Saturday 4 October 2008

Will China’s Economy Sink with the US Crisis?

Anyone who believes China is set for smooth-sailing as the US sinks is likely to be as wrong as those arguing a year ago that the sub-prime-loan crisis was containable.

Many Chinese are recession virgins - they are far more used to booming than slowing growth. Equity investors are far more accustomed to double-digit gains than big drops in shares. It’s an open question how this year’s 58 per cent plunge in Chinese shares affects sentiment.
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Guanyu said...

Will China’s Economy Sink with the US Crisis?

By WILLIAM PESEK
4 October 2008

FEW questions confound economists more: What might tip China into the meltdown that so many have feared for so many years? Possibilities include overheating, social instability, corruption, pollution, debt crises, war over Taiwan and a post-Olympics growth swoon. It’s a perfectly rational expectation. No rapidly industrialising nation has ever avoided some kind of crisis, least of all upstarts in Asia.

The list rarely, if ever, included a Wall Street crash. And yet, financial troubles in the US may be the catalyst that devastates the world’s fourth-biggest economy.

This will sound like a reach to those viewing Asia’s strengths. China, for example, is enjoying 10 per cent growth as US lawmakers argue over rescuing markets and averting a depression. With its US$1.8 trillion of reserves, China could bail out the US without batting an eye.

Japan is returning to acquisition mode after its banks avoided the toxic debt devastating US peers. Mitsubishi UFJ Financial Group Inc’s US$9 billion investment in Morgan Stanley this week is a case in point. After years of lecturing Japan about its shaky banks, the US is coming hat-in-hand to Tokyo.

Yet China’s chances of avoiding the US crisis are dwindling by the day. ‘US consumers are tapped out and they’re going to stop buying Chinese exports,’ says Simon Grose-Hodge, a strategist at LGT Group in Singapore. ‘There’s no way China’s domestic demand can take up that slack.’

Adds Michael Pettis, a finance professor at Peking University in Beijing: ‘We should all hope the recession associated with the US financial crisis is very, very mild.’

The odds of a mild US slowdown are declining almost as fast as stock prices. Even with hundreds of billions of dollars worth of Wall Street bailouts, consumption decreases and big job cuts will probably intensify.

The slow drip, drip, drip nature of Wall Street’s swoon should concern officials in Beijing. China’s mercantilist model makes the most populous nation dangerously dependent on consumers in the biggest economy.

Growth in Asia will experience quite a setback if the US enters a prolonged period of weakness. While a Japan-like ‘lost decade’ isn’t the best-case scenario, Americans aren’t sitting on the kind of savings that Asians are. As US growth slows, debt is reduced and households increase savings, exporters such as Hong Kong, South Korea and Thailand must look elsewhere for demand.

Europe and Japan may be of little help. Japan is on the verge of a recession, while Europe is becoming increasingly vulnerable to events in the US. China will be hurt by all of the above, ridding Asia of a key source of stability.

Many say China’s slowing from 10 per cent growth to 8 per cent isn’t a disaster. Yet if a government relies on rising prosperity to conceal domestic challenges - including the widening gap between rich and poor - slowing growth is a major problem. Nothing less than a drastic rebalancing will be required: More domestic consumption, a strengthening currency and greater investment in healthcare, pensions and education. Pulling that off quickly and with minimal disruption would be a feat like no other in economic history.

Asia decoupling

Anyone who believes China is set for smooth-sailing as the US sinks is likely to be as wrong as those arguing a year ago that the sub-prime-loan crisis was containable.

One of the key points here is the importance of Asia decoupling itself from the US once and for all. It’s easier said than done. It’s often pointed out that Asia is holding the cards. Were China to dump its US$519 billion of Treasuries, the US would be in for a shock. So would China, as the fallout in the US would drag on China’s all-important export industries.

Many Chinese are recession virgins - they are far more used to booming than slowing growth. Equity investors are far more accustomed to double-digit gains than big drops in shares. It’s an open question how this year’s 58 per cent plunge in Chinese shares affects sentiment.

There is reason to think Asia can stand its ground. The region’s improvements since the 1997 crisis left banks stable, markets humming and currency reserves at comfortable levels. Turmoil in the US is encouraging Asia to take steps to become more independent from bigger economies. Nations such as China are succeeding by ignoring advice from officials in Washington. After years of being lectured to bolster its banks, China is watching as the financial system the US espoused as optimal crumbles.

The reluctance of Asian banks to buy hard-to-value securities such as collateralised debt obligations left them in ‘rock solid’ financial shape, says Marc Faber, managing director of Marc Faber Ltd in Hong Kong. Also, central banks have been taking steps to boost investor and consumer confidence. If things get shakier, though, Asia could be dragged down with the US economy.

Amid unprecedented upheaval, it almost seems fitting that a risk few considered a year ago could be the one to undermine China.

William Pesek is a Bloomberg News columnist. The opinions expressed are his own.