Economy

By Arthur Kroeber

Is China’s credit binge a financial time-bomb waiting to blow the country’s much-vaunted economic miracle to smithereens?

Beijing has long bet that the problem of bad loans can be solved by pushing off the day of reckoning into the future, with rapid economic growth reducing the size of the problem.

So far that calculated bet has proved a sound one.

But the unprecedented expansion in bank credit this year, coupled with last month’s decision to roll over for another decade the bonds used to finance the first non-performing loan (NPL) workout of 1999, make it a good time to submit this policy to a stress-test.

By Arthur Kroeber

“China’s spirit”, opined the People’s Daily in a recent editorial, is a “Great Wall” built to ward off global crisis.

In purple prose heralding China’s recent heroic successes, the editorial extols the Communist Party for leading China back from the global economic abyss after the country recorded 7.9 per cent growth in the second quarter of this year.

“This situation in China is in sharp contrast with Western developed nations, where the economic growth has kept sliding,” it concludes.

The nauseating tone of the editorial reminds us of a famous quotation by the Roman historian Livy, explaining why the Carthaginian commander Hannibal failed to destroy the Roman Empire.

“Capua was Hannibal’s Cannae,” Livy wrote. It is a judgment that China’s leadership (and smug editorial writers) would do well to heed today.

By Tom Miller

And lo, did Beijing wave its magic wand, and there was much rejoicing!

China’s economy grew 7.9 per cent faster in the second quarter of this year than it did during the same period last year. That means GDP expanded by 7.1 per cent in the first half and is now set to hit the government’s magic 8 per cent target for the year.

Beijing’s massive fiscal and monetary stimulus appears a roaring success. The combination of central government deficit spending and a tsunami of bank loans mean that the total amount of extra cash pumped into the economy above a business-as-usual scenario could be in the order of US$1,000bn this year alone.

But paying for stimulus projects is putting strain on local finances. Only around 30 per cent of the stimulus cash will come from central coffers, with the rest provided by local governments and companies, largely paid for by bank loans and bond issuances.

By Tom Miller

Beijing and Shanghai are currently the only two Chinese cities that have unquestionable “megacity” status, with populations well in excess of 10m.

But over the next 15 years, 60 new cities with populations of 1.5m-5m are likely to sprout in China, including six new cities – Tianjin, Guangzhou, Shenzhen, Chongqing, Chengdu and Wuhan – with real urban populations exceeding 10m.

Managing this vast migration in a sustainable manner will require more than steel and cement: creating patterns of urban growth that use resources efficiently and avoid irreversible urban sprawl will determine whether the country’s cities become livable economic centres or urban dystopias fugged up with exhaust fumes.

Most important, creating a viable social welfare system may determine whether these mega-cities are paved with gold or strewn with beggars.

By Arthur Kroeber

We had the somewhat qualified pleasure last week of attending the spring meeting of the International Institute of Finance — the assemblage of the great and the good of the world banking industry— which this year was held in Beijing.

Although as usual for such events there was a certain amount of high-level pabulum, two clear messages emerged from the cogent presentations by Chinese speakers.

By Arthur Kroeber

US Treasury secretary Timothy Geithner’s visit to Beijing this week is sure to reinvigorate debate about a new world order run by a “G2” condominium of the US and China.

Speaking at Peking University on Monday, Mr Geithner emphasised the importance of bilateral relations. “China and the United States individually, and together, are so important in the global economy and financial system that what we do has a direct impact on the stability and strength of the international economic system,” he said.
 
Now, it is perfectly accurate to note that the US and China have a uniquely symbiotic relationship, that they will soon be the two largest national economies, and that many important global problems such as climate change cannot be solved without the active participation of both.
 
Yet none of these facts, singly or collectively, implies that a Sino-American condominium is either a viable or a desirable outcome. Both logic and evidence, in fact, suggest the opposite.

By Tom Miller and Arthur Kroeber

A couple of months ago, a number of excitable reports predicted that mass lay-offs in China’s export heartlands could spell social chaos. Twenty million angry migrant workers had lost their jobs and revolt was in the air, we were told.

So just how bad is the labour situation? Not nearly as bad as many people feared.

