Sunday, August 30, 2015

China, economic growth, and the future - 4 articles

[Four articles on China. Firstly, is China strong and promising, or a house build on sand?

Secondly, Why the China problem is so complex.

Thirdly, Chian's debt is 282% of GDP. This is large. This is a problem. Or it should be a problem. Or is a problem just waiting to show itself. It's only a matter of time. Because all financial crises start with the same problem: too much debt. BUT, China has huge reserves and this gives them the resources to deal with a crisis and to ameliorate any effects. So they could still "pull it off".

Fourthly, China is not going to collapse. Huge growth is over, but there will still be growth.]

The New “Two Chinas” Question

NEW YORK – To anyone over the age of 60 who follows world affairs, the term “two Chinas” recalls the post-1949 competition for diplomatic recognition waged by mainland (“Red”) China and Taiwan, or, more formally, the People’s Republic of China and the Republic of China. By the early 1970s, just about every country fell in line with the People’s Republic’s demand that it alone be recognized as the legitimate sovereign government of China. The mainland was simply too large and too important economically and strategically to alienate.

Today, a new, but very different, “two Chinas” question is emerging. It centers on whether China is best understood as a strong country, with a promising future despite some short-term difficulties, or as a country facing serious structural problems and uncertain long-term prospects. In short, two very different Chinas can now be glimpsed. But which one will prevail?

Until recently, there was little reason to ask such a question. China’s economy was growing at an astounding average annual rate of 10% or higher for more than three decades. China had overtaken Japan as the world’s second largest economy. Hundreds of millions of Chinese had entered the middle class. China’s model of authoritarian efficiency seemed attractive to many other developing countries, particularly in the wake of the 2008 global financial crisis, which began in the United States and thus seemed to discredit American-style liberal capitalism.

But the question of China’s future has become unavoidable. Officially, economic growth has slowed to near 7%; but many believe the real number is below 5%. The slowdown should come as no surprise; all developing economies experience something similar as they grow and mature. Nonetheless, the speed and degree of change have caught the authorities off guard, and have stoked official fears that growth will fall short of the rate needed for the country to modernize as planned.

The government’s alarm at the sharper-than-expected economic slowdown was reflected in its heavy-handed intervention in July to freeze stock markets in the midst of a dramatic price correction. That move was followed this month by a surprise devaluation of the renminbi, which suggests that the shift away from export-led growth is not working as hoped.

Meanwhile, President Xi Jinping’s anti-corruption campaign increasingly looks like a strategy to consolidate power, rather than an effort to reform China’s state for the benefit of its economy and society. Corruption is pervasive, and Xi’s campaign remains broadly popular. But the wave of prosecutions that Xi has unleashed is discouraging Chinese officials from making decisions, owing to their fear that they could face criminal charges in the future.

As a result of these developments, one hears much less of late about the Chinese model and more about the Chinese reality. Aside from slowing growth, that reality includes severe environmental damage, one result of decades of rapid, coal-fueled industrialization. According to one estimate, air pollution is killing 1.6 million Chinese per year.

China’s aging population, an unintended consequence of its draconian one-child policy, poses another threat to long-term prosperity. With the dependency ratio – the proportion of children and pensioners relative to working-age men and women – set to rise rapidly in the coming years, economic growth will remain subdued, while health-care and pension costs will increasingly strain government budgets.

What is increasingly apparent is that China’s leaders want the economic growth that capitalism produces, but without the downturns that come with it. They want the innovation that an open society generates, but without the intellectual freedom that defines it. Something has to give.

Some observers, fearing a rising China, will breathe a sigh of relief at its current difficulties. But that may prove to be a shortsighted reaction.

A slow-growth China would undermine the global economic recovery. It would be a less-willing partner in tackling global challenges such as climate change. Most dangerous of all, a struggling China could be tempted to turn to foreign adventurism to placate a public frustrated by slower economic growth and an absence of political freedom. Indeed, there are some signs that the authorities are doing just this in the South China Sea. Nationalism could become the primary source of legitimacy for a ruling party that can no longer point to a rapidly rising standard of living.

