Opinion

The Great Debate

China and the world economy

July 24, 2009

gerard-lyons Dr. Gerard Lyons is chief economist and group head of global research, Standard Chartered Bank. The views expressed are his own.

The world is witnessing a shift in the balance of power, from the West to the East. This shift will take place over decades, and the winners will be:
- Those economies that have financial clout, such as China
- Those economies that have natural resources, whether it be energy, commodities or water, and will include countries, some in the Middle East, some across Africa, Brazil, Australia, Canada and others in temperate climates across, for instance, northern Europe
- And the third set of winners will be countries that have the ability to adapt and change. Even though we are cautious about growth prospects in the U.S. and UK in the coming years, both of these have the ability to adapt and change.

China is at the center of this shift.

The scale and pace of change in China is breathtaking. Against this backdrop of dramatic change, let me look at China’s impact on the global economy, especially in the aftermath of the financial crisis.

It is now clear that the financial crisis was a result of three key factors: an imbalanced global economy; a systematic failure of the financial system in the West; and a failure to heed the many warning signs.

The world needs to move towards a more balanced economy. But that will take years. The imbalanced nature of the world economy led some to point the finger of blame at the savers, such as China. The 1944 Bretton Woods agreement placed no obligation on savers, countries with current account surpluses. The obligation to change was put on those countries with the deficits. This has to change.

Whilst China and other savers may not be the main source of the recent problem, they are part of the solution.

To move to a balanced global economy, the West, or at least countries like the U.S., the UK and Spain, need to spend less, save more. In contrast, regions like the Middle East and Asia need to save less and spend more. It sounds easy. It is not. It requires a fundamental shift in China and in Asia’s growth model.

At the recent Asian Development Bank (ADB) meeting in Bali, the President called for Asia to rebalance its economy by: expanding the social safety net; providing assistance to small and medium-sized enterprises; and deepening bond markets.

Amongst those present, I detected more enthusiasm for the social safety net than for further financial sector innovation. One of the lessons of the 1997-98 Asian economic crises was the need to open up the financial sector at a speed best suited to domestic needs. One speed does not fit at all. Yet, it is important that if Asia is to see a shift in its growth model it needs to see a reduction in savings and this will be achieved sooner by deepening and broadening its capital markets.

This involves many changes, such as increased personal finance and allowing people to borrow against future income. It requires deep and liquid corporate bond markets, shifting the region’s culture away from equities, and giving firms alternative sources to bank lending and, in China particularly, reducing corporate savings, possibly through higher dividends.

China will play an important role in this process. It has already helped regional integration, building on the Chiang Mai Initiative, and it has engaged in a number of bilateral swap arrangements with countries around the world.

Another important global impact is the importance of China in helping world trade, investment and financial flows. Over the last decade the three words seen most regularly were “Made in China”. Over the next decade the three most common words might be “Owned by China”. China’s stock of overseas direct investment is one-thirtieth of that of the USA. The stock of foreign direct investment in China far exceeds the total amount China has invested overseas. Last year, China’s investment overseas was $50 billion. Now this is changing. Chinese firms are taking advantage of a strong renminbi and of strategic backing from Beijing to expand overseas purchases.

The impact of China on global commodities is already evident. China’s rapid growth and its strategic needs saw it accumulating increasing amounts of commodities. For instance, it accounts for about one-third of global demand for aluminum and copper, and as much as 38 per cent for zinc. In the first half of this year there has been stockpiling by China of a range of commodities. This stockpiling could be explained by many factors, including the strength of the Chinese yuan and the weakness of commodity prices. In future years one would expect this to continue. And it will not just be metals. Demand for food and soft commodities will be important. As incomes rise, food tastes will change.

Furthermore, 28 per cent of Europe’s land is arable, while this figure is 19 per cent for the U.S., but for China it is only 10 per cent. As a result, China will not only buy commodities, but it will also invest in countries producing commodities. This will reinforce the new corridors of increasing trade and investment flows between China and Africa, Latin America and the Middle East.

China’s purchase of commodities has a direct link into the inflation outlook globally. In previous years, CPI figures around the world could have been renamed China Price Indices, as China exported deflation. In the next few years, if there is an inflation issue it is likely to be through higher commodity prices, with China’s demand exerting a key influence.

