Thursday, December 15, 2011

Risks ahead after China's credit bubble bursts

China may be seeing the effects of the global economic turmoil that has already enveloped Europe and the US. While China's politicians have been generally upbeat about the economy, new data released recently suggests the property bubble has burst [something tvnewswatch predicted might happen back in September], and that the country faces difficult challenges ahead. And how it reacts may have far reaching implications for the rest of the world.

No bail-outs

Earlier this month China had already indicated that it was unlikely to help out Europe as it struggles to pull itself out of deficit. Vice Foreign Minister Fu Ying, said that Europe could not expect China to use its $3.2 trillion foreign exchange reserves to help rescue indebted nations.

While she did not explicitly rule out using part of China's reserves for more targeted measures, Fu Ying implied China was not going to step in by using its "savings" to bail out the crisis-stricken Europe.

"We cannot use this money domestically to alleviate poverty," Fu said. "We also can't take this money abroad for development support." [Reuters / Business Week / Xinhua / China Daily]

Although China has said it fully supports Europe in overcoming its debt crisis, it seems clear that Fu was reacting to growing economic problems at home. Support is likely to come in ways other than direct financial help. According to the China Daily, such aid would only come through a continuing "foreign policy of promoting peace, development and cooperation." This would not include financial tools, Fu Ying reiterated a few days later.

It appears that China has its own economic problems, and is now less willing or unable to help bail out other struggling countries.

Lack of transparency

Reliable financial data is difficult to come by in China. Just as the state controls the flow of news, financial information is also stifled. For example a French business website found itself blocked in 2007 after it suggested censorship went beyond restricting political content, and could affect the flow of economic and business data.

The Observatoire International des Crises website ( had posted an article, titled "Shanghai, mon amour," (Shanghai, my love) which warned companies about the risks of trading with China. But the report did not go down well with Chinese censors who blocked the website.

Such blocks raised concern both for those doing business with China as well as press freedom organisations. "Internet filtering is not just a problem for political activists, it also affects those who do business with China," an article published by Reporters Sans Frontières asserted. "How do you assess an investment opportunity if no reliable information about social tension, corruption or local trade unions is available? This case of censorship, affecting a very specialised site with solely French-language content, shows the government attaches as much importance to the censorship of economic data as political content."

"The free flow of information online is not only a human rights issue, it is essential to lasting economic growth and the creation of solid trade relations with other countries."

The Observatoire International des Crises (OIC) is a French organisation that produces a magazine on crisis management methods for businesses. The article that prompted China's censorship, written by Didier Heiderich, said: "The Middle Kingdom has managed to divert international investments for its benefit, obtain technologies without anything in return other that the promises arising from our own imagination, gag its dissidents - including those abroad - and ensnare the west in its golden clutches (...) Perhaps it is time to realise this before we are closed in the Chinese trap for good." [PDF]

The OIC later issued a release condemning the censorship of their website, saying it showed "the extreme fragility of freedoms" in China. "It seems to us to be more evident than ever that companies setting up, relocating or buying in China should be discerning and vigilant, acting with industrial rigour and social and environmental responsibility," the release said.

Little change

Little has changed over the past four years despite a greater influx of foreign business into China. In November 2009 the European Centre for International Political Economy (ECIPE) released a report saying that censorship was a inhibitor of trade. "Censorship is the most important non-tariff barrier to the provision of online services, and a case might clarify the circumstances in which different forms of censorship are WTO-consistent," said the study by Brian Hindley and Hosuk Lee-Makiyama [Australian].

In respect to possible US involvement the Trade Representative's office consulted with industry groups about China's Internet policies, spokeswoman Carol Guthrie said at the time. Two groups with links to Google, the Computer & Communications Industry Association and the First Amendment Coalition, told the trade office that China's restrictions on Internet access and content discriminate against US Internet companies and online commerce.

"Cold War"

"There is a little bit of a Cold War going on here," said Michael DeGolyer, a professor of government and international studies at Hong Kong Baptist University. "This is a way of putting pressure on China in a way that is going to be popular with many countries."

But it isn't just the Internet which is restricted in China. Technology companies are "feeling less welcome and finding it increasingly difficult to do business in China", according to John Neuffer, vice-president for global policy at the Information Technology Industry Council, a lobby group. An evolving regulatory regime, targeting information technology-related products, is the chief cause of this sentiment. "Once every bit of the organisational infrastructure falls into place and every rule is implemented, there will not be much of a China market left for us," the regional head of a foreign semiconductor company claimed.

It started in 1999 when Beijing declared that all providers of encryption-related software would be required to disclose their source code. But fears were allayed the next year when the government issued a "clarification", saying the rule would only apply to products whose "core function" was encryption. Since 2006 Beijing has put in place the Office of Security Commercial Code Administration (OSCCA), responsible for supervising and certifying encryption-related products and their suppliers. This has placed Chinese institutions and companies under pressure to buy information security products only if they have domestic certification. It is a requirement that foreign suppliers often cannot satisfy.

