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China's leaders talk of rebalancing the basis for Chinese growth, shifting from exports and investment to consumption.
That makes a lot of sense to me. China's economy is every bit as unbalanced as the global economy. The conventional wisdom - see the Economist survey - is that China's domestic boom can continue despite China's own imbalances, just as an unbalanced global economy (watch for the March and April Trade deficit) can continue to grow in an unbalanced way.
But China already invests a lot and exports a ton. And that creates a risk that investment may tank or exports may tumble - ending China's ennui-inducing period of stable 10% plus growth.
China's leaders recognizes these risks in their rethoric - along with the need to address the growing rural/ urban divide. But the policy steps taken so far are far too timid to make a difference. The data is rolling in, and it isn't pretty. China is booming, no doubt -- rather uncutting the argument that China is too fragile for any further revaluation. But its boom continues to be driven by investment and exports, and thus adds to its internal imbalances. For the gory details, see Wachovia's useful data wrap.
China's 2006 trade surplus looks set to be even bigger than its 2005 trade surplus, which wasn't small. I realize a lot of people - a truly surprising number of people - haven't adjusted their rethoric since 2002, and think China's trade surplus with the US is offset by deficits elsewhere. It isn't. We now know that China's q1 trade surplus was close to $25 billion. And the first quarter is China's bad quarter.
And that was in the midst of an absolutely enormous run-up in commodity prices. Basically, China is exporting more than enough assembly to pay a much higher bill for all its commodity imports - commodities used both in the export sector and domestically. Value-added is rising as well. That trade surplus didn't materialize out of thin air.
March export growth was above 28%, while import growth was 20%. Q1 export growth was 26.5, q1 import growth was 25%. Forecast that out for 2006, and China's trade surplus would be close to $140 billion for 2006.
I don't think 2.1% + 1.3% - China's inflation difference v the US (about 2%) is going to cut it. I agree with Rajan and Prasad: Bigger changes are needed in the exchange rate -- and more generally.
What of efforts to slow China's reserve growth?
Also not working, judging from the $56b increase in q1.
China has more or less conceded that it doesn't need any more reserves. One official suggested China could make do with just $700b. And even that strikes me as a bit of overkill.
But right now China's reserves total $875b and they are rising fast.
To be honest, I don't think hot money flows into China fell quite as far as some people thought in q4, and I don't think they are rising quite as fast as some think now. Some tend to confuse changes in the dollar value of China's euros and yen with hot money flows.
But there is no doubt that money continues to find its way into China, that China has more reserves than it needs and that China has no plausible strategy to reduce its pace of reserve accumulation.
What of efforts to avoid over-investment?
Well, China's efforts to rebalance its growth away from investment without raising the cost of capital increasingly look to be about as effective as its efforts to reorient its economy away from exports without letting the renminbi move against the dollar.
Investment continues to grow far, far faster than GDP. The latest data puts fixed asset investment growth at nearly 27%, up from 26% last year. Those growth rates are nominal, not real, and the fixed investment number has some problems, but still. And given how fast investment and exports continue to grow, China's overall GDP numbers seem just a bit understated. Investment and exports are a big chunk of China's economy, and in nominal terms, both are growing faster than 25%.
China doesn't just have a boom in investment in factories either. The ADB reports that residential investment increased by nearly 20% in 2005 - and that was in the face of efforts to cool an overheated sector.
China has tried to curb credit growth from the big state banks. But the fall in credit growth in late 2004 and 2005 has not slowed investment, for reasons that I don't fully understand. And it is not clear anymore how effectively China has curbed credit growth, or for that matter, if it still wants to. The FT reports that bank lending increased by $137b in the first quarter alone. Andy Xie has more.
Bottom line: if China wants to rebalance growth away from investment, something needs to change.
What of efforts to rebalance government spending, so that more goes to rural areas?
I am inclined to share skepticism expressed by Tom Miller of the China Economic Quarterly. It is easy to announce an impressive increase in spending on rural areas. But with the overall economy expanding by 15% or so in nominal terms, big spending increases are needed just to keep state spending in rural areas constant as a share of GDP. Reorienting the budget requires much more dramatic steps than have been put forward so far:
Central government expenditure on rural areas is still rising more slowly than overall expenditure. While rural healthcare is in crisis, the state budget for hospital renovation and upgrading in the next five years is less than the cost of building a high-speed Maglev rail line between Shanghai and Hangzhou, two of the nation's richest cities. And plans to extend trials of a rural cooperative health system to 40 per cent of counties this year will see a payment to participating farmers of just US$5 per head.
And then there is the little matter of letting peasants own their own land. Joseph Wang - our resident astrophyscist/ aspiring quant/ China hand -- thinks that this wouldn't work without a less corrupt system of justice to enforce land rights. Maybe. But as the Economist survey and Tom Miller both argue, the inequities generated when the party seizes land for development are at the root of a lot of China's social problems. And it does seem a bit unfair that urban residents can benefit from apartment price appreciation while rural peasants cannot benefit from land price appreciation.
What of China's efforts to convince its companies to "go forth" and expand abroad?
Not much so far, judging from how small Chinese outward FDI remains relative to inward FDI - think $5b going out and $60b going in.
China's efforts to invest in oil production are hampered by the same forces that hamper the big Western companies. The oil exporters don't need investment capital. They are quite happy to reserve their oil production for their national oil companies. Iran may be the exception - but investing their creates a different set of problems.
Chinese firms don't have much incentive to invest abroad in sectors other than commodities. Remember a dollar (or RMB) goes a lot further in China than abroad. Why would say Shanghai Automotive want to build a factory in Europe to supply the European market if the RMB is at about ten to the euro? One often overlooked impact of the peg: it makes assets in China cheap in the eyes of those outside China, and foreign assets expensive to those inside China. That deters Chinese firms from investing in say US manufacturing, though no doubt Chinese firms are interested in buying distribution channels and certain types of technology.
But maybe Bear Stearns' plan to turn itself into the trading arm of China Inc. will be a bit more successful. Think of the potential synergies. Bear starts by managing the small fraction of China's reserves that have been transferred to China Construction Bank. Then it then uses China Construction to convince SAFE to let it develop innovative strategies to increase the return on a broader swath of SAFE's reserves ....
Andy Mukherjee claims that Larry Summers wanted to turn the IMF into a hedge fund in order to boost the return on the world's reserves. China seems to have gotten the message. But it figured that it would be easier to buy into a hedge fund -- or at least a big prime broker -- than to turn the IMF into a hedge fund. Why not let Bear lend China's reserves out to the hedge fund community rather than just lend them to the US treasury?
I am exagerrating a bit for effect. China does need to think about ways to get more bang for its reserve buck. And buying into a firm that can teach it the secrets of America's (financial) dark matter makes a certain amount of sense when you have as many dollars to invest as China does.
But talk of a strange world.
I wonder how the alliance between China's state capitalists and Wall Street traders will play politically. Particularly if China doesn't prove more willing to make other policy changes, and its vision of reform boils down to finding way to put its enormous reserves to work more effectively. Buying into Bear seems to help those in United States already winning from the modern China trade, and not do much for those on the losing end.