Re: China's Wealth Woes

[Robert Weinert]

THIS IS AN EXCELLENT ARTICLE - FOR THOSE INTERESTED IN FIAT CURRENCY & INTERNATIONAL BANKING - Bob

China's Wealth Woes
http://www.msnbc.msn.com/id/14535192/site/newsweek/

With its dollar hoard rising at $17 billion a month and about to pass the $1
trillion mark, Beijing is finding out that it is possible to have too much
money.

By George Wehrfritz
Newsweek International

Sept. 4, 2006 issue - Sometime over the next few weeks, a shipment of lawn
furniture, brake pads, lamps or the like is going to make history. The
manufacturer, one among tens of thousands churning out product 24/7 in China's
humming coast-al cities, will fill an order bound for the United States, take
payment in American dollars and add a 12th zero to Beijing's foreign
reserve—pushing the tally over the $1 trillion mark. Neither buyer nor seller
will realize the transaction's significance, and barring an unforeseen shock to
the global trading system, China's reserve will continue to rise by roughly $17
billion a month.

Beijing's growing dollar hoard represents the most dangerous imbalance in
today's global economy. The United States is both importing heavily from China
and borrowing heavily from the country to finance those purchases, pushing the
dollar down and putting the two economic superpowers on a collision course.
Washington politicians demand that Beijing raise the value of the yuan against
the dollar, and Chinese officials have hinted that if pushed too hard they might
shift their near-trillion-dollar reserve out of U.S . Treasury bonds, which could
trigger a U.S. and global recession. The main thing preventing this
confrontation is the fact that both sides have too much to lose. Former U.S.
Treasury secretary Lawrence Summers once called this "the balance of financial
terror." What has gone widely unremarked is that, increasingly, this balance is
threatening China as much as the United States.

The United States has been worrying for the past 25 years about a mounting trade
deficit and the threat it poses to America's financial pre-eminence. But China
now views its surplus with growing alarm, too. Its dollar mountain reflects huge
demand for Chinese goods and the Chinese currency needed to buy those goods. In
mid-2005, Chinese officials, under intense pressure, did allow the renminbi to
rise slightly, by just over 2 percent, but they fear—with some reason—that to go
further could undermine their export competitiveness and lead to bankruptcies.
Speculators, however, are betting that China will have no choice. The global
market assumption that the renminbi is destined to rise is now "the key problem"
for China's economy, warned the head of the National Bureau of Statistics, Qiu
Xiaohua, last week. "It is fair to say that China is actually fighting a game
against worldwide speculative capital ... If not handled properly, this will
damage the national interest and endanger ec
onomic security."

In an economy that, for all its might, is still in the developing stage, it is
no small trick to absorb $17 billion a month without destabilizing consequences.
The cash is leaching into the economy, fueling growth of 11.3 percent in the
second quarter, the fastest rate since 1994, threatening a meltdown. And every
solution begets new problems: China has tried command economics, like simply
ordering banks to grant fewer loans or publicly denouncing provincial officials
who spend too recklessly, but that undermines its efforts to reform the banking
sector using the market. It has tried raising interest rates, which can restrain
growth but also attracts more dollars—from investors seeking returns, not import
buyers—and weakens domestic demand. "They're in a trap," says Ronald McKinnon, a
Stanford University economist, in reference to China's surging exports and
undervalued currency. "And there isn't an easy way out."

Beijing works hard to dampen or "sterilize" the impact of the incoming dollars
on the domestic economy. To do this, the People's Bank of China (the central
bank) buys dollars from commercial banks for renminbi-denominated bonds, then
limits how much the banks can lend. Yet it's no coincidence, economists say,
that investments in fixed assets, from roads to real estate, have shot up in
tandem with the foreign-currency reserve since 2000. "This will be the sixth
successive year in which investment rises more rapidly than the underlying
economy," says Nicholas Lardy, a senior fellow at the Institute for
International Economics in Washington. "Not a sustainable recipe for growth."

