Or not.
China is to slow down. She must. The inability to do so will bring dire consequences, including a Great Depression like social disaster that topples governments.
The eye-catching number is the 10.9% GDP growth this 2nd quarter of 2006. Exceeding the target irked the central government. They ordered slowing down. Every local governments seem to be doing exactly the opposite — accellerating growth.
Consumption of key natural resources – oil, iron ores, copper, and soy beans – did not go as planned either. Per GDP unit, China today consumes more energy than US by a large amount. Granted, a growing kid must eat more, but obesity also takes painful years to fix. China accounts for the majority of increased demands for these commodities. She is also the primary reason for the global sky-rocketing prices. Mother earth cannot seem to catch-up.
More pundits predict the coming collapse of the China bubble recently. The theory goes: the growth attracts investments; the investors pursue the same fastest and biggest returns; over-build becomes over-capacity that leads to price wars; loss of profits bankrupt few companies; small collapses panicked the investors and they withdraw their money; decreased capital heightens interest rate and send more companies to bankruptcy court; spiral down and total collapse. History has seen so many of these cycles. Why would China be different?
Worst-case Scenario
What if the worst-case scenario happens?
China has a historically unique economical structure. Investments on fixed assets accounts for almost half of GDP, exportation and internal consumption for 40% and 37%, with exportation growing twice as fast as consumption. Saving rate is among the highest in the world. Citizen income is still low. And, stating the obvious, it has a large population base. This structure makes the bursting, if happens, different than that of, say, USA or Japan.
The fixed asset investments — buildings, factories, roads, public works, etc. — simply become under-utilized. During the internet bubble, companies installed huge amount of basic connectivity such as high-speed fibre cables. Those cables stay buried long after the burst and became part of the social infrastructure. We love it. Innovations spawned to exploit the excessive capacity and the society rejoices.
Most of those fixed investments are made by foreign companies in the form of FDI (foreign direct investments). When Japanese snapped up trophies properties like Rockefeller Center and Sears Tower, US citizens felt their heirlooms lost. Few years later, they can hardly hide their snickers when the recession rendered those investment much less.
The export industries will suffer slightly and temporarily, if that. This industry compete on price and quality. The excessive domestic infrastructure capacity will hold the manufacturing costs at bay. The population base supplies unlimited cheap labor. The imported machineries in the factories maintain quality. Raw materials are the same everywhere — the definition of commodity. I don't see how China export industry losing its competitiveness. Burst or not.
How about that 1.3 billions, or more, people. Wouldn't the collapse hurt them, turn them into rebels, and topple the government?
Remember how China was founded. Soon after 1911, Mao mobilized the poor and hungry to fight against Chang Kai-Shek's well-trained army. He won in 1949 — less than 60 years ago. This is the government (actually the culture) that wrote the book on controlling large number of people. No social disorder will occur.
The worst-case scenario is for è€å¤– (LaoWai: foreigners) only. It seems.
Possible Administrative Actions
Even that, the government will try not to bruise the friendly foreigners. (Don't kill the goose.) Here are some obvious and well discussed measures:
- Appreciating RMB:
Appreciating RMB will make so many happy. (For reasons befuddling some economists, US government is among them.) A stronger RMB reduces the huge foreign exchange reserve, decreases the value of foreign investments, and eases the current balance pressure. It also makes those oil, iron, copper, soy beans, and whatever China needs from abroad cheaper. This is too easy and obvious that government will certainly do it. The only question is how fast.
- Tightening Money Supply:
Raising interest rate can certainly do it effectively by making money costs more. Government can print less money, or increase the reserve ratio.
Banks make money by accepting deposits and lending out money. They can actually lend more than what they have, as long as the depositors do not all thdraw at the same time. To avoid catastrophic “bank runs,” the government requires banks to keep some cash to cover normal withdrawals. The percentage of cash, relative to total deposits, to keep is the reserve ratio. Since most people deposit the money they loan from one bank right back to the bank. The reserve ratio has a multiplying effect.
If the reserve ratio is 5%, a 1,000 dollar deposit allows the bank to loan out 950. If the 950 get deposited back to the same bank, it can then loan out 95% of that, or 925 dollars. The cycle continues until it reaches zero. At the end, the bank would have lended out 20,000 dollars from that original 1,000 deposit. If the reserve ratio increases just 1%, the bank would lend out 17% less money.
In July, 2006, China raised its reserve ratio to 8.5%, up 0.5%. (USA has currently 10% reserve requirement. This makes US banks less competitive than their China counter-parts.)
- Investing Abroad:
Remember foreign exchange reserve? It is the accuminated difference between export and import. China has the whopping 941.1 billion dollars as of June of 2006. Something must be done to digest this big pile of foreign money. They can purchase large ticket items, such as nuclear power plants for airplanes. They can acquire companies such as IBM's PC division. They can also loosen the decades long tight control on investment abroad. Soon, Chinese may be able to buy SUNW stock, or the Rockefeller Center.
- Raisig Taxes:
Hiking the tax rates weed out weaker companies and achieve the slow-down objective. This is, however, very unlikely. Taxes are burden to the society in general and historically hard go down, once raised. The long-term social consequences are difficult to predict. Most governments approach taxation very cautiously and I have not seen many discussions here.
There are, however, talks to level the playing field for domestic and foreign businesses. That's beyond the scope of this blog entry.
