Download The Yuan: The Cheapest Thing Going is Gone

The yuan: The cheapest thing going is gone
After enduring a decade of criticism for its weakness, China’s currency now looks
uncomfortably strong
Jun 15th 2013 | HONG KONG |From the print edition
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http://www.economist.com/news/china/21579488-after-enduring-decade-criticism-its-weaknesschinas-currency-now-looks-uncomfortably
TEN years ago, the yuan made its debut as a global economic bugbear. In June 2003, America’s then
treasury secretary, John Snow, publicly encouraged China to loosen a policy under which its currency was
pegged at 8.28 to the dollar. The next month four senators wrote an angry letter urging Mr Snow to
investigate China for “currency manipulation”. The country was intentionally undervaluing its currency,
argued Charles Schumer, a Democratic senator for New York. “The result is that everything they sell to
other countries is the cheapest thing going.”
A decade later, Mr Schumer and other senators are still bashing the yuan: eight of them re-introduced a bill
last week that would slap duties on currency manipulators. But much else has changed. Now allowed to
float by 1% a day on either side of a reference rate set each morning by the central bank, the yuan closed
trading on May 27th at 6.12 to the dollar, 35% stronger than its June 2003 rate. It has risen more against the
dollar since March than it rose in the whole of last year, and its climb against Japan’s currency has been
even steeper. Since November, when the markets began to anticipate dramatic monetary easing in Japan,
the yuan has gained over 20% against a weakened yen.
NYT
Consumer Anxiety in China Undermines
Government’s Economic Plans
By EDWARD WONG AUG. 28, 2015
Lin Mo, who wrote a popular financial advice column, said she had received
hundreds of messages from “very terrified” readers. Credit Jonah M. Kessel/The
New York Times
BEIJING — In recent days, an advice column has circulated widely on China’s most popular social media
phone app. Titled “Guide on Safe Passage Through the Economic Crisis,” it is aimed at young Chinese
urban professionals. Its nuggets of wisdom include: “Work hard at your job so you are the last to be laid
off” and “In an economic crisis, liquidity is the number one priority.”
Zhang Yuanyuan, 31, a bank teller in Shandong Province, is among the thousands of people who have
shared it online.
“Last year we didn’t have any year-end galas or a bonus,” she said in an interview. “I think this year will be
the same.”
“I try to spend less,” she said, adding that she now buys cheaper clothes online instead of shopping in highend malls. “And I started car-pooling with co-workers to save on gas.”
Many young middle-class Chinese who grew up during the nation’s glittering boom years, when doubledigit growth was the norm, are suddenly confronting the shadow of an economic slowdown, and even hints
of austerity.
They are canceling vacations and delaying weddings and even selling recently purchased apartments to
have cash on hand. Those who have lost money in the ongoing stock market crash are especially anxious.
Their angst poses dual problems for China’s leadership. The ruling party bases its legitimacy on delivering
high rates of growth and employment. It also hopes to encourage consumer spending as a new engine of
growth as the manufacturing sector slows and to nudge the economy away from an investment-driven
model. Eroding confidence threatens both goals.
These days, Chinese are using the social media app WeChat to look for news and advice on the economy
rather than the state news media, which, at the orders of the Communist Party’s propaganda department,
have only had bare-bones reporting on the stock market crisis and the broader concerns over slowing
economic growth.
Earlier this month, China’s central bank devalued the Chinese currency, the renminbi, by the largest
amount in decades, signaling to outsiders that officials were worried about China’s growth rate, which the
government had earlier projected at 7 percent for the year. Then the sharp drop in the Chinese stock market
this week, following a steep midsummer fall that had been slowed only through muscular government
intervention, destabilized stock markets worldwide.
Through censorship orders, Communist Party officials have been trying to blunt the dire news at home. Not
only have the main party newspapers refrained from publishing relevant articles on their front pages, but
security officials have shown a willingness to go after Chinese reporters whose stories deviate from the
official narrative.
On Tuesday, a reporter for Caijing, a respected financial newsmagazine, was taken away by the police to
“assist in the investigation of” fabricating and spreading false information on futures trading, according to
Xinhua, the state news agency. Caijing had published an article on July 20 by the reporter, Wang Xiaolu,
saying that China’s Securities Regulatory Commission was looking to withdraw funds from the turbulent
stock market.
Despite Mr. Wang’s detention and a denial of the report from a commission representative, Caijing has
kept the article online. The magazine released a statement saying it did not know why the police had
detained Mr. Wang.
But censors have yet to prevent people from using search terms related to the economy or the stock market
on social media networks, so discussion is thriving online.
“In the absence of information about the stock market on official media, Chinese investors are relying on
social media, primarily the two ‘We’s — Weibo and WeChat — to get news about the economy,” said
Xiao Qiang, founder of China Digital Times, which tracks China’s media censorship.
He noted that WeChat was particularly popular because it was less “polluted” by posts from governmentsupported Internet users and because people could easily share news articles on the economy from Western
news publications, especially stories already translated into Chinese.
The author of the widely circulated financial advice column on WeChat, Lin Mo, once worked for a staterun business magazine, then started her own online writing about the economy. She said in an interview
that she had published her latest list of suggestions after getting hundreds of messages from “very terrified”
readers responding to one of her earlier essays on what she called an “economic crisis.”
“Many readers were asking me things like, ‘What should we do?’ and, ‘What if China becomes Japan in
the ‘80s?’” she said. “They are in their early 30s — the age to buy apartments or make investments or start
their own businesses. So they have big financial decisions to make, and in the current economy, they worry
about losing those investments in the slowdown.”
“Many of them are at a place in their careers where they want to leverage their current positions for higherpaying positions, and they worry about getting laid off by the new company in the economic winter,” she
added. “One reader told me that he left a state-owned travel agency to join a booming Internet-based travel
service because he felt he had to ‘embrace the Internet’ as a young professional. Now he regrets that
decision bitterly because the new company is having layoffs, and he might be laid off first.”
Continue reading the main story
Graphic: Why China Is Rattling the World
One Chinese woman who posted Ms. Lin’s column on her WeChat account said it “echoed the zeitgeist.”
She had tried to sell an apartment, but said, “Now I think I might hold off until the market recovers a bit.”
Among the most worried are university graduates. This year, nearly 7.5 million people graduated from
universities in China, a 3 percent increase over last year.
“The difficulty of finding employment in 2015 is still relatively high,” said Zhang Feng, director of the
career center of the Ministry of Education, according to an article on the ministry’s news site. “Both the
central and local economies’ growth rates have entered the ‘new normal.’”
Victor Shih, a political economist at the University of California, San Diego, said the slowdown
exacerbated worrisome trends in the job market.
“Highly paid professional jobs have been scarce for several years now,” he said, “and many young
graduates have depended on their parents’ connections to obtain entry positions in the government or stateowned enterprises. The current downturn will hit graduates without strong connections or specialized
skills.”
Ms. Lin said China’s young strivers “worry about a decline in life quality. They worry about never getting
that financial freedom they so badly want. They worry about never being able to retire early. They worry
about never being able to start their own business.”
Leisure spending still exists, of course. Popular restaurants in Beijing are crowded. Earlier this month,
groups of Chinese tourists snapped up all manner of luxury goods one weekend at Galeries Lafayette in
Paris, a high-end destination. Tour groups shuffled through the alleys and luxury shops of Venice.
But on Zhihu, the Chinese equivalent of the question-and-answer website Quora, hundreds of people have
submitted responses to questions from 2014 and 2015 that asked, “What things do you see in your
profession that indicate an economic slowdown?” The answers this year have ranged from “I’m in sales —
commission is impossible” to “I’m in construction. Last year we got four jobs and this year none. Layoffs
have started.”
Gao Yike, 25, who works at a real estate company in the northeastern provincial capital of Harbin, said in a
telephone interview that the project management department laid off employees in April. He said a growing
number of midlevel and senior executives were leaving the real estate industry for technology companies,
and that housing sales at his company were notably worse than last year.
“The golden age of the real estate market has come to an end,” he said.