China will have a big bearing on the dollar. There is a slow burning fuse under the dollar. Even if the U.S.’s economic power were to wane, it is important to stress that the U.S. is still the world’s major economy. There are no credible alternatives to the dollar. Long after the UK ceased to be the world’s major economy a century ago, sterling remained the world’s reserve currency for some time. During this crisis it was noteworthy that, despite much negative sentiment towards the dollar, in the time of trouble the depth and liquidity of U.S. financial markets helped support the dollar as a safe haven.

Furthermore, it would not be a surprise if – as a result of this crisis – more countries learned the lesson of Asian economies after their crisis, and decided to accumulate foreign exchange reserves. During this crisis those countries with high FX reserves were afforded an additional degree of protection. Of course, not all reserves need be in dollars. Even now, countries with large reserve holdings do not actively want to sell the dollar. It is not in their interests to do so. Instead of this active diversification – or outright selling of U.S. assets – there is what I call “passive diversification”, whereby a smaller but still sizeable proportion of their net new reserves are allocated to dollars.

For its reserve currency status the dollar needs to retain its status as the medium of exchange and as a store of value. Interestingly, China and Brazil recently agreed to pay each other in their own currencies, not in dollars as is the norm, whilst the pressure China has put on America regarding the dollar’s value highlights the concern some have over its future value.

China still has a huge balance of payments: its surplus reached 9.6 per cent of GDP last year. The authorities have kept the yuan stable versus the dollar, although this has meant it has appreciated on a trade weighted basis. The Chinese are also, it seems, encouraging trade settlement in Chinese yuan. Yet the reality is the Chinese yuan needs to become fully convertible for it to challenge the dollar and that is not going to happen any time soon. In the future I would expect to see more countries manage their exchange rate against the currencies of the countries with which they trade. This, plus the new trade corridors I mentioned earlier, and the likelihood of increased investment flows into emerging economies with higher growth rates, may all suggest downward pressure on the dollar. But this is likely to be a slow process.

On the global stage, China’s rise is also leading to the rise of State Capitalism. A couple of years ago we looked at this in the context of Sovereign Wealth Funds. Add in large foreign exchange reserves, government pension funds and state owned enterprises, and the role of the state has become far more important.

Finally, China’s influence on global policy forum is important. Already this crisis has seen a shift, with the G20 (Group of Twenty) taking a prominent role. The Chinese took a pro-active role ahead of the London Summit, which was welcome, and is perhaps a sign of things to come. One wonders, however, whether it is the G2 of the US and China that might emerge as the real power. Earlier this year President Obama signaled a shift from the Strategic Economic Dialogue, to the Strategic and Economic Dialogue. This extra word “and” signals perhaps a significant change.

Comments
15 comments so far | RSS Comments RSS

Hopefully (coming from the UK) the government can ween itself off the “leverage” binge it’s been on and start encouraging real productivity, growth and stability after having presided over a decade or so of the exporting of the drivers of productivity and growth to the Asia region in search of short-term benefits from cheap labour, less (or no) labour regulations and cheap over-heads, which is looking more like an own goal to me. Unfortunately I’m not convinced they haven’t completely lost the plot. Are they only going for short-term personal (or small group of recipients) gain?

Posted by Peter H | Report as abusive
 

Sir; while I agree with your broad view on China being the second major player on driving the world economy particularly on commodities and household electronics. There is one glaring flaw which might throw a spanner in its works, in its charge forward and that is internal politics China is not a democracy and its relationships with most of the other great powers and economies will always be viewed suspicously. Should the Chinese move to a democratic system their rewards may be greater and its influence stronger, but as things stand in my view it will only go so far and is very close to that now. Already in my country Australia there is a desire to limit Chinas ownership in companies due to the states hand in behind the scenes control and boardroom pressure. Most democracies baulk at this type of control by a second country on their economic checks and balances, but not usually if the company is in the free market and under normal market controls from a second country and also democratic. How do you punish a director of a said company where he is to a certain degree working under the second countries direction and not acting for the best interest of all shareholders and stakeholders as all directors should be. Second country meddling and actions seeking to manipulate markets cannot be tolerated especially from organized dictatorships. Close bonds and mutual aid and respected between democracies and above all trust are the main base to good free business.

