Column

THE CHINA SYNDROME

If the giant's economy collapses, the whole world will shake

May 17 2004
Column

THE CHINA SYNDROME

If the giant's economy collapses, the whole world will shake

May 17 2004

THE CHINA SYNDROME

Column

DONALD COXE

If the giant's economy collapses, the whole world will shake

THE MAY 3 ISSUE of Business Week has a scary cover: “CHINA HEADED FORACRISIS?” Inside is an eight-page article describing a boom headed for bust. The BW article is merely the latest and shrillest version of the emerging consensus on China: it has grown too fast, 45 per cent of its bank loans are bad, there’s too much hot money flowing in from abroad, there’s massive overbuilding of factories and office towers, SARS may return, and inflation certainly has. A worse crisis than the Chinese bubble of 1992-1994 when inflation hit double-digit peaks now looms. Then-premier Zhu Rongji burst that bubble with “draconian rules to stop rampant lending.” The result: a crash. China’s economy was so tiny back then that most of the world barely noticed.

With China now such a major player on the world’s economic stage, a crash now would wound the entire global economy. Commodity prices would tumble and return to the bear market conditions of the post-inflation boom of the late 1970s. I cite the BusinessWeek article because it summarizes the emerging consensus on a Chinese collapse. It is, I believe, no coincidence that commodities and commodity stocks plummeted just after the magazine hit the newsstands. April 28 saw some of the worst carnage inflicted on commodities since the boom began two years ago.

There’s no doubt the bosses in Beijing are scared about the nation’s runaway growth. Chinese statistics show that the GDP is growing in the 10-per-cent range, but some observers think the real growth rate is closer to 15 per cent. Since Chinese statistics are at least as prone to error as American data (which is frequently and embarrassingly revised), I should not be surprised if the critics’ calculations end up being closer to the truth.

There’s also no doubt that China needs to bring its growth closer to its long-term trend (a robust eight per cent) by controlling lending for capital investment. Some observers estimate that spending on construction, machinery and equipment is running at 45 per cent or more of total GDP, a dangerously high level. It means the nation is building too many factories and too many office towers and apartment buildings. Frantic overbuilding means creation of inefficient capacity that must eventually get written down or written off.

Yet world markets tumbled when China last month announced several measures including raising bank reserve requirements, imposed cutbacks on loans to build steel, aluminum and cement plants, and hinted at raising interest rates and maybe even raising the value of its currency, the renminbi. That’s dramatic, but not terrible news. If a man is driving a car in the rain at 150 km an hour and he approaches a dangerous curve, his passengers will doubtless feel vastly better if he decelerates to 75 without slamming the brake pedal to the floor.

CHINA’S astonishing wealth-creation machine is driven by endless supplies of low-cost labour, foreign direct investment and millions of entrepreneurs

Beijing now seems to be doing the right things. That’s good news if the second-most important economy in the world slows from warp to cruising speed. At that sustainable pace, China would keep on absorbing a growing percentage of the world’s exports, particularly oil, metals, grains, lumber and communications chips.

Are these policy changes too late to prevent a crash landing that will unleash a commodity bear market—or even a global recession? Hard to tell from here, but published official Chinese inflation statistics say that domestic inflation is still in the relatively low four-per-cent range (compared to 25 per cent in 1994), so a nationwide cooling-off would come in time to prevent a crash.

Skeptics note that Beijing no longer exercises as much economic power as the commissars in the provinces, many of whom are so terrified of triggering a rise in unemployment that they will keep on promoting frantic growth. The world’s last nominally Marxist, centrally controlled economy (apart from Cuba, Vietnam and North Korea, which are too tiny to count) has morphed in recent years into a loose federation in which most economic and financial decisions are made locally. That, of course, is the reason why China is a sensational success, but it raises the question: can Beijing’s bosses ban the boom?

Oddly, yes.

What we know about big governments is that they can’t create wealth and progress, but they can control or destroy wealth and progress. China’s astonishing wealth-creation machine is driven by endless supplies of low-cost labour, foreign direct investment and millions of entrepreneurs. Beijing’s contributions are its roles as facilitator, policeman, cheerleader, central banker, trade negotiator and, as in the case of SARS, crisis manager.

Beijing has enough muscle to rein in the runaway animal spirits, and it has enough wisdom to know how to use that muscle. The Asian economies that went bust in 1997 had overvalued currencies and tiny foreign exchange reserves. China has an undervalued currency and US$450 billion in reserves.

The most famous cover in BusinessWeek history was “The death of equities,” which came out in 1979 just before history’s greatest equity bull was born. It is a collectors’ item.

Perhaps this issue will turn out to be almost as valuable. li1]

Donald Coxe is chairman of Harris Investment Management in Chicago and of Toronto-based Jones Heward Investments. dcoxe@macleans.ca