Two friends sent me the Stratfor Geopolitical Intelligence Report on China’s Crunch time. One sought my opinion on it. Up and until the last portion of the piece, ‘China’s limited options’ I felt that I had very little reason to disagree. After that, the quality of analysis deteriorates. Assertions without substantiation are made. Incidentally, my Swiss and Italian friends countered their piece on Germany, published in February, in a well-informed manner.
America in the 1980s is different from America in 2010. It has far little leverage with China than it had with Japan in the 1980s. America can shut its market but he fails to mention that, for practical purposes, its recession and consumer debt deleveraging has already shut it.
China would be ill-advised to sell the Treasuries it holds because of the reactions it would elicit from the US and the storms that would be unleashed in global financial markets. That said, the dismissal of the possible harm that it would do to the US economy via a jump in the interest rate is against both logic and empirical evidence. In fact, it would be more devastating to the US economy.
The ‘icing on the cake’ is the last sentence: as to what would smash China first – US adoption of mercantilism or internal imbalances. Suddenly, it is taken as GIVEN that one of the two has to smash China. The possibility that China could grow its way out of trouble – at least for now – is totally dismissed without offering any proof as to why all that remains for China is to choose the method of being smashed to pulp!
Personally, I have been waiting for a crash in China due to the massive command capitalism system that they run. Timing that crash has proven to be impossible both because of the impossibility of predicting when their growth machine would stop running and due to lack of appreciation of what growth can do – it can wash away a lot of sins, for a long time.
Ask India about Unit Trust of India (UTI) and Resurgent India Bonds (RIB). The stock market rally bailed out the Indian government’s bailout of UTI and the Indian government’s Resurgent India bonds of 1998). Can China’s growth machine keep humming? For now, the short answer is yes and the long answer is yes, yes. Their internal infrastructure development is so poor that there is still a lot of catch-up growth that is waiting to be unleashed. It has enough and monopoly access to domestic savings to make those investments.
If India is counting on a 36% savings rate and an ICOR of 4 to talk of a 9% growth rate, I fail to see why that does not apply to China even if the ICOR there is 5. 40% savings rate would then translate into a real GDP growth rate of 8% there.
An Indian economist friend living in Boston stopped by at my office yesterday and said that the railway lines that have now been laid in China linking the interior parts to the coastal provinces and cities are going to reduce the logistic and transportation costs so much that the world might be overestimating the damage that a strong renminbi would pose to China.
China has couple of immediate issues to worry about. The property bubble in key cities and the problem of bank loans to the local government sponsored entities. Both are big but manageable problems, for now. China’s banks are going to require a good deal of recapitalisation in 2010-2011. I very much doubt that China would be able to pull another 2009 off in 2014 or 2015. Growth might begin to weaken with the working age population peaking around then. Second, most of the internal infrastructure development might be largely over by then. That is why liberalisation of financial market prices is the crucial test of China’s sustainability beyond 2015.
If they fail this test (i.e., if the technocrats lose out to mercantilist instincts of other bureaucrats and politicians and no worthwhile liberalisation of exchange rates and interest rates happens now), then one could start believing in China’s internal imbalances causing a collapse of the economic edifice. The other risk is the social construct. If the government retains its monopoly access to savings, if investment opportunities for savers remain thus restricted and/or are unaffordable and if wage growth is restrained, then the social discontent could boil over.
Hence, for this purpose, two things are required: One is the aforementioned financial liberalisation and two, is the improvement in worker compensation and higher government outlays on education and health.
The bigger risk than these two risks for China is the risk of paranoia. The relatively stiffer sentence on the Rio Tinto executives in China and the fallout with Google exemplify that risk and that finds no mention. A senior Asia executive from another internet company in the US – that shall remain unnamed here – also expressed deep frustration with the firewalls in China.
A regime that is paranoid and is filled with hubris is prone to making dangerous miscalculations and setting off a chain of events that it might not be able to control. I think that the Rest of the World (RoW) should be thinking of ways to deal with an assertive, aggressive and even arrogant China, arising out of its economic success rather than betting on an implosion in China to do its job for them. Arvind Subramanian has made some constructive suggestions, for instance, on the question of China’s exchange rate policy.
Further, there is no reason for comfort for the RoW (for instance, many emerging economies would find themselves in deep water if China implodes) in a China implosion scenario. That would set off beggar-thy-neighbour reactions globally. At the same time, there is no room for smugness either in the developed world for an imploding China would also be an angry and vengeful China.