Posted by Peter Mitchell | Report as abusive
 

Can you say

“Economic War”? Amazing we go in a freefall from idiocy on Wall St. and China comes out smelling like money.

I hate coincidences

but this is too much.

Posted by C.D. Walker | Report as abusive
 

China is kicking tail and taking names and the world sits by and watches sitcoms on TV or gets into tangles at soccer matches.

The US has sent all but a little bit of its industrial and manufacturing jobs to China. China is growing economically. Duh! Our leaders in the US don’t care if this nation falls, so long as their own pockets are filled with cash. It’s all about personal gain and not so much about country. It’s the republican way and it has been for years.

When we collapse it will be because of failed republican economic policies that don’t put America first.

Posted by Geoff | Report as abusive
 

The cracks in China are beginning to show.

The only reason it has such growth at this time, is because it is the only country that fixes it’s currancy value to the slavery standard.

The developed nations are willing to play China’s game, as long as there is profit to be made from sweatshop labour. And this helps the West in their own economic development. But at the end of the day China has no real friends, only business partners.

And with the largest population on the planet, China has to keep it’s growth at high levels. Sooner or later this might not be able to continue. And if growth starts to fall, this will lead to fracture and social unrest.

And on that day, the developed countries will not lift a finger to help their main economic rival. Instead, the developed nations will probably just take the opportunity to step on China’s fingers, in order to help it down the slippery slope of democracy.

Posted by Anon | Report as abusive
 

While the trend with China is true, it is NOT a function of real economics. It is purely due to the political choices made by US Presidents and Legislators. The only reason China has an economy at all is for the following fundamental reasons:

1) US Environmental policy that China is exempt from (especially in energy, mining, and the carbon tax)(The US Auto industry is a great example)
2) US Worker and Product Safety policy that China is exempt from
3) The strong arming of the US government on businesses to accept bad labor union agreements
4) Poor US fiscal policy and debt management (spendig more money than available and squashing private enterprise (the source of that revenue))

One day, when the people of the USA finally realize that private enterprise is far more important than government, China will no longer be a “financial” tiger. Until then, China will dominate the artificial world economy.

Posted by Mike | Report as abusive
 

It is purely a fact that workers in developed west countries do not want to work as hard as these in the east. While at the same time, they need a lot of expenses like high wage, good benefits etc, Good example is comparing Japan’s car makers with Detroit’s big three. Thus problem is from west people but not any others.

Posted by True_teller | Report as abusive
 

What most of the diagnoses and suggested cures ignore is that the worldwide financial crisis was demand driven and panic aborted rather than of “imbalances” in savings rates, balance of payments, etc. More ver, there has been a consistent tendency to fail to recognize, let alone address, the root problem, which is how to avoid “bubbles” without at the same time heading off healthy growth in the economy. Three propositions:

1. Consistent good demand news spawns demand “bubbles” which manufacture their own liquidity

As former Fed Chairman Greenspan has noted, the central banks have no means for preventing or shortstopping bubbles, apart from taking the entire economy into recession or keeping the economy unnessarily poor. In today’s environment of sophisticated communications, taking away the liquidity “punchbowl” is no small task, because demand can stimulate into existence many sorts of financing options. Also, bubbles in their early stages are hard to distinguish from healthy growth and indeed they contain within trhem a nugget of healthy growth (e.g., google was destined to prosper even though it was part of the .com “bubble”).

2. Diminishing good news spawns spotty weakness in bubble demand, which in turn stimulates fast-acting cuts and demand and bubble-bursting

If as occurred in 2007 received wisdom becomes that home prices will go up only 4% next year rather than the 10% or more of the prior two years, buyers move into wait and see mode or cancel transactions. As a result, home prices in fact go down, which in turn creates an accelerating panic and a crush at the exit doors.

In today’s world, the compression in the time it takes for people’s mood to shift means that the “bubble cycle” is both shorter and steeper.

3. Panic in turn causes customers and investors far away from the direct impact of the bubble to take defensive actions that impact not only day-to-day transaction volumes and prices, but institutional structures.

