International Perspective, by Marshall Auerback
China: The New Fulcrum Of The Global Economy?
December 30, 2003
For a country that was once deemed a “strategic competitor”, and the subject of a multiplicity of threatened trade sanctions over the past few years, the striking change in tone that characterised the recent meeting between President George Bush and Chinese Prime Minister Jiabao Wen implicitly suggests a belated American recognition of China’s increased leverage as America’s new paymaster.
Clearly, this marks a watershed change: The recent history of US/China relations under the later years of the Clinton administration and then under Bush has hitherto been marked by increased enmity: the demonisation of China in the Cox committee report on spying published some 3 years ago, the accidental bombing of the Chinese embassy in Belgrade in 1999, the harassment of Taiwanese-born scientist Wen Ho Lee on the grounds of espionage (the charges were later thrown out in court), and the leaking in the New York Times of a Department of Defence document recommending the sale of the sophisticated Aegis-class destroyers to Taiwan just prior to the April 2001 US-China spy plane incident (in direct contravention of an accord the Reagan administration signed in the 1980s with China, committing the US gradually to reduce the quantity and not improve the quality of arms sold to Taiwan). Furthermore, during the last 4 years the United States has also signed agreements with Japan enlarging the latter’s military commitments, undercutting its pacifist constitution (much to the disquiet of the Chinese government, which still has vivid recollections of the Japanese occupation), and securing Tokyo’s agreement to remain a privileged base for American military operations (the EC-3 spy plane, which was the flashpoint of the spy plane dispute, flew from a Japanese base). There has also been a persistent reluctance, until last month, for the Bush administration to affirm publicly the country’s longstanding “one China” policy, the ambiguity leading many in the Chinese government to suspect covert US support for Taiwanese independence.
Concurrent with these diplomatic developments has been a significant ratcheting up of trade tensions between the U.S. and China and signs that this trend would gain greater momentum in the run-up to the Presidential election cycle. The Democrats in the U.S. Congress have already put forward proposals for trade sanctions aimed at China, which in a political year would play well with voters in several key electoral states.
Against this backdrop, we have also been increasingly watchful of the political situation developing between China and Taiwan. President Chen of Taiwan is running for re-election in April, 2004 and he is campaigning, in part, on and around the issue of a declaration of independence for Taiwan — to which the Chinese government remains vehemently opposed. As Larry Jeddeloh argued in a recent Institutional Strategist piece:
“For demographic as well as other reasons, a referendum on independence would be highly popular, an almost certain winner with the Taiwanese people. Currently, President Chen has been dancing around the issue, on one day calling Chinese missiles pointed at Taiwan an act of terrorism, while softening his rhetoric the following day.
We are told the Chinese leadership is very concerned President Chen will introduce a referendum on independence and for years the threat of U.S. intervention, should China attack Taiwan over this issue, looms large in the thinking of the Chinese leaders.
We believe China has the technology to attack Taiwan, probably with success, due to a far greater level of technology expertise (missiles) than may be expected. For proof of China’s advance in this area, we need only look at their recently successful launch and retrieval of their first astronaut. Was he really recovered within meters of his target loading zone?”
All the ingredients, therefore, appeared to be in place for further deterioration during last month’s summit in Washington. And, yet, the reverse appears to have occurred. President Bush reiterated his country’s longstanding support for a “one China” policy (despite the support of some elements of his administration for a more pro-Taiwan independence posture), and warned President Chen against an independence referendum. There is also speculation that the Taiwanese President was effectively told to “behave or you’re on your own”.
Such a surprising posture comes shortly after Bush iterated his desire for “a forward strategy of freedom in the Middle East” as the governing basis for his country’s foreign policy in that region. The irony of this “democracy advocate” sternly warning the Taiwanese against the exercise of the latter’s own democratic franchise has been duly noted by many, but most have failed to consider the President’s limited room for manoeuvre. As Robert Samuelson of the Washington Post noted last week, “A great drama is now unfolding in the world's money markets. In 2003 the United States' current account deficit (a broad measure of trade) will total about $550 billion, a modern record. Because Americans pay for imports with dollars, this means that every day, foreigners must decide whether to keep about $1.5 billion in dollars.” If America’s largest foreign creditors, such as China, sell dollars for euros, yen or other currencies, the dollar's external value will drop cataclysmically -- with huge and possibly disruptive consequences for the US.
