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Greenspan: China may be overheating
Updated: 2004-04-21 10:50

U.S. Federal Reserve Chairman Alan Greenspan warns there is increasing concern in China that its economy is overheating. But Greenspan believes China can reset its currency peg without destabilizing its banking system if it does so carefully.

U.S. Federal Reserve Chairman Alan Greenspan. [Reuters]

China's currency now trades in a narrow band against the dollar of 8.28 yuan.

It has come under heavy pressure from the United States and Europe in recent years to revalue the yuan. Critics say China's currency is held at an artificially low level, which gives it a trade advantage.

China says a move to greater yuan flexibility is desirable, but it will not happen in the short term because of the damage it might cause to Chinese and Asian economic stability.

In remarks to the U.S. Senate Banking Committee Tuesday, Greenspan said the major problem for China was not so much the strong demand for commodities. Rather, it was the inceasing concern "that they are overheating as a consequence of fairly rapid increases in the money supply, which has been going up approximately 20 percent a year."

The World Bank alluded to a similar concern in its East Asia economic update released earlier Tuesday.

The bank said that while China remains the driver of regional growth, there was a risk to the region from a "hard landing" as the Chinese authorities endeavor to slow the country's growth rate to more manageable levels.

China grew at a red-hot pace of 9.1 percent last year -- by far the strongest in East Asia. This year its forecast is for 7.7 percent, falling to 7.2 percent in 2005.

Greenspan said China's state-run enterprises make up a significant proportion of the country's output, which makes the economy less flexible than that of the United States.

"They recognize this and they're moving to try to find appropriate balance and implicit in that is clearly going to be a greater flexibility of their exchange rate," Greenspan said.

"Clearly (there's) going to be at some point -- hopefully ooner rather than later -- a reduction, if not the ultimate removal, of the capital controls on Chinese residents in the accumulation of foreign assets," he said.

Delicate process

Greenspan said the shift by China to reduce capital controls was "a very delicate process" because the Chinese banking system is not in robust shape.

"They are moving as best as I can see in the right direction, endeavoring to contain this. And I think it is in everyone's interest that China move forward but they don't move forward in an unbalanced way, which could create great difficulties for them and they will create significant problems for Southeast Asia, Japan, and indirectly for us," he said.

China's weak banking system is believed to be troubled with bad loans, and the government has moved in recent months to rein in credit.

But analysts say reform of China's financial system could take three to five years.

Greenspan said China would have to be very careful where it chooses to reset its currency peg.

"Because if they set it with too small a change from where we are today, the markets would quickly presume there will be further adjustments and they will get a very large increase in capital inflow, which will create even a greater problem," he said.

"There is, I agree, a peg level which probably prevents that from occurring, (but) I don't know where that is. I'm not sure they do. But they're working toward some sort of resolution of the type you're suggesting, as best I can judge."

In broader remarks about the U.S. economy, Greenspan told the Senate Banking Committee that deflation was no longer a threat.

"Threats of deflation, which were a significant concern last year, by all indications are no longer an issue before us," Greenspan said.

That was viewed as a possible hint that the U.S. central bank is closer to raising its target for a key short-term interest rate.

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