Monday, January 18, 2010

China: A brewing confrontation?

It seems that China is, at last, really being noticed by mainstream analysts. When I see really, I am referring to the key part that China is now playing in the world economy. Of particular note is that the growing share of the world export market held by China and that China is now the world's largest automotive market (mentioned in a recent post).

Perhaps it is these statistics that have served to focus minds.

The actual analyses that are being offered, and the opinions about what might be done about China, are varied. A good contrast can be found between Dylan Grice of Socgen and the Economist magazine. Grice notes that different standards are applied when analysts and investors view the Chinese economy, and provides an example in the comparison of value between Lloyds of the UK and ICBC of China. Both are part government owned, both have potential risks in their loan book, but Lloyds is potentially subject to malign government intervention, whereas ICBC is actually subject to malign government intervention. Despite this, the valuation of ICBC is much higher.

Grice sees this as an example of irrational exuberance on the part of investors towards China. He notes that there is a boom in credit in China, and questions the idea that an infrastructure investment boom will not lead to a bust, citing studies that show that such a bust is possible.

The Economist offers a very different perspective, giving their article the title 'China's Economy: Not Just Antother Fake'. They commence their article with the many aspects of the Chinese economy that might look bubble like, and make comparisons with the conditions in Japan before the Japanese economy popped. However, they go on to say the following:
Scary stuff. However, a close inspection of pessimists’ three main concerns—overvalued asset prices, overinvestment and excessive bank lending—suggests that China’s economy is more robust than they think. Start with asset markets. Chinese share prices are nowhere near as giddy as Japan’s were in the late 1980s. In 1989 Tokyo’s stockmarket had a price-earnings ratio of almost 70; today’s figure for Shanghai A shares is 28, well below its long-run average of 37. Granted, prices jumped by 80% last year, but markets in other large emerging economies went up even more: Brazil, India and Russia rose by an average of 120% in dollar terms. And Chinese profits have rebounded faster than those elsewhere. In the three months to November, industrial profits were 70% higher than a year before.
In a later article (1), the Economist discusses the rise and rise of China's exports, and asks whether the growth might continue. They again compare China with Japan, and note that Japan's exports peaked once Japan had moved up the value chain. However, in the case of China, it is possible to move up the value chain, and keep lower value exports, as China can substitute the low for high value in the coastal cities, and still keep the low value in the inland provinces.

An even more optimistic assessment of China's prospects comes from Foreign Policy magazine (sorry, no link and reliant on memory for the article details). The thesis of the article was one in which China would rapidly develop to become the most dominant economy, and signals the decline of Europe and the US in comparison. Whilst the Western economies might not decline in absolute terms, the article saw them losing economic power and influence.

So where do I stand on the question of the prospects for China? In a series of articles (see links in the notes at the end) I have offered a cautious view of China's prospects. In my first article, at the start of the economic crisis, I suggested that China, on balance, would be likely to come out of the crisis stronger:
So where does this leave the economic future of China? Where would I place my bet? Would it be on ongoing growth, recession and instability, or what outcome? The honest answer is that I would not place the bet at all but, with a gun to my head forcing me to to make the bet, I would choose continued economic growth, albeit at a slower pace than before. In the meantime the Western world needs to accept that it is no longer in a position to continue with its complacency. China poses a real and ongoing threat to the world economic order, and will continue to grow at the expense of the West, unless the West responds by restructuring of their economies through (real) improvements in education, lowering their cost base, and taking an aggressive approach to intellectual property and fair trade (for why, see here).
You will note that this is a very cautious prediction. I have highlighted some of the potential problems in the Chinese economy, such as the frothiness of the housing market, potential for dud lending by the Chinese banks, and (above all else) the potential for social unrest if Chinese growth ever goes into reverse, and many other concerns.

Within all of the discussions of China, there is often a fundamental problem. This is the idea that China sits as a stand alone entity, in which the policy of China might just be continued. I have frequently highlighted the mercantilism policy of China, and have long been arguing that, unless China acts to trade more fairly, it should be subject to trade sanctions. I have highlighted the manipulation of currency, the theft of intellectual property, and the conditionality of inward investment (with insistence on the transfer of technologies), as well as many other problems.

In August 2008, for example, I argued strongly that it was time to get tough with China, and highlighted a series of unrelated stories, all of which pointed to China using mercanilist methods to enhance their economic position. Whether they are making threats to destroy the $US, using the media to slander overseas businesses, arranging theft of intellectual property, China appears to be set on a course of establishing itself as THE economic power of the world. For example, I have previously mentioned the use of hacking by China to steal commercial secrets from overseas competition, and (again) this is actually starting to be noticed more widely.