Mr. Gao had also lost half of his initial investments in the stock market, and he said he now planned to
spend less — for instance, trying to stay with friends rather than in hotels on a trip to the United States next
month.
Ms. Fang, an employee of a freight shipping company in Beijing who asked to be identified only by her
surname, said the entire shipping industry had been hit hard.
She said she and her husband still felt secure — her husband works at a state-owned company and “lives
off the Communist Party’s money.” But Ms. Fang said she had stopped buying luxury goods and was
“consciously preventing myself from buying things that are not necessities.”
Ms. Zhang, the bank teller in Jinan who had posted Lin Mo’s advice column, said there could be a silver
lining in the upheaval.
“Maybe the economic slowdown is not such a bad thing,” she said. “There is less overtime work. If there is
no point thinking about making money, we can think about things that don’t involve making money, like
spending time with parents or reading a book.”
China’s competitiveness on world markets depends not only on the price of its currency but also on the
price of its goods and workers at home. The Bank for International Settlements calculates a “real” exchange
rate for 61 economies that takes account of inflation differences between them. Since 2010 China’s real
exchange rate, weighted by trade, has risen faster than any other, with the sole exception of Venezuela’s.
The price of labour is also rising faster in China than in its principal trading partners. The Economist has
calculated an alternative “real” exchange rate, weighted by trade with America, the euro area and Japan,
which takes account of unit labour costs in all four economies. By this measure, China’s real exchange rate
has strengthened by almost 50% since Messrs Snow and Schumer began their currency-bashing ten years
ago. If the yuan was the cheapest thing going back then, now its cheapness has all but gone. Some
economists, such as Diana Choyleva of Lombard Street Research, even wonder if the yuan is now
overvalued.
This long-term strengthening of China’s real exchange rate reflects deep historical forces, such as China’s
rapid economic growth, stronger labour laws, and shrinking working-age population. But the more recent
surge in its nominal exchange rate is puzzling and awkward. It comes at a time of disappointing growth,
falling inflation (only 2.1% in the year to May) and flagging exports (which grew by only 1% over the
same period).
What is causing this sudden strength and why are China’s policymakers tolerating it? Peng Wensheng of
CICC, a Chinese investment bank, argues that the currency’s rise this year reflects the persistence of higher
interest rates in China than elsewhere, and the disappearance of devaluation fears. Benchmark interest rates
in Shanghai have long been three to five percentage points higher than similar rates in London. Last year,
when China’s economy was faltering and its leadership was in flux, the appeal of these higher rates was
offset by fears that the yuan would fall. Those worries eased this year, prompting short-term capital to flow
back into China, much of it disguised as export earnings.
Track global exchange rates over
time with our interactive Big Mac index
That explains the motivation of the capitalists, but what about the communists? As the yuan has floated up
within its daily band, the central bank has largely accommodated its movements, raising its morning
reference rate by a similar amount.
The government’s tolerance for a stronger yuan may reflect its larger reform ambitions, argues Mark
Williams of Capital Economics, a consultancy. Last month Li Keqiang, China’s prime minister, said that an
operational plan for easing capital controls would be put forward later this year. If the yuan were much
below its market value, relaxing capital controls could invite a destabilising influx of foreign money. By
that logic, the government might have seen a stronger yuan as a necessary precondition for looser controls.
If so, then the currency volatility of recent months may have stalled these grand designs. In the past few
weeks, the foreign-exchange regulator has clamped down on hot-money inflows disguised as export
earnings. And the yuan’s climb has levelled off. The removal of China’s capital controls was always going
to be a gradual and careful affair. It has been ten years since China’s currency ripened into a big
international controversy. It may take another ten before it matures into a fully convertible international
currency.
The Future of the Yuan: China's Struggle to
Internationalize Its Currency
Mallaby, Sebastian; Wethington, Olin. Foreign Affairs 91.1 (Jan/Feb 2012): 135146.
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Abstract (summary)
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According to a growing chorus of pundits and economists, China -- already the world's most prolific
exporter, largest sovereign creditor, and second-largest economy -- will someday soon provide the world's
reserve currency. According to this view, just as the dollar dethroned the British pound in the interwar
years, so the yuan will soon displace the dollar, striking a blow to US interests. As the economist Arvind
Subramanian recently wrote, the yuan could become the premier reserve currency by the end of this
decade, or early next decade. This view has gained traction as Chinese leaders have launched a concerted
effort to internationalize the yuan. During the G-20 summit in November 2008, at the height of the
financial crisis, Chinese president Hu Jintao called for "a new international financial order that is fair, just,
inclusive, and orderly." Beijing soon began to encourage the use of its currency in international trade, swap
arrangements between central banks, and bank deposits and bond issuances in Hong Kong.
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According to a growing chorus of pundits and economists, China-already the world's most prolific exporter,
largest sovereign creditor, and second-largest economy-will someday soon provide the world's reserve
currency. According to this view, just as the dollar dethroned the British pound in the interwar years, so the
yuan will soon displace the dollar, striking a blow to U.S. interests. As the economist Arvind Subramanian
recently wrote, the yuan "could become the premier reserve currency by the end of this decade, or early
next decade."
This view has gained traction as Chinese leaders have launched a concerted effort to internationalize the
yuan. During the g-20 summit in November 2008, at the height of the financial crisis, Chinese president Hu
Jintao called for "a new international financial order that is fair, just, inclusive, and orderly." Beijing soon
began to encourage the use of its currency in international trade, swap arrangements between central banks,
and bank deposits and bond issuances in Hong Kong. During the first six months of 2011, trade
transactions settled in yuan totaled around $146 billion, a 13-fold increase over the same period during the
previous year. By mid-2011, yuan deposits in Hong Kong equaled $85 billion, a roughly tenfold jump since
Hu's 2008 statement. The yuan is already accepted as a form of payment in Mongolia, Pakistan, Thailand,
and Vietnam. Chinese authorities have indicated that as soon as 2015, they want the yuan to be included in
the basket of major currencies that determines the value of Special Drawing Rights (sdrs), the reserve asset
issued by the International Monetary Fund. And Beijing has announced its intention to transform Shanghai
into an international financial center by 2020.
There is also no denying that the dollar is vulnerable. Central banks traditionally hold foreign currency
reserves to ensure their ability to buy imports. But today, more of the world's imported goods come from
China than from the United States. Central banks also hold reserves to ensure their ability to service debt
payments to foreigners. Yet such payments flow increasingly to China, and although China's lending is
largely conducted in dollars, dominant creditors ultimately tend to insist on lending in their own currency.
To make matters worse for the dollar, it is losing value- instead of storing it, as reserve currencies are
expected to do. Meas - ured against the currencies of the United States' main trading partners, the dollar has
lost a quarter of its value since the advent of the floating currency system in 1973. Over the past four
decades, it has lost four-fifths of its purchasing power as measured against a basket of consumer goods.
This decline makes central bankers in emerging economies understandably nervous about holding dollar
reserves.
Yet the emerging narrative about the yuan's ascendance is mostly wrong. The global rise of China's
currency will be slower than commonly predicted, and the yuan is more likely to assume a place among
secondary reserve currencies-the euro, the yen, the Swiss franc, and the British pound-than it is to displace
the dollar as the dominant one. Nor is it even clear that China wants the yuan to replace the dollar. Beijing's
steps toward currency internationalization reflect not a fully formed, coherent long-term strategy but rather
an evolving process shaped by splits among China's policymakers over the scope and speed of financial
reform. Far from confirming the inevitability of the yuan's rise, China's uncertain effort to internationalize
its currency has exposed the profound struggles that lie behind the country's larger push to transform its
economic model.
THE RELUCTANT RISE OF INTERNATIONAL CURRENCIES
One might assume that as a country approaches great-power status, it will naturally attempt to
internationalize its currency. In fact, rising powers have often done just the opposite. As the economist
Jeffrey Frankel has shown, that is what the United States did in the interwar period and what Germany and
Japan did in the 1970s, even though the currencies of all three countries later became international. In each
of these cases, both the public and policymakers were initially skeptical of the benefits of allowing their
currency to be used widely abroad.
