The Chinese Economic Miracle? Posted by: Jon Henke
on Friday, February 03, 2006
Stratfor has a fascinating analysis of the incredible growth that China has experienced in recent years. [alt:free link] China's remarkable growth, Stratfor argues, has not been entirely real. What's more...
Western markets have been at least subconsciously aware of this for a decade. More than half of the $1.1 trillion in foreign direct investment that has flowed into China since 1995 has not been foreign at all, but money recirculated through tax havens by various local businessmen and governing officials looking to avoid taxation. Of the remainder, Western investment into China has remained startlingly constant at about $7 billion annually. Only Asian investors whose systems are often plagued (like Japan's) by similar problems of profitability or (like Indonesia's) outright collapse have been increasing their exposure in China.
The Chinese capital market, in short, has been the beneficiary of onerous tax policies, as well as a generally weak Asian investment market. Their growth, however, "does not equal health". China may have capital, but it remains in many ways a command economy, with the concomitant "inability to allocate capital efficiently".
As Stratfor describes the long-standing Chinese model...
Until very recently, China's economic system operated in this way:
State-owned banks held a monopoly on deposits in the country, allowing them to take advantage of Asians' legendary savings rate and thus ensuring a massive pool of capital. The state banks then lent to state-owned enterprises (SOEs). This served two purposes. First, it kept the money in the family and assisted Beijing in maintaining control of the broader economic and political system. Second, because loans were disbursed frequently and at subsidized rates — and banks did not insist upon strict repayment — the state was able to guarantee ongoing employment to the Chinese masses.
This last point was — and remains — of critical importance to the Chinese Politburo: they know what can happen when the proletariat rises in anger. That is, after all, how they became the Politburo in the first place.
The cost of keeping the money circulating in this way, of course, is that China's state firms are now so indebted as to make their balance sheets a joke, and the banks are swimming in bad debts — independent estimates peg the amount at around 35-50 percent of the country's GDP. Yet so long as the economic system remains closed, the process can be kept up ad infinitum: After all, what does it matter if the banks are broke if they are state-backed and shielded from competition and enjoy exclusive access to all of the country's depositors?
But in an increasingly connected world economy, can China keep this up? Not without sacrificing their position in the global economy. So, China is making an effort to reform, including some financial sector rehabilitation and increased transparency to encourage foreign investment.
Of course, from our perspective, this is a healthy development, too. After all, increased connectivity means increased co-depencence, increased leverage and decreased chance of a destabilizing Chinese foreign policy. The more diverse the vested interests, the less likely China will be to take risks.
Still, Stratfor wonders, what of the "existence of a few hundred billion dollars in dud loans — linked to tens of thousands of dud firms for which the central government is now directly responsible"? Both apparent Chinese solutions retain strong components of the command economy. They may forestall social turmoil, but they do not necessarily constitute sustainable, long-term wealth creation. At some point, the inherent contradictions and paper tigers in the Chinese system will collapse. Though, with what effect, we can't tell yet.
In the meantime — and since China's domestic financial policies are largely out of our hands — I think this is all the more reason to support even the limited entry of Google into China. As Michael Stickings at The Reaction notes, "Google's censored presence in China may yet be the thin end of a wedge that is essential to opening up China to alternatives to its brutal totalitarianism". If major changes are coming, we'll be much better off if the Chinese understand and identify with the Western world to some extent.
If Enron, Global Crossing or the Arthur Anderson accounting scandals were "economic disasters," then what should we call the opaque accounting rules, government intervention in the economy, and monopoly CCP leadership of China, Inc.?
If Clinton’s dot.com boom was a "bubble," I wonder just how much "air" is in the Chinese economy. And how far back should I stand to be safe when it pops? -Steve
Asian investment in China will of course exceed Western investment. Say you owned a factory in Taiwan that exported for many years to America...of course you see the value of moving to China and recreating your glory years of cheap labor and big volumes.
US manufacturing firms might invest in China, but those that are left from the previous migrations of factories to HK/Taiwan/Korea are in high volume consumer goods (toothpaste) or high tech and mainly looking at the local or regional market. The US importer of textiles, toys, or TV’s won’t be investing in a China factory.
Same with real estate, where Taiwanese who experienced a similar boom economy in a similar culture know what to invest in and with greater gusto.
Yep, a lot of the money is being recirculated to get better tax deals. Or even to be allowed to import product under preferential deals.
Yep, a lot of loans have been made to a staggering number of local people to open massive factories on the "if you build it, they will come" philosophy. That’s gotta hit a wall eventually.
In the meantime enjoy your "China price" products.
But without some fairly severe adjustments, this shift would swiftly suck the capital out of the Chinese banking system. After all, if you are a Chinese depositor, who would you put your money with — a foreign bank offering 2 percent interest and a passbook that means something, or a local state bank that can (probably) be counted on to give your money back (without interest)?
The banks don’t have the peoples money, they have loaned it out and the loans are not being paid off and wont be paid off. When people go to the bank to withdrawal money and the money is not there, the word spreads, you get a run on the banks and the start of a good old fashion financial panic.
No economy in the world has ever industrialized without going through multiple recessions/depressions/panics. It is not a question of if but when and how the China bubble will pop. Large numbers of newly unemployed people who have recently moved from the country to the city are going to cause a real political crisis. To avoid this, my guess is that China will recapitalize the state run banks by printing money. Not sure what that will look like. Massive inflation? Or will China sell off all those US government bonds they are holding to recapitalize the banks?
I think Lighthouse nailed it. Looking at a chart of Chinese GDP growth rates, the trend stabilizes between roughly 7% and 9% beginning in 1997. Prior to that, it had the tendency to swing wildly from 15% to 4% and back to 15%. Either the government has figured out how to manage the economy quite consistently or there’s something else going on. I’m not a big believer in conspiracy theories, but I wouldn’t put much money in the MSCI China index personally.