Hot money covets China

An estimated US$80 billion hot money flushed into China mainland in the first season, leaving the accumulative sum to a whopping US$800 billion. The speculative money finds China a haven for the following reasons.

 

1, China is somewhat insulated to the credit crunch
As the economy in US and other developed markets are experiencing drastic corrections, China still sustains its double digit economic growth this year.

 

2, High expectation for RMB (Chinese currency) exchange rate hike
RMB is said to be undervalued for at least 20%. The Chinese administration acknowledged the fact and let RMB appreciated by 7% against USD in the first season in 2008, leaving the annual appreciation range to 10-15%. 

 

 

3, High net investment value of RMB denominated assets
Besides the currency appreciation, the value of RMB denominated assets, such as securities and real estates, has seen continuous double-digit gains in the past few years. The momentum is set to continue because of the undergoing urbanization and market-oriented economic reform in China.  

 

 

4, High interest rate

In order to prevent Chinese economy from over-heating, the Chinese administration introduced a slate of measures since the end of last year; interest rate has been raised consecutively since then. The current one-year borrowing rate stands at 7.47%; the one-year deposit rate is 4.14%. The rate gap between China and the US is 2.14 percentage points (Fed lowered rate again to 2% last week). The huge gap, which is still widening, stimulates more hot money flow from US and other low interest rate markets to China.

 

 

Fed cuts rate again, but less desperately

US Federal Reserve announced early this morning that the federal funds rate will be cut to 2% from 2.25%. It is fed’s seventh cuts in a row since the credit crunch unfolded last summer. So far the aggregate rate cuts accumulate to 3.25 percentage points.

 

Fed may suspend rate cutting  

Compared with the previous cuts early this year, Fed’s move this time was far less desperate. The previous rate slashes were deemed as hasty contingent efforts. The 0.25 percentage point cut came exactly as the market had expected.

 

However, the moderation of Fed in rate cut does not pull people out of judgement that the Fed was terrified by the current economic downturn, and its consecutive rate cuts showed lack of other macro tools which can alleviate the pessimist sentiment hovering in the market. Rate cut is the only weapon left in Fed’s arsenal.

 

Repeat of vicious cycle  

People doubt that what Fed can do the next if the recession in the States continues to deteriorate. After the massive tax rebate and seven rate cuts, there is almost no room for further economic stimulus that the Fed can utilize to spur the economy. The latest figures substantiated the already well-accepted claim that US is now in recession and the overall situation is going to worsen.

 

Moreover, Bernanke and Fed are actually repeating what Allen Greenspan had done in the aftermath of 911, slashing interest rate in order to boost lending and borrowing in the financial system. However, we should not forget that it is Greenspan’s over-reacted rate cuts led the financial sector into credit frenzy. The ensued credit frenzy and excessive capital volatility spawned sub-prime-led credit crisis that we see now.

 

Is Fed bringing an end to the economic woe or it is generating something more horrible for the next cycle?