Rising powers have had two reasons to fear the internationalization of their currencies. The first concerns
competitiveness. When foreigners buy and hold a currency, they increase its value. This appreciation
persists as long as the buyers hang on to the currency as a store of wealth. A stronger currency hurts a
nation's exports by making its goods more expensive abroad and creates more competition for domestic
companies by making imports cheaper for consumers.
The second reason to fear currency internationalization concerns control of the financial system. Like
China today, Germany, Japan, and the United States all emerged as trading powerhouses at a time when
their financial systems were tightly regulated. Governments capped interest rates on bank deposits and
restricted the investment opportunities of pension and insurance funds so that capital remained cheap. But
this "financial repression" stuck savers with low returns, and the demand for artificially cheap capital often
exceeded the supply, leaving some borrowers frustrated. Currency internationalization threatened the
cheap-capital development model by freeing savers and borrowers to find one another abroad, beyond the
reach of regulators.
These reservations about currency internationalization have contributed to long lags between a nation's
emergence as a first-rank power and the widespread use of its money by foreigners. The United States
became a larger economy than the United Kingdom in 1872, but the dollar did not begin to displace the
pound as the reigning international currency until World War I, and the process was not completed until
after World War II. Even then, the United States frequently appeared indifferent to its currency's newfound
status. In the 1970s, President Richard Nixon abandoned the gold standard, sacrificing the international
prestige of the dollar on the altar of domestic stimulus. Likewise, Japan resisted currency
internationalization until the 1980s, when it became impossible to resist American pressure to allow U.S.
financial firms to enter the Japanese market. The deutsche mark became a reserve currency because
foreigners wanted to hold it, not because German authorities actively sought that outcome.
CHINA'S DOLLAR TRAP
If other rising powers have resisted the internationalization of their currencies, why is China's policy so
different? The answer is that the recent global financial crisis confronted China with the dangers inherent in
dollar hegemony. China's economic model had relied on boosting exports by keeping its exchange rate
undervalued. This required China's central bank to purchase large quantities of dollars, reinforcing the
dollar's status as the global reserve currency. But the crisis revealed that the benefits of this model were
smaller than they appeared and that the costs could be significantly higher.
The crisis showed that by basing its growth on exports, China had laid itself open to a sharp reversal if
foreign markets seized up. In the first quarter of 2009, collapsing demand in Europe and the United States
caused China's annual growth rate to fall to 6.2 percent, after hitting ten percent or more in each of the
previous ten quarters. The crisis also highlighted the potential costs to China of accumulating dollar
reserves. To keep the yuan undervalued, China had bought $1.5 trillion worth of U.S. financial assets,
including about seven percent of all the bonds issued by government-linked lenders, such as the
disastrously overleveraged Fannie Mae and Freddie Mac. The crisis convinced Beijing that it could one day
take a serious loss on those investments.
China's leaders responded to the shock by criticizing the international financial system. The effort was
launched by Zhou Xiaochuan, the governor of the People's Bank of China (the country's central bank). In
an article posted on the bank's Web site in March 2009, he called for far greater use of sdrs as an alternative
to the dollar. Other Chinese officials followed Zhou's lead, arguing that the basket of currencies that
determines the value of sdrs should be expanded to include the yuan and that, in preparation for that
change, the yuan should be internationalized. Echoing the complaints French leaders made in the 1960s
about "exorbitant privilege"-a country's ability to borrow cheaply and seemingly without limit in its own
currency-Chinese officials and scholars argued that the United States abuses its monetary freedom and
passes on the costs to the rest of the world in the form of currency depreciation and financial instability.
The U.S. Federal Reserve's subsequent quantitative easing and the U.S. Congress' chaotic efforts to grapple
with the national debt only increased China's frustration.
Even before the crisis, China had been engaged in an internal debate about its export-led growth model.
Several years ago, reformers began arguing that an excessive reliance on exports could be dangerous and
that China needed to rebalance its growth by encouraging more domestic consumption. In place of financial
repression and cheap capital, these reformers wanted savers to get a decent return, which might give them
the confidence to consume more. In place of an artificially low exchange rate, they wanted to allow the
value of the yuan to rise, which would reorient Chinese firms away from exports and toward the domestic
market.
The reformers claimed a small victory in 2005, when China loosened its exchange-rate peg. But in general,
the reform agenda has struggled. State-owned banks do not want to pay depositors market interest rates.
Politically connected borrowers, such as the state-owned construction companies that build China's
impressive infrastructure, do not want to give up access to cheap capital. Politically connected exporters, on
whom provincial governors count to create jobs in their regions, do not want to give up the competitive
advantage created by a favorable exchange rate. Groups that have an interest in reform-savers who receive
artificially low returns and consumers who pay a high price for imports-are no match for powerful
producers.
Prior to the financial crisis, the case for reform was also tainted by the suspicion that it represented a
capitulation to U.S. demands to let the yuan appreciate. But once the crisis exposed China's vulnerability,
reform acquired a fresh patriotic gloss: advocates could paint themselves as challenging the dangerous
hegemony of the dollar. This reframing was enough to tip the political center of gravity away from the
status quo. Criticism of what Chinese scholars called "the dollar trap" became widely accepted, and by
extension, internationalization of the yuan became an official goal, even though many of China's leaders
continued to believe in export competitiveness, highly regulated capital markets, and a state-controlled
banking system.
In effect, the government wanted to have it both ways: booming exports, but reduced accumulation of
dollars; continued funneling of cheap loans to favored companies at the expense of savers, but also more
domestic consumption. Internationalization of the yuan emerged as an official goal not because it resolved
the long-running debate between reformers and mainstream opinion. Rather, it became policy precisely
because it blurred that division, allowing people who disagreed to unite-at least in the short term.
OF CARTS AND HORSES
One consequence of these internal conflicts is an unorthodox sequencing of reform. As the economist
Takatoshi Ito has explained, the best way to open a repressed, autarkic financial system is to begin with
domestic financial reform. Before large amounts of foreign capital are permitted to flood in and out of a
country's system, banks need to be well capitalized and competently regulated. Bond markets must be deep
and liquid, so that they can absorb foreign money without experiencing dramatic price swings. The
authorities must welcome a variety of investors, with differing time horizons, investment objectives, and
worldviews-a form of diversity that reduces destructive herd behavior. Only once the domestic financial
system has been fortified in this manner is it safe to open the economy to foreign capital inflows, allow the
exchange rate to float, and let the country's money circulate offshore. Currency internationalization should
be the endpoint of reform, not the starting point.
China is not following this sequence. Mainstream Chinese political opinion still resists rapid domestic
financial reform and exchange-rate flexibility, so reformers have pushed forward with currency
internationalization before the standard preconditions have been met. Since Hu's speech in 2008, China has
signed largely symbolic centralbank swap agreements with 13 countries, including Argentina, Belarus,
Indonesia, Malaysia, and South Korea. In September 2011, Nigeria's central bank announced that it would
convert between five and ten percent of its reserve assets into yuan. But the most significant reforms began
in April 2009, when China's government permitted five pilot regions-Dongguan, Guangzhou, Shanghai,
Shenzhen, and Zhuhai-to begin conducting trade with Hong Kong in yuan on a trial basis. In June 2010, the
experiment was extended to 20 provinces, cities, and autonomous regions. Last year, it was extended to the
entire country. The resulting explosion of yuan-based trade has been hailed by some as a success. But as
Peter Garber of Deutsche Bank has explained, the growth has been revealingly lopsided, resulting in some
serious unintended consequences.
Because foreigners expect China's currency to appreciate against the dollar, they are eager to buy any yuan
that reach Hong Kong, where the currency is called cnh, to distinguish it from the mainland currency,
which is sometimes referred to as cny. As a result, cnh tend to command a premium against the dollar,
opening up a gap between the onshore yuan-dollar exchange rate, which the Chinese government manages,
and the offshore cnh-dollar exchange rate, which it does not. This differential creates an incentive for
Chinese importers to pay foreign suppliers in cnh, rather than in dollars purchased from the central bank at
the lower official exchange rate.
