those were lessons not lost on Beijing’s policymakers.

One lesson that was lost on many Westerners, or at least has been widely forgotten, was that the forced rapid appreciation of the yen, did not eliminate America or Europe’s trade surpluses with Japan in the 1980s. They were caused by structural issues requiring different remedies. The same is true of China’s surpluses. Getting its currency in equilibrium is part of ending its own economic imbalances. As they apparently say in India, or at least in movies about India, everything will be all right in the end–and if it’s not all right, it is not yet the end.

The Chen Case: A Inconvenient Test Of China-U.S. Relations

The flight of Chen Guangcheng from house arrest in Shandong to the refuge of the American embassy in Beijing comes at a highly inconvenient time for Sino-U.S. relations. U.S. Secretary of State, Hilary Clinton, and her counterpart at the U.S. Treasury, Timothy Geithner, are due in Beijing this week for what were routine bilateral talks. These will now be overshadowed by what is an embarrassment to Chinese authorities and a problem U.S. diplomats could do with out given all the other glowing embers of contention between the two countries. Clinton has advanced the dispatch of some of her sherpas in an effort to defuse the situation before she arrives. Her assistant secretary of state, Kurt Campbell, is already in Beijing, several days ahead of his planned arrival.

Both governments are staying mum on Chen’s case. The Americans haven’t officially acknowledged Chen is sheltering in their embassy. China’s foreign ministry spokesman says they have no information about Chen’s whereabouts. Whatever. With China’s leadership mired in the Bo Xilai affair and Amerca’s in a presidential election, both governments will want a quiet solution, but are unlikely to get it because of the domestic political pressures.

The Obama administration was criticized domestically for not granting Wang Lijun, Bo’s police chief in Chongqing, asylum when he went to the U.S. consulate in Chengdu to reveal that Bo’s wife Gu Kailai was implicated in the murder of British businessman Neil Heywood. To deny asylum to Chen, if he asks for it, a person whose case the Americans have repeatedly raised on human rights grounds, would open the Obama administration to charges by his Republican opponents of again being “soft on China”, just as they accuse him of being over trade, currency and other economic issues. The administration, which doesn’t have the luxury of being able to criticize from the campaign trail without having to deal with the fallout from “interfering in China’s domestic affairs”, has been trying to walk a tightrope between promoting human rights without that a getting in the way of working with Beijing on global and regional issues that affect U.S. national interests.

With China’s rise as a regional and economic power, the two countries’ national interests intersect ever more frequently–Syria, Iran, North Korea, South China Sea, Taiwan–to list some current points of tension. All are ones where nationalist voices can be raised strongly at any time, and amplified by domestic politics. Within China, it doesn’t take much for the conservatives in Beijing to resurrect the specter that Washington is exploiting Chinese domestic events to weaken or encircle the country. One reason that the diplomats on both sides want a quiet, face-saving resolution to the Chen affair is that both sets know they have bigger issues to fight over.

Older readers may remember the case of Fang Lizhi, who sheltered in the U.S. embassy in Beijing for more a year in the wake of Tiananmen in 1989. It was caustic to China-U.S. relations.  The relationship has matured but also become more complex since. Yet a diplomatic sweeping under the carpet of an inconvenient affair is not what the diplomats are likely to get.  Chen is going to be a stern test of the bigger relationship.

Trade For Two, And Two For Trade

The South Korea-U.S. free trade agreement comes into force today–as this Bystander feels sure you have noted in your diaries. It is tangental to our brief but worth noting in passing for several reasons. Beijing, Seoul and Tokyo hope to start the sharp end of talks on their own free trade agreement later this year. China is both being dragged and dragging its trade partners before the World Trade Organisation with some regularity. And while the next round of the WTO’s global free trade talks, the Doha round, is proceeding even more glacially than reform in China, free trade agreements are popping up everywhere.

Nearly three score have come into force since January 2008. The total in effect is fast approaching 300 and many more are being talked about. (Trade trivia question: now Mongolia has struck a free trade agreement with Japan, which is the one WTO member left that is not party to any free trade agreement?)

The days when free trade agreements were seen as undermining the multilateral global trading system seem distant memory. Bi- or limited plurilateral regional free trade agreements will shape trade policies for the foreseeable future. They are also more suitable for developing existing cross-border trade flows being created by the needs of global logistics chains. Whether they undermine the big benefit  of multilateral agreements, that they increase trade overall by lowering restrictions across the board, is moot. But then the Doha round isn’t doing anything to boost trade overall for as long as it remains stalled.

The most significant of the free trade agreements under discussion for  the Asia-Pacific region is the Trans-Pacific Partnership (TTP) that the U.S. is taking over. China is on the outside of that at this point. Japan is the swing state. If it joins the TTP, China’s exclusion will be of more consequence than if it does not. Another free trade agreement in the pipeline that has implications for China is one between the EU and India. Meanwhile, Washington and Seoul are putting in place another piece of the new world trade order.

Footnote: The answer is Mauritania.

