Page 2 of
2 It's not
China's markets - it's the model By Scott B MacDonald
has been more
than 10% and investment has flowed into
construction, real-estate markets and industrial
inventory.
Easy bank credit has also meant
many first-time borrowers putting their money into
the stock market. One observer noted: "Mortgage
applicants often conspire with real-estate agents
to secure home loans before shifting funds to a
third-party bank account." That loan often goes
into stocks.
According to Yin Jianfeng, a
researcher at the Chinese Academy of Social
Sciences' Institute of Finance and Banking, some
300
billion to 500 billion yuan
($38.7 billion to $64.6 billion) of banks loans,
almost all refinanced mortgages and revolving
consumer loans, may have gone into the stock
market in the past year. This works well when the
stock market goes up, and the Shanghai and
Shenzhen indices were up substantially before
February 27, and have recovered since to record
highs. However, when the market moves lower and
values plunge, panic ensues.
Chinese
government measures have had only a limited
success at cooling the boom. While February 27 was
a signal that something is wrong - an overheated
stock exchange and probable insider trading - a
more fulsome unraveling of Chinese stock markets
could spread into other parts of the economy. The
issue of fast money and weak regulation continues
to dog the economy, a potential Achilles' heel
that only reinforces the need for changes in the
economic model.
One aspect of China's
success has been its ability to deliver on strong
economic growth. If nothing else, that has meant
the Chinese economy remains on the move and, with
it, the belief that some of the benefits of the
system can be obtained by all. Take away the fast
pace of growth, and the myth of upward social
mobility gets stripped from the social equation
and the door opens for discontent on a large
scale.
Most Chinese are aware that they
live in a more affluent society, but differences
between the growing upper and middle classes and
the rest of the population, much of it still
rural, represent a growing societal faultline. The
ratio of urban to rural incomes is now 3:1, while
there is a tenfold divide between per capita GDP
in the wealthiest coastal province and the poorest
landlocked region. China's approach to
globalization is creating two countries. One is
connected to the global grid, increasingly
affluent and influential. The other country is
less connected, poorer and lacking influence. But
the second China is growing more aware of
corruption, the weak rule of law, and the
disparity of national wealth. These two worlds are
moving into collision as the rural population
wants and needs change, but the urban population
is more driven by the desire for the status quo.
Social unrest in the countryside is a
growing concern. China's globalization has brought
tremendous benefits, but continued change does not
necessarily offer more upside. Hence China's very
success is pushing it into a new environment of
conflicting socio-economic currents.
The quest for a harmonious
society China's leadership is aware of the
scope and scale of the challenge. Last October,
Premier Wen Jiabao outlined his vision for a
"harmonious society", which emphasized the need to
deal with socio-economic disparities.
Last
month, Wen admitted that the growth model needed
refining to protect the environment and those less
well-off in society. At the same time, China's
national legislative body approved a corporate
income tax (which ends special benefits for
foreign firms) and finally (after 13 years of
debates and amendments) a law providing protection
to private property ownership. Both of the last
mentioned are radical steps forward as they move
China more in line with other countries, though
the action vis-a-vis foreign firms could hurt
foreign investment.
While China's
leadership recognizes the need to change the
economic model, to slow the pace of growth and to
distribute national wealth better, there remains
pressure not to move too quickly, especially from
interest groups, including members of the ruling
Communist Party. Wen stated last month: "For our
socialism to go from being immature to mature,
unperfected to perfected and undeveloped to
developed, will take a very long time." But China
may not have that much time.
China needs
to shift from such a heavy reliance on
export-geared manufacturing to the development of
higher-paying services for local consumption. This
would certainly help stimulate consumption, help
unwind industrial overcapacity, mitigate trade
friction with the US, Japan and the EU, and slow
the pace of potentially inflationary
foreign-exchange accumulation (now more than $1
trillion). It would also ease over time the
pressure for China to let its currency appreciate;
such a measure could be taken in an incremental
fashion as the service sector grows in strength.
Globalization and its potential
disconnects Although there is a steady
drumbeat for China to move rapidly to let its
currency float and to adopt protectionist trade
acts like the one currently under consideration in
the US Congress, the changes that count the most
come from China. This is because they are
important for the future of that country in its
maintaining political order in a changing society
and becoming a more reliable member of the
community of nations.
Any major disruption
of the Chinese economy could have a negative
impact on the US economy, considering that Chinese
savings help fuel the US consumer binge. The
Chinese, along with other Asian central banks,
have been some of the largest buyers of US
Treasuries and corporate debt. According to the
rating agency Fitch, Chinese holdings of US
Treasury securities amounted to $350 billion at
year-end 2006, in addition to an estimated $230
billion in US agency bonds. This has been an
important source of capital as the US consumer has
been running on either negative or close to
negative savings rates for the past couple of
years.
In a sense, Chinese savings help US
consumers buy Chinese exports on sale at Wal-Mart,
Target and other retail discounters, while the low
costs of production put many of the same people
out of work. Consequently, China looms large in
the US economy, both as a low-priced source of
consumer goods and capital as well as a
competitive economic challenge.
Conclusion If China does not
make the changes needed in its model, the next
time Shanghai is hit by a stock-market meltdown,
the danger could well be that the ripples will go
deep into the country's political economy. Such a
development would certainly hold out the threat of
what China's leadership fears the most - societal
upheaval that ousts the old regime and ushers in
another one of the Middle Kingdom's periodic bouts
of chaos and warring kingdoms. And that would be
in no one's interest.
Dr Scott B
MacDonald serves as a senior consultant at KWR
International, Inc.
(Posted with
permission from KWR
International, Inc, a consulting firm
specializing in the delivery of research,
communications and advisory services.)
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