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China not immune to US
woes
By Scott B MacDonald
China has been one of the key dynamos in
Asia's economic development since its reforms began in
1978. While the 1997-98 financial crisis rocked Asia,
China sailed through the period without a devaluation
and managed relatively strong growth. Increasingly, China
is looked upon as the next economic power in
Asia, especially when compared with troubled Japan.
Shanghai is regaining its stature as an Asian financial
center. It has even been argued that China has immunity
from any potential second downturn in the United States
economy. But anyone banking on China's ability to
sustain strong economic growth with a sick US economy
should guess again.
If the US economy slows
considerably, let alone falls into a double-dip
recession, China would be completely at risk. Chinese
exports to the United States climbed by 19.1 percent in
the first half of 2002, a substantial increase from the
anemic 2.7 percent in the second half of 2001.
Considering that domestic demand in China is under
considerable pressure from reform-driven layoffs in
state-owned enterprises, exports now play a more
critical role in sustaining economic growth. Exports
account for about a fifth of the Chinese economy.
Without strong export growth, there is a danger that
overall economic expansion will cool and with then
social unrest could follow.
There are two pivots
in the interrelationship between the US and Chinese
economies: the health of the US corporate sector and the
strength of the US dollar. The current mayhem in the US
business world is not positive news, as it potentially
reduces the ability of those companies - many of which
are already bringing foreign direct investment to China
- to continue to expand operations in Asia's largest
country. Strategic planning, market studies and the
hiring of local expertise in the China market are not as
important as making certain that the company uses
acceptable accounting standards, access to credit lines
continues and the chief executive officer and chief
financial officer stay out of media headlines. The stock
market's volatile nature and the nervousness of
investors distract corporate attention from conquering
the Chinese market. While this is not likely to hurt in
the short term, the impact of this in the medium term
could be harmful to China's growth prospects as foreign
capital flows are likely to slow. China needs that money
to fund its development.
The US dollar should be
another worry for China. Although in the short term this
is not likely to have much effect, as the yuan is
partially pegged to the dollar, in the long term it
could be highly problematic. Part of the problem is the
increasingly interconnected nature of China and the rest
of East Asia. Beyond the substantial volume of Chinese
exports to the United States, other economies are quite
dependent on shipping parts and components to China for
goods that ultimately are shipped to the US. It is
probable that the increase in exports to China by other
Asian economies in the first half of the year reflected
the strong US demand. The danger is that ongoing
weakness of the US dollar could trigger protectionist
attacks on China and increase pressure on the yuan to
appreciate. China's highly competitive export machine
has made the Asian nation the world's sixth-largest
exporter and earned it a massive trade surplus of US$23
billion in 2001. However, China has become the largest
source of the US trade deficit and is one of a handful
of countries to run a trade surplus vis-à-vis Japan. The
danger for China is that if the US dollar weakens for a
lengthy period of time, Chinese exports will benefit
from greater price competitiveness in foreign markets,
which could cause US, Japanese and European
manufacturers to lobby for more protectionist measures
against Chinese goods.
Considering that the
George W Bush administration has become increasingly
protectionist to curry political favor at home, this is
a very real threat to Chinese exports. In addition,
Japanese manufacturers and farmers have also sought to
reduce the inflow of cheaper Chinese products. If China
entered into a trade war with the United States and
Japan, prospects for growth via exports would diminish.
This, in turn, would have an impact on other Asian
economies that export to China as part of a production
process.
Another reason China should be
concerned about Wall Street's chilling downturn is that
beyond China's dynamic economic growth, strong export
expansion and massive foreign-exchange reserves is a
soft underbelly. The financial system is weak, with a
number of the major state-owned banks having critical
problems with non-performing loans. Within five years,
World Trade Organization membership will allow foreign
banks to accept local-currency deposits from Chinese
citizens. If foreign institutions take enough deposits
from China's four major state-owned banks, China could
have a massive banking crisis, which it would be
hard-pressed to finance.
Complicating matters,
China's stock markets are not fulfilling their role of
being a key source of capital for the country's major
companies. Rather, they are fighting accounting fraud,
share-price manipulation and inadequate transparency.
Related to all of this is China's heavy reliance on
deficit spending. It is estimated that the budget
deficit will widen from 2.7 percent of gross domestic
product (GDP) last year to a little over 3 percent this
year. Behind these numbers, infrastructure spending
surged 24.4 percent in the first half of 2002. Anyone
traveling to China can see the hand of state spending in
roads, airports and other infrastructure projects. All
the same, it is no mystery that the spending comes
before the planned change of political leadership this
year when President Jiang Zemin is expected to step down
and his heir apparent, Hu Jintao, assumes command.
Political stability has a price.
China sits in
an interesting position. While the United States
struggles with the threat of a double-dip recession,
Japan is attempting to maintain an anemic recovery, and
Euroland putters along, China is still enjoying strong
economic growth. Yet there is a timer on China's ability
to maintain that pace of growth with its major markets,
in particular the United States, in trouble.
Globalization has made China much stronger, but
it has also revealed its major weaknesses. Like it or
not, China's fate is linked to that of the United
States. Wall Street has an impact on Beijing. With a
change of leadership looming in China, these linkages
and their consequences will have to be considered and
tough decisions be made, especially in regard to
cleaning up the financial system.
Ironically,
the call for US corporations to clean up their corporate
governance and finances should have a similar effect in
China. Without financial cleanup and improved corporate
governance, China's strong past performance could go the
way of the Internet and dotcom boom in the United
States.
Dr
Scott B MacDonald is the director of research for
Aladdin Capital and co-author of a forthcoming book,
Carnival on Wall Street: Global Capital Markets in the
1990s (John Wiley & Sons).
(©2002 Asia Times Online Co, Ltd. All
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China and the
global security web