Rare Earths Pas De Deux

The joint complaint the U.S., EU and Japan are bringing to the WTO against China over rare earths has been a case in waiting ever since the U.S. and the EU won over other Chinese industrial raw material export restrictions in January. Those set a precedent for the successful argument that export restrictions by commodity producers glut domestic markets and thus let raw materials to be bought cheaply to domestic manufacturers in a way that can be considered trade distorting.

In the case of rare earths, the group of minerals used by high-tech, military and green technology manufacturers of which China produces 90% of the world’s supply, Beijing says it is prudently managing a scarce resource plagued by illegal mining–though rare earths would be less of a scare resource if more mines in the U.S., Australia and South Africa driven out of production by an earlier glutting of international markets were to reopen. The Catch-22 is the more mines that reopen, the more international prices are pushed down making reopening of more uneconomic, and leaving Chinese producers with great sway over international supplies.

This is a delicate dance for both sides, and one with political sub-themes, too, with there being leadership elections in Beijing and Washington. The two sides have 60 days to work out a deal before the complainants can ask the WTO to rule, which is what this Bystander expects to happen. However, we still hold to our view that, recent precedent not withstanding, this is far from an open and shut case. Beijing’s tough enforcement of its environmental protections of rare earths makes the case that they are a mere pretext for protectionism more difficult to sustain  than was the case with the export restrictions on coke, zinc, bauxite and the six other raw materials that the WTO ruled in January did break world trade rules.

Beijing’s Common Cause With Washington In Myanmar

Myanmar stands as a good example of the cooperation and competition that characterizes the relationship between Beijing and Washington. Much of the commentary on Hillary Clinton’s visit to Myanmar, the first by a U.S. Secretary of State in half a century, has concentrated on how Washington wants to detach Beijing’s hold on Naypyidaw. This is seen as part of a grander plan on the part of the Obama administration to counter China’s growing influence in the region. Yet, to this Bystander, it seems that not only can the U.S. do no more than loosen Beijing’s grip, from tight to firm, but also that is now, on balance, in Beijing’s interest that Myanmar emerges from its international isolation.

That isolation has left China as Myanmar’s largest trade and investment partner. Construction of the Myitsone dam may have been suspended but work on six other Chinese-built dams continues. The road, rail and energy pipeline connections across between Yunnan province and Myanmar’s Bay of Bengal coast are being developed by the day. Chinese companies have a first mover advantage that could be readily exploited if international sanctions on Myanmar are lifted and its population of 60 million is provided with an opportunity to catch up with the economic progress of the rest of Southeast Asia.

Neither U.S. nor Indian firms are in any position to leapfrog Chinese ones in Myanmar, any more than Washington or New Delhi will leap ahead of Beijing politically. The security risk to China’s southwestern reaches is marginal compared to the potential economic and political gains.

Beijing certainly does not want a full-fledged democracy that is in Washington’s pocket on its doorstep. Yet it would not be adverse to a more broad-based government in Naypyidaw that could bring to an end Myanmar’s minority ethnic conflicts. These insurgencies are primarily being fought along the length of the border with Yunnan. China’s commercial interests in extracting Myanmar’s natural resources and sending cheap manufactures in the opposite direction are far better served by peace than strife. As we have noted before, Beijing does not want another flood of refugees from the fighting.

Nor would China be too sorry to see North Korea lose a fast friend and export trans-shipment point in Burma. That would only make Pyongyang more reliant on Beijing, and reduce by one the potential ranks of nuclear armed neighbors.  Meanwhile, Beijing and Naypyidaw are strengthening their military ties. Min Aung Hlaing, the new commander of Myanmar’s armed forces, may have pointedly made his first foreign visit to Vietnam, but he was in Beijing earlier this week to sign a memorandum of understanding with Chen Bingde, his PLA counterpart, to deepen military cooperation. He also met President-Assumptive Xi Jinping. Closer military ties will help China’s naval reach into the strategically important waters of the Indian Ocean.

State media has stuck an uncommonly neutral tone in its coverage of Clinton’s visit to Myanmar, highlighting her promotion of economic reforms and the need for ethnic conflicts to be resolved. Beijing has more common cause with Washington on both those fronts than those looking for a grander geopolitical game imagine.

U.S. Forces To Australia And Beijing’s Response

This Bystander is shocked, shocked to find that geo-politics is going on in the region!

China And The U.S. Play Free Trade Chess

Free trade agreements (FTAs) are easier said than done. U.S. President Barack Obama acknowledged as much when announcing an outline agreement to expand the TransPacific Partnership from four to nine as a basis for a regional FTA. There is much detail to be negotiated. It will take years, not months. Many devils must be confronted.

For one, Obama’s domestic opponents are not going to hand him a political and economic victory with a general election barely a year away. Even in the highly unlikely event a final TTP agreement could be reached quickly, a Republican-dominated House of Representatives could block a vote for Congressional approval before the election. Nor are Republicans likely to allow an agreement containing what Obama called ‘high standards’, code for among others environmental and labor protections and local sustainability rights that are an anathema to many of Obama’s opponents.