As Chinese importers take advantage of the favorable Hong Kong exchange rate, they move money from
the mainland into cnh accounts in Hong Kong and then use those cnh to purchase goods from foreign
exporters. The foreigners then either hold the cnh in expectation of appreciation or, if they are not
interested in currency speculation, sell the cnh to other foreigners who are keen to take the bet. In this way,
Chinese currency piles up in Hong Kong. Some market analysts predict that, having already grown tenfold
since Hu's speech in 2008, Chinese currency deposits in Hong Kong will quadruple from today's level by
the end of 2012, rising to the equivalent of around $340 billion.
That is not what Chinese policymakers intended. Technically, the deregulation of yuan-denominated trade
payments applies to Chinese exporters as well as importers. If exporters took advantage of the new
freedom, the pools of cnh building up in Hong Kong would be drained as quickly as they accumulated. But
the incentives for exporters are the opposite of those facing importers. Rather than going through Hong
Kong, exporters are better off taking payment in dollars and then selling the dollars to the central bank at
the managed rate, which renders the dollar artificially valuable.
The upshot has been a classic demonstration of the law of unintended consequences. Before the opening of
the Hong Kong cnh market, Chinese importers bought foreign exchange from China's central bank,
reducing the bank's stock of dollar assets. Now, importers can obtain foreign exchange indirectly from
foreign speculators in Hong Kong, leaving more dollars on the central bank's balance sheet. Put another
way, Chinese importers' ability to pay foreigners in cnh has the effect of removing a significant source of
dollar purchases from the world's currency market. Assuming that the central bank wants to maintain the
yuan-dollar exchange rate, it must offset this effect by increasing its own dollar holdings. China's attempt to
internationalize the yuan, which sprang partly from a desire to reduce the government's exposure to dollars,
has actually had the reverse effect of increasing the central bank's already vast dollar holdings.
Even beyond this irony, the policy is proving costly. Assuming that China will one day stop holding down
the value of its currency, China's central bank will eventually suffer a portfolio loss as the dollar falls to its
natural exchange rate against the yuan. The more dollars the central bank accumulates, the larger this
eventual loss will be. Moreover, as the central bank acquires additional dollars, it pays out yuan. To avoid
inflation, this monetary expansion has to be "sterilized" by the issuance of bonds or the acceptance of bank
reserves on which the government pays interest, imposing a further cost on the Chinese government. The
challenge of sterilization grows when the money in cnh bank accounts is used to purchase cnh bonds and
then the issuers of these bonds repatriate the capital to the mainland. As long as the Hong Kong market
remains comparatively small, China can absorb these costs with little difficulty. But if the authorities are
serious about internationalizing the yuan in a sustained way, the costs will quickly grow and the unintended
consequences will likely become harder to manage, especially in the absence of domestic reform.
RISKS OR REWARDS?
The tensions in China's currency policy emerge clearly from the wide range of official statements intended
to explain it. Some leaders openly state a preference for diversification away from the dollar but are careful
not to call for the yuan's preeminence, even within the next several decades. Rather, they predict a lengthy
and complex process of change in the international monetary system, with increased demand for yuan
restricted mostly to East Asian markets. Other policymakers in Beijing advocate including the yuan in sdrs
and believe that sdrs should ultimately displace the dollar as the world's main reserve asset. But even as
they advance this vision of a radically transformed monetary order, these officials shy away from
acknowledging a policy of currency internationalization, speaking instead of a more limited agenda of trade
and investment facilitation. They suggest that their policy is a response to market demand; by allowing
yuan to be used in trade transactions, these officials maintain, China is merely acceding to requests from
importers and exporters. China has concluded swap agreements with foreign central banks only because
foreigners requested them, they claim-despite the fact that foreigners have drawn down only a small
fraction of the yuan swaps that Beijing has provided.
Yet even though China's leaders struggle to rationalize a conflicted policy, it would be wrong to conclude
that yuan internationalization is doomed. After all, China has managed such contradictions successfully
before, often pursuing reform not by tackling the status quo head-on but rather by allowing an alternative to
grow up around it. For example, in the 1980s, during the early stages of the transition away from central
planning, farmers were still required to meet Maoera quotas and were paid at prices set by the central
planners, but farmers were also allowed to sell anything they produced in excess of their quotas on the new
free market. Today, private companies coexist with state-run firms and five-year plans exist alongside a
capitalist freefor- all. In a similar fashion, China is allowing a free yuan capital market to grow up in Hong
Kong in parallel with the largely unreformed, restricted capital market on the mainland. The policy mix
might not be consistent, but it could ultimately prove effective.
Indeed, inconsistency might hold some advantages. It allows China to experiment with change while
retaining the option to retreat if the side effects become intolerable. It could permit policymakers to foster
the development of the Hong Kong market, so that the institutions necessary to make a currency market
function can gradually take shape there. If Chinese and foreign companies issue greater volumes of cnh
bonds of short and long duration, a market-driven yield curve will emerge, Chinese traders will learn the art
of interestrate arbitrage, and Chinese companies using this market will learn the ropes of treasury
management. The system can be tweaked and tested before it is rolled out on the mainland, and in the
meantime, it may generate price signals useful to China's government. If the cnh appreciates suddenly
against the dollar, this will warn the authorities of rising pressure from speculation. If short-term interest
rates rise relative to long-term ones, this might signal that investors have become pessimistic about the
economic outlook. In time, the onshore and offshore markets could conceivably converge as capital
controls are loosened.
Of course, there is a significant risk that a gradual approach- and the resulting tension between a free
offshore market and a controlled onshore one-could prove hard for the Chinese government to manage. The
rising cost to the central bank of purchasing dollars to offset foreign yuan holdings in Hong Kong might
encourage foreign speculators to bet that the central bank will seek to reduce that cost by allowing faster
yuan appreciation; the result could be even more speculative purchases of cnh, setting off a vicious cycle.
Likewise, leakage of capital from Hong Kong to the mainland could fuel inflation; as the economist Robert
McCauley has explained, this fate befell the United States when it clung to capital controls in the face of
growing offshore dollar markets in the 1970s. But it is also possible that the benefits of China's
experimental technique could outweigh its obvious costs and contradictions. Anyone who has watched
China's extraordinary economic performance, achieved while it ignored many of the West's textbook
development prescriptions, should be modest in predicting that China will inevitably trip up this time. But
even if China's policy of gradualism with regard to its currency succeeds, the yuan is not going to displace
the dollar anytime soon. The dollar enjoys an advantage that its predecessor, the pound, never had:
formidably deep capital markets both inside and outside the United States, which operate mainly in dollars.
The chief purpose of a reserve currency in today's global economy goes beyond its traditional ones. Central
banks hold foreign exchange war chests not just as a cover for essential imports and debt payments; they
hold them as insurance against the virulent crises to which modern finance is susceptible. As capital
markets have gone global, banks all over the world have borrowed in efficient dollar-based markets. As a
result, when markets suddenly dry up, borrowers are left screaming for dollars. So long as dollar funding
remains attractive to private firms, central banks will hold a large proportion of their reserves in dollars,
too. Even if the dollar loses value steadily, central banks will probably be prepared to absorb that cost,
which amounts to an insurance premium.
Given China's economic strength and the likely appreciation of its currency in the future, the yuan might
eventually emerge as a secondary reserve currency. If a reliable yuan bond market develops, first in Hong
Kong and then perhaps on the mainland, foreigners will increasingly include yuan assets in their portfolios,
alongside British pounds, euros, Swiss francs, and yen. Asian nations, with deep economic links to China,
will be particularly likely to do so; the yuan already serves as an unofficial anchor for several of their
exchange rates. But that is a far cry from displacing the dollar. China is rapidly catching up to the United
States in terms of the overall size of its economy, and perhaps in other measures, too. But China's monetary
dominance should not be assumed. If it ever does arrive, it will have been long in coming.
Sidebar
The emerging narrative about the yuan's ascendance is mostly wrong.
The internationalization of the yuan has allowed people who disagree to unite-at least in the short term.
