Barry Ritholtz, the author of Bailout Nation and blogger, had a quick, dismissive comment on the third quarter gross domestic product (GDP) growth rate in China of 8.9% from a year ago because it lacked details. There is no expenditure breakdown of GDP growth. At the same time, since China is among the four countries (the other three are Brazil, Indonesia and Saudi Arabia) that have barred the publication of their annual Article IV consultation reports with the International Monetary Fund (IMF), independent verification of the state of the economy’s health is not possible.
In the private sector, there are inherent conflicts of interest in research produced by many financial institutions. With its ample foreign exchange reserves, sovereign wealth funds and asset management institutions, China trades in international securities in large volumes. These generate brokerage commissions. Further, Standard Chartered Bank estimates that China’s outbound direct investment (ODI) this year (including loans) would be around $150 billion. Even excluding loans-for-oil transactions, the total ODI would be around $40-50 billion. Advising the various Chinese companies on these transactions generates fee income. Hence, very few investment houses pick up the gumption to question the numbers, raise concerns over sustainability and desirability of high growth and point out the risks of asset bubbles.
Their attitude to China mirrors their earlier attitude to dot-com companies. Instead of questioning their valuations and alerting investors to the dangers of investing at such prices, they came up with innovative arguments to justify the market prices of dot-com companies.
That apart, the danger for the world is not that the mantle of global economic leadership could pass into China’s hands from the US one day, but that one does not know how well- or ill-prepared China is for that role. No independent agency is prepared to raise the red flag. Readers should recall the haste with which Ernst and Young withdrew its assessment in May 2006 that bad loans in China’s banking system were around $900 billion. The Chinese government and central bank sources put it at less than $200 billion.
This raises questions on China’s willingness to subject itself to international scrutiny when domestic checks and balances are absent. All global hegemons make their own rules and then make the pretence of obeying them, but in the case of the US, it has an independent and free media and Congressional oversight. The dual-party system lends its own balance, too. While the former Soviet Union had the US to deal with, an enfeebled US, dependent on China to finance its profligate government spending, is unable to play a similar role now.
Victor Shih in a brief but cogent article (“Why China isn’t ready to lead”, The Wall Street Journal, 22 October) highlights through concrete examples the arbitrary manner in which China puts its own and short-term interest ahead of the rules of the game that were established before the game began. He points out that both domestic private entrepreneurs and foreign investors have been hurt by recent decisions. One was the decision to nationalize hundreds of privately owned or leased coal mines. That hurt domestic private investors. The other was the announcement by the state-owned asset supervision and administration commission in September to foreign banks that state-owned enterprises might not honour their obligations under loss-making derivative contracts since they were not authorized to enter into those contracts in the first place!
Recently, Nobel laureate Paul Krugman accused China of stealing jobs from other poor countries. He offered no proof. In trade matters, assembling evidence is not easy and, hence, conclusive judgements are harder. However, in East Asia, if one looks at investment spending, formation of new companies and export growth, these have languished since the Asian crisis of 1997-98. The crisis itself was precipitated, among other things, by the devaluation of the Chinese currency in December 1993.
Indirect evidence supports Krugman’s claims, however. In a recent research paper, Bin Xu and Jiangyong Lu submit that in China, an industry’s level of export sophistication is positively related to the share of wholly foreign-owned enterprises from OECD (Organisation for Economic Cooperation and Development) countries and the share of processing exports of foreign-invested enterprises, and negatively related to the share of processing exports of indigenous Chinese enterprises. In other words, if one excluded foreign enterprises, China still competes in labour-intensive, price-sensitive low-value-added goods.
The danger is clear and present. That in the exuberance surrounding China’s rise, trumpeted by various private sector players for their own narrow ends, the world ignores the still-underdeveloped state of institutions and authoritarian control in addition to its benign neglect of dangerous trends and strains developing in the Chinese society and economy.
It may be that the next global crisis is made in China for, with its excess savings and reserve accumulation, it was the Siamese twin to the US’ excess spending. Veteran investor Jeremy Grantham assigns a one in three chance of a “major China stumble” in the next three years.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views. Your comments are welcome at firstname.lastname@example.org