Since the ascendancy of Hu
Jintao to the top job in China, it is fair to say
that Western observers have been disappointed with
the reforms carried out so far. While there are a
number of reasons for this, I believe that two
specific issues and one historical one are tying
Hu's hands.
The historical reason is easy
to understand and can be encompassed in two words:
Mikhail Gorbachev. As for the structural causes,
the first is the banking problem that I mentioned
before (Indian, Chinese banks plunge at
different rates, August 3), while the
second has much to do with today's geopolitical
situation (China and India in World War
III, July 26).
The reforms that
I am concerned about are transformational economic
reforms, mainly in the areas of industrial
organization
and capital efficiency. I
am not concerned about political reforms at this
stage, believing instead that the general
population will some point embrace the Taoist
principles of self-preservation to overthrow the
Confucian ethic that has been imposed on them, and
which only the ruling elite hold dear.
Banking reforms It is fair to
say that confidence in money, if not banking
systems per se, has always been central to the
functioning of any Chinese government. Throughout
history, we have seen kingdoms fall when traders
stopped extending credit to their sovereigns. One
of the main reasons that Chinese traders used
precious-metal ingots for many centuries was the
lack of faith in paper money, ironical given that
China invented the idea.
Banking, though,
has been more of a modern invention. Until very
recently, Chinese found the idea of depositing
their savings with an unknown and, worse,
unrelated person odd. This led to the use of
banking-type institutions mainly by rich traders,
and mainly for the purposes of settling
transactions. It is no coincidence that today's
bamboo networks across Asia center on very
specific banks that were all formerly
family-owned. This can be observed in Taiwan, in
Hong Kong, in Singapore and across Southeast Asia.
The general public's confidence in banks
is connected with confidence in their rulers. More
than any occupying power and certainly more than
the Kuomintang, China's communists have
appreciated this, which is why they have
approached the subject of banking reforms
carefully. However, as I mentioned in my previous
article on Chinese banks, the survival of any
government in China depends its success in
generating jobs.
The day that the millions
of people thrown off from the agricultural labor
force join hands with the hundreds of thousands
left unemployed by China's privatizing the public
sector must be the stuff of nightmares in the
Zhongnanhai.
This is where the need to
maintain public confidence in the banking system
comes in conflict with the need to continue to
maintain employment levels. While strong and
successful banks would rather have little to do
with moribund but employment-generating,
state-owned enterprises, they have little option
but to feed them credit. If they failed to do so,
they would lose state backing and risk a run on
deposits.
The government's approach to
this problem has been to open up parts of the
banking system to foreign ownership in preparation
for a more complete opening by 2009 as required by
World Trade Organization. To entice foreigners
into owning shares in problem banks, the
government in essence segregated bad assets into
separate areas, leaving the shell of a profitable
entity with good assets available for public
ownership.
But the root causes of problem
loans, namely the state's directing banks to lend
money to unprofitable state-owned industrial
organizations to maintain employment, have not
been addressed, which is why today's good banks
will be tomorrow's bad ones.
Why not
more industrial reforms? As I explained
before, the average price charged by Chinese
manufacturers on their exports has been
falling, rather than rising in line with
commodity prices and other cost factors, including
labor and land. With few Chinese companies
commanding brand recognition - notable exceptions
being Lenovo and Haier - the bulk of Chinese
production goes to own-brand products distributed
from the likes of Wal-Mart. Unable to make profits
on their exports, Chinese manufacturers have
instead taken to making money speculating on
property.
It stands to reason that
American consumers purchasing cheap home
appliances from Wal-Mart would like prices to stay
fairly low - all the more as they are probably
borrowing the money to pay for the purchases as
well. Mass-market consumers in the US, who buy the
bulk of Chinese exports, are in essence living on
borrowed money.
Keeping them in the buying
mood entails keeping interest rates low, which is
why the Chinese government has been buying up so
many US Treasury bonds in addition to all
securitized bonds.
Leaving all that to one
side, what would be the best circumstances for
real industrial reforms? Clearly, this would
require elimination of unprofitable capacity,
creation of new product capacity and for existing
capacity to become more profitable. The three
conditions are inter-linked, since more profitable
companies are the ones that will create new
products.
They are the ones that will
eventually employ the people thrown out of work by
companies shutting down product lines rather than
continuing to sell to Wal-Mart at prices below
costs. Hence it is easy to surmise that
raising prices will be the key element in
China's succeeding in its industrial reforms. That
is where the second part of the story plays a
spoiler role.
Now think of World
War III I've already written about the
challenging geopolitical situation. I hope readers
won't accuse me of caring more about China's
welfare than that of billions who will directly
suffer from the conflict. However, I remain of the
view that China and India will be the biggest
strategic beneficiaries of a mutually destructive
war between the West and Islam, even if such a
benefit only unfolds over the long term.
Mounting tensions in the Middle East will
cause oil prices to double, at the very least.
Increased fears of terrorist incursions will keep
consumers off the streets. To entice consumers
back to shops, prices will either have to be very
low even as borrowing costs remain negligible
(which is affected by interest rates). Any way you
look at it, China remains vulnerable.
There is an old saying that if you owe a
million to the bank, you are in trouble, but if
you owe the bank a hundred million, it is
the one in trouble. The Chinese government is
roughly in this position - its trillion-dollar
holdings of foreign-currency reserves depend very
much on these economies not encountering
disastrous inflation.
It also needs
Western economies to keep ticking on, because
otherwise there would be no one to buy the
billions of dollars' worth of exports being
produced every day.
As I wrote before,
China has little baggage to carry into any battle
between the West and Islam, and will therefore
align with whichever side suits its interests
best. To keep the oil flowing in, and its exports
of goods flowing out, China is constrained by
being unable to participate in the
hostilities. Instead, it will cooperate fully with
the West to ensure that no weapons of mass
destruction from the likes of Iran and Pakistan
are delivered against the US and its allies.
Back to the reform question - the above
are the reasons Hu Jintao and his comrades refuse
to engage more aggressive reforms. The dangers of
mis-timing are too great at this stage, and the
benefits are long-term in any event.
Thus
it is that reforms are the dog that did not bark
in Hu's China, much like the canine character in
the famous Sherlock Holmes story. It's a curious
incident, but one that becomes understandable when
you realize that some people love dogs, especially
with black bean sauce.
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