Post a Comment On: China Matters

But Will It Be Enough?

The Independent’s Clifford Cooney puts his hoof in it:

With China facing its worst financial crisis in a century, Premier Wen Jiabao assured comrades that the economy would still grow by 8 per cent this year.

Worst Chinese financial crisis in a century?

Worse than the 16% drop in GDP and the death of 40 million people when the Great Leap Forward crashed and burned in 1961?

Well, maybe Cooney’s talking about a crisis in the financial system, not the general economy.

But worse than the hyperinflation under Chiang Kai-shek during World War II?

Hard-money libertarian Richard Ebeling tells us:

In June 1937, 3.41 yuan traded for one U.S. dollar. By December 1941, on the black market 18.93 yuan exchanged for a dollar. At the end of 1945, the yuan had fallen to 1,222 to the dollar. And by May 1949, one dollar traded for 23,280,000 yuan.

Maybe Cooney is thinking of the fall of the Qing Dynasty in 1911 which threw China’s entire population of eunuchs—perhaps the era’s closest analogue to financial writers-- into unemployment?

Actually, Cooney’s trouble is simply careless reporting (or to be fair, maybe careless editing).

China Daily reports:

China's highest leadership… recently said that this year would be "the toughest year" so far this century for the rural economy given falling produce prices and the grim employment situation.

Get it? This century a.k.a. the last eight years. That makes sense.

The article (China Daily, not Cooney) provides more useful information on the government’s thinking.

The wages of migrant workers accounts for half of rural incomes. Of the roughly 130 million rural workers employed outside their hometowns, about 20 million returned home without jobs.

It’s important that unemployed migrant workers can hunker down on the farm instead of rioting there, or in the cities.

The government is approaching the income issue holistically, by boosting the purchase price of wheat (to provide a direct shot of income to rural families) and by providing RMB 20 billion in subsidies to rural areas for the purchase of electrical appliances (to boost rural purchasing power and also sustain utilization—and employment—in the coastal factories).

The government’s challenge in sustaining and growing rural incomes does not appear to be insurmountable.

If we accept that the Chinese economy flat-lines, instead of growing at the 8% that the government optimistically says it will (and is the minimum to keep up with demographics and avoid a reduction in per capita rural income), the math for the countryside looks something like this:

2008 per-capita rural income = 4,761. 8% of that is RMB 381. Multiply that small number by the big number—700,000,000 rural people, you get RMB 267 billion, about $40 billion USD at the current exchange rate. That would be on top of the RMB 600 billion (US$ 86 billion) the government is already spending on rural subsidies, according to Xinhua.

That adds up to $126 billion in rural stimulus in 2009.

By an interesting coincidence, the Chinese government announced that it will run a budget deficit of RMB 950 billion—or $130 billion—in the coming year in order to do its Keynsian thing for the nation’s economy.

That’s 3% of GDP—not excessively high, but not great, according the boffins at the IMF. 3% is the level that the EU tries to cap for its members. 3% is also a lot better than the USA will be doing in 2009.

However, by running prudent and careful fiscal policy in previous years -- reflected in low deficits and debt -- China has created fiscal space that it can now use to fight the downturn, said [Vivek Arora, International Monetary Fund Senior Resident Representative in China].

"In this sense, China is in a relatively strong position," he told Xinhua.

In comparison to other countries, China's deficit-GDP ratio was "at the higher end of the middle range", said Gao Peiyong, deputy head of the CASS Institute of Finance and Trade Economics.

The United States set its budgeted deficit at 12.3 percent of its GDP for fiscal year ending Sept. 30, 2009, while the 27-nation European Union forecast 12 of its members will see their deficit-GDP ratios exceed 3 percent this year.

The interesting, dare I say $390 billion question is, what happens if the world can’t get its economic act together in the next couple years.

China can’t run these big deficits indefinitely, as Xinhua noted:

[T]he biggest challenge for China's fiscal authorities will be how to sustain a continuous deficit expansion in the coming two to three years, [Gao Peiyong, deputy head of the CASS Institute of Finance and Trade Economics] said.

Prior to announcement of this year's budget, China’s debt to GDP ratio was 18.3%, comfortably below the red line of 60%. That’s RMB 5.5 trillion of outstanding government debt on a GDP of 30 RMB trillion. Three years of trillion-RMB deficits is probably sustainable, but it would bring China up to the same debt level that the USA is currently at (before the current stimulus package)—somewhere in the mid-30s. That’s not a place where China would want to be, for economic/inflation reasons.

Three years may be enough time to see the light at the end of the tunnel in a recession, but not a depression.

Recessions are bumps in the road on the way to sustained, consistent global growth. Depressions are a hole in the road that can take a decade to climb out of, once you fall in.

That’s why the Chinese government is regarding the Obama administration’s floundering on the financial question with a combination of exasperation and anxiety.

From Beijing’s view, better to acknowledge the insolvency of AIG, BofA, Citibank, and a raft of European banks as soon as possible, force the shareholders to take their haircuts, and get the global financial system back in the business of lending again—and the global economy back in the business of growing.

China will be hard-pressed to ameliorate a recession that lasts longer than three years. A sustained global depression tacked onto the crash of the Western financial system may indeed yield China’s greatest financial crisis in the last century—and rescue Clifford Cooney from the embarrassment of today’s column.