The US and others will need to push back to ensure that China does not act on such a temptation. But these countries would be equally wise to signal to China that it is welcome to take its place among the world’s leading countries if it acts responsibly and according to the rules set for all.

But the bigger policy choices will be China’s to make. The government will need to find the right balance between government interests and individual rights, between economic growth and environmental stewardship, and between the role of markets and that of the state.

The choices China faces are as difficult as they are unavoidable. Major social unrest cannot be ruled out. The one certainty is that the next three decades will not mirror the last three.

China’s Complexity Problem

NEW HAVEN – There are many moving parts in China’s daunting transition to what its leaders call a moderately well-off society. Tectonic shifts are occurring simultaneously on several fronts – the economy, financial markets, geopolitical strategy, and social policy. The ultimate test may well lie in managing the exceedingly complex interplay among these developments. Is China’s leadership up to the task, or has it bitten off too much at once?

Most Western commentators continue to over-simplify this debate, framing it in terms of the proverbial China hard-landing scenarios that have been off the mark for 20 years. In the wake of this summer’s stock-market plunge and surprising devaluation of the renminbi, the same thing is happening again. I suspect, however, that fears of an outright recession in China are vastly overblown.

While the debate about China’s near-term outlook should hardly be trivialized, the far bigger story is its economy’s solid progress on the road to rebalancing – namely, a structural shift away from manufacturing and construction activity toward services. In 2014, the services share of Chinese GDP hit 48.2%, well in excess of the combined 42.6% share of manufacturing and construction. And the gap is continuing to widen – services activity grew 8.4% year on year in the first half of 2015, far outstripping the 6.1% growth in manufacturing and construction.

Services are in many respects the infrastructure of a consumer society – in China’s case, providing the basic utilities, communications, retail outlets, health care, and finance that its emerging middle class is increasingly demanding. They are also labor-intensive: in China, services require about 30% more jobs per unit of output than do capital-intensive manufacturing and construction.

Largely for that reason, China’s employment trends have held up much better than might be expected in the face of an economic slowdown. Urban job growth averaged slightly more than 13 million in 2013-14 – well above the ten million targeted by the government. Moreover, the data from early 2015 suggest that urban hiring remains near the impressive pace of recent years – hardly the labor-market stress normally associated with economic hard landings or recessions.

Services are also the ingredient that makes China’s urbanization strategy so effective. Today, approximately 55% of China’s population lives in cities, compared to less than 20% in 1978. And the share should rise to 65-70% over the next 15 years. New and expanding cities sustain growth through services-based employment, which in turn boosts consumer purchasing power by trebling per capita income relative to that earned in the countryside.

So, despite all the handwringing over a Chinese crash, the rapid shift toward a services-based economy is tempering downside pressures in the old manufacturing-based economy. The International Monetary Fund stressed the same conclusion in its recent Article IV consultation with China, noting that labor income is now expanding as a share of GDP, and that consumption contributed slightly more than investment to GDP growth in 2014. That may seem like marginal progress, but it is actually quite rapid relative to the normally glacial pace of structural change – a process that began in China only in 2011 with the enactment of the 12th Five-Year Plan.

Alas, there is an important catch. While progress on economic rebalancing is encouraging, China has put far more on its plate: simultaneous plans to modernize the financial system, reform the currency, and address excesses in equity, debt, and property markets. Meanwhile, the authorities are also pursuing an aggressive anti-corruption campaign, a more muscular foreign policy, and a nationalistic revival couched in terms of the “China Dream.”

The interplay among these multiple objectives may prove especially daunting. For example, the confluence of deleveraging and the bursting of the equity bubble could create a self-reinforcing downward spiral in the old manufacturing economy that shakes consumer confidence and offsets the emerging dynamism of the new services economy. Similarly, military adventures in the South China Sea could damage China’s links to the rest of the world long before it is able to count on domestic demand for economic growth.

Ironically, China’s juggling act may prove even more difficult for the authorities to pull off in a market-based, consumer-oriented system. Caught in the transition from China’s tightly controlled, state-directed model, the government seems to be waffling – for example, by stressing a decisive shift to markets, only to intervene aggressively when equity prices plummet. Likewise, it is embracing more of a market-based foreign-exchange regime while guiding the renminbi lower.

