movements of the yuan

the chinese yuan strengthened to a twenty year high against the dollar this past week.  at the end of the 27th, the yuan was trading at 6.0686 to the dollar.  the historic high signifies a buoyant chinese economy, but on the flip side, this present success can only mean that american exports in china could become more competitive even as the chinese economy opens up to foreign exports.  apple begins selling its iphone through china mobile in january.

unfortunately, a lot of the money being created in china comes from a shadow banking system that the chinese central bank has been slowly trying to quell this year.  banks in china "typically scramble for short-term cash to meet month-, quarter- and year-end regulatory requirements. Demand for cash is also high among Chinese companies seeking to meet year-end payments, too." individuals with political or business connections have been able to borrow money from state controlled banks which receive loans from the central bank at very loan interest rates.  these individuals then provide loans to the wider chinese economy at extremely high interest rates.  several problems develop from a system like this.  first, wealth becomes concentrated abnormally in the hands of just a few shadow bankers while state run and private banks do not make the returns they could if they had loaned the money directly.  second, artificially inflated interest rates from shadow banking make it harder for individuals and business to repay loans, and the inflated repayment means that less money is being directly injected into the economy.  third, the high interest rate loans are less likely to be repaid and are thus across the board more risky.  subsequently the state controlled banks are less likely to be able to re-pay the central bank, producing fears of a wider financial instability.

the chinese government has attempted to rein in this risky lending, but has been mostly unsuccessful as of yet. writers for the new york times note that, “the central bank allowed rates late last week and early this week to soar to unsustainable levels. Instead of regularly scheduled open-market operations, the bank tried unconventional methods of guiding money markets.” However, the central bank was forced to quickly inject fresh money into the banking sector as interest rates soared.

this seems like the creaks and groans of a giant, growing economic system.  more growing pains for a young economy.  the central bank wants to move the financial system away from the artificial risk created by the shadow banking system.  the question now will be whether banks will be able to clean their balance sheets of the toxic loans before a financial meltdown not orchestrated by the central government occurs.  if the central government does more to investigate and imprison politicians and businessmen directly involved in graft (as it has been recently doing,) the banks might correct their lending practices directly.  this correction would still produce some short term jolts as less money could potentially be made, but more long term stability.