It may be the case that the Bush administration just has too much on its plate right now, and cannot afford to pick a fight with China. And the Chinese might opportunistically feel that if Taiwan was to be “returned to the motherland”, now was the optimum time to do it.
On the other hand, the recent rapprochement with China might also reflect Washington’s belated recognition of the extent to which it depends on the “kindness of strangers”, particularly those of the Asian variety (which collectively represent the largest foreign claim on US assets). Ironically, this realisation comes just at a time when China’s own acute vulnerabilities are becoming more apparent. China has been booming and it has undeniably become a key component in this year’s global reflation story. But China’s growth has been driven by capital spending. Its investment ratio at 43% of GDP is at an historical high. One must ask, is overinvesting in China now expanding the global output gap, with implications for the trend in inflation in the US?
In this regard, it is worthwhile quoting from a recent paper presented by the Hon Apurv Bagri:
“Arising from this growth in China are two issues, which haunt global manufacturers, and one that will test the inventive ability of the country’s central bank.
The first of the two issues is a consequence of the Chinese business model. This is built around the notion of creating a large critical mass of capacity and then finding the market to fill it. Once one company finds a new growth sector all others want to chase after it. As a result, in virtually all sectors, capacity exceeds demand by a factor of two, or three, and even more in some cases.
In consequence, product and conversion prices have collapsed across the board with very few exceptions. Take just two examples that are typical of what has been happening. The price of a conventional room air conditioner has fallen from nearly $700 in 1990 to $300 in 2000 and just $120 this year. In my own industry, conversion prices for ACR copper tube have collapsed, also, from US$2400 in 2000 to around $900 this year with the industry expecting further declines next year. This is a fall of 38% in just two years and my industry friends fear that it could continue.
Many, who have close ties to local banks and governments, get interest free loans for extended periods, often 20-30 years; in reality free cost of capital. They buy the land, build their factory, install the equipment, inflate asset values and repeat the process. The problem is that as so many of them in the same sector are following the same or similar business model, product and conversion prices are forced lower to the point that in many, many cases prices no longer cover operating costs. Thus, the profits, which are being reported, are more often than not illusory. Even if they go into bankruptcy, not an easy outcome in China, the machinery will still exist for another company to acquire for a few cents on the dollar.”
-“The Dragon & the Elephant Growth Prospects for China & India Challenges & Opportunities”,-The Hon Apurv Bagri, at the Third City of London Biennial Meeting, November 2003
For all of the talk about China’s “unfair trade practices” stemming from its decision to peg the renminbi against the dollar, credit subsidies of the sort described by Bagri would constitute a far more powerful prima facie case against the country in the event that the US appealed to the WTO. Unfortunately, the Bush administration has not taken this route. Treasury Secretary Snow has spent virtually all of 2003 harping on the need for currency revaluation. There are now indications that the Chinese might finally move in this direction, if a recent report from the Taipei Times newspaper is to be believed:
China's central bank is quietly moving ahead with a plan to peg the yuan to a basket of 10 currencies, instead of the US dollar alone, the state press reported Monday.
The prospective 10 currencies would represent the bulk of China's trade with the rest of the world as well as its main sources of investment, the China Business Post reported, citing sources with the People's Bank of China.
At a later phase China could eventually allow a "managed float" that would permit the currency to move within a set range.
The report gave no timetable for implementation of either phase and stressed that the potential policy change was still being studied.
It comes as a group of US government experts prepares to visit Beijing next month to discuss possible changes to the existing foreign exchange rate structure.
China has effectively pegged the yuan at about 8.3 yuan to US$1 since 1994 but it has come under increasing pressure, particularly from the US, to revalue.
China has publicly maintained that the problem is structural, reflecting its much lower labor costs, but has signalled a certain willingness to investigate a more flexible currency structure.
China has been studying a peg of the yuan to a basket of currencies since the beginning of the year in order to allow the exchange rate to appropriately reflect the country's trade performance and avoid short-term foreign exchange rate fluctuations, the China Business Post said.
