“Have no friends not equal to yourself.”
- Confucius, The Confucian Analects
“To have little is to possess. To have plenty is to be perplexed.”
- Lao-tzu, The Way of Lao-tzu
What’s interesting about the quotes from these two great sages of humanity is a very simple common element the Chinese have endured as part of their collective soul for millennia: be wary of the world and always be aware of “more.” While the last notion is a bit of an aphorism, it is only one of the paradoxes that China faces now that it has solidified its preeminence in the world, moving ahead of Germany as the third largest economy and close on the heels of a fait acompli to overtake Japan’s long-held number two spot. Throughout its long history China has vacillated from these philosophical tenets through adherence — the Han Dynasty, the Boxer Rebellion, in a dark way Mao’s rise — yet abandoning them through the last years of the Yuan Dynasty’s failed excesses. In fact, some could argue that Deng Xiaoping’s radicalism towards economic freedom had undone these simple, long-cherished values by “unfortunately” opening the door to “western capitalist doctrine,” or conversely has emboldened these philosophies by embracing them and China’s place in a modern world.
Regardless, the result is that it has propelled China — prematurely or not — into the mantle of its global leadership role. The underlying driver of this long, slow, never-ending movement is its people’s malleability and acceptance to endure just about anything. It is in this context Chinese policy makers and the wildly paced market activity of its citizens redefine the country’s economic manifest destiny. This economic freedom is certainly tempered with a tightly controlled social and governmental control as they charge headlong (although not entirely by their design) into a Western-defined world of government, economics, finance, military, culture, health, philosophy, law, innovation and speed. We examine China’s current economic situation and impact on currencies, but also look at a broader set of inputs that could help define this great “sleeping bear” (defined commonly in the 60s and 70s in the new paradigm of their nascent, de facto global leadership role, which for better or worse will be increasingly defined by strategic military might).
China faces some interesting, highly visible global scrutiny that spans their society’s politics, economics, cultural activities, finances, military and sense of societal well-being. It’s evident that China has come a long way when we see it mentioned in the headline press about: trade sanctions against the U.S. over its Taiwanese military sales, currency revaluations, real time altering of U.S., Eurozone and Japanese balance sheets, being a lynchpin in climate change policy and even odd coverage about topics such as Stephon Marbury’s (a former NBA basketball player) entry into the Chinese league’s basketball team or having their Ministry of Finance minions meeting with the Mayor of Montgomery, Alabama. The issue they increasingly face is reflected in the Lao Tzu quote above: “... to have plenty is to be perplexed.” The flashpoint of this thought is its relationship with the U.S.
First Front: The Economy
The foundation of the U.S. – China relationship is the economy. The U.S. has never had a complete rival during the 20th century that has challenged it both economically AND militarily. The U.S. still has no competitors yet, but it is the most vulnerable it has ever been in this century on both fronts. However, when China is pitted against the U.S. in terms of how it views its global leadership role, a representative viewpoint is expressed by a Chinese official quoted in the November 11, 2009 edition of The Nation who said, "When America talks about strategy, it implies military, security, confrontation. In China, we have a much broader view of the idea of 'strategy.' We mean something that is long-term and systematic." This distinction will drive what makes for successful long-term strategy. We’ll examine what could be considered the proverbial three legs of the leadership stool: the economy, the military, and society.
Fiscal Stimulus, Lending, Overheating?
A big question in 2010, as a result of the quite effective USD $400 billion fiscal stimulus of 2009, is whether China is spawning another bubble or whether they have sound economic growth. The quick answer very much seems to be the latter. Why? The government, rightly, acted quickly to ward off an overheating economy by recognizing the limits and usefulness of its fiscal stimulus. The stimulus was directed almost solely at increasing bank lending to spur domestic demand. As a result, that surge in bank lending and public works spending boosted investment to a nearly unprecedented degree. The National Bureau of Statistics (NBS) says capital formation contributed 92.3 percent of China’s economic growth in 2009, or eight percentage points of the 8.7 percent overall growth rate. Final consumption contributed 4.6 percentage points or more than 60 percent of the growth. To offset this — and the market is nodding its approval — it is limiting bank lending.
New yuan loans are likely to be capped at around 7.5 trillion yuan this year. Analysts say the decision to hike the amount of money banks must park at the central bank by 0.5 percentage points will have minimal impact on banks’ profitability and won’t hurt their capability to lend. Every 0.5 percentage-point hike in the reserve requirement ratio would cut banks’ net interest margin (a key factor that determines banks’ profitability in China) by a mere 0.006 percentage points and earnings by 0.4 percent.
A strong punctuation point to ward off excess non-productive capital was its somewhat surprising move in early February when the People’s Bank of China (PBOC) hiked the Reserve Ratio Requirement (RRR) by 50 bps to 16 percent for large commercial banks and 14 percent for small banks. Given the rapid growth in the economy and increasing inflationary pressures, moves along the tightening path (after lending was curtailed in H209) is welcome to prevent further overheating. That said, the 50 bps hike in the RRR is without much bite, given the level of excess reserves at the PBOC. Thus we expect further tightening measures to control inflation will be implemented in coming months and should have the intended effect of maintaining an 8-10 percent growth rate for the year without causing unnecessary inflation or boom-bust anomalies. Another area of risk for stable and rapid growth stems again from fears of a property and or stock bubbles.
