China is facing a host of problems including acute inequalities, regional imbalance, rampant corruption, choking pollution, bursting stock and real estate bubbles, and bankruptcies of labour-intensive exporters no longer competitive. She has just launched a ‘circular economy’ law to promote sustainable development and a new reform initiative to address rural inequalities. But these have nothing to do with the current global financial maelstrom. Leaving them aside, China has so far coped with the world’s historic financial storm pretty well.
This is, however, not very surprising. China’s finances are relatively much more isolated from external influences by tight exchange and macro-economic controls. They are also backed by the world’s largest foreign currency reserve by far, standing at over US$1.8 trillion, growing at the rate of US$1.7 billion a day.
There are, however, major dynamics that set China’s economy apart from the West. While the West’s economies are mostly consumer-debt driven, China’s is not. Household indebtedness accounts for only 14% of China's GDP, compared with 140 – 180% in the West, which is much more vulnerable to fluctuations in consumer interest rates and bank credits. With government costs and contingent liabilities skyrocketing from various banking bailouts, public debt in Western countries is also expected to mount with public finances under much greater pressure. For example, UK's public debt has now been raised to exceed 50% of GDP, while China’s public debt stands only at about 18%. In addition, infrastructural investment is steaming ahead in China's second and third-tier cities as part of the largest and fastest urbanization program in the history of mankind. This will provide a vast consumer market driven by China’s rising ‘middle class’ (McKinsey Global Institute, Preparing for China Urban Billion, March, 2008). This would also serve to re-balance China’s eschewed economy over-dependent on exports. With inflation coming down from 8.7% in February to 4.9% in August, the prognosis of China’s economy should not be too dire. By all estimates, China’s GDP, albeit slowing down, is still expected to grow at some 9% in 2008 and a little less in 2009.
The second are China’s recent efforts to join the world’s ‘capitalist club’ by encouraging her enterprises and her sovereign wealth to take equity stakes in overseas businesses. So far these have caused concerns and apprehensions on both asides. China has found that her overtures are not always welcome, as in the case of CNOOC’s earlier thwarted attempt to acquire UNOCAL, a US oil enterprise. So far, her equity stakes ranging from Blackstone, Barclays to Fortis Asset Management, have resulted in huge book losses, which are facing increasing criticisms back home. But it is much better for these funds to go abroad than to be locked inside China where they are prone to stoking domestic inflation and inefficient or illegitimate allocation. These funds are vast: sovereign wealth initially entrusted with the state investment agency China Investment Corporation alone amounts to US$200 billion. Separately, the State Administration for Foreign Exchange, responsible for managing China’s gigantic foreign currency reserve, has even much deeper pockets. They are as eager to find more profitable investment opportunities abroad as China’s home-grown enterprises are in ‘going–out’ in search of global markets and expertise. They should be proactively engaged in the West to create a win-win situation for both sides.
Third, and perhaps even more importantly, is China’s investment of some US$600 billion of her vast foreign currency reserve in US treasuries. This, along with a similar investment by Japan and the rest by oil-exporting countries in the Middle East, accounts for the total of 1.803 trillion worth of foreign-owned US treasuries, according to a Congressional Research Service Report of 12 March 2008. While the world’s financial tempest is raging, these investments are now even more crucial than before in maintaining international confidence in the US Dollar as the Fed’s balance sheet is being stretched by those mother-of-all banking bailouts.
The current financial maelstrom is the outcome of a colossal systemic failure. The symbiotic dependence of a consumer-debt-hungry US and reserve-accumulating countries willing to invest in low-yielding US treasuries has been taken advantage of in building a global financial market with over-leveraged cheap credit resting on a house of cards. Mixed with recessionary trends, the problem has become more difficult to unravel. Therefore, in addition to restoring confidence in the banking sector, concerted international action is now urgently required to develop an effective package of fundamental solutions:
(a) a better code of conduct for banks and financial institutions, including how best to regulate mortgage-backed securitization, leveraged derivatives, short-selling, mark-to-market practices in a free-falling market, consumer indebtedness ('responsible consumerism') and the role of rating agencies;
(b) a more stable global financial architecture with better coordination to minimize exchange rate volatility;
(c) global mechanisms to reduce the international mismatch between lack of liquidity and excess liquidity - by channeling the excess savings locked up in sovereign wealth funds to productive channels, subject to sensible safeguards;
(d) a better role of the state in market capitalism, not least as many emerging markets, China included, are encouraged to avoid state intervention;
(e) a mutually-beneficial role for the CRIMB countries (China, Russia, India, Middle East and Brazil) in helping to nurse the global economy back to health.
In all these tasks, as the fourth largest economy and amongst the world’s fastest growing emerging markets, China clearly has a significant role to play as a major stake-holder, together with the other CRIMB counterparts. Confiding discussions and solutions to the G7 may be a matter of priority in restoring international confidence in inter-bank lending. But wider cooperation including China will be required if the global financial system and the world economy are to be put on a much firmer footing for the years to come.
www.andrewleunginternationalconsultants.com