Another embarrassment of China's rising fortune is that it has begun to
undermine financial reforms launched a decade earlier. To make banks more
market-oriented, Beijing has discouraged politically motivated lending to
debt-laden state enterprises, welcomed minority foreign partners and made bank
chiefs accountable for their profits and losses. Yet the People's Bank also
undercuts those profits when it forces banks to help sterilize dollars by buying
low-interest renminbi-denominated bonds. Regulators also set real interest rates
artificially low (currently under 3 percent) to deter the "hot money" betting on
a yuan revaluation, but that cheap money flows into new factories and property
developments. "Wholly or partially state-owned enterprises continue to receive
most of the funding," says a new study by McKinsey & Co., noting that the
pattern "not only explains the large volume of nonperforming loans in China's
banking system but also decreases the economy's overall productivity
."

Beijing is justifiably worried that any significant rise in the value of its
currency could create psychological momentum for more appreciation. "The more
people buy into the argument, the worse it gets," says Nicholas Kwan, regional
head of economic research at Standard Chartered Bank in Hong Kong. "By the time
[the renminbi] reaches the point where everyone thinks it has risen enough,
they're in big trouble." But the longer Beijing keeps its currency artificially
low, argues Lardy, the more capital will be misallocated into marginal
investments, the slower banking reforms will progress and the costlier the bill
for nonperforming loans in the financial system will ultimately be. Lardy
figures (conservatively) that the renminbi is undervalued by about 15 percent,
and says that if the currency were actually allowed to rise that much, many of
the investments now being made in China would be pushed into the red.

Why not simply spend the dollar reserve? That's what Japan did in the '80s and
early '90s, when its export surplus was mounting and its top corporations and
tycoons bought everything from Hollywood studios to impressionist masterpieces.
Indeed, Chinese experts are mulling spending ideas, mostly of a far less
glamorous sort, from building a strategic petroleum reserve at a cost of $30
billion to forming a Chinese Peace Corps, with thousands of humanitarian
workers. But none of that, economists say, is enough to significantly slow the
growth of China's foreign reserves. "The problem with these ideas is that you
can't actually spend much money on them," says Stephen Green, head economist for
Standard Chartered in Shanghai. "They don't have many choices."
Still, China is trying to spend down at least some of its trade surplus by
investing abroad. Beijing's model here is Singapore, which spends its own huge
trade surplus (in excess of 10 percent of GDP) on things like telecoms and ports
abroad, says Kwan. "The Singaporean way is not to hold too many T-bills, but to
buy stock in Microsoft or banks in Indonesia." Now Beijing is encouraging
Chinese insurance companies and pension funds to invest $8.3 billion in foreign
bonds and securities, and urging others to buy up strategic raw materials,
particularly petroleum reserves, in places like Africa.

The catch here is that, as an emerging giant, China can't fly under the global
radar like tiny Singapore. Witness what happened when Chinese oil giant CNOOC
tried to buy Unocal last year, only to be run off by U.S. congressional
opposition. This kind of backlash against Chinese acquisitions is likely to rear
its head again, even though it offers a solution to today's huge trade
imbalance.

So China continues to park the bulk of its reserve in U.S. Treasury bills, the
bonds in which creditors hold most of America's huge public debt. China now owns
some $330 billion worth, second only to Japan's $640 billion. Thus China fuels
American consumption, not the emergence of a Chinese consumer market that could
drive long-term growth.

The roots of this contradiction go back to the early 1980s and the start of
reform in China, when the late patriarch Deng Xiaoping opened the manufacturing
sector, but not the banks, to foreign investors. The good news was that the
closed system inoculated China against the rush of global capital that toppled
banks across Asia in the crisis of 1997-98. The bad news: banks had no
competitive incentive to learn proper risk management, or to introduce modern
retail banking or consumer lending. Now the system is such a mess that China
fears to open it. And it sits on a huge pile of idle dollars that its own banks
are unable to employ fully at home.

All of which speaks to a fundamental dilemma: who wants to be a trillionaire?
China does, for sure, but it is also increasingly aware of the burdens of
wealth.

--
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