Asset Bubbles: Property, Financial Securities
Property prices in 70 of China's large and midsize cities rose 7.8 percent in December from a year earlier, extending November's 5.7 percent rise, the National Development and Reform Commission said Thursday. Prices in December rose 1.5 percent from November, accelerating from November's sequential rise of 1.2 percent as reported by the economic planning agency. December was the seventh consecutive month that urban property prices rose from year-earlier levels. All of this does not bode well. However, with bank lending cooling down, double digit price increases are unlikely to come from excess governmental capital liquidity versus true economic capital formation through growth. For example, China's manufacturing activity grew at a relatively rapid clip in January and producer prices rose sharply despite Beijing's recent efforts to curb booming bank lending, two industry surveys showed. This is an area of real risk to China that should be watched.
Currency, Inflation, Economic Health
In addition to tightening on the monetary policy front, we now also expect the Chinese authorities allow the CNY to resume its appreciation path. While the timing of when the appreciation trend will resume is unclear, we anticipate a 5 percent appreciation on a 12-month horizon. The market currently prices a 3.2 percent strengthening move. This will have little impact on inflation. We now expect inflation to average 3.5 percent in 2010, up from the previous 2.4 percent, with a peak rate of over 4 percent in Q3. While we have long expected policy tightening from the Chinese in response to precisely strong growth and inflationary pressures, we have brought forward the timing to later in Q1.
Second Front: The Military
Today’s leadership still comes down to military might and most of that still a function of nukes. Take that out of the equation and the foundation for China’s military might is quite sound and growing rapidly. China spent US $70 billion in 2009 on its military or about 1.7 percent of its GDP. However, many refute that figure and it includes many different inputs that are out of the scope of this article. That said, the Rand Corporation estimates that based on purchasing power parity China could have spent up to 2.3 – 2.8 percent of its GDP. What does this mean? In effect, it buys China nearly the equivalent of what Russia has in its entire arsenal of combat aircraft, submarines and transport, with more than four times the troops. The only two areas it is underserved versus Russia are nuclear weapons and tanks. Add to it the fact that China need not fund global operations, implying that most of this funding is an investment and has a truly modernized war machine if needed. The U.S., on the other hand, spent $553 billion in 2009, with about $130 billion for contingent overseas operations (i.e., the War on Terror). This is now growing to over $880 billion in 2010 with about $200 billion going to the war, all of which comprise about 4.7 percent of GDP, which in effect is about 9 to 1 in spend versus China. The important aspect of this is that China has been growing its productive capital use (purchasing power parity) at nearly 200 percent per year. It is no secret that China is preparing itself for leadership in this area and the only thing that prevents it from being at the top of the ladder is nuclear capability.
Case in Point
China announced its plans to punish U.S. companies involved in a $6.4 billion arms package for Taiwan. What’s interesting about this development is that for the first time China said it would impose unspecified sanctions on unnamed companies involved in arms sales to Taiwan and scale down contacts with the United States. While the Chinese government has not named any specific companies for sanctions, a strong possibility could be to Boeing, the No. 1 U.S. exporter, which has huge commercial interests in China for its commercial aircraft sales among other technology sales. United Technologies also has significant sales in China, where it sells Carrier brand heating and air-conditioning, Otis elevators and escalators and other products. Let’s see how this plays in the Obama administration should there be an impact to U.S. jobs with the continuation of the prior administration’s policy regarding military sales to Taiwan. This is the beginning of a very long-term set of low conflicts and a real war of capital.
Third Front: Society
Given that this topic can fill the U.S. Library of Congress, we will make note of the Google row to highlight a key societal flashpoint. The Google issue, for now, will serve nothing more to the Chinese government as a sideshow because: 1) Google is a far third in Web visitor traffic in China, 2) Google has not found a reliable way to replicate its business model and, most importantly, 3) the Chinese government wants its 300 million Web users to click onto Baidu and Sino, which for the most part they do. What the Google row has brought into focus is the boundaries of the government interest in freedom of choice and, more mundanely, the scope of its tolerance for its trading partners. You don’t think Microsoft, IBM, GE, Boeing, Fox, Warner Brothers and thousands of other multinationals are not raising their eyebrows over this? The second implication is what the Chinese people will think of the government’s action. Is there a “virtual Tianmen Square” in the making or will they grumble a bit and just click www.baidu.com?
This conundrum has forced the PROC into a psychological call on whether it abandons the philosophy noted at the beginning of this article or creates entirely new ones, defined by the modernity and weight of its new place at the global leadership helm. And the real competition remains with the U.S. Will China believe it to be a “friend” not equal to itself? Stay tuned.
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