Add to that a stop-start commitment to reform of state-owned enterprises and China could inadvertently find itself mired in something comparable to what Minxin Pei has long called a “trapped transition,” in which the economic-reform strategy is stymied by the lack of political will in a one-party state.

Under President Xi Jinping’s leadership, there is no lack of political will in today’s China. The challenge is to prioritize that will in a way that keeps China on the course of reform and rebalancing. Any backtracking on these fronts would lead China into the type of trap that Pei has long feared is inevitable.

Economic development has always been a daunting challenge. As warnings about the “middle-income trap” underscore, history is littered with more failures than successes in pushing beyond the per capita income threshold that China has attained. The last thing China needs is to try to balance too much on the head of a pin. Its leaders need to simplify and clarify an agenda that risks becoming too complex to manage.

A warning on China, specifically about its debt, now seems prescient

August 26

CAMBRIDGE (MASSACHUSETTS) — Mr Kenneth Rogoff has long warned of a potential financial crisis in China.

Mr Rogoff, a professor of economics at Harvard University, accurately predicted the eurozone debt crisis and, for years, has been telling anyone who would listen that China posed the next big threat to the global economy. He is starting to look right, again.

“In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could,” Mr Rogoff said on Monday from Cambridge, Massachusetts, repeating a favourite line from German economist Rudi Dornbusch.

Mr Rogoff, who is a chess grandmaster, has made a career of studying financial crises. After the 2008 crisis, he co-authored This Time Is Different, a seminal book that examined more than a century of financial crises.

Every financial crisis, he and his co-author, Ms Carmen Reinhart, concluded, stems from the same simple problem: Too much debt.

To understand the wild machinations of the stock market in recent days in the United States and abroad, you need to look no further than China’s astounding debt load and sputtering economy — and its ability to infect the rest of the world.

“China is the classic ‘This time is different’ story,” Mr Rogoff said, rattling off all the different rationalisations for why the country convinced itself — and many others — that it could load up on debt, but was somehow immune to the laws of economic gravity. He cited the Chinese government’s control over the markets, the hundreds of millions of workers migrating to cities and the country’s saving rate of about 30 per cent of disposable income as some of the reasons that China was said to be impervious to a severe downturn.

“It’s very vulnerable,” Mr Rogoff added. “There is a lot of debt.”

How much debt remains an open question, given the opacity of China’s market. The country’s debt load rose from US$7 trillion (S$9.78 trillion) in 2007 to US$28 trillion by mid-2014, according to a report published earlier this year by the consulting firm McKinsey China.

“At 282 per cent of gross domestic product, China’s debt as a share of GDP, while manageable, is larger than that of the US or Germany,” said the McKinsey study. “Several factors are worrisome: Half of loans are linked directly or indirectly to China’s real estate market, unregulated shadow banking accounts for nearly half of new lending, and the debt of many local governments is likely unsustainable.”

The question, then, becomes how interconnected China’s economy is to the rest of the world. That is exactly what investors have been trying to determine over the past several weeks, as China’s government devalued its currency and tried — and failed — to stabilise its plummeting stock market. The drop has been exacerbated, in part, by debt, as over-extended Chinese speculators who borrowed money to buy stocks are now being forced to sell, creating a vicious circle.

Of course, Mr Rogoff is not the first person to identify China as a potential risk. Earlier this year, The New York Times highlighted the views of Mr Henry Paulson, the former US Treasury Secretary and Sinophile, who said: “Frankly, it’s not a question of if, but when, China’s financial system will face a reckoning and have to contend with a wave of credit losses and debt restructurings.”

And hedge fund manager James Chanos has been sounding the alarm on China for years, recently declaring: “Whatever you might think, it’s worse.”

There are, of course, significant political reasons that China needs to convince the world and its own citizens that it can manage its convulsing financial markets and slowing economy.

“Financial meltdown leads to a social meltdown, which leads to a political meltdown,” Mr Rogoff said. “That’s the real fear.”

Mr Rogoff pointed to another factor that has contributed to China’s financial woes. “The crisis in Tianjin fed into the mix,” he said, referring to the deadly explosion on Aug 12 in the port city that killed more than 100 people.

