• Thu
  • Oct 23, 2014
  • Updated: 8:22am

China's economic 'rebalancing' likely to hurt world's emerging economies

PUBLISHED : Saturday, 01 February, 2014, 4:56am
UPDATED : Saturday, 01 February, 2014, 5:05am

Countries that supply China with raw materials got a taste in January of what the future holds as the world’s second-largest economy prepares to restructure itself and dampen its mega-growth of the last two decades.

Rattled investors engaged in a massive sell-off of stocks and currencies from so-called emerging markets, hammering countries from Brazil to South Africa that have profited from mining exports to China.

This won’t be the last time the world’s markets react - some would say overreact - to what some call China’s “rebalancing.” China is just getting started on boosting the domestic economy and scaling back the kinds of resource-intensive industries that have made it the world’s manufacturing giant. Because of China’s enormous size and economic clout, even a few baby steps can make the world tremble.

Michael Pettis, a professor of finance at Peking University, said China’s transition would harm numerous developing countries, particularly those that had invested heavily in exporting iron and other metals to China.

“There is no way around it,” said Pettis, who’s also a senior associate in the Asia Program at the Carnegie Endowment for International Peace. “If you are Brazil, Peru . and you made a big bet on (metal) commodity prices, you are going to be very disappointed.”

China isn’t the sole source of financial headaches for certain emerging economies. The U.S. Federal Reserve has been “tapering off” its bond-buying programme that helped supply many of these countries with foreign capital to fuel their exports.

But for big mining industries in Brazil, Australia, South Africa and other countries, diminishing returns from China are looming, and alarming. China’s steel industry consumes more than 60 percent of the world’s iron ore imports; a staggering figure, given that China is also the world’s largest producer of iron ore.

China uses much of that steel to pump up the economy with government-funded infrastructure projects. But excess investment in subways, bridges, steel mills, housing projects and factories has left the country with massive debt and pollution problems. “Investment is like opium for government,” one Chinese business leader, Cheng Siwei, said in a story published Thursday in China Daily, a government-controlled newspaper.

Some U.S. economists said they were surprised at how world markets responded to reports that Chinese manufacturing had contracted in January for the first time in six months.

“We all knew that China’s growth rate had to slow. We all knew that the growth rates of the past 30 years were unsustainable,” said Jock O’Connell, a California-based trade economist. “Now, apparently, slower growth in China has investment analysts on Wall Street sounding a trifle hysterical.”

O’Connell noted that China’s gross domestic product is expected to grow this year at a very respectable pace: roughly 7.4 percent, as opposed to 7.7 percent last year, according to some estimates. But for Wall Street and world markets accustomed to years when China’s economy regularly hit double-digit growth, that drop is a disappointment.

It also comes amid rising concerns about China’s debt problems and so-called “shadow-banking” sector.

Dominated by government-controlled entities, China’s banking system is actually two systems. Regular depositors in this country of 1.3 billion people open accounts that offer low interest rates, supplying the government with cheap capital for infrastructure projects. Seeking higher returns, wealthier Chinese have been putting their money into investment funds and other forms of shadow banking, which largely are unregulated by the government.

In January, a major Chinese investment fund nearly went into default. The fund - issued by China Credit Trust Co. and marketed by Industrial and Commercial Bank of China Ltd., the world’s largest bank - was set up to raise money for a coal-mining company, the Shanxi Zhenfu Energy Group. When the company’s leading shareholder was arrested and accused of banking irregularities in 2012, it focused attention on the coal company’s finances and the riskiness of many shadow-banking investment funds. Days before a default was possible, China Credit somehow came up with the money to pay off investors, possibly helped by a bailout from a government-controlled bank that was worried about a “run” on other investment trusts.

Analysts differ on whether these trusts are a ticking time bomb for China. Victor Chu, a Chinese investment banker who’s the CEO of First Eastern Investment Group, acknowledges the rising debt of shadow banks but said recently that he thought it could be handled. “It’s still a manageable part of the system. . It’s totally manageable,” he said during a panel discussion on China at the World Economic Forum in Davos, Switzerland.

In order for China to “manage” its shadow banking and change its overall economic focus, it will have to enact policies that will upset some of its political elite, Pettis said. The nation’s staggering growth has been based on low interest rates for bank depositors, low wages for workers and an undervalued currency, all of which have promoted exports.

But that growth model has kept household spending low, resulting in an unbalanced economy. The government’s challenge now is to increase domestic spending, which will help some Chinese industries but hurt others that are dependent on the traditional economic model of heavy industry and exports.

On a global scale, Pettis said, the good news is that some countries will benefit from China’s transition, even as others are harmed. Wealthier Chinese families will want better meat and produce, giving countries that export food to China a boost. Countries such as Mexico also may benefit, he said, since their manufacturing bases will be better able to compete worldwide as China’s wages rise.

These changes won’t happen rapidly, Pettis said, but they have started and will surely cause more market eruptions as Beijing enacts them. “Keep an eye on China,” he said. “The next year will be very interesting.”


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This article is now closed to comments

China will act in its own best interest hence one must not see too much on its re-balancing act. It has reached a stage where it needs to re-structure its economic model as the one in the past has run its full course.In economic parlance it has no choice but to re-structure its economic model the fallout of which will painful and hurt others too. Its not advisable to depend on one huge market alone but to spread ones wings around.
Lombard Street’s Charles Dumas also argues that Renminbi is overvalued right now.
Ongoing overvaluation is forcing China's debts up.
The PBOC/government should act now to allow for a managed devaluation than risk a greater crisis tomorrow.
As of 31 Jan 2014, the ten-year US treasury yield has fallen below 2.7% for the second time since the start of this year --- a red flag has been raised.
The present crisis has spread to the European EM markets.
The affected EM countries may have to implement measures of capital control to avoid a destabilization of their economies.
With so many EM countries’ currencies (together with the Japanese Yen) depreciating against the US$ and hence the Renminbi, perhaps it’s time for China to stop revaluing or even devaluing (massively) her own currency.
Unlike the Asian Crisis in 1998, this time it’s really different --- China has to deleverage while experiencing a much slower growth rate than before.
It’s not an appropriate time for China to act as a gentleman while the other countries are pursuing beggar-thy-neighbour policies and exporting their recession to the other countries.
Through the development of the last three decades, China has become a adolescent.
Her development over the next three decades will decide if it becomes a bona fide superpower, like the United States, or a middle-income-trapped country, like the Latin America.
China is seeking to walk the path, in the next three decades (that took the United States a century), in transitioning from an industrialized, manufacturing heavy society to a society more focused on technology and labour productivity.
She has to transition from the export-led model of growth to a domestic consumption-driven model --- a daunting task, but one that must be done to avoid the middle-income trap.
Favourable institutional arrangements and productivity enhancement along with high technology development and transfer are the keys to success.
(From ‘Strategic Priorities’)
The most worrisome part of China's boom is that much of it was based on out-of-control credit growth.
Financial crises that are built on debt are like houses built on quicksand.
Shadow banks are entities that borrow money for the short term and invest it in long-term assets.
These entities are not depository institutions and are not properly regulated.
This reminds us very much of the shadow banking system in the United States that encountered problems in 2007.
You may say Chinese government debt as a percent of GDP is not high.
But countries like Spain had lower debt before their property bubbles burst, only to see debt
skyrocket once the crisis arrived.
(From 'Code Red')
In 2004, Jim Rogers, one of the smartest investors of commodities, wrote the book ‘Hot Commodities’.
In it, he said that the coming long commodity bull market will end in 10 years.
Today it’s 2014 --- he’s exactly right!
With commodities it’s critical to invest at the beginning of a supercycle --- the present increase in the price of iron ore outpaced the biggest bubbles of the past few decades: gold in the 1970s, the Nikkei in the 1980s, and the Nasdaq in the 1990s.
But a commodity bull market is really just a bottleneck and as a species we’ve succeeded in bottleneck removal --- the biggest mining companies worldwide are encouraged by the higher prices to boost output by a crazy amount.
Betting on commodities implies betting against human ingenuity.
(From ‘Code Red’)
Rebalancing is going to take decades and its questionable if it will ever occur under the current political system....the rebalancing is more likely to hurt China than other countries and the ensuring economic chaos will leave Chinese economic policy disjointed, fragmented and inconsistent. This will cause FDI to flee en masse. The fact is, that which needs to be done and reformed is incompatible with the current political system and the goals are competing. This is why China is more likely to go from crisis to crisis until it descends into chaos.


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