On March 16, 1979, Columbia Pictures released The China Syndrome featuring Jane Fonda, Jack Lemmon and Michael Douglas. In the film's fictional disaster scenario, a US nuclear-power-plant accident creates a mass of molten reactor fuel so hot that it threatens to burn through the reactor's steel vessel and the plant's reinforced-concrete foundation, descend into the Earth and exit the opposite side of the planet in China (a phenomenon dubbed the China syndrome, hence the film's title). Twelve days after the film's premiere, the Three Mile Island nuclear-power-plant accident shook the United States. Nothing melted through.
But could the much-feared meltdown of the overheated Chinese economy now burn through to the US (or, for that matter, Japan and the European Union) and wreak global economic havoc? I doubt it. But there are plenty of danger signals, and it pays to review the numbers and assess the potential damage.
The danger signals are real enough. On April 28, Chinese Premier Wen Jiabao told Reuters, "Fixed asset investment is accelerating too quickly and at too large a scale ... Money supply and credit have been growing too fast. Inflationary pressure is mounting ... We need to take effective and very forceful measures to resolve those problems as soon as possible."
On Thursday, April 29, non-Japan Asian stock markets tanked on the Wen statements. Asian currencies declined sharply against the US dollar. On Friday, Japan's Nikkei 225 stock average (the Tokyo market had been closed on Thursday for a national holiday) precipitously declined by more than 2 percent. Global commodity markets in metals, thriving on China demand for the past 18 months, got hammered. US markets were spared to some extent, as the US is a large net importer from China and not as dependent on Chinese demand. But the US bond market, supported by sizable Chinese purchases of US treasury notes with dollars bought in the foreign-exchange market to maintain the Chinese currency's dollar peg at about 8.28 yuan to the dollar, certainly felt the impact of Wen's remarks. Bond traders believe that a weaker Chinese economy will take the upward pressure off the yuan and lead to a reduction in interventions and foreign-bond purchases by the People's Bank of China, the central bank.
Initial market reactions to Wen's policy pronouncements may well have been overdone, but they were by no means just panicky or irrational. Japanese export growth last year, which was the principal driving force behind economic recovery, was to a large extent fueled by China's demand. Exports to China grew about 40 percent while they declined by some 7 percent to the US. Overall, two-thirds of Japanese export growth was due to growth of the China market. What's particularly worrying to Japanese policymakers is that a large portion of exports to China flowed precisely into the most overheated sectors of the economy - steel, autos and construction - which are targeted for government-decreed slowdown.
Big impact on Japan, Korea
And not only Japan will be affected. South Korean exports will suffer as well. The impact on Taiwan and Southeast Asia will be more limited as exports from there are mostly semiconductors and consumer electronics, Chinese demand for which will likely continue to grow.
The benign scenario is this: The Beijing government and the People's Bank of China will take a carefully calibrated approach to overheating, make sectoral and regional distinctions, and slow fixed investment in and credit extension to, for example, the steel and auto sectors and construction in coastal areas, while increasing investment in the bottleneck oil, gas and power sectors.
If successful, this approach should slow overall investment, which grew 53 percent year-on-year in January-February as the result of 170 percent and 140 percent increases in steel and autos, respectively. But it would not seriously slow general economic growth, since higher infrastructure investment would partially compensate for losses elsewhere and consumer demand would remain largely unaffected. Gross domestic product (GDP) growth would decrease marginally from 9.1 percent last year to around 8 percent in 2004. Inflation would remain contained in the 3-5 percent range, as some supply-side shortages are removed while ample cheap labor keeps costs down. (In this context it is worth noting that the hyperinflation of the early 1990s was ignited and fed by consumer demand, while recent inflationary pressures are mainly supply- and production-cost-related.)
Chances for successful implementation of the benign scenario are in my opinion above 50 percent. Moreover, if the sectoral-regional cooling approach should prove too slow in taking hold, the government and central bank have the option of raising interest rates and/or revaluing the yuan to a certain extent (perhaps 3-5 percent) to put an across-the-board chill on economic activity. The government wants to avoid general monetary-policy tightening as that would indiscriminately affect all sectors and regions and, in fact, hurt the weaker the most. But it may ultimately have no choice - and therein lies the danger of a hard-landing scenario with global consequences, as China, which last year accounted for just 4 percent of world GDP, nonetheless produced 16 percent of global growth.
Beijing is prepared to take tough administrative measures to enforce slowdown of investment in designated sectors and regions. Recently, 10 steel-company executives were arrested when they were found to have gone ahead with an unauthorized US$1.3 billion new steel project. But the concern, of course, is that for any one group of "over-investors" caught, there could be 10 not taken to task - either because their activities remain undetected by the central government or they enjoy enough political protection to get away with it. Every local government now wants its own steel or auto plant in order to become "gloriously rich" in pursuit of Deng Xiaoping's famous dictum; local banks assist them in their pursuit. Front-loading has become rampant as tighter money is expected down the road.
It's looking like a runaway train
Even with the central government's best of intentions and well-laid plans, it will be difficult to slow, let alone stop, what is looking ever more like a runaway train. Money-supply growth stoked by relentless bank lending, foreign direct investment and currency-market intervention funds is back above 20 percent on-year after slowing a bit to 18 percent late last year and in January-February. Inflation, while still benign at about 3.5 percent, could reach 5 percent in the near term. As outstanding loans by the big four state banks exceed 160 percent of GDP, new bad loans are inevitably being created at a high rate, even as the non-performing-loan ratio is stable or declining on new lending.
In light of this, interest rates may have to go up substantially and a yuan revaluation to about the Hong Kong dollar rate to the US dollar of 7.8 may be required, hitting banks' profits at precisely the time when they are restructuring and fighting for their very survival. The hard-landing scenario starts with a local bank run to which the government reacts too late, with a general financial system meltdown as the consequence.
That's the horror scenario, the 1997 Asian financial crisis repeat, the China-syndrome outcome. As indicated above, I don't foresee its realization - though, with some 40 percent of all bank loans in the non-performing category by international standards, there is no denying its possibility. The more likely outcome is the Three Mile Island one: some rough sailing, some scary moments, but no breach of the containment vessel. But even so, Japan, South Korea, and to some extent the rest of Asia will not get away unscathed as China slows down.
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