Very clearly, we were headed for an institutional collapse-stimulated depression, not because of pre-panic “imbalances” in the economy, but because of the sky is falling panic. Governmental action to preserve institutions, notably banks, helped curb panic. On the other hand, adding liquidity and guarantees so that banks would not collapse could save the instututions to fight a future day, but not create demand for loans. Banks can “push” money just as GM and Toyota can push cars, but customer demand rather than supplier inventory is king.

Nobody has responded to Alan Greenspan’s observation about the lack of ability to deal effectively to mitigate the impact of bubbles on either the up or down side. Assorted good housekeeping regulatory notions and “save more” rhetoric does not address the realities that drove the panic.

 

The fear most western countries have are due to lack of understanding of China. Keep in mind that China did not ever invade western countries using force when it was the largest economy for last 18 out of 20 centuries. and this is not china’s interest..

China does have its internal problems (given the size of the country and population), but not too much to worry about by the west.

Posted by Kevin | Report as abusive
 

This post, while certainly informative, is based far too much on fantasy and speculation.

First, while we are clearly in agreement that China may manipulate state owned companies, this manipulation reaches much deeper and is especially corrosive. We know that China exerts a far stronger grip on its press and bureaucracy, then other comparable economies. So with this secrecy and limits on information, how can we trust that China’s state published statistics are accurate?

Basically, the Party could claim any level of growth they want, it would be impossible for western observers and analysts to accurately verify. A recent Reuters article just stated that they obscure their actual debt holdings. So, really anything that emanates from the state must be considered circumspect at best.

The second major caveat to this discussion is the simmering socio-political undercurrents. In recent weeks there have been ethnic riots in the west, labor unrest in the north and east, and small scale demonstrations virtually throughout the country. Despite the impressive, yet likely fabricated growth rate, there appears to be many fault lines in the relationships between the people and state. While they are currently being contained, this could change very easily. The state may have exceptional control, but they realize that they cannot contain widespread unrest indefinitely. If a cohesive revolutionary front emerged, it would play havoc with China’s security and development.

We must remember, that despite the impressive numbers, and obvious economic improvements, most of the country resembles the 3rd world. The state exerts a penetrating and pervasive grip on almost all aspects of life. Human rights and environmental degradation are also huge, yet still easily overlooked, issues.

Clearly, China has a long way to go before it can be considered a developed economy. If anything, India has far more economic potential than China, and should be the country we most actively invest in. Until China comes to terms with its problems at home, it will never be a great power.

Posted by Greg | Report as abusive
 

Kevin I think you might find that Gengis Khan and his army (who arguably also united China into more or less what it is today) did invade the west in the 13th century. By a curious twist of fate it take some of the pressure off the European armies not over-run by them by plowing through the Muslim armies in the east who had been on a mutually antagonistic series of campaigns against the west.

Posted by Peter H | Report as abusive
 

Hi, there,

The ongoing US-China strategic and economic dialog will help both countries understand each, this is 21 century, let us encourage solving differences through dialog, a more civilised way, in my view, China is dong a good job in making itself rich, its people wealthier and a more open society, US is also heading to the right direction by stopping the war in Middleast and turning its attention to its economy……

Posted by Billy | Report as abusive
 

This is a good article.
Today,also read of 53 American financial institutions are very bad shape.
Now,it is the right occasion to ink with China for more trade and commerce ,and it will give more economic advantages to America,.
As a ordinary,with less insight,I welcome new,real steps by America and China for more economic,trade co-operation for future benefits.

 

our China’s economy is based on the environment polution. sooner or later, we have to pay back for it. now Dalian city of liaoning province established a PX chemical project,which is only 20 km from city center. not soon later, all dalian citizens will suffer from the polluted air. and Dalian will not be a beatiful city of software develpment and tour, however, it will be a chemical and heavy industry city.

Posted by wendy | Report as abusive
 

West needs to look at its base first, i think the fundamentals are shifting, boy now you learn!
I don’t see Chinese taking any interest in leading the world or trying to accomplish ! The eastern men are survivalist my partner! they can consume all the bull, yet we have some hope they learn! But I have my doubts if Yuan will be in my pockets!

Posted by Sodash | Report as abusive
 

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