"The stuff the Chinese government is asking for is stuff we don't give to governments," says a US executive. "If we were to comply and it became known that we disclosed our source codes to Chinese labs, it would damage our standing in other markets." [FT / tvnewswatch]


Such policy is as much to do with protectionism and self interest, as well as control and censorship. There is also a tit-for-tat approach by China's legislators which continually change the rules. After a long running battle between the US and China over trade tariffs [Guardian] this week saw Beijing impose additional duties on cars imported from the United States [Guardian].

Such plans will do little to build confidence in an already strained relationship between China and the US. It may also damage China's economy which is beginning to show signs of cracking.

Signs of cracks

A report on the country's Homelink property website suggests that new home prices in Beijing fell 35% in November from the month before. If true, the calibrated soft-landing intended by Chinese authorities has gone badly wrong and risks spinning out of control, the Daily Telegraph reports .

The growth of the M2 money supply slumped to 12.7% in November, the lowest in 10 years. M2 is a categorisation which represents money and "close substitutes" for money. It is a broader classification of money than M1, which does not include bank reserves. Economists use M2 when looking to quantify the amount of money in circulation and trying to explain different economic monetary conditions. As such M2 is a key economic indicator used to forecast inflation [See Wikipedia].

There are other concerns too. New lending fell 5% on a month-to-month basis and the central bank has begun to reverse its tightening policy as inflation subsides, cutting the reserve requirement for lenders for the first time since 2008 to ease liquidity strains.

The big question is whether the People's Bank of China can do any better than the US Federal Reserve or Bank of Japan at deflating a credit bubble.

Falling stocks

There are warning signs in the Chinese stock market with the Shanghai index having fallen some 30% since May. It is off 60% from its peak in 2008, almost as much in real terms as Wall Street from 1929 to 1933.

Such drops should be concerning both investors and business, some analysts are saying. "Investors are massively underestimating the risk of a hard-landing in China, and indeed other BRICs (Brazil, Russia, India, China)... a 'Bloody Ridiculous Investment Concept' in my view," says Albert Edwards at Societe Generale.

"The BRICs are falling like bricks and the crises are home-blown, caused by their own boom-bust credit cycles. Industrial production is already falling in India, and Brazil will soon follow."

Interconnected world

Production and exports have fallen significantly over the past year in the new industrial power bases as demand in the US and Europe has dropped due to the credit crisis. China's industrial output grew at its slowest pace in more than two years in November and inflation dropped as the global economy weakened further. It was something that even Beijing could not hide. The country's consumer price index, a key gauge of inflation, rose 4.2% year-on-year in November, well below the 5.5% recorded in October and just above the government's 4% target and the slowest pace since September 2010 [Telegraph].

Looming trade wars

The fallout from this could result in further economic turmoil as East and West embark on a massive trade war, Albert Edwards at Societe Generale says.

"There is so much spare capacity that they [China] will start dumping goods, risking a deflation shock for the rest of the world. It no surprise that China has just imposed tariffs on imports of GM cars. I think it is highly likely that China will devalue the yuan next year, risking a trade war," he said.

Of course China is not in the quagmire of economic chaos faced by Europe and the US, but it has become reliant on its export trade to bolster its economy. China's Gross Domestic Product is worth $5,879 billion or 9.48% of the world economy, according to the World Bank. This is significant when compared to its GDP in 1998 when it stood at around $1,000 billion.

Difficult times ahead

In the coming years China will face a difficult time as it attempts to balance its own economy while trying to appease both foreign markets and growing domestic problems. In the past year the country has seen growing social unrest, especially in its industrial power bases such as Guangdong. In an attempt to push forward its rapid industrial development, China has often ridden roughshod over people's land rights. But increasingly those affected have taken to the streets to complain [BBC]. An ever widening gap between rich and poor is another troublesome issue China will face in the coming years.

Some have long predicted China will face great difficulties such as Gordon Chang who published "The Coming Collapse of China" in 2001. While China has yet to fall, Chang maintains that the the country faces some stark problems which may make the country difficult to deal with in the coming years.

But if China is collapsing, why should the West be worrying? Because "China's leaders could get very aggressive in the meantime," Chang says, in an interview with Fox News earlier this year. While he was very much pointing to China's militaristic ambitions, especially as regards Taiwan and the South China Sea, such aggressiveness may also manifest itself in other areas such as business and finance. As China's leadership attempts to protect its own financial interests there will be little room to manoeuvre for western economies who are facing their own domestic problems.

China 'is disintegrating'

"China is disintegrating in terms of its social context. We have all these protests, all these riots , all these murders. It is a really a very tough time now for China's leaders," Chang asserts.

As to whether China's dictators will fall, as seen in other countries around the world in past decades, Chang insists it is only a matter of time.

"It's going to happen in China as well, because you have people who don't agree with what the Communist Party is doing. They really do like the prosperity, but they don't buy into the ideology, and they hate the corruption and many of the other things that have gone along with progress, or what we see as progress. So China's leaders are very insecure with regard to their own people."

But with insecurity comes fear, which could turn to hostility and even war. It cannot be forgotten that World War II was rooted in problems emanating from the economic woes following the Great Depression in the early 1930s. As the world slides deeper into economic chaos, the risks of trade wars may be the least of our concerns.

tvnewswatch, London, UK

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