The upshot of China's currency policy has been a classic demonstration of the law of unintended
consequences.
The tensions in China's currency policy emerge clearly from the wide range of official statements intended
to explain it.
Even if China's gradualism succeeds, the yuan is not going to displace the dollar anytime soon.
AuthorAffiliation
Sebastian Mallaby is Director of the Maurice R. Greenberg Center for Geoeconomic Studies at the Council
on Foreign Relations. Olin Wethington is Chair of Wethington International and previously served as
Assistant Secretary for International Affairs and as Special Envoy on China at the U.S. Department of the
Treasury. This essay draws on a collection of CFR working papers available at www.cfr.orgfficgs.
Don’t Expect China to Devalue the RMB
Source: Getty
Michael Pettis Op-Ed May 8, 2014 Financial Times
Summary
The simple formula that says a cheaper renminbi will spur exports and increase
China’s growth is misguided; far more important are concerns about destabilizing
capital flows and economic adjustment.
Recently a number of economists, most of them foreign, have called for China to devalue the renminbi,
arguing that the more than 30 per cent revaluation since 2005 has left it with an overvalued currency. This,
they claim, has hurt Chinese exports and is holding back economic growth.
They are probably wrong about growth and almost certainly wrong about their evaluation of China’s
currency regime. The policies of the People’s Bank of China (PBoC) reflect a domestic debate that is as
much political as it is economic.
Two main issues matter. First, capital flows are very sensitive to medium-term currency expectations. Any
significant change in the direction or pace of capital inflows can hurt the banking system. For 20 years,
China’s foreign currency reserves have soared because of net inflows. As the PBoC monetised these
inflows, the country’s financial system developed around the consequent rapid money expansion. In recent
years, while net inflows have remained high, the bulk of these inflows has switched from the current
account to the capital account.
Michael Pettis
Nonresident Senior Associate
Asia Program
More from this author...
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What drives reserve growth today, in other words, are capital inflows, of which a
significant share may be speculative money seeking the positive interest carry on
the renminbi plus currency appreciation. If the PBoC were credibly to change
appreciation expectations without raising interest rates, speculative inflows could
easily become outflows which, when combined with what may be significant flight
capital, would put potentially dangerous pressure on the domestic financial system.
The second issue that matters concerns the role of the currency in China’s economic adjustment. The
currency regime helps determine how the costs associated with China’s difficult rebalancing will be
assigned among different sectors within the economy. Policies that boost growth in the tradable goods
sector can easily come at the expense of growth in other sectors. Devaluing the renminbi, in other words,
might not increase growth so much as transfer growth from the capital intensive, service or government
sectors to the tradable goods sector.
This is something that has been missed by most analysts calling for renminbi devaluation. If China were
suffering from unemployment, a cheaper currency would certainly boost export growth and, probably with
it, GDP growth. Unemployment would also drop.
But unemployment levels in China are low and wages rising. Devaluing the renminbi, while boosting
exports and constraining imports, would cause the tradable goods sector to bid up wages, so that its growth
would come largely at the expense of non-tradable goods, most importantly the service sector. This is the
opposite of what China needs and contradicts the rebalancing plan called for by Beijing during the Third
Plenum last year.
Rebalancing requires that interest rates, wages and the currency rise in the aggregate in order to increase
the household income share of GDP, along with higher direct and indirect transfers from the state to
households. Only by sharply increasing household income can higher domestic consumption growth
prevent a sharp downturn as Beijing reins in runaway investment.
But devaluing the renminbi puts even more pressure on the other transfer mechanisms. Whatever exporters
would gain from a cheaper currency, the capital-intensive sector would lose from higher interest rates or the
labour-intensive sector would lose from higher wages. This is likely to hurt economic growth in the
aggregate as much as a cheaper currency will help higher exports spur economic growth.
This is how we must think about the currency regime – not in isolation but as part of the process of
rebalancing the economy away from its over-reliance on investment and towards a greater role for
consumption. If China were suffering from high unemployment, devaluing the currency, assuming that it
does not increase trade tensions and invite retaliation, would boost GDP growth and lower unemployment.
Under current conditions, however, it merely reduces the share of the adjustment cost that must be borne by
the tradable goods sector and increases the share that must be borne by other sectors. In the end there may
be good reasons for doing so, but for now it isn’t obvious either that China should help exporters at the
expense of non-exporters or that exporters are politically more powerful than other sectors of the economy.
The simple formula that says that a cheaper renminbi will spur exports and increase China’s growth –
especially needed as Beijing weans the country off its addiction to investment – is misguided. Beijing’s
choice of a currency regime must accommodate concerns about a destabilising shift in capital flows and
about how the costs of economic adjustment are to be shared. These concerns are far more important than
simply reducing export prices.
The Economist
China’s exchange-rate policy
Currency peace
Devaluing the yuan would do China more
harm than good
Feb 21st 2015 | SHANGHAI | From the print edition
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CHINESE officials tired of defending their exchange-rate policy can at least appreciate the irony in the
latest charges levelled against them. For years foreigners accused them of keeping the yuan artificially
weak to boost exports. Now, domestic critics say, they are doing just the opposite: keeping the currency
artificially strong and, in the process, wounding the economy. Some predict China will soon change course
and engineer a devaluation. But just as the Chinese authorities did not resort to a big one-off appreciation
when the yuan seemed too weak, they are unlikely to embark on a dramatic devaluation now that it is
looking strong.
The yuan has been one of the world’s top-performing currencies this year. The reason is simple. Although
China claims to be trying to manage the yuan’s value against a basket of currencies, in practice it is still
loosely pegged to the dollar. As the dollar has risen against most currencies over the past seven months, the
yuan has hitched a ride. The dollar is up by 18% since July against the world’s seven most traded
currencies, but by only 0.6% against the yuan (see chart). As a result, the Chinese currency is at an all-time
high in trade-weighted terms.
Those forecasting devaluation believe the state of the economy does not justify such strength. More than
$90 billion (nearly 3% of quarterly GDP) flowed out of China via its capital account in the fourth quarter, a
record deficit. The central bank sold a small slice of its nearly $4 trillion foreign-exchange reserves at the
same time, implying that it intervened to prop up the yuan.
Devaluation would, all else being equal, let Chinese exporters regain some lost competitiveness. By raising
the cost of imports, it would also help China stave off deflation. With monetary easing from Japan to
Europe setting up several currencies for bigger declines, it is fair to ask whether China can afford to sit on
the sidelines.
Yet the costs of devaluation outweigh the benefits for China, for two reasons. First, it is doubtful that it
would deliver the desired economic outcome. Despite talk of currency wars, Asian countries have so far
avoided full-scale hostilities over their exchange rates. If the region’s biggest economy launches an
offensive, others would surely follow, wiping out any advantage it hoped to gain. In fact, a devaluation
might hurt the economy. A falling yuan might spur the outflow of capital. It would certainly endanger
China’s companies, which have amassed $1 trillion in foreign debt, which would become more expensive
to service if the yuan lost ground.
Second, the politics of devaluation would harm China. In the short term, there would be renewed
complaints in America about Chinese currency manipulation, raising the possibility of countermeasures. In
the longer term, it would hamper China’s efforts to make the yuan a rival to the dollar. The strongest
reserve currencies serve as safe havens when others are in turmoil. During the Asian financial crisis of
1997-98 and the global meltdown of 2008, China maintained a steady exchange rate against the dollar,
despite having ample cause to allow depreciation. Such actions have bolstered the yuan’s credibility. A
rush to devalue now would undermine it.
That said, some weakening of the yuan is likely in the coming months. The central bank has long vowed to
give the market greater sway over the exchange rate. With the current-account surplus narrowing and
capital flowing out, the market is pointing to at least mild depreciation.
The central bank has also vowed to make the exchange rate more volatile, to wrong-foot speculators and
force companies to do a better job of hedging their exposure to different currencies. Guan Tao, an official
with the foreign-exchange regulator, sounded such a warning this month, citing an ancient proverb: “A
wise man should not stand next to a dangerous wall.” The dollar’s relentless rise may dislodge a brick or
two, but China is not about to let the yuan collapse.