The purpose in highlighting these points is that there has been a complacent attitude to the mercantilism of China, but the winds of change are blowing. China has a club to beat the world with, which is the holdings of massive foreign reserves. In an early post I highlighted that it was better to face down China now, rather than later. The ongoing growth of reserves held by China would just make confrontation ever more difficult. The complacency over the method of the ascent of China is now disappearing, but the potential dangers of confronting China have now grown. Nevertheless, there is an increasing recognition that something has to give. This from Roger Bootle in the Telegraph:
The looming threat to the world economy comes from the same source which contributed so much to the financial crisis, namely the draining of demand from the world economy through excessive Chinese saving. But now it will come at a time when most countries of the West are in no position to offset this effect through more stimulus policies and indeed, as in the case of the UK, may actually be about to tighten fiscal policy. We may be not far off the point where, if the Chinese don't take steps to make their trade with the West more balanced, then the West will take steps to do it for them.
Such sentiments can be found elsewhere, and I even find myself in agreement with Krugman, who is arguing against allowing the ongoing manipulation of the value of the RMB. However, what remains missing from these analyses is the complete picture. It is not just the matter of currency manipulation, but the many other policies of the Chinese government in conjunction with the currency manipulation. There is a pattern here, and I long ago discussed this in another post, saying the following:
It is very clear that China intends to rise economically by any means, fair or foul. The crazy part is that the foul is unnecessary, and one then becomes very suspicious of the underlying motives for such methods.
I have not detailed the many individual stories that support the argument of this post, as they can be found in other posts (see list at end). The important point is that, if considering the future of China, it is necessary to consider the actions of China's key trading partners. My best guess is that the situation will not be endured by China's' trading partners much longer - that China will be confronted over the mercantilism. This is, of course, in the hands of politicians, who are by their nature unpredictable. What approach, when, or how they might seek to address the problems, and how China then responds, will play a key part in the determination of whether China continues on the current upward trajectory.

My best guess is that China is heading for very troubled waters. I do not think, as the economic crisis proceeds, that the world will sit by and watch as China continues with the current policies. At the same time, China knows that it must continue to grow if it is to achieve social stability, and that means that it fears make any concessions. In fact, from the point of view of the Chinese government, China MUST continue to grow. That means that they will not back down easily, as the mercantilism is a key element in the level of their growth. In other words, the stage is being set for a confrontation, and the outcome of the confrontation might have profound effects on the ascent of China.

(1) 'Fear of the Dragon', Economist print edition, 9th January 2010

Note: Links to previous posts on China. These posts are the ones that are largely focused on China, but there is discussion of China in other posts. From Trade and Forfaiting Review:

Shanghai Suprise

From the Blog:
  1. July 2008, China - What Future?
  2. August 2008, China Propping up the $US
  3. January 2009, Free Trade 'Yes' - Mercantilism 'No' - Why China Should be Shut Out
  4. January 2009, The Myth of the Eternal Status of the $US as 'the' Reserve Currency (post indirectly associated with China)
  5. February 2009, China's Pivotal Role in the Next Step for the World Economy
  6. Fenruary 2009, China and the US - Fighting on the Edge of a Cliff
  7. March 2009, Economics and Power, the Loss of US Power
  8. March 2009, China, Gold and the $US
  9. April 2009, China as the World Economic Power?
  10. April 2009, The RMB as the Reserve Currency
  11. May 2009, China, the RMB and the $US
  12. July 2009, The RMB as the Reserve Currency - an Update
  13. Sep, 2009, The Rise and Rise of China
  14. Sep, 2009, China and Treasuries: A Puzzle
  15. Oct, 2009, The Great 'Shift' China and the West
  16. Jan, 2009, China on Track - The Car Industry
And the role of China in the development of the broader economic crisis can be found here (on Huliq).


  1. if you look at actual trade figures you'll find that china runs sort-of-balanced trade with most nations with the us being a major outlier.
    there's a deficit with the eu as well but even then there's e.g. germany which manages to balance trade with china.

    reminds me of the olympics, once china eclipsed the us all sorts of bogus reasons were brought forward.
    for future western reactions you may want to read this article.,1518,443306,00.html

    An Argument for a Trans-Atlantic Free-Trade Zone

    By Gabor Steingart

    Asian businessmen are probably the friendliest conquerors the world has ever seen. But despite the politeness and the smiles, Western governments must act quickly to combat the rise of China and Asia. The West should discuss an ambitious project: a European-American free-trade zone.

