China: Watch this Space!

(A short note written for and published by the Asymmetric Threats Contingency Alliance (ATCA) dated 1 March, 2007. Also published on the restricted ATCA distinguished list and added to "Open
ATCA" at the "IntentBlog" based in Los Angeles, California, as well as Mumbai, India)

This seems to be another instance when China sneezes and the rest of the world catches a cold. Mainland China shares registered a drop of some 9% on Tuesday 27th, the sharpest one-day fall in a decade, and the world's leading stock markets all ran for cover.

I was asked why at CNBC Europe's Power Lunch TV interview this morning. After all, the size of China's stock market is not that large.  I said it was a combination of salient factors. First, the China Mainland market (the 'A-shares') was already showing an alarming sign of being in a bubble.  It has risen by 130% in a single year. Ordinary citizens are known to raise mortgage loans to bet on shares. In China, where stability is paramount, there is increasing speculation that the leadership will be cracking the whip to rein in some of these excesses at next week's National People's Congress in Beijing. When nervousness mounts, the mood is that the devil will take the hindmost.

Second, along with Alan Greenspan's warnings about the US economy, the International Institute of Management (IIM) was re-ringing the alarm bells about the US's accumulated huge national and consumer debt as well as her weakening global competitiveness, even in some service sectors (Policy White Paper -- US Economy Risks and Strategies 2007-2017). More people are beginning to wonder if the emperor has still got enough clothes on.

Third, it is not the size of China's stock market but the fact that China has become so intertwined with the global economy, from financing US deficit spending, suppressing world inflation and interest rates, providing off-shored manufacturing, influencing commodity prices, to diverting international trade and investment flows. All these are magnified by financial concentration and imaginative leverage amply explained by our distinguished ATCA colleague Dr Malmgren.

I also said that China's fundamentals remain generally robust. Indeed, the same IIM Report seems to ask where investors would rather put their money -- in an economy that continues to spend alarmingly more than it produces or in one the other way around. That, of course, is a gross over-simplification. Notwithstanding her dazzling achievements, China is very much caught in her own success. Huge challenges are looming in energy constraints, environmental degradation, unbalanced regional development, declining export profitability, inadequate social and healthcare provision, and struggles to invent her own products and build a better brand as a nation.

But China is a land of paradox and opposites, as long exemplified in her ancient philosophy.  She is decentralized as much as she is centralized.  All of the above challenges have been crystallized and flagged up in her remarkable 11th Five Year Plan (2006-10) including Sustainable Development, Balanced Development, Innovation, and Governance (if not 'Government') for (if not 'by' ) the People. Party Secretaries have long had to showcase their ability to deliver the goods if they want to further their political careers. NGOs and indeed Christianity are becoming increasingly noticeable. The road ahead is still long and tortuous, but decades of consistent, double-digit growth in a country with the population the size of a fifth of mankind is not likely to come about with a wobbly foundation.

As I mentioned in my recent think-piece (China and the Middle East: an Eastern Alchemy for Global Harmony, ATCA, 17 February, 2007), China has recently approved the creation of a State Foreign Exchange Investment Corporation to diversify the investment of her foreign currency reserve (initially 'just' its annual increment of USD 210 billion). More than catching a cold, the world has to watch this space.

Andrew K.P.Leung, SBS, FRSA

www.andrewleunginternationalconsultants.com