The Economist
China's economy
Coming down to earth
Chinese growth is losing altitude. Will it
be a soft or hard landing?
Apr 18th 2015 | ZHENGZHOU | From the print edition
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WHEN “60 Minutes”, an American television news programme, visited a new district in the metropolis of
Zhengzhou in 2013, it made it the poster-child for China’s property bubble. “We found what they call a
ghost city,” said Lesley Stahl, the host. “Uninhabited for miles and miles and miles and miles.” Two years
on, she would not be able to say the same. The empty streets where she stood have a steady stream of cars.
Workers saunter out of offices at lunchtime. Laundry hangs in the windows of the subdivisions.
The new district (pictured), on the eastern side of Zhengzhou, a city of 9m in central China, took off when
the provincial and city governments relocated many of their offices there. Then, high schools with
university-sized campuses began admitting students, drawing families to the area. Last autumn one of the
world’s biggest children’s hospitals opened, a gleaming facility with cheery colours and 1,100 beds. Chen
Jinbo, one of the area’s earlier residents, bemoans the lost quiet of a few years ago. “Rush hour is a hassle
now.”
The success of Zhengzhou’s development belies some of the worst fears about China’s overinvestment.
What appear to be ghost cities can, with the right catalysts and a bit of time, acquire flesh and bones. Yet it
also marks a turning-point for the Chinese economy. Zhengzhou still has ambitious plans, not least for a
massive logistics hub around its airport. With such a big urban area already built up, though, vast
construction projects have a progressively smaller impact on the economy. The city’s GDP growth fell to
9.3% last year from an average of more than 13% over the preceding decade. The downward trend will
continue. As the capital of Henan, one of the country’s poorest provinces, Zhengzhou had anchored the
country’s last, large, fast-growth frontier. Its maturation signals that the slowing of China’s economy is not
a cyclical blip but a structural downshift.
When growth flagged in powerful coastal provinces a few years ago, the poorer interior picked up the
slack. It was large enough to do so, for a time. Henan and the other inland provinces that have a similar
level of income per head have 430m residents, nearly a third of China’s total. If they were a sovereign
country, they would form the world’s seventh-biggest economy, ahead of both Brazil and India. The far
west is China’s final underdeveloped region but it carries much less weight: it makes up less than a tenth of
the national population.
So the question for China is not whether growth will rebound to anything like the double-digit pace of the
past. Instead, it is whether its slowdown will be a gradual descent—a little bumpy at times but free from
crisis—or a sudden, dangerous lurch lower. Figures released on April 15th revealed a further loss of
altitude: GDP in the first quarter grew by 7% from a year earlier, the lowest since the depths of the global
financial crisis in early 2009. Signs of stress are emerging: capital is leaving the country, public finances
are more stretched and bad debts are rising.
Yet that is not the full story. China also has impressive underlying strengths and a new determination to fix
its most harmful distortions. “Growth will keep on declining,” says Xiang Songzuo, chief economist with
Agricultural Bank of China, a state-owned lender. “Our main wish is that the decline go smoothly.”
Storm warning
The darkest cloud over China is its property market. Factoring in its impact from steel to furniture, it has
powered nearly a fifth of the economy. Now, it is set to subtract from growth. House prices have fallen by
6% over the past year, the steepest drop since records began. It is not the first time that the property market
has looked fragile, but previous dips were driven by deliberate policies to cool the market. In recent
months, it has been the opposite: demand has failed to respond to a series of boosts such as cheaper
mortgage rates. This has prompted predictions of a coming crash.
Problems are real but such disaster warnings rest on a misdiagnosis. The oft-heard idea that China is sitting
on mountains of unsold homes is an exaggeration. Those making this claim point to the gap between
property sales and construction. Sales of residential housing last year were 20% higher than they were in
2009, but projects under way have more than doubled since then, according to official data. If true, it would
take five years to consume the pipeline of homes being built, up from three before the global financial
crisis.
But many of those projects are in fact little more than holes in the ground. Some have been halted for a lack
of funds, others because developers want to wait to sell into a stronger market. The evidence for this is
actual construction activity, indicated by property completions as well as cement production (see chart 1).
These are a much closer fit with sales. It will take 16 months to clear China’s inventory of new homes at
the current sales rate, up from ten months when the market was in better shape, according to E-House, a
property consultancy. This points to a deterioration but hardly a nightmare.
That China’s property market is not about to collapse under the weight of oversupply is good. The bad
news is that its growth is stalling. The housing sector started to take off early this century after the
government allowed ownership of private property. Mass migration to cities added to demand; China’s
urbanisation rate has more than doubled to 55% today from 26% in 1990. Both these factors are fading.
Many Chinese have already upgraded to snazzier flats than their original state-issued boxes. And the pace
of urbanisation is slowing.
Many analysts now expect housing sales, which have reached about 10m units annually, to start falling
soon. There will still be homes aplenty to build but fewer with each passing year. Those who were overoptimistic about the longevity of the boom are paying a price. Chinese steelmakers had created capacity for
1.2 billion tonnes a year. The 820m tonnes produced last year may well be the top.
Property is thus turning from a driver into a drag for the Chinese economy. Wang Tao of UBS, a bank,
estimates that every ten percentage-point drop in construction growth cuts as much as three percentage
points off GDP. She forecasts a deceleration of about half that pace this year.
The more sedate reality is sinking in. In the south of Henan province, the county of Gushi had wanted to
expand its central city to reach a population of 1.2m, from 500,000 now. Construction work is feverish. The
clang of hammers and the growl of diggers reverberate throughout its streets. But with housing sales failing
to meet expectations, Gushi has lowered its sights. It is aiming instead for a population of 800,000. Muddy
fields on the outskirts that had been zoned for development seem destined to remain untouched.
Dragged down by debt
One way China could rekindle its property market is by using its banks to pump cash into the economy, as
it did in 2008 when the global financial crisis struck. Yet that would be a dreadful mistake. Officials have
their hands full already trying to deal with the legacy of the previous lending binge. Total debt has surged,
rising from about 150% of GDP in 2008 to more than 250% today (see chart 2). Increases of smaller
magnitudes were precursors to financial turmoil in Japan in the 1990s and much of the West over the past
decade.
With debt clogging up the economy’s gears, Chinese lending has grown less potent. In the six years before
the financial crisis, each yuan of new credit resulted in about five yuan of economic output. In the six years
since the crisis, each yuan of credit has yielded three of output. Banks report that a mere 1.25% of their
assets have soured, but investors price their shares as if the true number is closer to 10%. Within banks
themselves, there is distrust. “The headquarters don’t believe the provinces,” says a credit officer with a
major lender.
Until recently China could grow its way out of debt trouble. That is no longer an option. With deflation
arriving and the economy weakening, nominal growth is a third as fast as a few years earlier. In the year to
the first quarter of 2015, nominal GDP grew by only 5.8%. The financial system is also far more complex
than it was in the late 1990s, the last time China had a surge in bad debts. State-owned banks accounted for
almost all lending back then. Since the financial crisis their share has fallen to less than two-thirds. Loosely
regulated “shadow banks” make up much of the rest.
But there is no ironclad law that a big rise in debt must result in crisis. Much depends on how liabilities are
managed. China has several advantages. The vast majority of its debts are held at home. In many cases both
debtors and creditors answer to the same master, the government. A state-owned bank is not about to call in
a loan from a state-owned shipbuilder. This buys it time to sort out the mess. Debts are also concentrated.
Households have not borrowed much, nor has the central government. The main culprits are local
governments and a relatively narrow group of companies: state-owned enterprises, property developers and
construction firms.
China’s defences are now being tested by the prospect of the first big default in its property sector. Kaisa, a
developer embroiled in a corruption case, is in negotiations with bondholders to restructure its debt. So far
there has been no contagion throughout the financial industry. Investors have come to the same conclusion
as Moody’s, a ratings agency: it is an isolated case, not symptomatic of systemic risks.