  2. Slightly off-topic, but here is an excellent article at Billyblog about why the EU needs a federal fiscal policy and how in the absence of one it will be better for some states to leave the EMU:

    Exiting the Euro?

  3. Did you catch this one at zerohedge:

  4. CE, I noticed much Western antagonism towards China over the failed Copenhagen conference. Do you really not think there is any significance to this global warming malarkey? My gut feeling is that Western governments such as the UK's were wrong-footed in their assumption of public credulousness and the control of China's growth they thought they were going to have as a result of forcing through carbon cap-and-trade etc.

  5. Bull. Who said the Europeans and Americans ascended to power by playing fair?
    Colonialism? Slavery? and lately QE are practices no one would consider fair.

    Free trade isn't essentially fair but it's there and most politicans agreed to it.

    Places with better economies tend to educate even their unskilled workers better than average college graudates n America. America was never ever #1 when it came to education. America had always imported their scientific talent. If it wasn't for WWII, and the migration of skilled talent to American shores for sanctuary, I doubt America would have ascended to where it had. What has happend in the last thirty years is that the cost of living has gotten so high in western countries that they are unfavorable places to do business. IF western countries want to be competitive, they need to bring these costs under control.

    Europe needs to stop importing unskilled Muslim immigrants who are hostile to European values. If they decide to keep allowing Muslims to emigrate from regions like North Africa they must--MUST-- give them work to do when they come to Europe so that they 're too busy to turn to dispair and resort to fantaticism . Sadly, a place like France would rather continue allowing people from former colonies in North Africa, who have historically been treated like shit by the French to emigrate to France and then be descriminated against to the point they can't obtain employment. What happened to all the care that an aging population would need? Instead there is a welfare state instead of work for people brought in do work. The welfare state doesn't sit well with Muslims. Idleness is practically a vice for them.
    It's not that immigration couldn't work at all in Europe, it's implementation is incorrect in most places. I agree tht they can't be considered citizens in countries where citizenship is defined by ancestory but they could be consided Guest EU workers or something with the right to work at least (and maybe not the right to prorecreate. There's nothing wrong with denying people the right to reproduce if they're allowed to be given a political voice,not citizenship just limited rights, and are explained why they cannot reproduce:because they come from countries where overpopulation has crippled economic development. The guest workers could argue that outstanding debt to colonial powers like France play a role but that stinging little fact is drawfed by overpopulation.) What I have stated doesn't apply to The United Kingdom 100 percent because The United Kingdom's immigration policy is well...different from that of mainland Europe. For one thing, their population isn't shrinking so they may not need a lot more immigration. I think. I may be wrong on that.

    The forum revolving around this blog ocasionally embraces nonsense like the complete denial of global warming but can it not be agreed upon that a semi-educated Christian Haitian immigrant would cause less cultural conflicts than a Muslim from North African in France ?

  6. I'm sorry that the above came off as a rant. It started as a reaction to sentiment about China's undervaluing of its currency as being unfair by comparing to really unfair practices. Leverage is inherantly unfair. Nothiing in capitalism is about being "fair" It seems like a point of moral vanity in retrospect.

    Then I started talking about Europe's immigration policy as an important component in Europe's economic competitiveness since Europe's population is shrinking too small and is too expensive, really too old, to compete with emerging economies.

    What both emerging and twilight economies will have to do is deal with failed states. So far China has a better record of dealing with failed states than the West, which has insisted on the humanitarian-non-economic kind-of-aid-except-for-crippling-debts for the last fifty years. Of course, I'm generalizing so if if there's an exception to that generalization, point to it. I won't mind being corrected. Remember,the key term is "failed state".

    Isolationism is another policy that may be considered but I believe that will be elbowed out by some kind of fascism.

  7. There have been some interesting links posted and I would recommend them to all. The Spiegel, and the Zero Hedge links both offer interesting perspectives. The Spiegel article is an interesting reaction to the rise of the East, and the article is most interesting for the implicit sense of the threat of the East to Western power.

    Lord Keynes: Thanks for the link. As a regular reader like yourself will know, I have long expressed my doubts about whether the Euro might survive the crisis. There are certainly cracks in the Euro, but we will have to see how the politicians actually play it.

    Lemming: The main significance is that it is another means to de-industrialise the a note, the climategate fallout continues:

    "According to multiple press reports, when NASA corrected the error, the new data apparently caused a reshuffling of NASA’s rankings for the hottest years on record in the United States, with 1934 replacing 1998 at the top of the list."