All those are the quick and dirty domestic political battles. Japan’s decision to join promises a hundred years war. Japan’s new prime minister, Yoshihiko Noda, has risked splitting his party in doing so. He will now need to turn the country’s three most powerful and insular domestic political constituencies, farmers, doctors and the construction industry. Doing so would mean a deep structural change to Japan’s political system. That may be long overdue, but it will not be quick in coming. That alone should not imbue supporters of the expanded TTP FTA with great confidence. Nor should the rapid turnover of recent Japanese prime ministers. Noda is the sixth in five years.

It is already two years since the U.S. applied to join the four-member TTP and started to orchestrate its expansion to nine, including bringing in its two most important treaty partners in the region, South Korea and Japan, as well as regional allies such as Thailand. There have already been nine rounds of TTP expansion negotiations. These are painstaking processes.

The Obama administration’s move was part a a bigger game of FTA chess that it is playing with China for influence in the region. Washington is playing the APEC side of the board while Beijing is playing the ASEAN side. (The side story for those choices is that the Asia-Pacific Economic Community is a group of economies, so can include Taiwan, whereas the Association of South-East Asian Nations comprises countries, so does not. Taipei has expressed interest in joining the TTP FTA, and while Washington has been scrupulously silent on the point, the absence of any outright rejection is being taken in Beijing as unacceptable tacit support.)

Beijing, meanwhile, has been doing what it can to slow up the TTP expansion, and pushing a series of bilateral trade agreement with ASEAN nations and the concepts of regional trade pacts between ASEAN plus three (itself, South Korea and Japan) and ASEAN plus six (adding Australia, New Zealand and India). The U.S. is notable by its absence. Hence Washington’s attempts to involve all the same countries, with the one obvious exception, to much the same purpose but under the aegis of APEC.

This is not necessarily disliked by most Asian countries as it allows them to keep both regional superpowers from being too dominant as they jockey for supremacy. The most extreme example of this is that both China and the U.S. are trying to create trilateral free trade agreements with South Korea and Japan. Two tracks. Double the trouble. And any end game still a long way off.

Beijing’s Currency Wars Playbook

Beijing will play its usual defense against the moves in the U.S. Senate to twist China’s arm to appreciate its currency against the dollar: vociferous denunciation of Washington for turning protectionist and initiating “trade wars” while patiently waiting out the start of any serious hostilities, calculating that the threat of them will eventually recede.

The denunciation has duly come with Foreign Ministry spokesman, Ma Zhaoxu, saying the bill now in front of the U.S. Senate proposing punitive measures against any country that is shown to be manipulating its currency — for which read China — “seriously violates rules of the World Trade Organization and obstructs China-U.S. trade ties”. He told U.S. Senators to abandon protectionism and stop politicizing economic issues. He also told them to “stop pressuring China through domestic law-making”. Co-ordinated sentiments have been expressed by the central bank and the commerce ministry.

While perhaps nobody outside the U.S. Congress really believes that a sharp revaluation of the yuan on its own will eradicate America’s trade deficit with China or create the new domestic jobs the U.S. is having such trouble generating, Beijing will know that even if the Democratic majority in the U.S. Senate passes the bill, the legislation will likely founder in the Republican controlled House of Representatives. Even if it does not, it is highly unlikely to survive a presidential veto. That is the past pattern of such proposed legislation. Support for this year’s bill appears to be stronger, helped by its narrower provisions and the background of sluggish U.S. growth and joblessness, but the odds remain long that it will become law.

At the very worst from China’s point of view, and the bill does become law, it will be cheaper politically for Beijing to fight any punitive measures through the WTO than it would to be seen to capitulate to foreign pressure. Meanwhile, it can bide its time, letting the gradual appreciation of the yuan that has been underway since June last year (up 7% against the dollar since then and 10% against the euro) ease the U.S. pressure, which is anyway likely to abate after next year’s U.S. elections. Simultaneously, it buys more time for the economy, particularly the export-manufacturing sector, to adapt.

China’s policymakers are quite happy for the yuan to appreciate. It will help them both fight inflation and restructure the economy. They just want do it to their timetable, not Washington’s–and they have the playbook to do that.

Beijing Happier Than It Says About U.S. Arms Sale To Taiwan

Beijing does not come away badly from Washington’s sale of $5.3 billion-worth of arms to Taipei. Washington backed off including in the deal 66 new F16 C/D fighter jets that Taipei wanted. Taiwan will only get upgrades to its aging F16 A/B fleet, but not the 66 new F16 C/Ds it had requested. That was the price the Obama administration had to pay for keeping relations with Beijing on an even keel. Given the PLA’s modernization, Beijing will be just fine with that. Nor will it be too concerned about the rest of the deal, which includes air-to-air missiles, guided bombs, radar and training.

For all its bluster, Beijing never really thought it could scupper the whole deal. Keeping the military technology gap between the PLA and Taiwan’s armed forces as wide as possible was always its realistic goal in this case. Tick the achieved box. Similarly, possible retaliation, such as suspending military exchanges, as happened in January 2010 after Washington authorized the sale of $6.4 billion-worth of arms to Taiwan, will be hollow threats as doing so would remove the incentive for Washington to show restraint in future sales.