The amount of attention that’s gone towards Rmb revaluation in the last several days seems out of place, if only because gradual appreciation of the currency appears obvious and inevitable given that numerous agencies and bureaus are putting in place machinery to deal with its impacts, such as SAFE diversifying away from USD exposure as much as possible or Shanghai and Shenzhen stock exchanges moving towards international Rmb denominated listings, which will eventually require free(er) capital flows.

Rmb appreciation will not materially affect the U.S. trade deficit, and it will have questionable near-term impacts on imbalances. As Chinese gain more purchasing power, they will likely do things like leave the lights on after 5:00pm (and consume more coal and oil as a result), pushing up energy prices. Americans will then (broadly) be forced to pay more to drive their hummers and power their plasma televisions, increasing the United States’ total import bill. Furthermore, there will likely be some level of input-import substitution occurring within China itself, if mainland manufacturers find that they can suddenly purchase other components more cheaply. Threatening sanctions to hasten this process – for dubious gain – is nationalist stupidity at its most pure.

For what’s at stake among various interest groups within China, we turn to the eminent Professor Pettis:

A revaluation shifts wealth from the Chinese government and the manufacturing sectors (and some wealthy Chinese) to Chinese households — which, by the way, is pretty much what is meant by “rebalancing” in the Chinese context. There are many other ways besides revaluation to shift income this way. The PBoC can raise deposit rates, wages can rise faster than productivity, companies can be privatized by giving away shares to the pubic, and so on. They all have the same effect. They shift resources to households and away from producers, infrastructure investment, and real estate developers. This allows household income to grow relative to national income, which ultimately increases the consumption share of GDP.

Domestic Chinese exporters don’t have a leg to stand on for a weak Rmb peg, at present. That doesn’t mean they aren’t lobbying for it, though. To the extent they will be able to sell an us vs. them narrative, anti-China sanctions will only provide more ammunition to make the case for more domestic subsidies, be they explicit (tax breaks) or implicit (currency).

Ten men and ten women of average looks walk into a meat market bar in Shanghai. Since they are in China the men must use crass displays of wealth and status to attract mates, and each expect to gain 500,000Y of status from marrying (at least their parents will stop bothering them.) These will be split evenly between the two partners in a 50:50 split. Harmony ensues.

If instead there are 10 men and 9 women, as a result of Momma and Pappa Zhou slavishly adhering to cultural taboos that demand production of a male offspring, the results change dramatically: one man will be unpaired, and if everything is equal and he is rational (and wants p00n), he should be willing to spend all of his surplus to securing the affections of a woman. This quickly reduces men’s payoff to just over zero, and women gain 499,999Y from the exchange. Harmony does not ensue as the unpaired male must resort to a selective combination of World of Warcraft and pillow marriage.

Several ‘long-term-mating’ equilibriums will emerge among different social strata. Yuppie urbanites will find a relatively equal gender balance, since they need marriage and children for status. The ultra-wealthy will enjoy multiple partners as the rewards to being an extremely high status male go up, so also will the effort that goes into acquiring the attention of an extremely high status male. Very poor rural migrants will be left with an even worse gender imbalance, and move into some sort of sharing arrangement with lower status females.

For Chinese men, a house is a very important asset in attracting a woman, and not unreasonably as it represents stability amid a rapidly transitioning economy with no real social safety net. Previously I’ve asserted that the link between getting-some (and having a family, I guess) was not that strong, since the low-status men group wouldn’t be in much of a position to afford houses anyway. This paper presents convincing evidence to the contrary, as household savings rates are higher in provinces with higher gender imbalances. A summary:

“The increased pressure on the marriage market in China might induce men and parents with sons to do things to make themselves more competitive,” Wei says. “Increasing savings is one logical way to do that, to the extent that wealth helps to increase a man’s competitive edge. Parents increase household savings mostly by cutting down their own consumption.”

… “We find not only that households with sons save more than households with daughters in all regions,” Wei says, “but that households with sons tend to raise their savings rate if they also happen to live in a region with a more skewed sex ratio.”

Calling something an ‘inflated asset’ and ‘bubble’ requires an a-priori notion of what a non-distortionary equilibrium would produce. If gender imbalances are affecting competition, and as a result, reservation prices for apartments, there will be considerable skew vis-a-vis models that consider income alone.

