International | Nov 24 2009
By Greg Peel
China wants to be a world player. Indeed, China wants to be a superpower, if not THE superpower. With a population of over one billion, a GDP growth rate set to return shortly to double figures (if such figures can be trusted), and a lack of democracy considerations hindering the executive decision-making process, China may be forgiven for believing it’s already well on the way.
There is little doubt that the four trillion renminbi the Chinese government threw at its domestic economy in 2008 has been the most important factor in stabilising the global economy in 2009 among all fiscal and monetary stimulus measures across the globe, including the US printing press. China’s plan was simple: use part of the excessive stockpile of foreign reserves built up from export receipts in the past decade and hand it to local banks, encouraging them into a spending competition with a bias towards local infrastructure and local consumption. By sheer weight of money and population, rapidly stimulating China’s domestic economy when the global economy was on its knees would provide a flow-on effect, helping to stabilise developed economies. In particular, buying up as much of the world’s natural resources as possible would return the world to a positive bias.
Is China playing the role of a benevolent God? No – China simply wants to return the global economy to economic growth so that its all-important export industry can also return to normal, thus returning to rapid GDP growth without government support.
Failed UK newspaper tycoon Robert Maxwell once boasted to his CFO that his business owed only three billion pounds to its bankers while rival tycoon Rupert Murdoch’s business owed ten billion. Ergo, Maxwell was the winner. But his CFO was quick to point out that at 3 billion, the banks controlled Maxwell, but at 10 billion, Murdoch controlled the banks. The banks could afford to let Maxwell fail but they couldn’t afford to let Murdoch fail.
China cannot afford to let the global economy fail. Without the global economy, China would return to being an overpopulated land of subsistence farmers. China’s billions in foreign reserves have been accumulated over the past decade by selling goods designed in the developed world back to the developed world after passing through the deflationary gate of cheap Chinese labour. If the world no longer has the money to pay for such goods – cheap or not – then it’s all over. Ergo, China decided the best way to keep its customers is to indirectly prop them up until they can operate on their own again.
Which is all well and good. If you polarise the world down to China the producer on one side and America the consumer on the other, China the “banker” is simply lending money to America the “Murdoch” on top of money already lent in order to ensure the relationship does not fold. The obvious problem, however, is that America cannot simply keep building debt upon debt.
Because we now know what happens when that bubble bursts.
One can easily rattle off the many reasons for, and events which led to, the GFC, most of them centred in the US. What China would never publicly admit is that its own policies were just as much a cause of the GFC as any other. Yet China continues to buy US bonds – lends the US money – for fear that the house of cards it had a hand in creating will come tumbling down again. Had China’s currency not been pegged to the US dollar, the internecine relationship of debtor and creditor would never have flourished longer than it took for Chinese economic emergence to result in the appreciation of its currency. Chinese goods would not have been “cheap” for too long, and soon enough Americans would not have been able to afford them over any other.
But while the creditor/debtor relationship – the so-called “global imbalance” – continues to teeter on the brink of mutual destruction, the Chinese cannot afford to attempt to affect a rebalancing too quickly. Had the UK banks in the eighties called in Murdoch’s loan only to force default, the banks would have also failed. By working with Murdoch to ensure he could ultimately keep his debts at bay through business growth meant both parties survived.
President Obama was in China last week telling counterpart Hu Jintao he must allow the renminbi to appreciate. Only then would the US trade deficit be able to reduce to save the US dollar from collapse. Commentators sniggered at the idea of the debtor telling the creditor how to run his business in order that the debtor may prevail. It would be like Murdoch telling the banks they must put his interest rate down. But Obama no doubt knew long before the official meeting that the demand was pointless. China will do what China wants to do in its own good time.
And that includes allowing the renminbi to appreciate against the US dollar, but slowly so not as to trigger aforementioned mutual destruction.
It took until 2004, post the tech-wreck and 9/11 recession across the developed world, for Chinese GDP growth to really fly into bubble territory. By mid 2005, China realised it had to start appreciating the renminbi. Its trade surplus had quadrupled since 2003. It did so – by 20% to 2007. Yet by 2007 China’s trade surplus had doubled again. The pace of appreciation was enough to reduce the exponent of growth, but not the value. On the flipside of this equation was a growing US deficit.
