China

There is currently a debate raging inside the China National People’s Conference about the future direction of the enormous Chinese economy. The recent economic crisis has highlighted a weakness of the Chinese economy, its reliance on exports. With decreasing demand in most parts of the western world Chinese exports took a significant hit, this forced Beijing to enact a massive investment and loan program. This position is unsustainable for the Chinese because it encourages risky lending and inflation due to access to easy money. Chinese president Hu Jintao is currently pushing for a fundamental shift in the structure of the Chinese economy to secure it against future downturns in the global economy, and to prevent massive inflation and un-productive allocation of capital. The president plans to reign in the growth in most coastal areas by increasing wages and making these areas less competitive. This, combined with other initiatives, will increase the competitiveness of the manufacturing industry inland and will focus the economy more towards selling goods domestically. This can be achieved because of heightening levels of Asian consumption; by 2006 Asian consumer spending had surpassed that of the United States for the first time. In China car sales have jumped 59% since 2009 and imports have increased by a staggering 56%. Some claim that this growth in consumption can be attributed to the massive stimulus plan in China and the housing bubble that it has been believed to have created. However, unlike the United States most homebuyers in China actually own most of the value of their homes. One quarter of Chinese homebuyers pay upfront and the average mortgage only covers 50% of the property’s value. Also, unlike other Asian countries like Japan, which essentially built roads to nowhere in order to keep the population working, China is in need of infrastructure development. Hu is currently being challenged by an opposition which wishes to keep the Chinese economy focused on exports. This side of the argument is supported by powerful interests in the exporting sector, who do not want to see their profits go inland. However, if Hu is able to push his new economic policy through there could many implications for the United States and the rest of the world.

During the economic crisis the Chinese have kept the value of their currency pegged to the dollar so that Chinese industry would be given a favorable position when exporting to the United States. If China decides to focus more on domestic consumption there will be less incentive for the Chinese to keep their currency pegged to the dollar thus leading to the appreciation of the RNP against the dollar. This will have two effects, firstly it will make U.S. firms more competitive in the Chinese and domestic market as Chinese goods will become more expensive. But because of this Americans will experience an increase in the cost of many goods, think anything you purchase at Wal Mart. Perhaps because of the possibility of decoupling China has been slowly taking steps towards establishing the RNP as an international reserve currency. In September 2009 the Chinese government issued 6 billion Yuan of bonds in Hong Kong. This is an important move because it is the first time China is selling bonds in the international market place. This is seen more as a move towards establishing the Yuan as an international currency than to raise funds because the Chinese are not in need of any additional funding. RNP denominated bonds would encourage corporations to issue debt in the Chinese currency and encourage new markets for financial products based on the RNP.

Another important implication of this potential decoupling is the effect on the amount of treasuries and dollars the Chinese will buy. Currently China owns about 1 Trillion dollars of United States debt which amounts to nearly half the stock of treasuries thought to be in the hands of foreign official owners. China holds so much U.S. debt in order to keep its currency pegged to the U.S. dollar, if this is no longer necessary China may curb its purchasing of U.S. debt. Additionally this will further hedge the Chinese against potential fluctuations in the U.S. market. The potential effects of this can already be seen; in 2008 China purchased bonds equal to about half the size of our budget deficit while in 2009 China only purchased bonds worth 2% of the deficit. This is very significant for the United States. Reduced demand for U.S. treasuries could drive up interest rates, push down home prices, and possibly start a run on the dollar as investors lose confidence in the currency. The U.S. economy is currently dependent on artificially high housing prices and other government stimulus efforts. These efforts were highlighted last week in my examination of Fannie and Freddie. The stimulus is dependent on debt issued to foreign economies, mainly China. If foreign nations do not purchase our debt and we are forced to sell it to the Federal Reserve massive inflation could follow. If there is a decreased for demand for U.S. debt we will see interest rates rise and investors will become less willing to take on this debt. If the U.S. is not able to finance its spending it will quickly be left with a huge deficit that it will be unable to repay which would have many disastrous effects not only for the United States but most of the world.

Update March/17/2010: China has concluded its National People’s Congress and has announced its plan for the direction of the Chinese Economy. China will continue its government stimulus efforts to encourage economic growth. Interestingly this money will be spent on reducing citizen’s biggest expenses, mainly by encouraging the construction of affordable housing and reducing the costs of healthcare and education. These changes confirm that China is moving towards a self sustaining economy by increasing the purchasing power of the Chinese consumer.