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 Arthur Kroeber

One baleful consequence of the global financial crisis has been a swarm of ill-informed commentary about the decline of the US and the dollar, and the rise of China and the renminbi. Such hyperbolic claims about a tectonic shift in global power relations are bunkum.

Since last November, the People’s Bank of China has initiated more than $100bn in renminbi swap lines with various other central banks, mainly in the developing world. There also has been lots of noise about increasing the use of renminbi in regional trade transactions.

These developments have led many to speculate that China aims to make the renminbi a major global currency, and that it is just a matter of time before the currency of the world’s largest creditor supplants that of the world’s biggest debtor as the major global reserve asset.

On the potential for the renminbi itself as a reserve currency, commentators frequently confuse three distinct concepts: currency internationalisation, reserve currency, and dominant global reserve currency.

By Tom Miller

They may not be as sexy as their Martini-sipping namesake, but bonds are important. A properly functioning bond market helps allocate capital efficiently and allows central bankers to set appropriate interest rates.

But the stunted Chinese bond market has long been a weak link in China’s bank-dominated financial system.

Two years ago, when Beijing ditched a quota system that limited annual corporate bond issuances to Rmb100bn and required that all bonds be underwritten by state-owned banks, hopes were high that the corporate bond market would spark into life. The new regulations were expected to give a new funding avenue to listed companies with weaker links to the state, and provide all listed companies with access to cheaper credit.

After a good start, however, corporate bond issuances, or gongsi zhai, fizzled this year: issuance in the first four months was a round, fat zero.

But there are signs that the bond market is picking up elsewhere – namely under the guise of medium-term notes, or zhongqi piaoju. Mid-term note issuance reached Rmb280bn in January to April, 60 per cent more than total issuance in 2008.

At Galanz’s main factory in Shunde, an industrial town an hour’s drive south of Guangzhou, hundreds of blue-shirted young men bend over 200m-long trestle tables, drilling screws into a line of shiny new microwaves.

Galanz, a household name in China but still unknown in much of the world, makes one of every two microwaves found in households across the globe.

This scene, repeated in thousands of factories lining the Pearl River Delta in Guangdong province, is an example of what the “factory of the world” does best: marshalling millions of migrant workers to produce cheap consumer products in dizzying quantities. Galanz’s 47,000 workers have the capacity to produce 28m microwaves per year.

But if countless media reports are to be believed, Galanz – along with thousands of other export processors in the PRD – should be in its death throes. With export markets collapsing across the developed world, thousands of manufacturers are teetering on the verge of collapse.

And with government statistics indicating that more than 60,000 factories shut their gates last year alone, armies of unemployed migrants are preparing to rampage across southern China, leaving destruction in their wake.

Dragonbeat is off on a tour of the Pearl River Delta this week, but will return with some thoughts next Monday.

When the Communist Party announced last October that it was reforming rural property rights, it was initially greeted as a radical move that would finally set Chinese farmers free from the shackles of the state.

The Party communiqué was actually far less revolutionary than the headlines suggested – largely ratifying existing practices and assuring farmers that their land rights would be solidified. Most importantly, Beijing remained opposed to granting individual farmers the right to mortgage their land.

But a new pilot project in the northeast province of Liaoning, where 151 rural households have been allowed to use their land-use rights as collateral for mortgages, shows that change may be afoot. By giving farmers practical access to credit for the first time, the pilot project has the potential to turn rural households into economically significant players.

Liaoning’s Faku county is the first to be selected as part of an experiment launched by the People’s Bank of China to allow a handful of rural counties in nine provinces to pilot new financial products. Whether this experiment is extended to other counties will indicate whether a breakthrough in rural financing is likely.

Extending the project nationwide would boost agricultural productivity and increase rural household incomes. Beijing wants to expand credit to help farmers weather the economic downturn in the short term and to boost rural consumption in the long term.

Under current law, farmers are allowed to transfer their individual land-use rights but cannot use them as collateral for mortgages. This massively restricts farmers’ ability to invest and consume.

The legal regime for rural land developed over the past three decades. After decollectivisation in the early 1980s, farmers received 15-year individual cultivation rights for a set amount of agricultural land. These were subsequently extended to 30 years in the 1990s.