In that respect, China’s debt problem is similar to its property malaise. An acute crisis is unlikely, but the
prognosis is still bleak. Credit growth has fallen below 15% year-on-year, down by more than a quarter
from the average of the past decade. But since nominal growth is even slower, China’s debt-to-GDP level
continues to rise. Lending will thus have to slow yet further, one more dark cloud over the horizon.
Back-up power
Reporting about China’s economy sometimes gives the impression that it is one giant credit-fuelled
property bubble. Were that true, the twin slowdowns in construction and lending would be enough to
wrestle growth down to the low single digits, perhaps even into recession—a scenario touted for years by
the most bearish analysts. China’s downturn still has a way to run but such pessimism has consistently been
wide of the mark. A simple, if under-appreciated, reason is that it is a continent-sized economy, with a lot
more going for it than one or two industries. And although the days of explosive catch-up growth are over
now that China has gained middle-income status, it has scope for more moderate catch-up. Its per-capita
GDP at purchasing-power parity is $12,000, not quite two-thirds that of Turkey and barely a third of South
Korea’s.
A much-needed shift towards consumption-led growth is just getting under way. Investment accounts for
50% of economic output, well beyond what even Japan and South Korea registered in their most intensive
growth phases. Without rebalancing, overcapacity in industry would only get more severe, further
undermining the return on capital. At last, there are glimmers of hope. Investment growth has halved in
recent years but consumption growth has held steady; in future, as China’s growth slows, consumption
should contribute a bigger share of it (see chart 3).
This is in part testament to the government’s progress in constructing a social safety net. Health insurance,
old-age benefits and free schooling, though works in progress, appear to have helped check the remarkable
propensity of Chinese to save. At 40% of income, the household savings rate has stopped rising in recent
years.
Still more important is a change in economic structure. Services took over from industry a couple of years
ago as the biggest part of China’s economy, and the gap has widened. Last year services accounted for
48.2% of output; industry’s share was down to 42.6%. Services are more labour-intensive, which brings
two benefits. First, China is now able to generate many more jobs at lower levels of growth. Though
growth dipped to its slowest in more than two decades last year, China created 13.2m new urban jobs, an
all-time high. Second, the strong jobs market has allowed wages to keep on rising at a steady clip, a
prerequisite for getting people to consume more.
Even in Gushi, a county officially classified as impoverished, people throng to clothing stores, beauty
parlours and the town’s one foreign restaurant (a KFC). Like many there, Zhang Youling, 43, spent much
of his adult life away, going to where the jobs were. He worked as a builder in Beijing, a courier in
Shanghai and an ice-cream wholesaler in Zhengzhou before returning to Gushi to be with his wife and two
children. For the coming summer, he has set aside 6,000 yuan ($970) to take them to Beijing on holiday.
“We used to save everything. These days we have the confidence to spend some of what we earn,” he says.
Changing course
It would be complacent to expect that rebalancing alone will spare China from trouble. Surging debt and
property overinvestment stem from flaws in the economy’s foundations. Regulations constrain investment
options, making property one of the few viable assets; this drives up house prices. Local governments have
limited tax powers, and so rely on land sales; this leads to more property development. The belief that the
central government will always prop up cities induces banks to lend with little regard for creditworthiness;
this heaps bad debt onto the economy.
These interlinked problems were easily ignored while growth surged ahead. Now the government can avoid
them no longer. It is trying three kinds of reform.
The first is financial liberalisation. Monetary policy is virtually unrecognisable from five years earlier,
when the central bank controlled all key interest rates. Funding costs throughout the economy are now
more market-based. Banks compete for deposits with an array of investment products; households place
30% of their savings in bank-account substitutes, up from 5% in 2009. Official deposit rates are still fixed,
but regulators have given banks flexibility (currently, a 2.5-3.25% range) and hint at full liberalisation
within a year.
The government has also relaxed capital controls. Companies previously needed approval for overseas
investments above $100m; late last year the threshold was raised to $1 billion. In recent months, capital
outflows have surged. Some say this is because Chinese are losing faith in their country. Regulators are far
more sanguine, pointing to it as a sign of a better-balanced economy. The alternative—trapping money in
China at artificially low interest rates and encouraging wasteful investment—was bound to be more
destructive.
Jam today in
Zhengzhou
The second area for reform is fiscal, a push that has just begun. The problem is that municipalities have too
many spending obligations and not enough revenue. The central government will provide more funding and
give local governments new taxation powers. Under a revised budget law, all provinces are, for the first
time, allowed to issue bonds, albeit subject to central approval. The finance ministry has also started to mop
up their debts; it plans to restructure 1 trillion yuan of liabilities.
Bureaucratic reforms are the third focus. Here, progress has been uneven. Changes to the householdregistration system, or hukou, to allow rural citizens to settle in big cities have been halting. More is needed
to make for a healthier labour market. China has also disappointed those hoping for bold reforms of
sluggish state-owned enterprises, but smaller shifts may help. By injecting assets from unlisted state parents
into listed subsidiaries, groups such as Citic will face closer market scrutiny. At the same time, the
government is loosening its grip on other important levers. It has simplified the process for registering new
companies. Entrepreneurs can now, for instance, use non-cash assets as capital. They created some 3.6m
firms last year, up by nearly 50% from 2013.
Reforms are themselves generating new risks. A bull run in the stockmarket over the past six months is
beginning to resemble the asset bubbles that often arise when countries plunge into financial liberalisation.
But keeping the previous economic system in place would be more dangerous. It would make growth faster
in the short term but at the cost of ever more debt, heightening the risk of an eventual crash. Taken
together, the policy shifts should smooth China’s transition to slower but more resilient growth.
The transition will take time. For now, investment still accounts for half the economy. In Zhengzhou, a
layer of construction dust covers much of the city’s southern half. Along with building a vast new airport
terminal, workers are digging tunnels for five new subway lines. Traffic is snarled for hours in the evening
as trucks haul pillars into place for elevated highways. The pressing concern for residents stuck in the
congestion is not economic collapse but rather the continued headaches of growth, even if it is a little
weaker than last year.
The Economist
The yuan: Feeling valued
The IMF changes its tune on China’s
currency
May 30th 2015 | SHANGHAI | From the print edition

THERE was a time when virtually all the ills of the world economy were blamed on the yuan. Critics
charged that China’s intervention to suppress its currency had led to anaemic imports from Europe and
America, to a savings glut that flooded America with cheap credit and even to the global financial crisis,
since the cheap credit enabled irresponsible lending. The allegations were exaggerations. But it was evident
that China had held its exchange rate down, boosting its companies at the expense of others. So it was a
notable shift when the International Monetary Fund declared this week that the yuan was “no longer
undervalued”.
Not everyone agrees. Jack Lew, America’s treasury secretary, was quick to say that he still sees the yuan as
undervalued. With China in their sights, American senators passed a bill earlier in May that could lead to
sanctions against foreign countries deemed to manipulate their currencies. The IMF’s previous assessment
that the yuan was too cheap had lent a veneer of intellectual credibility to such drives. Its new language
strips that away.
Related topics
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International Monetary Fund (IMF)
China
Business
The yuan
Foreign exchange
The change was a long time in coming. The IMF had signalled for months that it was likely to soften its
stance. After all, over many years, the Chinese authorities have allowed a persistent, if gradual,
appreciation. The yuan has climbed by a third against the dollar in the decade since it was formally depegged. More striking has been its climb against other currencies, especially over the past year. By staying
basically level with the dollar during a period when the greenback has been appreciating strongly, the yuan
has gained 14% against a trade-weighted basket of currencies since mid-2014, according to the Bank for
International Settlements (see chart).
That has had an impact. Roughly $300 billion, a record amount, flowed out of China via its capital account
over the past two quarters. In part that is because some firms thought that, with the economy slowing, the
yuan might depreciate. That in itself is a sign that it is more fairly valued than in the past: investors disagree
about whether it ought to go up or down.
Track global exchange rates over time with The Economist's Big Mac currency index
Yet China has not abandoned currency intervention altogether. Although the central bank has stepped back,
traders say it is still the biggest player in the local foreign-exchange market. The direction of its
intervention has changed, however. Left to its own devices, the yuan would in all likelihood have
depreciated in recent months. The central bank appears to have propped it up. Analysts say it has wanted to
send a signal of confidence about the economy.
