A story up on Bloomberg may be far more significant than its bland headline, “China to Spur Domestic Demand to Stabilize Economy, Wen Says,” suggests.
In recent posts, we’ve inveighed about the dangers of the path China is now on. Its economy is unbalanced to an unprecedented degree. Exports plus investment account for a full 50% of GDP, an unheard of level. And the investment share, which is now larger than the export contribution, is increasingly unproductive. It now takes $7 of borrowing to create every $1 of GDP growth in China. That’s a terrible ratio for a supposedly emerging economy. Even the US is only $4 or $5 of borrowing for every $1 in GDP growth.
Creditor nations (the ones in China’s position) suffer the most in financial crises. That has not happened yet because the world (including China) has engaged in massive monetary stimulus and China has kept its currency artificially low via currency manipulation. That means it has maintained its trade surplus at the expense of others (most notably Japan, but other developing economies have suffered too).
The rest of the world tolerated China’s mercantilism when everyone was in growth mode. But China has made a monstrous mistake, and it is a fundamental, strategic error. At least until now, it gave no sign of planning to change from a mercantilist model. All the signs from China have been that its leaders think that if it can avoid what happened to Japan , ie being forced to revalue its currency (per the 1985 Plaza accord), all will be well. It actually has been moving to a LOWER consumption share of GDP post crisis, the reverse of what you’d see if it were trying to rebalance the economy.
This movie has ended badly for everyone who has tried China’s game plan. As Michael Pettis has pointed out, China has the largest foreign exchange reserves relative to GDP of any country in modern history. Next two are the US on the eve of the Great Depression and Japan at the end of its bubble era.
So Wen’s remarks, if they are sincere, may signal a fundamental shift in posture, which would be very welcome indeed. As much as the US also badly needs to rebalance its economy too, we cannot get very far if the Chinese do not cooperate.
But Wen’s remarks may simply be another gambit. Recall that China announced its intention to move to a more market based currency on the eve of a G-20 meeting at which it was set to encounter a firestorm of criticism over its sharp rise in exports in the previous month. The move was widely hailed as a major shift; we were virtually alone in dismissing it as a headfake. Events have proven our assessment to be correct. Thus there is good reason to suspect that Wen’s remarks are mere posturing.
First, Wen’s comments are very conveniently timed; they come on the eve of another semi-annual Treasury deadline and in the runup to the Congressional mid-terms, when political scrutiny is at a high level. Even though the House voted to give the President more latitude to impose tariffs on countries that keep their currencies artificially low, Geithner made remarks to try to defuse the situation. Wen’s comments may simply be an empty concession.
Second, everyone understands that switching to more consumption is a very long term project. China could get away with a ton of foot dragging if it were making legitimate moves in that direction, as it needs to. Failure to change means it is effectively exporting goods and related unemployment to other countries. In a period where everyone expects protracted low growth, when there is already a large overhang of unemployed workers, that will not wash. If China does not get with the program, other countries will start retaliating on the trade front.
So as much as this story sound like good news, we need to see action before we can take it seriously. This may simply be a bit of theatrics to placate China’s unhappy trade partners. From Bloomberg:
The global financial crisis has shown the need for China to focus on “structural problems” in its economy including taking steps to encourage more domestic demand, Premier Wen Jiabao said.
“We can rely on stimulating domestic demand to stabilize and further grow the Chinese economy,” Wen said in an interview with CNN’s “Fareed Zakaria GPS” program taped Sept. 23 in New York and scheduled for broadcast today. In the interview, Wen, 68, also said he’s concerned China’s stability may be threatened by inflation and corruption and that he remains committed to pressing for changes in China’s political system.
Wen said he argued even before the recession that China’s economic development “lacks balance, coordination and sustainability. This financial crisis has reinforced my view on this point.”
While these statements are encouraging, enough of the rest of his remarks were disingenuous to raise concerns. In particular:Wen said China’s goal is to “have balance and sustainable trade with other countries.”
“China does not pursue a trade surplus,” he said.
Tell that to Japan. China’s purchases of yen bonds have been a major culprit in driving the yen to unprecedented levels and pushing that weak economy back into the ditch. And what about the rare earths ban? Oh, China denied that it has one despite ample evidence to the contrary.
I hope Wen is sincere but China’s track record says there isn’t much reason to trust mere statements from its officialdom.