Since then, various laws have gradually turned these informal use-rights into much more formal and secure property rights. Together, these laws supposedly grant individual farmers an indivisible, perpetual property right to their land – including the ability to lease out or transfer their use-rights.

However, Beijing views land reform as a trade-off between economic development and social stability: privatising land would create huge assets and increase agricultural productivity and rural incomes, but it would also risk separating farmers from their ultimate source of financial security – their land.

Although the broad trajectory of land reform supports more flexible rural land-use rights, Beijing has opposed granting individual farmers the right to mortgage their land for social and, therefore, political reasons.

Partly, the government fears a return to the dark old days of pre-Communist China when, according to Party propaganda, peasants were rent slaves bound to unscrupulous and rapacious lenders. But today’s prohibition on mortgaging farmland, which prevents farmers from improving their circumstances through better access to capital and credit, amounts to an alternative form of economic servitude.

If Liaoning’s pilot project were extended nationwide, it would boost agricultural productivity and increase rural household incomes – a vital step towards shifting the economy to a more sustainable, consumption-based model.

Fears that landless farmers potentially pose a risk to social stability could scupper any genuine reform – but any loosening of the shackles that tie farmers to the land is a positive development. Watch this space.

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 autumn’s sudden collapse in commodity prices left a lot of China bulls with egg on their faces. Didn’t China’s insatiable demand for stuff, driven by a long-term process of urbanisation and rising incomes, guarantee the good times would roll for another two or three decades?

For the past seven years, commodity prices were essentially considered a simple function of Chinese demand. As the world’s top consumer of aluminium, copper, lead, nickel, tin, iron ore, steel, coal, wheat, rice, palm oil, cotton and rubber, China was thanked (and blamed) for heralding a new era of inflated raw material prices. After the commodities crash, this theory appears in tatters.

Indeed, over the next two or three years China is likely to play only a small role in setting global commodity prices: even if Chinese demand recovers, markets will be overwhelmed by shrivelling demand everywhere else.

But after the rest of the world stabilises and excess production capacity is absorbed – somewhere between 2010 and 2013 – China will again emerge as the key driver of global demand. Assuming that Beijing maintains economic and social stability – and there is no evidence to suggest that it will not – the pace and scale of industrial and urban development in China should drag up commodity prices. China’s enormous size renders its urban growth even more significant for global markets than was Japan’s in the 1960s and 1970s.

The pace of urbanisation in China, largely driven by rural migrants fleeing the penury of the fields for a better life in the city, is unprecedented. In 1980 a paltry 20 per cent of Chinese citizens lived in urban areas, a figure associated with the poorest countries on earth. By 2030, when more than 1bn Chinese citizens will live in towns and cities, that figure will reach 70 per cent – a higher proportion than in Japan or Italy today.

A recent study by the McKinsey Global Institute forecasts that 100 new cities with populations of 500,000 to 1.5m will mushroom across the country over the next 15 years; these will be joined by a further 60 new mid-sized cities with populations of 1.5m to 5m. By 2025, current trends suggest that six new cities – Tianjin, Guangzhou, Shenzhen, Wuhan, Chongqing and Chengdu – will join Beijing and Shanghai with real urban populations exceeding 10m.

As China’s growth and urbanisation continues for another couple of decades, Chinese demand for commodities will rise substantially – especially hard commodities used for building houses and roads. China has only just reached the most commodity-intensive stage of urbanisation, with metal intensity four times higher than in developed countries and twice as high as in other developing countries, according to the World Bank.

The uptick in metal intensity, which began in the mid-1990s and accelerated at the beginning of the 2000s, correlated with an increase in the urbanisation rate from 30 to 40 per cent. In 2007, more than 50 per cent of Chinese steel and 44 per cent of copper demand was gobbled up by the construction and infrastructure industries. Metal intensity growth is projected to peak along with the population growth rate around 2015, but remain high through 2030.

Global commodity markets have tanked and Chinese demand has stuttered. But the hungry dragon is not yet sated – he’s just pausing between courses.

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.”

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