    More dodgy data..

    Anonymous: Thanks for the clarification, made whilst I was writing this comment.

    General: Please accept my apologies for so few replies recently. There has been a lot of news to digest. Of particular interest is this from Mervyn King of the BoE:

    They [British people] will see their standard of living fall over the next two years as salary freezes and rising inflation eat into incomes, Mervyn King said.

    “The patience of UK households is likely to be sorely tried over the next couple of years,” Mr King said, dashing hopes that Britain could recover quickly from the deepest slump in post-war history.

    This is the adjustment that I have long spoken of. However, I think that it may be more dramatic and painful than Mervyn King acknowledges. I suspect that, by now, he has absorbed the depth of the UK's problems, and his comments are probably moderated for political reasons, as well as for the concerns of creditors.

    The other news is that inflations is taking off. It is not just the VAT increase, but broad based inflation. The gilts markets, already twitching, are going to get very, very nervous. Reality, it seems, is intruding upon the fantasies.

  8. A number of things:

    One, the idea that only China is practising mercantilism is a white lie. All Western nations do practice mercantilism.

    For instance, u have mentioned the IP. So, why are patent under WTO (TRIPS) while IP from third world are under the toothless WIPO? Do not listen too much to Western propaganda and fail to see the reality.

    The unpalatable truth is this. Free trade cannot work between developed (high cost nations) and developing nations like China. The eventual result will be economic destruction of the West.

    Thus, the West has only two choices:

    (a) Reject free trade with low cost nations. This will be good also for developing nations for they will be able to protect their industries as developed nations did.

    (b) Change its taxation paradigm so as to remove the thing that leads to high cost of manufacturing in the West. This will be also good for third world nations will also do the same. However, do not count on this for vested interests are too strong at the moment.

    Another saviour will be a major innovation in the West. However, this is doubtful.

    Two, as concerns whether China is using "bad methods" to rise, I will only let you read what Churchil said in the Parliament in 1914:

    "we are not a young people with an innocent record and a scanty inheritance.We have engrossed to ourselves . . . an altogether disproportionate share of the wealth and traffic of the world. We have got all we want in territory, and our claim to be left in the
    unmolested enjoyment of vast and splendid possessions, mainly acquired by violence, largely maintained by force, often seems
    less reasonable to others than to us."

    Does that sound like the West rose by playing fair? In fact, the West is still using force to maintain what was acquired via violence. However, the chickens are coming home to roost.

  9. Here is an excellent article at Billyblog about hyperinflation and why it is unlikely:

    Its a hard road

  10. In news on China, Beijing has ordered banks to set aside more reserves, and its central bank raised interest rates on one-year bills so that they can rein in asset bubbles.

    Precisely the sort of regulation that should have been done in the West in the 1990s and 2000s to prevent the asset bubbles we had here.

    As I have said before repeatedly, one secret to China's success is its regulated banking system. It is essentially a public utility form of banking - precisely what many Western countries had from 1945 to the 1980s, and what we need to return to now.

  11. I liked this on green economics:

    "The carbon market, by penalising actual producers, allows for a transfer of funds from the productive economies of the east to stagnant economies like Britain’s. In turn, some of this money gets paid to underdeveloped regions in order that they do not develop (the trees must be left standing)."

  12. Sorry, Cynicus but no cake.

    The article's reading by me ended when I came across this cheeky little blurb.
    "James Delingpole is a writer, journalist and broadcaster who is right about everything. He is the author of numerous fantastically entertaining books including Welcome To Obamaland: I've Seen Your Future And It Doesn't Work, How To Be Right"
    The article is hardly an article. It's,in fact,a platform for a few sound byte like quotes. Delingpole's kind of journalism leaves much to be desired,like objectivity and and a lack of an authoritarian tone.

    The scientists at Climategate, as you've stated before, were found to be omitting data that would complicate what deniers probably like to call " the narrative of global warming." under political pressure.
    1934 could have been warmer because of a number of factors, including solar activity. Climatology is complex. It's a science that relies on computer models running variables. It's over the heads of ideological pundits to comprehend or explain. Politicans are trained to not tell people anything people wouldn't like to hear. People don't generally like take responsiblity for their actions. The Earth's atmospheric content is believed to be influenced by living organisms, namely by microrganisms and later plants over billions of years. It's wrong for any person to believe that the activity of humans can have no long term impact on the Earth's ecology. Humans have killed off enitre species and have changed the course of rivers but don't believe that they can change the chemical composition of the atmosphere.Yeah, OK.


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