On March 16, 1979, Columbia Pictures
released The China Syndrome featuring Jane Fonda,
Jack Lemmon and Michael Douglas. In the film's fictional
disaster scenario, a US nuclear-power-plant accident
creates a mass of molten reactor fuel so hot that it
threatens to burn through the reactor's steel vessel and
the plant's reinforced-concrete foundation, descend into
the Earth and exit the opposite side of the planet in
China (a phenomenon dubbed the China syndrome, hence the
film's title). Twelve days after the film's premiere,
the Three Mile Island nuclear-power-plant accident shook
the United States. Nothing melted through.
But
could the much-feared meltdown of the overheated Chinese
economy now burn through to the US (or, for that matter,
Japan and the European Union) and wreak global economic
havoc? I doubt it. But there are plenty of danger
signals, and it pays to review the numbers and assess
the potential damage.
The danger signals are
real enough. On April 28, Chinese Premier Wen Jiabao
told Reuters, "Fixed asset investment is accelerating
too quickly and at too large a scale ... Money supply
and credit have been growing too fast. Inflationary
pressure is mounting ... We need to take effective and
very forceful measures to resolve those problems as soon
as possible."
On Thursday, April 29, non-Japan
Asian stock markets tanked on the Wen statements. Asian
currencies declined sharply against the US dollar. On
Friday, Japan's Nikkei 225 stock average (the Tokyo
market had been closed on Thursday for a national
holiday) precipitously declined by more than 2 percent.
Global commodity markets in metals, thriving on China
demand for the past 18 months, got hammered. US markets
were spared to some extent, as the US is a large net
importer from China and not as dependent on Chinese
demand. But the US bond market, supported by sizable
Chinese purchases of US treasury notes with dollars
bought in the foreign-exchange market to maintain the
Chinese currency's dollar peg at about 8.28 yuan to the
dollar, certainly felt the impact of Wen's remarks. Bond
traders believe that a weaker Chinese economy will take
the upward pressure off the yuan and lead to a reduction
in interventions and foreign-bond purchases by the
People's Bank of China, the central bank.
Initial market reactions to Wen's policy
pronouncements may well have been overdone, but they
were by no means just panicky or irrational. Japanese
export growth last year, which was the principal driving
force behind economic recovery, was to a large extent
fueled by China's demand. Exports to China grew about 40
percent while they declined by some 7 percent to the US.
Overall, two-thirds of Japanese export growth was due to
growth of the China market. What's particularly worrying
to Japanese policymakers is that a large portion of
exports to China flowed precisely into the most
overheated sectors of the economy - steel, autos and
construction - which are targeted for government-decreed
slowdown.
Big impact on Japan,
Korea And not only Japan will be affected. South
Korean exports will suffer as well. The impact on Taiwan
and Southeast Asia will be more limited as exports from
there are mostly semiconductors and consumer
electronics, Chinese demand for which will likely
continue to grow.
The benign scenario is this:
The Beijing government and the People's Bank of China
will take a carefully calibrated approach to
overheating, make sectoral and regional distinctions,
and slow fixed investment in and credit extension to,
for example, the steel and auto sectors and construction
in coastal areas, while increasing investment in the
bottleneck oil, gas and power sectors.
If
successful, this approach should slow overall
investment, which grew 53 percent year-on-year in
January-February as the result of 170 percent and 140
percent increases in steel and autos, respectively. But
it would not seriously slow general economic growth,
since higher infrastructure investment would partially
compensate for losses elsewhere and consumer demand
would remain largely unaffected. Gross domestic product
(GDP) growth would decrease marginally from 9.1 percent
last year to around 8 percent in 2004. Inflation would
remain contained in the 3-5 percent range, as some
supply-side shortages are removed while ample cheap
labor keeps costs down. (In this context it is worth
noting that the hyperinflation of the early 1990s was
ignited and fed by consumer demand, while recent
inflationary pressures are mainly supply- and
production-cost-related.)
Chances for successful
implementation of the benign scenario are in my opinion
above 50 percent. Moreover, if the sectoral-regional
cooling approach should prove too slow in taking hold,
the government and central bank have the option of
raising interest rates and/or revaluing the yuan to a
certain extent (perhaps 3-5 percent) to put an
across-the-board chill on economic activity. The
government wants to avoid general monetary-policy
tightening as that would indiscriminately affect all
sectors and regions and, in fact, hurt the weaker the
most. But it may ultimately have no choice - and therein
lies the danger of a hard-landing scenario with global
consequences, as China, which last year accounted for
just 4 percent of world GDP, nonetheless produced 16
percent of global growth.
Beijing is prepared to
take tough administrative measures to enforce slowdown
of investment in designated sectors and regions.
Recently, 10 steel-company executives were arrested when
they were found to have gone ahead with an unauthorized
US$1.3 billion new steel project. But the concern, of
course, is that for any one group of "over-investors"
caught, there could be 10 not taken to task - either
because their activities remain undetected by the
central government or they enjoy enough political
protection to get away with it. Every local government
now wants its own steel or auto plant in order to become
"gloriously rich" in pursuit of Deng Xiaoping's famous
dictum; local banks assist them in their pursuit.
Front-loading has become rampant as tighter money is
expected down the road.
It's looking like a
runaway train Even with the central government's
best of intentions and well-laid plans, it will be
difficult to slow, let alone stop, what is looking ever
more like a runaway train. Money-supply growth stoked by
relentless bank lending, foreign direct investment and
currency-market intervention funds is back above 20
percent on-year after slowing a bit to 18 percent late
last year and in January-February. Inflation, while
still benign at about 3.5 percent, could reach 5 percent
in the near term. As outstanding loans by the big four
state banks exceed 160 percent of GDP, new bad loans are
inevitably being created at a high rate, even as the
non-performing-loan ratio is stable or declining on new
lending.
In light of this, interest rates may
have to go up substantially and a yuan revaluation to
about the Hong Kong dollar rate to the US dollar of 7.8
may be required, hitting banks' profits at precisely the
time when they are restructuring and fighting for their
very survival. The hard-landing scenario starts with a
local bank run to which the government reacts too late,
with a general financial system meltdown as the
consequence.
That's the horror scenario, the
1997 Asian financial crisis repeat, the China-syndrome
outcome. As indicated above, I don't foresee its
realization - though, with some 40 percent of all bank
loans in the non-performing category by international
standards, there is no denying its possibility. The more
likely outcome is the Three Mile Island one: some rough
sailing, some scary moments, but no breach of the
containment vessel. But even so, Japan, South Korea, and
to some extent the rest of Asia will not get away
unscathed as China slows down.
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On March 16, 1979, Columbia Pictures
released The China Syndrome featuring Jane Fonda,
Jack Lemmon and Michael Douglas. In the film's fictional
disaster scenario, a US nuclear-power-plant accident
creates a mass of molten reactor fuel so hot that it
threatens to burn through the reactor's steel vessel and
the plant's reinforced-concrete foundation, descend into
the Earth and exit the opposite side of the planet in
China (a phenomenon dubbed the China syndrome, hence the
film's title). Twelve days after the film's premiere,
the Three Mile Island nuclear-power-plant accident shook
the United States. Nothing melted through. 