For much of the 20th century, Hong Kong’s success was predicated on the failure of mainland China and the city owes less to free institutions than it does to historical circumstance. The contrary argument, where Hong Kong is held up as a paragon of laissez-faire utopia typically glosses over these circumstances. This risks trivializing the challenges involved with creating sound and scalable legal and economic institutions (in some sense, historical circumstances made it much easier for Hong Kong leaders to do just that). Proponents of laissez-faire policies point to HK as an example which proves that all a nation needs to do is adopt free market policies in order to grow its wealth. After all, HK has no natural resources to speak of (aside from a deep water port).

While I’m all for laissez-faire utopias,* there’s a certain amount of qualification necessary when discussing Hong Kong’s success. Rapid growth in Singapore, Hong Kong and Taiwan occurred after 1949, when a lot of the formerly mainland bourgeoisie fled throughout the greater Chinese diaspora, taking with them their money,** and much more importantly, their skills. Today, people often hold up Hong Kong and Shanghai as rival cities, since the latter is attempting to become a regional/global financial hub. Many in Shanghai feel this would be the case already were it not for the half-decade of non-participation in the world economy that the mainland experienced after 1949; the fact that people went to Hong Kong was “because they couldn’t go to Shanghai.”

Examining average incomes in both cities, it becomes clear that the largest gaps existed during the height of the mainland’s various socialist experiments. Now that the mainland has stopped the crazy train, some of those who left after the revolution are heading back. Just as significantly, the mainland is able to tap into an (up until 1990) unrealized pool of talent and skill. This isn’t to suggest that all of Hong Kong’s success in the last fifty years has been due to the fact that it benefited from the lucky few who were able to escape the revolution (who were largely those with the wealth/network resources to do so), though it’s certainly a very important source of HK’s success (combined with the fact that, for the same period, it was the only route into China for limited trade).

Institutions alone aren’t the result of Hong Kong’s success, though it’s certain that without them the city would have languished, regardless of circumstance (a la Macau). Institutions are extremely important for wealth creation and, generally, there are several interrelated factors at work that are important for applying them outside of the very limited geographies in which they seem to work:

1. if legal rules are codified without underlying capacity, they will be unenforceable [i.e.: making a law that everyone in the US should have 6 months of holiday every year for mental health reasons.]
2. certain rules are required for social coordination. The best types of these rules seem to be idiosyncratic [decisions or rules that might not make logical sense but produce a positive outcome approaches that are successful and are replicated.] To some extent these can be imposed; though if an authority oversteps the constraints of item 1 they will find their authority quickly undermined
3. people tend to achieve some basic level of coordination with or without a centralized legal structure. The exact nature of this matters, however, as it seems to be a continuum between mafia-anarchy and despotism. Best to have something a bit more benevolent, from the perspective of the participants.

Hong Kong’s history provides an interplay of all of these factors, since the British authorities were able to replicate rules and laws they knew were generally useful and produced positive outcomes. These were adapted for a local context, and the city simultaneously benefited greatly from geography and a windfall of talent after the Communist revolution. Currently, however, simply pointing at Hong Kong’s policies (which are outcomes of a particular process) and declaring that copying them would create prosperity is wishful thinking at best. A much more interesting project would be to determine the process that creates these policy outcomes, which are probably slightly different if one is dealing with a diverse set of national and cultural contexts.

More generally, the inner contrarian wonders whether democracy should be an explicit goal of aid or internal development policy. Singapore did just fine (for a certain class of people) without serious democratic reforms. The more I learn the more it seems that democracy is the result, and not the cause of, prosperity and free social systems. The success of the Chinese diaspora in places like Singapore and HK should fill China watchers with considerable hope for the future of the mainland, barring an asset price implosion. Beijing planners have explicitly used Singaporean and HK technocracies as a deliberate model, and it will be very interesting to see how extensively these systems can be replicated over a much larger and diverse population.

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The SEC recently moved to limit short selling, with some fairly technical rule changes, cutting off robust feedback mechanisms in financial markets and catering to the interests of increasingly ensconced oligarchs.

Meanwhile, Chinese regulators are continuing to liberalize financial markets, and will soon introduce rules to allow large institutional investors to trade index futures. In isolation, this may not make much of a difference for the near future (particularly given limits on participation). As part of a broader trend it is very important: the “China collapse imminent” story is, at present, predicated on a property bubble that will collapse and saddle banks with lots of dead loans. At the same time, the mainland is derided as pursuing policies which solidify global imbalances (or, the process by which Chinese savers are shafted with artificially low rates of return, and Westerners get cheap credit that we proceed to do stupid things with).