Mr Rogoff said the explosion had undermined the credibility of the Chinese government, because so many questions remained unanswered and the response had been inadequate. So, does he believe that China is headed for a terrible hard landing that will lead to a global recession?

Well, despite the market tumult and his persistent warnings, Mr Rogoff believes that the past several weeks have only raised the prospects of a meaningful crisis. But with China’s trillions of dollars in reserves, he thinks the country may have sufficient tools to prevent a calamity that spreads across the globe.

“If you had to bet,” Mr Rogoff said, “you’d still bet they’d pull it out.”


What lies beneath China's financial tremors?

John Wong

Aug 29, 2015, 

China's financial fluctuations have sent world markets reeling. But fears of an imminent collapse in the Chinese economy are unfounded
The recent volatility in global currency and stock markets has continued to hog newspaper headlines around the world. It was triggered first by the devaluation of the Chinese yuan on Aug 11 and then the Shanghai stock market crash earlier this week ("Black Monday"). Such are the financial tremors in China that have wreaked havoc on the world's foreign exchange and capital markets.

Stripped of various media hype and sensational headlines for a cool analysis, many would view these developments as rather incomprehensible. The Chinese yuan, after ending its de facto peg to the US dollar in 2005, has been steadily appreciating over the years. Just how could its initial 1.9 per cent devaluation against the US dollar be dubbed "sharp devaluation" by Western media?

It was merely a small step primarily meant to correct the yuan's exchange rate misalignment caused by China's weaker macroeconomic fundamentals, including slower export growth and increasing capital flight.

Even after a second day of equally small devaluation, the yuan has since depreciated only about 3.8 per cent against the US dollar while it has since appreciated heavily against all major currencies: Up over 10 per cent against the South Korean won and the euro, and almost 20 per cent against the yen.

The contagion effect of the Shanghai stock exchange rout on the global capital markets is even more unfathomable. Granted, financial markets everywhere are often driven by sentiment, expectations and herd instinct, but it is difficult to explain and justify why "Black Monday" could have been triggered by the 8.5 per cent sell-off in the Shanghai market, which has been going up and down for several months.

Before this, it had already experienced three large single-day drops of 8 per cent since January. At its peak this June, the market had gone up 150 per cent in one year.

The market was over-valued, with the average price/earnings ratio more than 30 at its peak. Hence the inevitable but normal correction.

Furthermore, the Shanghai Stock Exchange is still a relatively small market (only the fifth in the world), which is essentially not widely open to foreign investors.

It is therefore hard to understand how a single-day market correction in Shanghai could have caused the Dow Jones to shed 1,000 points!

Is this just "irrational gloom"? Or we have over-exaggerated China's real financial muscles?

During the 1997 Asian financial crisis, as the region's stock markets all plunged, Wall Street held its ground. This eventually stabilised the global financial markets.

Why not this time? Has the US lost its former financial dominance? Or we have given too much credit to the rising yuan? When China catches a cold, does the US also sneeze?


Behind all the panic and gloom was the heightened concern about the health of the Chinese economy - even to the extent of fearing its imminent collapse!

As China is the world's second-largest economy accounting for 13.4 per cent of global GDP (or 16 per cent by the purchasing power parity measure), as compared with 22.5 per cent for the US economy, its ebb and flow is apt to produce a significant contagion effect across the world.

Since 2009, China has become an important economic growth engine of the world, regularly accounting for a third of annual global growth. Not surprisingly, China has become the leading trade partner for 75 countries. Countries from Australia (one-third of its exports go to China) to Brazil have come to depend heavily on China as a market for their primary commodity exports while China is also an important market for manufactured exports from industrial countries, from South Korea (one-quarter of its exports) and Japan to Germany.

Any major slowdown in China's growth will therefore herald a potential global slowdown.

Economists have long been sceptical about the tenuous relationship between real economic growth and the performance of the stock market, with the former recording its activities at yearly or at most quarterly intervals, whereas the financial markets operate mostly on short term, daily or even instantaneously.

But this has not prevented financial journalists and market pundits from using certain macroeconomic indicators to generate the required "sentiment" to move the market.

