Full speed ahead to another Asian meltdown

Sydney Morning Herald

9 May 2005
As trade partners waited all last week for a Chinese
revaluation, economists saw a leadership focused more
on letting the good times roll while they can. Hamish
McDonald reports from Hong Kong.
For Jim Walker, the chief economist at CLSA
Asia-Pacific Markets in Hong Kong, the signs are
coming thick and fast.
At the Crown Casino in Melbourne, the front money for
gambling junketeers this Chinese New Year was double
the amount that Asian high-rollers plonked down last
In Shaanxi, a province in China’s inland normally
regarded as heavily in surplus with labour, minimum
wages have just been increased 30 per cent.
At Disneylands around the Pacific rim, signs are going
up in Chinese. “They went up in Portuguese a year
before the [Brazilian] rial crashed,” the Scots
economist notes wryly.
All these, Walker says, point to China coming to the
late stage of its frenetic economic cycle, one
characterised by massive oversupply of a currency so
long pegged to the US dollar its holders treat it as
the same.
Across town at investment bank Morgan Stanley, its
China-watching economist Andy Xie also sees an
economic machine going at high speed towards a crash,
similar to the meltdown that hit Asian economies in
“China is an export and investment-driven model and
the connection between exports and investment is
basically that the state banking system takes the
money earned by exports and puts it into investment
regardless of returns,” Xie says. “That model is
likely to last until the crisis.”
Neither of these two economists see China’s leaders as
likely to respond in more than a token way to the
invitation by many Western financial chiefs, most
recently at last week’s Asian Development Bank
meeting, to start taking the medicine early in the
form of a currency revaluation.
Walker says the signals he’s been getting are that
Chinese officials agree they have to do something to
placate the baying trade protectionists in the US and
Europe, set off by the 35 per cent surge in China’s
first-quarter exports.
But he says it will probably be “disappointing”,
perhaps only a one percentage point widening of the
band around the peg of 8.28 yuan to the US dollar
maintained for the past 10 years. Maybe over a couple
of years, the band could be widened further.
Xie says he expects Beijing will keep stalling,
keeping the expectations of a yuan float or
revaluation alive so that speculative inflows from
overseas Chinese keep flowing in but trying to put off
the evil day as long as possible. Xie thinks they can
spin it out another two years.
“If China appreciates the currency like other people
are urging, China will eventually have a financial
crisis just like in South-East Asia [in 1997],” Xie
These views are in distinct contrast to some others.
On Friday, for example, the ING Bank’s team in Hong
Kong said China could reform its exchange rate within
three months. “We have changed our view on the initial
revaluation and now expect it will be big, around 10
per cent,” the bank said. “Our change of view that the
initial yuan revaluation will be big stems from the
heightened threat of loss of market access.”
While the outside world views China as an emerging
super-economy, Xie and Walker portray it in different
ways as a more fragile developing country with classic
Xie says the case for currency revaluation is a
“bubble” itself; like the other bubbles, a revaluation
is supposed to deflate. “With an emerging market
economy, the pressure for currency to appreciate –
usually it’s a bubble,” he says.
“Look at what happened in South-East Asia 10 years ago
or in Latin America before that. Currency value
depends on competitiveness and also financial health.
In emerging economies, you cannot maintain financial
health, so periodically you have a financial problem.
You have an over-expansion of money supply and you
eventually have currency depreciation. China is no
Walker sees China hitting a wall, chiefly in the form
of a labour shortage; not the much-publicised
reluctance of inland Chinese recently to serve as
factory fodder in the sweatshops of Guangdong, the
industrial province bordering Hong Kong, but supply
gaps in skilled workers and managers.
With about 1 million Taiwanese already employed on the
mainland – about 10 per cent of the island’s workforce
and therefore probably close to the limit – newspapers
in Hong Kong and South-East Asia are packed with ads
for supervisory or technical jobs in China.
Looming ahead, perhaps in 2007 when a year or two of
vanishing profits finally cause a contraction in
business activity, is China’s first serious slowdown
in years, one that could bring new kinds of pain, the
CLSA economist says.
“This is the first truly capitalist cycle that China
has had,” Walker says. “They’ve had upswings and
downswings before but they’ve all been state
sector-led. It’s all been manufactured by the
government. This time round there will be bad debts
accruing to private sector companies and the banks
will react much more differently to that.”
The fuel for the overheated economy is coming from the
central bank’s conversion of rapidly accumulating
foreign reserves – which hit $US610 billion ($783
billion) at the end of last year and are on track to
grow another $US250 billion this year – into yuan and
then trying to “sterilise” the monetary effect by
forcing Chinese banks to buy low-yield bonds.
As two New York University economists, Nouriel Roubini
and Brad Setser, pointed out in a widely remarked
paper last week, the central banker’s efforts had been
only partially successful and the sterilisation effort
limited their ability to apply conventional
interest-rate remedies to excessive demand.
Nor was the diet of low-yield government paper doing
much for profitability in the scandal-prone Chinese
banks, whose non-performing loans Roubini and Setser
put at somewhere between 46 and 56 per cent of China’s
Also last week, the ratings agency Standard & Poor’s
said recapitalisation of two of the big four state
banks – the Industrial and Commercial Bank of China,
and the Agricultural Bank of China – would require
injections of between $US110 billion and $US190
Indeed, the weak position of the Chinese banks and
their huge requirements for capital are cited by Xie
as one more reason against early revaluation. As well
as adding to bad debts by raising domestic real estate
and other prices in relative terms, a higher yuan
would require more US dollar investment to achieve
sound capital adequacy.
Although disposal of bad debts via asset management
corporations is lagging badly, Chinese financial
authorities are still hoping to bring two large banks
– the China Construction Bank, whose assets are mainly
infrastructure loans to governments, and the Bank of
Communications, which already has a 19.9 per cent
“strategic” holding by HSBC – to international share
offerings in coming months.
Like others, Roubini and Setser found a Chinese
economy driven by cheap factor inputs – including
credit, energy and land – rather than productivity
growth. “In this dimension, China looks like the
‘Asian Miracle’ that went bust in the 1990s,” they
There was a growing perception, at least among Chinese
economists, of the “bad bargain” in the China economic
model, whereby foreign investors were guaranteed an
effective 15 per cent return and China put the
earnings into US dollar reserves earning 4 per cent.
They, like CLSA’s Walker, see a need for China to
switch to an economic model more driven by domestic
demand. “China’s existing growth model looks to be
running up against real limits, both internally and
globally,” Roubini and Setser wrote. “Sustaining
growth will require re-orienting China’s economy and
relying at least for a while on rapid expansion of
domestic consumption to sustain growth.”
Revaluation would help do that but at the price of an
unknown amount of short- to medium-term pain. Xie says
that’s the hidden purpose of many advocates of
currency reform. “What those people are trying to do
is to make China crash, now,” he says. “They don’t
believe the political system will tolerate real
financial reforms unless it is forced to. But the
economic consequences are serious. What you are
talking about is stagnation.”
Xie says Beijing hopes to insulate China from the
approaching crisis. “Senior leaders know what’s going
on,” he says. “They hope to accumulate as much capital
as possible, as many people getting rich as possible,
so when you need to make a dramatic overhaul of the
economy the country is still stable because enough
people have jobs.”


Leave a Reply

Your email address will not be published. Required fields are marked *