It is so nice when a consensus forms among the economic commentators. There is going to be a recession in America, the pack says, and probably in Britain too, for we have both sinned with our debt, our deficits and our soaring house prices. But the world as a whole won’t suffer, as the great emerging economies of Asia—ie, China and India—will carry on booming regardless. News that China’s GDP expanded by an extraordinary 11.4% last year, its fastest rate for 13 years, only strengthened this view.
When a consensus is so clear, it is always time to wonder whether it might be wrong. That contrarian instinct was reinforced this week by the way Asian stockmarkets, including those in Mumbai, Shanghai and Hong Kong, reacted to markets in America and Europe by going through wild gyrations of their own. A widely followed measure of such shares, the MCSI Emerging Asia index, was down 25% at one point this week from its October high.
Why should that be, if Asia is just going to boom on regardless? The answer is, in part, that stockmarket traders are wild, emotional creatures and we risk going mad if we try to understand their every move. But another part of the answer is that the sanguine consensus is likely to be only half-right. The half that is wrong offers some good reasons for concern about Asia.
The half of the consensus view that looks right is the half that says that China, India and the surrounding countries are not dependent on exports to America any more, and they are not dependent on foreign capital any more either. Exports to America account for about 8% of China’s GDP and only 2% of India’s, so while a big drop in those exports would have some effect, it is not going to be crippling. Moreover, it has already been happening: exports to the US from China have been declining for several months now, but overall growth keeps barrelling on.
The reason is that capital is abundant, and it is being spent on new buildings, roads, stadiums, bridges, airports—you name it. In economic crises of old, the developing countries got hit twice over: by the loss of their export markets in the West, and by the withdrawal of their capital by panicky international bankers and investors. In the past decade, the tables have been turned: China, other Asian economies (though not India) and the Arab oil producers have been the providers of capital to the West, not the receivers of it.
One of the most extraordinary statistics about the Chinese economy is that capital investment accounts for 45% of GDP. The equivalent figures for America and Western Europe are 15-20%. That investment is being financed by China’s own savings. So sub-prime losses in America, bank frauds in France and panics in London are irrelevant to developers in Beijing or Shanghai.
As long as those developers keep on investing in new roads and buildings, the Chinese economy will keep on growing. Perhaps declining exports to America and Europe could reduce China’s growth rate from 11.4% to 9% say. But that is still pretty good, and would still mean that China offers a strong market for its Asian neighbours too.
That is the correct half of the consensus. It doesn’t really apply to rich Japan, for its domestic economy is weak so the loss of exports to the US will injure it more. Things are a bit different in India which does need to import capital for unlike China it runs a deficit, but it too has an investment boom and so far its companies have been finding it easier to raise capital since the credit dramas began last August, not harder, as investors desert the loss-making markets of the West.
Where the consensus is likely to be wrong, however, is in its implicit assumption that these Asian economies are not going to be facing problems of their own—problems that do have some link to the difficulties facing America and Europe. Chief among those problems is inflation.
Rising prices for food, energy and other commodities, partly caused by strong Asian demand, lie behind the high interest rates and inflation worries that were spooking the Bank of England, the European Central Bank and, until its big interest cut this week, the US Federal Reserve. They are also a big worry for India and, even more so, China.
In recent years, China has followed a policy of keeping its currency cheap against the dollar in order to help exports. To do that, its central bank has had to focus its monetary policy on the currency and not domestic inflation, building up vast foreign-exchange reserves (now, $1.4 trillion, the world’s largest) and allowing credit inside China to be ultra cheap. Hence all that investment in buildings and, by speculators, in Chinese share markets. But hence, too, rising inflation.
Now, consumer-price inflation is over 6%. Wages are also rising rapidly. When inflation last got badly out of control in China was in 1988-89, which encouraged workers to join the student protests in Tiananmen Square. To avoid any repeat of that, government policy is beginning to change. The currency is being allowed to appreciate more rapidly against the dollar, thus reducing import prices. Interest rates are being raised. The revaluation is likely to accelerate, the clampdown on credit growth to get tighter. The danger is that China’s investment bubble could then burst.
The best parallel for China today is Japan in 1970. At that time, Japan had been using a cheap yen to boost exports, cheap capital encouraged an investment boom and environmental degradation prompted popular protests (remember Minamata disease?). Then, in 1971 it was forced by Richard Nixon to revalue the yen and in 1973 the global oil shock brought inflation. The result? Not a disaster for Japan but a wrenching change: revaluation and rising industrial costs forced the economy to shift from the era of the motorcycle to that of the microchip.
China faces the same sort of pressures now: currency revaluation, inflation, environmental damage. China now needs to move its economy sharply upmarket. As Japan showed during the 1970s, it can be done. But it won’t be easy. Which is why those stockmarket traders in Asia were right to turn a bit wild and emotional this week.