This time round, the obvious culprit was China's economic "slowdown". Indeed, it is this perceived China slowdown that fuelled the contagion of the financial tremors. Unfortunately, China's economic slowdown has been grossly exaggerated and the nature of its slowdown widely misunderstood.


China's economy experienced phenomenal growth of 9.8 per cent a year during 1979-2013.

Growth first started to decelerate in 2012 to 7.8 per cent; and then to 7.7 per cent for 2013. The decline got more dramatic last year, with only 7.4 per cent growth, the lowest in more than two decades. For this year, growth is likely to come down to 7 per cent, or, as predicted by the International Monetary Fund, just 6.8 per cent.

No economy can keep growing at close to double-digit rates forever without running into various constraints. China's hyper-growth for well over three decades has been historically unprecedented, and was much longer than what Japan, South Korea, Taiwan, Hong Kong and Singapore had experienced before - just a little over two decades of such high growth for Japan, South Korea and Taiwan, and substantially shorter for Hong Kong and Singapore.

China has been the most remarkable for sustaining such a long period of high growth, partly because it has far greater internal dynamics in terms of having much bigger hinterlands along with a larger labour force, especially compared to other dynamic East Asian economies.

Still, China's growth must come down after so many years, due to the inevitable weakening of its major growth drivers or the drying up of its sources of high growth.

For years, its growth was primarily fuelled by the rise in fixed assets investment (growing at over 20 per cent a year) and exports (at over 10 per cent a year). In the first seven months of this year, investment was up only 11 per cent while export growth experienced a contraction of 1 per cent.

Clearly, its era of high growth is over.

China's economic slowdown had been widely reported and indeed expected, although some international media mischaracterise it with sensational labels like "hard landing".

Put into proper perspective, China's present "lower" growth is "low" only in its own context, as its current 7 per cent level of growth is still remarkably high by any regional or global standard, and certainly well above the average global economic growth of 2.8 per cent for last year.

In fact, given China's mammoth economy of over US$10.4 trillion (S$14.6 trillion) in GDP, a "mere" 7 per cent growth would enlarge its GDP in a single year by an amount equivalent to 80 per cent of Indonesia's total GDP or one-third of India's.


This explains why the present economic deceleration has not much worried the Chinese leadership, which has officially embraced slower growth as the "New Normal".

Chinese President Xi Jinping had dismissed fears of 7 per cent growth as "actually not all that scary". He also pointed out that China's 7.7 per cent growth in 2013 had added to China an increment of GDP in a single year that was equivalent to its entire GDP of 1994.

Mr Xi clearly understands that economic growth is all about increases in GDP at compound interest rates.

What is more crucial to Mr Xi is whether the Chinese economy is on track to rebalancing its pattern of growth. China wants to have growth that is less dependent on investment and exports and more dependent on domestic consumption. It wants to continue to upgrade its economic structure towards a more efficient growth based on higher productivity.

China's present economic slowdown is also not just about the change in the magnitude of growth, but also the nature of its growth.

Years of hyper growth have left behind a lot of "excesses" in terms of over-production and over-capacity as well as a huge domestic debt overhang. Thus, the manufacturing sector that used to grow at double-digit rates, registered only 6 per cent growth in the first seven months of this year.

China currently has huge stocks of surplus raw materials and minerals, and this explains why it currently faces low import demand from primary-producing countries. This also explains why it is pushing hard for its One Belt, One Road project as a way to digest its industrial over-capacity.

More significantly, its growth pattern has started to shift, with growth increasingly driven by domestic consumption. This means that its future 7 per cent or so growth generates more GDP in consumer goods and services, and less in output from the heavy industry sector like iron and steel.

China's imports of certain raw materials and minerals are set to decline further. This is bad news for some primary-export Asean countries. In short, it is not just China itself, but the world at large that also has to adjust to China's economic slowdown.

But the story of China's growth has been well-forecast and is by no means unexpected.

The critical thing right now is not to misinterpret the fluctuations in the yuan and stock markets, which are just corrections to overvaluations in the past, certainly not a signal that the Chinese economy is about to collapse.
The writer is a professorial fellow at the East Asian Institute, National University of Singapore.

No comments: