Friday, April 24, 2009

China as the World Economic Power?

When I first wrote a post on this blog devoted to China in July of last year, I emphasised how opaque China was as an economy. For example, I suggested that the housing construction boom might be a bubble (which proved to be the case), but could offer no solid backing for it. As such, my thoughts on the future of China were cautious:
The Chinese economy may, or may not be, at a point where internal growth within China has the potential to take up the slack. Has it yet reached that point? It is very difficult to say. It is a finely balanced point, but the economic growth of the coastal areas is now being replicated in the interior. Can the growth in the interior maintain the momentum of the coastal cities? The Chinese government has huge reserves to draw upon should the economy falter, and may seek to use those funds to further develop the interior of the country. There is also an ongoing and dramatic process of infrastructure investment which may help carry China through the bad times.

Furthermore, China has being making ever stronger inroads into markets such as Africa, and South America. Whilst these can not replace the US and European markets, they may serve to ameliorate the effects of a downturn.

As you will note, there are many question marks here. There are many 'experts' in China trying to wade through the piles of figures trying to see what will happen with China. The trouble is that many of the statistics are either opaque or suspect. In this situation, it is just as well to rely on intuition.
In a later post I emphasised the mercanilist approach of the Chinese government, and have followed that theme through many of my subsequent posts. However, the major question mark over the future of China has remained, and my posts have tried to balance the potential for huge economic success with the risks to the Chinese economy from the world economic crisis.

As China's importance in the world economy has become ever more apparent, there has been growing interest in the state of the Chinese economy. I have recently seen some reports which consider the future of China and there are mixed views. For example the D&B Riskline report for April rates China as a 'slight risk' with the trend 'deteriorating'. with very little economic growth for this year and the next. By contrast, the Economist magazine is painting a picture of strong growth on the back of the Chinese government stimulus:
At first sight, the GDP figures published on April 16th were disappointing. China’s growth rate fell to 6.1% in the year to the first quarter, less than half its pace in mid-2007. On closer inspection, however, the economy is starting to perk up. Comparing the first quarter with the previous three months, GDP rose at an estimated annualised rate of around 6%, after nearly stalling in the fourth quarter (see chart). By March the economy was gaining more speed, with the year-on-year increase in industrial production rising to 8.3% from an average of 3.8% in the previous two months. Retail sales were 16% higher in real terms than a year ago, and fixed investment has soared by 30%, signalling that the government’s infrastructure-led stimulus is starting to work.
What we have here are two very different perspectives on the Chinese economy, which appears to be the norm for analysis of the Chinese economy. To give a perspective on the opacity of the Chinese economy, analysts often use proxy measures such as electricity output to try to understand what is really going on. Understanding the Chinese economy is no easy matter.

The problem that this presents is significant. There are two very different futures that might arise depending on the growth in the Chinese economy. One scenario is of a collapse into disorder, and the other is to increasing dominance in the world economy.

As I have mentioned in previous posts, there is a belief that China needs to maintain a growth rate of 6% in order to maintain social stability. This is needed to soak up the ever expanding labour force, and failure to do so is supposed to create significant risks. In particular, the legitimacy of the Communist government rests on the pillars of economic growth and nationalism, so that any major drop back in growth might see a significant rise in discontent. An earlier report in the Economist highlighted the problems that students are having in obtaining employment after graduation, and pointed out the risks in such a situation:
Campus stability has long been a worry to China’s government. Students took a leading role in several outbreaks of pro-democracy unrest in the 1980s, including the Tiananmen Square protests of 1989. Student demands for political change have been rare since then, thanks largely to an improvement in career prospects brought about by the economic take-off and the freeing of state controls. (In the 1980s, graduates had to accept the jobs they were assigned by government.)
On the one hand, therefore, we have a scenario in which, if the economy slows significantly, there is a major risk to the stability of China overall. On the other hand there is the possibility that China will continue to grow, and the consequences of such ongoing growth might lead to a very different outcome for China.

If we assume that the growth scenario is correct, the position of China in the world economy becomes ever more important. It appears that China is currently making the opening bids to establish the RMB as a reserve currency, and I have posted on this subject several times. For example, in a recent post, I pointed out the many moves that China is making to achieve this goal:
In other words, China is now actively positioning itself as (at the least) a major issuer of reserve currency, but is doing so in a way in which - if their attempt were to meet resistance or fail - they can step back and point out that it was never their intention. They can therefore proceed with an official position of support for SDR, whilst acting to develop the RMB as a reserve, whilst never risking losing face. It is a very effective way of operating.
The post details a series of actions by the Chinese government to establish the RMB as an international reserve currency, along with some consideration and speculation about the Chinese government's thinking. You may wish to read the post before continuing. In another post (again, you may wish to read it before continuing), I made an even more speculative consideration of what the Chinese government may be aiming to achieve, and how they might achieve it. In essence, I speculated on how China might take advantage of the economic crisis to become the world economic power.

Within the speculation, I suggested that China would discreetly start to dump treasuries, and would move their reserves into a broad based portfolio of assets. Whilst China has promoted the IMF SDRs as an alternative reserve currency, I proposed that this was a red herring which would allow China to undermine the $US without actually promoting the RMB as a replacement. However, the SDR approach is being taken seriously by some:

But in recent weeks, China has begun to address each of these dollar-forever arguments head-on, taking baby steps on the long road toward diversifying away from the U.S. dollar and moving instead toward the establishment of an alternative world reserve currency.

The signs began to emerge in mid-March, when Chinese Prime Minister Wen Jiabao publicly announced that he was "worried" about China's exposure to the dollar. Shortly thereafter, Zhou Xiaochuan, the governor of the Chinese central bank, released a policy paper suggesting the creation of a "super-sovereign reserve currency" to replace the dollar as a reserve currency over the long run. Specifically, he suggested the creation of a fund, managed by the International Monetary Fund, through which dollars could be exchanged for Special Drawing Rights (SDRs), an IMF-created international reserve asset whose value is fixed by a basket comprised 44 percent of U.S. dollar, 34 percent of euro, and 11 percent of each pound and yen.

However, it is now apparent that China has made significant moves towards gold, and this was one of the moves that I suggested in the post. This would help bolster the RMB as a reserve currency. We now have the following from the FT:
China revealed on Friday that it built up its gold reserves by three quarters since 2003, making it the world’s fifth largest holder of bullion.


Hou Huimin, vice general secretary of the China Gold Association, said China should build its reserves to 5,000 tonnes.

“It’s not a matter of a few hundred, or 1,000 tonnes. China should hold more because of its new international status, and because of the financial crisis,” he said. “The financial crisis means the US dollar’s value is changing fast, and it may retreat from being the international reserve currency. If that happens, whoever holds gold will be at an advantage.”

In addition to this, China is also building up stocks of other metals such as copper. In the D&B report, this is viewed as a move towards supporting government infrastructure investments. An alternative view comes from Ambrose Evans-Pritchard in the Telegraph:
China's State Reserves Bureau (SRB) has instead been buying copper and other industrial metals over recent months on a scale that appears to go beyond the usual rebuilding of stocks for commercial reasons.


The beauty of recycling China's surplus into metals instead of US bonds is that it kills so many birds with one stone: it stops the yuan rising, without provoking complaints of currency manipulation by Washington; metals are easily stored in warehouses, unlike oil; the holdings are likely to rise in value over time since the earth's crust is gradually depleting its accessible ores. Above all, such a policy safeguards China's industrial revolution, while the West may one day face a supply crisis.

Beijing may yet buy gold as well, although it has not done so yet. The gold share of reserves has fallen to 1pc, far below the historic norm in Asia. But if a metal-based currency ever emerges to end the reign of fiat paper, it is just as likely to be a "Copper Standard" as a "Gold Standard".

The moves of the Chinese government are increasingly fitting with my speculations on a move by China to rapidly achieve economic dominance. However, it is necessary to consider the other side of this coin, which is that China is also quite vulnerable to social unrest.

The key question that keeps nagging at me is which way will China go in the coming year? Will it be a slide into disorder, or a successful bid for economic dominance? Are there other middle paths, and what might they be? Are they really making a bid for economic dominance - to be the new economic power?

With such an opaque system, it is not possible to be sure of anything. However, all the indications appear to point to an ongoing strategy from the Chinese government of placing China at the centre of the world economy. Whilst all the recent moves of China might be coincidence - responses to changing circumstances - there does seem to be an emerging pattern in their actions. If it is more than coincidence, we may be witnessing one of the most dramatic peacetime shifts in power in modern history. It could well be that China is returning to its traditional position as the preeminent country in the world.

Only time will tell......


  1. On Industrial Policy in Argentina Under Peron 1946-1955Although this does not relate directly to the present post, but an earlier argument, I will still post it here.