According to local statistics, China's major trade partners in 2002 were the US, Japan, Hong Kong, and the Euro zone countries, followed by Indonesia, Malaysia, Singapore, Thailand, South Korea and Taiwan.
There is also talk of China seeking to reduce its bilateral trade surplus with the US through increased purchases of U.S. grains, corn, beans, and wheat and substituting purchases from Southeast Asia. It is also far from coincidental that Boeing, America’s number one export company, announced the go-ahead for its 30 year multi-billion dollar 7E7 program, just days after Jiabao Wen’s visit to Washington last month. It is highly unlikely that Boeing would have proceeded with the program unless they were highly confident that orders for commercial aircraft were about to strengthen.
Unfortunately for the Bush administration, such accelerated import purchases are ultimately predicated on a continuing boom in China. But as Morgan Stanley’s Andy Xie has recently illustrated, China’s monetary authorities might be moving aggressively toward increased credit restriction, which might hamper China’s proclivity to accelerate American imports. Here are the latest renminbi banking statistics collated by Xie:
Banking Survey: Loans
1994 -- 829
1995 -- 1023
1996 -- 1308
1997 -- 1227
1998 -- 1574
1999 -- 1142
2000 -- 1140
2001 -- 832
2002 -- 4706
1H03 -- 1805
3Q03 -- 700
4Q03 -- 300
Increase, Rmb bn
If Chinese growth slows, unemployment and unused capacity will rise and its ability to absorb further American imports will be correspondingly reduced.
For all of the talk of America’s massive credit expansion being the unhealthy source of much global growth, China’s increasingly “bubble-lised” economy is beginning to play a comparably important, albeit increasingly unstable, role. Indeed, it is not too far to say that we are in the midst of a major transition in which China becomes the fulcrum on which future global growth will pivot. It is almost always the case that such momentous geopolitical/economic shifts are accompanied by a huge degree of disruption, and the gradual rise of China as global economic locus might be no different. Consequently, anything that undermines its growth could have a comparably destabilising impact on the global economy, as would the end of the Greenspan-induced credit bubble in America.
It may be, in fact, the case that China’s monetary authorities are fully aware of the country’s underlying fragility and that the mooted notion of re-pegging the renminbi against a basket of currencies would provide scope, not for gradual revaluation, but devaluation. The virtue of a direct currency peg is its underlying transparency, something which is clearly lost in the event that a link is established against a basket of currencies, the composition of which is as yet indeterminate and easily manipulated. It makes little sense to move to such a basket if the real objective is the expedient of gradual revaluation of the renminbi in a highly transparent way that would curry more favour with Washington.
But if the attempt is to achieve covert devaluation in response to weakening domestic conditions, then such a move makes much more political and economic sense. If this is indeed the road China is choosing to go down, it will certainly reduce its ability to continue purchasing US assets at the rate at which it has been doing over the past few years, which has perilous implications for the dollar exchange rate. Indeed, one would envisage similarly smaller inducements to purchase US assets on the part of all of Asia, since most would almost certainly respond to a Chinese devaluation (covert or overt) by a comparable competitive currency devaluation – a great backdrop for gold perhaps, but certainly not in the interests of global economic stability.
Today, China uses the peg to recycle massive dollars back into Treasuries to the US, which enables it to continually expand its capital expenditure to overproduce goods that the world doesn't need and which the Americans can only buy on credit. It has become an increasingly important, albeit fundamentally unhealthy, dynamic in terms of engendering the current blow off witnessed in many areas, notably commodities. If the Chinese do embrace a gradual de-linkage against the dollar, then there will be a risk of at least a short-term downdraft in growth in East Asia, even as Japan and Europe will be struggling to a greater degree. Were a financial accident in the US to arrive at the same moment -- always a possibility -- then one could easily envisage a synchronised global growth stall. This is not what the doctor ordered in a world already characterised by massive manufacturing overcapacity and virtually no pricing leverage, but it may be (given China’s underlying financial fragility) the means by which the Chinese seek to devalue their way out of disaster. How China copes with its ongoing financial problems, and the corresponding global policy response, are likely to be major themes emerging in 2004. |
