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China is in the news again

The parallels with the Greek crisis are as plain as a carbuncle on the face of a much loved friend. Except that the problems in China and Greece stand at polar opposites of the great currency debacle.

Greece is suffering because she badly needed a much cheaper currency during the boom years. The economy appeared to grow fat on the bounty of a strong euro. In fact, fat is all  it was. She has become bloated, and her economy’s arteries have furred over with debt and lack of productivity.

China, on the other hand, is anorexic. Her lean economic machine doesn’t have enough fat. She grew reliant on exports. In other words, China’s growth was dependent on her trading partners’ profligacy. Without US debt, there would have been no Chinese growth miracle.

Now, talk is that China wants to correct imbalances by pushing up wages. See: China solves economic crisis, with cunning plan

And yet in Greece, the only sustainable solution is to see wages fall. According to Roger Bootle, writing in today’s Telegraph, since Greece joined the euro, Greek unit wages have risen by 31 per cent; in Germany they have increased by just 7 per cent. See: The current Greek crisis is merely act one of a much wider tragedy

Meanwhile, also writing in the Telegraph, Hugh Hendry warned that now the export boom is over, China is turning to investment as its route forward. But it is investing in over capacity, and as such is building up a bubble. Mr Hendry says: “The ancient ethical system of Confucius is silent on the subject of modernisation. There is no proverb counselling that ‘wise men not invest in over-capacity’. Perhaps there should be.”

Then in The Times, Irwin Stelzer used his weekly column to focus on China and its policy regarding her currency. The one thing that articles by Stelzer all have in common is that there is at least one anti-Obama comment. This time he said this about Obama: “The president feels he needs China, which is why he abased himself before his hosts on his visit to Beijing.” Stelzer said: “One thing is certain. China’s continued rapid economic growth, combined with slower growth in the West, will increase pressure on Obama to have China declared a ‘currency manipulator.’”

 The issue of China is important. Actually it is very important. A bursting of the Chinese bubble could have ramifications that will be far more serious than the little local difficulty of EU sovereign debt.

Today we attempt to summarise the key points regarding China, whether she sits over a bubble that will burst, either condemning the global economy to even more misery, or maybe instead smugness in the West, as politicians queue up to say: “Told you so.”

The currency row

In his piece for yesterday’s Sunday Times, Irwin Stelzer said: “When the recession began, the Chinese halted a modest rise in their currency in order to stimulate exports. Now they say that if their imports continue to boom they would contemplate a 3 per cent rise in their currency later this year. So much for Treasury secretary Tim Geithner’s statement to a Senate committee: “I think it’s quite likely they will move” on the currency issue — unless Geithner considers 3 per cent a significant move.”

It seems that politicians from Capitol Hill to Brussels all agree. China must let the yuan appreciate.

But in China, the media and economists are left speechless. How dare the US blame China. The US goes out and spends money it doesn’t have, and now she has the cheek to blame China for saving too much; it is too rich for words.

The reality is that probably both the Chinese and the US views are right.

The first thing which is undeniably true, is that Western profligacy fed Chinese growth. Without US, and to a lesser extent UK debt, China quite simply would not have grown anywhere near as fast as she did. The equation is simple and unambiguous, and yet it gets forgotten. If a country, on the back of surging productivity sees its capacity rise, but consumer demand does not keep pace with rising demand, then one of three things happens. Either that country suffers from mass unemployment, it sees a rise in investment that bridges the gap between supply and demand or it exports. If it exports, then by definition the rest of the world must be importing more than they export. In short, if China saves and exports, the rest of the world must spend and import. See: Why Sudoku explains what’s wrong with the economy

And yet, China remains a poor a country. In absolute terms she may be rivalling Japan for the position of the world’s second largest economy, but on a per person basis she remains a minnow. China is a developing economy, a country where productivity per person lags way behind the levels seen in the developed world. The wise men of economics seem to agree that developing economies need a cheap currency. The US benefited from a cheap currency when she was still a developing economy in the nineteenth century.

The real problem with global imbalances is not simply that China is exporting more than she imports; a deeper problem is that the world’s second and third largest developed economies, Japan and Germany, are exporting more than they import. The problem is compounded by the fact that China also happens to be the world’s most populous country. The global economy can contain developing economies growing via a policy of keeping their currencies cheap, providing that these developed economies are relatively small. When it is China, then the story changes.

Meanwhile, in China a host of reasons are put forward to say why it is the West’s fault and not theirs.

One argument, this put forward by the much respected former Morgan Stanley economist Andy Xie, is that the US itself is a currency manipulator. He argues that the US is manipulating its currency via the Fed printing money and zero interest rates. He suggests that by doing this, the US is flooding the global economy with dollars, and as a result is creating the foundations for hyperinflation, and will ultimately inflate its way out of debt.

Mr Xie’s ideas pander to the fear, common in China, that the US is using a backdoor way of getting out of meeting its obligations. China is Uncle Sam’s main creditor. As such it is terrified of the danger that US inflation will rocket, devaluing the true value of her US assets.

Mr Xie’s remedy is for the Fed to up interest rates to 3 per cent. And in saying that he gets into silly territory. Should the US follow his advice, economic depression would follow as surely as night follows day, and the danger of global conflict would then become very real.

Another economist who specialises in China, Brian Reading, argues that if China were to open itself to global markets it is far from certain the yuan would appreciate. He says Chinese individual savers would then invest their money abroad, pushing down on the yuan, counteracting the currency markets.

In the West, it is argued that Chinese individuals don’t save enough and that this problem can be overcome if the Chinese State provides a better social welfare service. That way, Chinese individuals will be less scared by the prospect of that rainy day, for example losing their job, ill health or retirement, and spend more.

But an article from the Far Eastern Economic Review dismisses that argument, suggesting that given the level of China’s GDP per capita, its expenditure on social welfare is actually already very impressive. The article goes on to argue that individual Chinese will be quite bemused if they hear about Western criticism saying they don’t spend enough. As far as they are concerned, they have seen a spending revolution.

The Far Eastern Economic Review piece suggested that the official data on Chinese savings does not show what is really going on. The problem, it says, is not so much that Chinese individuals are saving too much, rather that Chinese companies are saving too much, and it says the real problem here is that Chinese firms do not pay out high enough dividends.

Strangely, it goes on to conclude that the solution is indeed a more expensive yuan, but says while its conclusions may be the same as Western economists, its reasoning is different.

And that brings us back to the beginning. Maybe another solution to the Chinese problem of corporates saving too much would be higher dividends. Or maybe lower profits. Maybe the solution would be if they paid their workers more money.

It seems whichever way you look at it, the solution to China is one of two things. Higher wages, or a cheaper yuan. In the long run, the solution amounts to the same thing, it is just that higher wages are more politically acceptable. Unlike in Greece, where low wages are unacceptable, the only solution to the Greek crisis which doesn’t involve social unrest, is a cheaper currency and debt default.

For the next article on China see  China and the West – The difference is cultural