    I note that when Argentina under Peron (whose politics, repression, and support for Nazi war criminals, I should add, I utterly condemn) pursued industrial policy to modernize Argentina’s economy, 'Perón … was adamantly opposed to borrowing from foreign credit markets, preferring to float bonds domestically. He refused to enter the GATT (precursor to the WTO) or the IMF.'

    So it appears that most of Argentina’s state spending on industrial policy was funded by domestic purchasing of government bonds.

    One major flaw of Peron’s industrial policy was the failure to create basic industries to produce so many of the capital goods required for the larger-scale industries. The inability of the domestic producers to supply these capital goods led to a rise in the imports of capital goods from overseas. But until 1948 this was not a serious problem, because Argentina’s exports of primary commodities could fund this surge in imports.

    Significantly, the breaking point was hostile US policy that excluded Argentina from the Marshal plan and caused a collapse of its agricultural export earnings:

    U.S. policy also helped thwart Argentine growth during the Perón years. These disputes likely stemmed from the United States’ displeasure at Perón’s plans of anti-imperialist self-industrialization; by placing such embargoes on Argentina, the U.S. hoped to discourage the nation in its pursuit of becoming economically sovereign during a time when the world was divided into two spheres. U.S. interests feared losing their stake, as they had large commercial investments (over a billion dollars) vested in Argentina through the oil and meat packing industries, besides being a mechanical goods provider to Argentina … Congress was therefore disposed to a strong dislike of Perón and his government, and did all it could to hinder Argentina's becoming self-sufficient. Their most detrimental act was the 1948 exclusion of Argentina exports from the Marshall Plan, the renowned Truman administration effort to combat communism and help rebuild war-torn European nations by offering U.S. aid. According to Perón biographer Joseph Page, “the Marshall Plan drove a final nail into the coffin that bore Perón’s ambitions to transform Argentina into an industrial power.” It was because of this plan that Argentina had nowhere to send the agricultural goods which it had formerly been sending to Western Europe and using the profits to sustain their economy

    So it turns out that deliberate U.S. policy helped thwart Argentine growth during the lster Perón years. The crisis of 1948-1954 was not really caused by its industrial policy at all, whose main problem could have been solved by gradually using impressive export earnings to invest in local industries to produce basic capital goods (and thus decrease the imports of these goods from overseas).

    Industrial policy is badly needed in the UK and the US today. The argument for it is not refuted by Argentina's experience at all.

  2. As far as unrest is concerned, once social unrest flares up in the Western World that should pretty much help the CCP as they'll be able to point out the advantages of their leadership. If unrest turns violent in the West (see Argentina) they benefit even more as that would blur the lines between the reactions to unrest of Communists and Democrats.
    The biggest holder of Gold is the US, but IIRC their holdings are valued at only around $200bn, the Gold that China recently bought is worth about $13bn. There is quite simply not enough gold around as to be able to diversify into that at a large scale. However they may be able to get their hands on the IMF reserves.
    What, to me, increasinly looks like an option, as long as the dollar is stable, is that China gives its dollars to other countries in need of foreign reserves in exchange for a stake in something physical. The IMF does not have enough funds to cover Britain's deficit, China does. I think you remember the Suzerainity/Souverainty issue where is was supposed that Britain changed its policy in return for gilt buys.
    China's economy has been doing extremely well for the last three decades and at every step some people were screaming for a collapse that never came, even though the commercial real estate market looks oversized and there seem to be export overcapacities, anything else seems to be going fine. They just have too many people. Again, unrest will be taken care of once the West erupts, with France already showing signs, Spain posting unemployment of 20%, Britain and America posting huge deficits and some American's already taking to the street unrest in Paris, London, Madrid and Washington looks more likely than in Beijing.

  3. Interesting views from Charles Hugh Smith:

    China: Ascendant Superpower Or Just Another Nation with Structural Problems?

    "Maybe it won't be one superpower or two superpowers, but no superpowers: just a collection of nation-states of various sizes, all of which face a long list of structural problems."

  4. Since the days of Marco Polo's tales of China's vast sophistication, the West has always had a fascination with this huge nation. For centuries there have been many false starts, as China rejected Western ideals and technology. Could we again have another false start with the rise of Asia? The communist centrally planned ethos has slowly ebbed away but is still a prominent feature of the economy. As you state in this post regarding transparency, China indeed fiddle their stats. Growth also started from an unbelievably low base - they had nothing in 1979 as the Great Modernisation program under Deng Xiaoping began. Moves since have been frantic and radical, but old communism still lives in on, with a lack of respect for property and peoples rights. However China it seems this time in history wish to be involved in the global economy and become the next superpower. Gold and copper acquisitions are only the tip of the iceberg. Mining deals in Australia or Oil Deals with Hugo Chavez are also a few that have been occurring recently.

    All this growth will come at a cost. Specifically China will have a huge recession. Domestic demand can't pick up and replace Western demand. So in the short term China will have huge problems. As long as they use their reserves wisely, continue to attract foreign capital and move ever more to a market economy they will continue with their rapid growth in future years.

    I also have enjoyed reading some of your previous posts.

  5. Cynicus,

    An interesting article, but I think you should consider more carefully the language you adopt when describing China's social situation.

    You ask of China: "Will it be a slide into disorder, or a successful bid for economic dominance?"

    To my mind, this serves to falsely frame the nature of the debate by allowing the former to sound like and undesirable outcome, while the later to be appear as a positive which should be aimed for.

    Last week I was walking through my city centre (Leeds, UK) and saw an information stall manned by a young Chinese man. The man was handing out leaflets regarding the harvesting of organs from Falun Gong members- a practice he claims has been ongoing for the last decade and to which the West has turned a blind eye.

    How accurate these reports are I cannot say (though as an Amnesty International member of some years nothing would surprise me as to the depths of the China's disdain for human-rights)- but this is my point: Inspite of all China's recent 'success' in terms of economic growth, stories as barbaric as these still cannot be discounted out of hand.

    The Falun Gong are a dramatic example, but there are others: the Tibetans, Uighurs, Mongolians, the peasants and land-reformers of the 'interior regions' forcibly evicted from the land to make way for multinational agricultural companies, labour leaders, human-rights activists, journalists, and so on.

    The 'order' that exists in China today is the order of a police state. I thererfore think that it is wrong to characterise any break down in its structure as a 'slide into disorder' when it could, in reality, be seen a (long overdue) move towards democracy.

    Indeed, since this language of 'disorder' (or 'chaos' or 'anarchy') is precisely of the type employed by repressive regimes the world over to discredit popular movements and justify violent repression of them, we should consciously resisted this politically-loaded use of words.

    Was Tiananmen square a 'public disorder' or a 'violently supressed democratic uprising'? I guess it depends which newspapers you were reading.

    For all America's problems, it does (at the moment at least ) pay lip-service to the ideals of freedom and democracy; China doesn't appear to do even that.


  6. Can China be a world power given its self inflicted population time bomb?

  7. Tiberius,

    Your manifesto against Chinese fascists seemed a bit out of place. There are plenty of forums (economist comment pages for example) where people will debate you properly on these accusations. Sitting in comfort cheering on the coming "slide into chaos" of any nation or people means you have no idea what are the real implications of that.

  8. novice,

    re "Your manifesto against Chinese fascists seemed a bit out of place."

    It was a comment on a post about the future of China, I fail to see how it could be more 'in place'.

    "There are plenty of forums (economist comment pages for example) where people will debate you properly on these accusations."

    Yes, the internet is a big place.

    "Sitting in comfort cheering on the coming "slide into chaos" of any nation or people means you have no idea what are the real implications of that."

    I wasn't 'cheering on' anything; the last thing I'd want to see is another Tiananmen-style Chinese massacre.

    I suggest you reread my post more carefully.


  9. Tiberius
    "You ask of China: "Will it be a slide into disorder, or a successful bid for economic dominance?"

    To my mind, this serves to falsely frame the nature of the debate by allowing the former to sound like and undesirable outcome, while the later to be appear as a positive which should be aimed for."

    Correct me if I am wrong, I thought the negation of an "undesirable outcome" is a "desirable outcome". Perhaps I am dense, but repeated reading didn't change me initial impression.

    As for why I think your post a bit out of place is because the blog focuses on economics (with no lacking in criticism of China) while you are raising tired political points. If you think Chinese economic advance threatens the world as a whole, make that point on its merit, or brave some rebuttals on a political forum

  10. I would have to agree with Tiberius in that his comments are very pertinent. The questions that Cynicus raises in his post deal with the future of China with regards to both its political and economic environment. For instance, Cynicus brings up China's opacity as a potential stumbling block to its rise as a superpower. It will be interesting to see if China can succeed with a foundation of strict state control as opposed to a more laissez-faire, transparent style of governing.


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