This deficit sent the US dollar tumbling against floating currencies long before the words “sub-prime crisis” were ever uttered. But a weaker dollar did not stop Americans buying cheap goods on credit from China, because they did not stop being cheap. There was no apparent inflation in the US, and thus no reason for the Fed to raise its cash rate to stymie the out of control credit markets. In the end it wasn’t a pin that burst the bubble, it was a peg.
The US dollar is weakening once more, post GFC. This time, however, America is not buying Chinese goods in vast quantities on credit. In theory, the US trade deficit should fall and the Chinese surplus should fall, allowing a rebalancing. DBS Group Research notes the Chinese trade surplus should fall from US$296bn in 2008 to US$180bn in 2009. As a share of GDP, that would be a fall from 11% to 6%. China’s 10% plus GDP growth rate in 2009 is all about domestic demand and not about exports.
This equation might work if we do assume the world to be polarised into only China and the US. But it’s not. The rest of the producing world, from the largest manufactured good exporter Germany through Japan and down to raw material exporter Australia, is suffering as the US dollar weakens and currencies including the euro, yen and Aussie rise. But as the US dollar weakens, so too does the renminbi also weaken. This once again gives Chinese exports an unfair advantage over other exports.
Australia’s position is a conflicting one. The more China exports the more raw materials it needs but the more the Aussie appreciates the less Australia will receive for those materials.
We have thus passed down an indirect path which has led us from China saving the world to China once again destroying it, or at least assuring its destruction. In real equivalent exchange rate terms, DBS calculates the renminbi has already depreciated by 7% in 2009. Global balance can only be restored and danger subsequently averted if the renminbi appreciates. The appreciation of the renminbi can only be achieved by the Chinese authorities not removing their peg (instant disaster) but moving their peg. And such a move would have to outpace the equivalent effect of any further weakness in the US dollar – weakness which is supposedly assured as US debt levels continue to rise. (Check out the US “debt clock”)
It all sounds so simple. Unfortunately it’s not.
DBS does not believe China actually gets enough credit for stabilising global confidence with its stimulus policy. All the focus is on the undervalued renminbi instead, which one assumes makes China somewhat irate. And one must remember Japan, too, travelled down the “economic miracle” path several decades ago, eventually forcing it to appreciate the yen by a full 48% between 1985 and 1987 alone. And what happened? Asset bubble.
Japan appreciated its currency but kept its monetary policy loose to encourage the growth of the domestic economy; both policies intended to reduce Japan’s runaway reliance on exports. Not only did the stronger yen not stymie a surge of American demand for small, economic Japanese cars in the wake of the seventies’ oil shocks (and thus not reduce the trade imbalance), loose monetary policy encouraged a bubble in the Japanese stock and property markets.
That is exactly what is happening in China today.
In 1990, the Japanese bubble burst, and Japan then entered its “lost decade” (which is now really two lost decades). Clearly China has taken note of the Japanese lesson, and certainly won’t be dictated to by the debt-ridden US. So what on earth can China do?
DBS offers three options:
(1) Do nothing. Keep the exchange rate pegged and interest rates low to maintain domestic growth. Put up with persistent pleas from the US government and ignore the “hot money” flowing in from foreign speculators who assume the renminbi will have to appreciate like a pressure valve eventually. Deal with resultant price inflation. Bow to the inevitable asset bubbles.
(2) Appreciate the renminbi by measured steps – 3% per annum – and raise interest rates to stymie price inflation and asset bubbles. Speed up the process of Chinese financial market reform to encourage foreign investment and relieve the pressure on local banks, which in turn will lead to interest rates largely finding their own levels. Risk killing off domestic growth in the meantime.
(3) Appreciate the renminbi by 3% per annum but keep monetary policy loose to maintain domestic growth. Finally shut up the Yanks as a result. Watch the world start heading back towards balance but fuel a domestic asset bubble in the meantime and thus become Japan.
What would you do?