According to a recent survey of 68,000 migrant households in 31 provinces by the National Bureau of Statistics, 23m of 140m migrant workers failed to find jobs after this year’s lunar New Year in January. While 11m returned to the cities to look for work after the holiday, 12m stayed at home.

Since then, reports from individual provinces suggest that many of those workers have also returned to the factories and building sites.

In Guangdong province – a major export region that is home to around 20m migrant workers – the local government estimates that of the 10m migrant workers who went home for the lunar New Year, 9.5m have returned to the province. Of these, about 5 per cent (or 460,000 people) had not found jobs. As the FT’s South China correspondent Tom Mitchell pointed out, in the context of a province with a total population of 110m, half a million migrants is a sizeable but manageable army of unemployed.

Evidence from Henan province, one of the biggest sources of migrant labour in the country, confirms this trend. Many more migrants stayed at home after the New Year than in past years, but most have since returned to work or found local employment.

According to one survey of migrants in Xinyang, a prefecture-level city in southern Henan, 500,000 of the 650,000 migrants who returned home for the holiday had left again by mid-February. Of the 150,000 who remained, 50,000 found local work, leaving 100,000 – or 4 per cent of the total 2.7m area migrants – temporarily unemployed.

Aside from some localised protests directed at a handful of individual factories, laid-off workers have been far busier finding new jobs than venting their rage. This is unsurprising: migrants working in export factories and construction sites are accustomed to finding work where they can get it and many have been laid off before. Chinese migrant labourers are among the most flexible in the world.

Past experience also suggests that temporary economic hardship may provoke isolated protests but is unlikely to cause widespread social or political tensions. Between 1995 and 2005, China’s state enterprises shed 50m jobs. The laid-off workers lost what they had believed were jobs for life, which also provided them with food, education, health care and pensions. They had no skills and were effectively unemployable elsewhere.

Inevitably there were riots, particularly in the hard-hit northeast – but these were aimed at specific factories rather than the government or political system in general. And there was no serious, long-term damage done to China’s social fabric.

This is not to make light of the current situation: millions of vulnerable migrants have lost their jobs and times are tough. But the resilience of China’s workers should not be underestimated, and fears of social unrest caused by unemployed migrants have been greatly exaggerated.

By Tom Miller and Will Freeman

“Rebalancing the global economy” is the mantra of the day – and China, we are told, must play its part. That means shifting China’s economy away from an unhealthy reliance on exporting goods to foreign consumers and instead boosting consumption at home.

Last week, we argued that China’s fast pace of urbanisation, which is projected to see the urban population rise from 600m today to more than 1bn by 2030, would keep demand for commodities high. It seems a small leap of logic to conclude that growing urbanisation – and the accompanying rise of an “urban middle class” – will have a similar impact on consumer goods.

Last week we wrote that China was unlikely to make a substantial contribution to discussions about reorganising global economic governance.

Hours after our post went up, it was neatly contradicted by Zhou Xiaochuan, governor of the People’s Bank of China (PBoC), who published an essay on the bank’s website suggesting the creation of a new supra-national reserve currency to replace the US dollar. This was followed later in the week by another essay on how to secure global financial stability, and an article by a PBoC research institute on how to improve global economic regulation.

This was a salutary reminder that the Chinese government (or at least some members of it) can be a bit more agile than foreigners typically believe. It also sent a signal that China, unlike Japan, will not be satisfied with the status of a second-rate power. Japan in the 1980s expended enormous energy in fighting bilateral battles with the US but did little to make itself relevant to global economic decision-making. China has a long-term vision of its rightful place in the world and will work on a variety of fronts to secure that place.

That said, the PBoC papers are interesting more for their political than for their economic content. Their immediate aim was to establish a stance ahead of this week’s G20 meeting in London. The essence of that position is:

  • the root cause of this and previous financial crises was the special position of the dollar as the world’s reserve currency (and not, therefore, the “Asian savings glut”)
  • the self-regulation model for financial supervision touted by the US has been proved bankrupt 
  • global financial regulation (eg the Basel II accords on bank capital) needs to be made less pro-cyclical.

The second and third points fall well within the realm of conventional wisdom these days. But discussing them enabled Chinese officials to exact a little payback for all the sanctimonious hectoring they have had to endure from arrogant US officials over the years about the superiority of the American financial system.

Invoking a supposed principle of “oriental philosophy” that self-criticism is essential to self-improvement, the PBoC research department paper called on the US to exhibit remorse for its errors, stop blaming other countries for its problems, and reject the “prevalent complacency” that allowed its financial excesses to overwhelm the world. Such sermonising, though excusable, adds little to the sum of world knowledge.

Mr Zhou’s global reserve currency idea is more interesting. This is not because the proposal is likely to lead anywhere. There is almost no chance of that – as we suspect Mr Zhou knows.

But as a political statement it is ingenious. By arguing that the IMF should become the issuer of a new global reserve currency, Mr Zhou cleverly positions China as a champion of strengthening a rules-based multilateral system of global economic governance, rather than as a bare-knuckled aspirant hankering to knock off the current kingpin bully. Many have feared that China’s rise must be de-stabilising and that China will have no stake in “playing by the rules.” By identifying – accurately – the moral hazard and instability risk inherent when a single national currency serves the global reserve function, Mr Zhou articulates China’s national interest in promoting and participating in a rules-based, multilateral system.

This argument is directed at a domestic as well as an international audience. Some in the Chinese government fantasise that China’s big surpluses give it power, and that the renminbi can swiftly replace the dollar. Mr Zhou knows better, and is trying to steer the domestic debate in a more useful direction.

The second political purpose of Mr Zhou’s paper was presumably to suggest some conditions for China’s participation in the expansion of the IMF’s capital, which is a keenly-desired outcome of the G20 process. The rich countries want China to stump up US$100bn-US$200bn, largely to enable the IMF to bail out the bankrupt economies of eastern Europe. China rightly questions what benefit it would derive from paying such tribute. An expansion of its voting rights in the IMF is a paltry prize, both because it would take at least a decade under current rules to give China a voting share commensurate with its economy’s size, and because the IMF is marginal to global economic decision-making. By proposing a vastly stronger role for the IMF, Mr Zhou indicates that China deserves and seeks real influence, not meaningless trappings.
 
The global currency idea itself, however, is impracticable. Mr Zhou proposes that the IMF’s special drawing rights (SDRs) be converted into a global reserve currency, supported by large-scale issuance of SDR-denominated bonds. One obvious question is who would decide on the volume of SDR issuance – ie the size of the global money supply? The IMF is not set up as a central bank. The Bank for International Settlements is another possibility; but any multilateral institution would suffer from a diversity of masters with different political agendas and thus would find it difficult to shift monetary conditions decisively in times of crisis, which is an indispensable attribute of a central bank.

This points to deeper objections: reserve currencies are a reflection of political as well as economic power, and they are determined not by negotiation but by market activity. They are subject to “network effects” similar to those that apply for computer operating systems – the more people gravitate to a standard, the more incentive other people have to follow. Once a standard is established it is exceedingly difficult to dislodge.

Despite the current crisis, America’s political hegemony is secure and its ability to guarantee the long-term value of its debt securities is still superior to that of any imaginable political collective overseeing a global currency. The dollar’s position as the main reserve currency is still secure. But China has served notice that the US will need to work a bit harder to justify its “exorbitant privilege.”

Welcome to the Dragonbeat blog. Today, everyone with a serious interest in global issues needs to know about China. This blog expands the analysis of the Chinese economy previously found in the fortnightly column written by the China Economic Quarterly (CEQ) for FT.com. Dragonbeat’s principal writers are Arthur Kroeber, managing director of Dragonomics Research & Advisory, the parent company of CEQ, and CEQ managing editor Tom Miller. By moving to a blog format where you can expect a weekly post from us every Monday, we hope to provide a space where readers everywhere can share their views on China’s economy and its impact on the world. Our first blog post, written by Arthur Kroeber, is below:

The global financial crisis poses two challenges for China: one of domestic economic management and another of international economic diplomacy. How it addresses these two challenges will in large measure determine whether China takes up what it considers to be its rightful place as one of the world’s leaders, or subsides instead into a Japan-like irrelevance despite the size of its economy.

The domestic challenge is straightforward: China must find a new engine of productivity and employment growth to replace a long-running export engine that is likely to be out of commission for several years.

Dragonbeat is no longer updated but it remains open as an archive.

Readers of the Dragonbeat blog can now go to www.ft.com/dragonbeat to read the new Dragonbeat weekly column for insightful commentary and analysis on China.

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