CHINA’S strength in the world is evident to everyone, having just surpassed Japan as the second largest economy, after the USA, in current dollar terms.
China’s remarkable transformation into a dynamic thriving economy is due to the decision by her post-Mao Tse Tung leaders to embrace the wider world economy after a quarter century of actively rejecting it.
This embrace has, however, been selective.
Traded goods (by and large) flow freely both into and out of China.
Investment, on the other hand, flows freely into the Middle Kingdom but, as the huge ($2.5 trillion) pile of foreign reserves attests, the buck stops there.
The Chinese authorities argue that this is purely a function of prudent Chinese consumer appetites, which have lagged behind the surge in employment that has mopped up the tide of workers migrating from the hinterlands to the wealthier coastal cities.
Ultimately, they say, as they become wealthier, consumption will outpace investment and foreign producers will share in this bounty.
This is true to a degree, but, increasingly, a more hostile interpretation is gaining ground.
Many American politicians accuse China of being part of the cause of the credit crunch. Their argument is that the recycling of ever larger amounts of Chinese savings into US Treasury bonds artificially held down interest rates, encouraging house prices to rise and American consumers, befuddled by a bubble of illusory wealth, to over-consume.
The fact that the American financial authorities encouraged this trend by lax oversight of the mortgage market doesn’t completely nullify the thrust of the grievance, which is that the fixing of the exchange rate has locked American manufacturers into an uncompetitive position while also restricting the growth of Chinese consumer demand.
Trends that were acceptable while the American credit bubble was inflating are no longer so easy to digest.
With almost 10% unemployment in the US, the perception has increased that China is growing at America’s expense.
The exchange rate has therefore become a serious issue for the Obama administration.
Both the President and the Treasury Secretary have recently publicly characterised the yuan as undervalued, signalling American impatience at the limited movement that has occurred in the yuan/dollar exchange rate, after a policy of greater exchange rate flexibility was announced at the end of June.
Displeasure has culminated in legislation now making its way through Congress. Although the “Schumer” bill may not pass the Senate, the proposal for America to adopt powers to put punitive tariffs on goods produced by “currency manipulating” nations carries worrying echoes of the Thirties.
With China at the same time diversifying its foreign exchange reserves away from the dollar, while making only lukewarm noises in support of American debt, the image of a Mexican stand-off where nobody can win comes to mind.
Such tensions add to the general level of risk in global markets.
Ultimately, we think this is a banana skin that will be side-stepped, since greater yuan flexibility should benefit both China (through lower inflation) and her trading partners.
However, the mood would undoubtedly be a good deal more relaxed for equity investors if only China could spare a “jiao” (10 Chinese cents).
John Haynes,
Head of Research,
Rensburg Sheppards