Currently, a dearth of options for individual investors is only contributing to these distortions. Currency revaluation alone will not fix global imbalances, and a more efficient financial sector (say, anything with >0% return) would allow Chinese investors to save (incrementally) less, which is the only way trade deficits will actually shift in the long run.

Of the short selling rules change by the SEC, Robin Hanson nails it:

Anyone who believes that stocks which have fallen at least 10% in a day are an unappreciated good buy are free to grab that free money they think is lying on the sidewalk.  Clearly most folks don’t do this, and so don’t believe this, implying that short sales that push stock prices down on average give reliable bad news: this stock is worse than you thought.

Taxing short sales is an attempt to ban this bad news, to trick people into thinking those companies are doing better than they are.  After all, we all know that the financial crisis was not caused by banks making bad loans, it was caused by short sellers telling people that banks had made bad loans — if only we’d killed the messenger, we wouldn’t be in this mess, right?

When the crawling exchange rate revaluation was introduced in 2005, Chinese exporters claimed that it would ruin their competitiveness and lead to mass unemployment (and eventually a repeat of the Wuchang uprising, down with the man!) Instead of insurrection, total Chinese exports continued to increase during the period of the crawling peg. This graph shows the inverse of US-China trade deficit (effectively, Chinese net exports to the US) and the USD-CNY exchange rate (Chinese net exports to US, left axis, USD million; exchange rate on right axis):

Despite a rising currency and financial crisis, the Chinese trade surplus continued to increase throughout the last several years. This means that major exporters, who claimed that a stronger currency would harm sales to their primary market (the US), don’t have much of a foundation to stand on.

The Rmb will be revalued (likely another crawling peg); probably sometime in the next eighteen months. The central government has committed to a number of policy goals (decreased reliance on international demand, an increase in domestic purchasing power), both of which would be served by a stronger Rmb. Since exporters will be the major group opposed to a currency revaluation, the fact that there’s not a shred of evidence that they were harmed by the events of the past three years stands as a strong indictment of their case.

From FT Alphaville, more information about price changes in Chinese property in 2009. One chart depicts a three month moving average, demonstrating the speed of 2009’s price increases; and another that breaks it down by city. Price increases have been heavily concentrated in coastal cities (200% increase in Shanghai, 400% in Guangzhou). According to CRIC’s data, Wuhan’s housing prices fell during 2009. I recall some stories about real estate agents in Wuhan offering 50% discounts at the end of 2008, something that seems unimaginable given the long waiting lines that appear whenever new property goes on sale in Shanghai.

One of the counter arguments to the notion that China has a rapidly growing property bubble: a majority of the country’s 1.3bn people wants to move to the coastal cities (which account for about 5% of the total national population), and therefore use of averages (for example, years of average income required to purchase a flat in the city) that are appropriate in other contexts lead to skewed results. Examining only the top 5% of Chinese earners, for example, Shanghai land prices might not seem that outlandish. Anecdotally, this seems at least partially true: it’s difficult to describe the magnetic pull that the eastern metropolitan areas exhibit, despite their increasing unaffordability for most mainlanders.

Among mainland youth, I’ve not come across a single example of someone that did not have their heart set on going to one of the three major cities (Beijing, Shanghai, Shenzhen). This seems crazy given the living expenses that one has to deal with, along with (presumably) more competition for the career-track jobs that would make resettlement worthwhile. Surely the positive network effects of agglomeration cannot be worth the headache of dealing with high house prices and xenophobic city-dwellers, and upon first glance this slavish devotion to migrating east seems like another entry in the long list of mainlandgroupthink.

Puzzling until the actual extent of wage differentials became clear: GDP/capita in the large cities is around USD11,000, with second-tier cities about 50-70% of that. Within the U.S., metropolitan wage premiums are hardly so significant (potentially aside from Washington D.C., which sticks out like the governing municipality of a banana republic when examining US income data depending on how you slice it). I haven’t been able to find good information for the distribution via age/education levels, though anecdotally it seems to hold across the distribution.

This is worth noting: real-estate stocks (property developers) tanked in the last week and a half, likely the result of government announcements that they are planning to put the kibbosh on “real estate speculation.” There have been several policies enacted recently, such as a tax on secondary sales (which probably makes the affordability problem much worse, and will impact speculation only insofar as buyers have a limited time horizon). The national congress convenes in March, and the expectation seems to be that more incoherent contradictory nonsensepolicies issued then will address the issue. Until then, uncertainty is difficult to price. (Source: 大智慧, data retrieved 01.29.2010).