The IMF recognises that more reform is needed, calling on China to implement a truly floating exchange
rate within three years. But for American lawmakers who propose import duties against countries that
suppress their exchange rates, Chinese actions to bolster the yuan raise an awkward question. Would they
acquiesce to subsidies to help Chinese exporters which are being hurt by their government’s strongcurrency policy?
Morgan Stanley Sees $400 Billion China
Inflows Over Five Years
By Helen Sun 9 hours ago
6/11/15

Yuan liberalization and the opening up of China’s capital account are likely to
attract $400 billion of overseas funds to the nation’s stocks and bonds over
the next five years, Morgan Stanley estimates.
In the most optimistic scenario, inflows could exceed $1.2 trillion if its markets are fully open, analysts led
by Serena Tang wrote in a June 11 research note. A loosening of restrictions could also lead to almost $6
billion of annual outflows as domestic investors diversify their holdings, while funds moving in and out of
the country may increase yuan volatility, they said.
China is easing capital controls as it pushes for the International Monetary Fund to include the yuan in its
basket of reserve currencies at a five-yearly review in October. Freer access to the nation’s financial
markets will lead to the nation’s assets being included in global benchmarks tracked by fund managers.
New York-based equity index compiler MSCI Inc. this week deferred a decision on including yuandenominated stocks in an emerging-market gauge, citing investor concerns such as accessibility and capital
mobility. The potential initial weighting of Chinese shares in MSCI’s index would be about 1 percent,
which would bring $3 billion-$5 billion of inflows, according to Morgan Stanley. That into bonds will be
about $3 billion at the first stage.
The People’s Bank of China last week opened an interbank repurchase market to approved foreign lenders
and said it will start a cross-border payment system for the yuan by the end of the year. Although China’s
reforms will bolster the yuan’s case, inclusion in the IMF’s reserve’s basket will be “difficult” to achieve
this year unless the agency is more flexible with its criteria, according to Morgan Stanley.
NYT
China Devalues Its Currency as Worries
Rise About Economic Slowdown
By NEIL GOUGH and KEITH BRADSHERAUG. 10, 2015
Photo
Counting renminbi in Beijing last month. On Tuesday, China’s central bank set the
value of its currency nearly 2 percent weaker against the dollar. Credit Fred
Dufour/Agence France-Presse — Getty Images
HONG KONG — As China contends with an economic slowdown and a stock market slump, the
authorities on Tuesday sharply devalued the country’s currency, the renminbi, a move that could raise
geopolitical tensions and weigh on growth elsewhere.
The central bank set the official value of the renminbi nearly 2 percent weaker against the dollar. The
devaluation is the largest since China’s modern exchange-rate system was introduced at the start of 1994.
China’s abrupt devaluation is the clearest sign yet of mounting concern in Beijing that the country could
fall short of its goal of roughly 7 percent economic growth this year. Growth is faltering despite heavy
pressure on state-owned banks to lend money readily to companies willing to invest in new factories and
equipment, and despite a stepped-up tempo of government spending on high-speed rail lines and other
infrastructure projects.
A steep drop in the Shanghai and Shenzhen stock markets in late June and early July, only halted by
aggressive government actions, appears to have dented consumer demand within China. The China
Association of Automobile Manufacturers announced on Tuesday that nationwide car sales fell 7 percent
last month compared with a year ago. Excluding months distorted by the timing of Chinese New Year, it
was the steepest drop in sales since December 2008, at the depths of the global financial crisis.
What’s the Latest
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China’s central bank devalued the currency, the renminbi, by 2 percent
against the dollar on Tuesday.
The move is the biggest one-day depreciation since the country's modern
exchange rate system came into place in 1994.
It reflects the weakness in the Chinese economy.
A weaker currency would make goods more affordable for overseas
buyers, but it risks tensions with trading partners like the United States.
China will give the market a bigger role in exchange rates as it tries to have
the renminbi included as a global reserve currency like the dollar.
Weakening the currency raises the risk money will flow out of the
country, but the central bank has trillions of dollars in reserves as a safety
net.
China’s devaluation represents a difficult dilemma for the Obama administration. The United States
Treasury has tried to use quiet diplomacy in recent years to encourage China to free up its currency
policies, while blocking efforts in Congress to punish China for major intervention in currency markets
over the past decade to slow the rise of the renminbi. Many in Congress have long accused China of
unfairly building up its manufacturing sector at the expense of American jobs by undervaluing the
renminbi, and the Chinese devaluation could fan those criticisms.
In a seeming nod to such concerns, the central bank said that it would begin to use the market closing, not
the previous morning’s official setting, to calculate the renminbi’s official daily fixing against the dollar.
But China’s economic weakness now means that further opening up of the currency to market forces could
mean a weaker renminbi, not a stronger one. That, in turn, would make Chinese goods even more
competitive in the United States and Europe.
China’s central bank “has finally thrown in the towel on supporting the renminbi,” said Eswar S. Prasad, a
professor of economics at Cornell University. At the same time, he added, easing its grip on the currency’s
value “has blunted criticism by combining the currency devaluation with a more market-determined
exchange rate.” The United States and institutions such as the International Monetary Fund have called on
China to be more hands-off in managing the renminbi.
The Chinese currency has been a global point of contention for nearly a decade. China officially ended the
renminbi’s fixed peg to the dollar in 2005. Since then, it has risen in two long, slow climbs. The first was
from July 2005 to August 2008, when it was interrupted by the global financial crisis. The renminbi then
resumed its rise from June 2010 to early last year, when it dipped slightly, then stabilized.
The overall increase since 2005 has been more than 25 percent against the dollar. It has strengthened even
more against other major currencies, like the euro and the yen.
But the Chinese currency is not freely tradable, and its movements are tightly controlled by the
government.
Each morning in Shanghai, China’s central bank sets a midpoint for the renminbi’s value against the dollar
and other major currencies. This can be as much as 2 percent higher or lower than the previous day’s value,
although the change is almost always a tiny fraction of 1 percent.
But on Tuesday, the central bank fixed the value of the renminbi at 6.2298 per dollar, down 1.9 percent
from Monday’s official fixing. In a statement on its website, the central bank said it was seeking “to
perfect” the renminbi’s exchange rate against the dollar.
The bank, the People’s Bank of China, said it was reacting to trends in the market, where traders in recent
months had been betting on a weaker renminbi. In trading in mainland China on Tuesday, the renminbi
weakened further to close at 6.3231 per dollar, a drop of 1.8 percent from the close on Monday. By the end
of the Asian business day, it had fallen even further in offshore trading to around 6.36 renminbi per dollar,
a drop of about 2.7 percent, signaling overseas investors expected further weakening.
Changing Value
The Chinese authorities on Tuesday sharply devalued the country’s currency, the renminbi, relative to the
dollar.
The move also jolted the currencies of countries that depend heavily on China as a market for exports. The
Australian dollar fell 1.1 percent against the United States dollar on Tuesday, and the South Korean won
declined 1.4 percent.
“While China’s policy makers have long suggested that foreign exchange reforms would happen, the abrupt
nature of today’s announcement has injected considerable volatility into the renminbi and other Asian
currencies,” analysts at HSBC wrote Tuesday in a research note.
The central bank also said it would seek to prevent what it described as “abnormal” capital flows. Weaker
economic growth has prompted sizable outflows from China in recent months, which have most likely been
exacerbated by the country’s stock market volatility. A falling renminbi generally increases the risk of
more outflows.
While China grew at a 7 percent rate in the first half of the year, that was made possible mainly because of
a boost from the financial services industry, which benefited from the country’s stock market boom. With
the downturn in the nation’s markets over the past two months, growth is slowing more evidently.
This is despite an all-out effort by the government to prop up share prices. The measures included
extraordinary support from state-run banks, which in July made new loans worth 1.5 trillion renminbi, or
about $240 billion at the time, according to data released Tuesday. The last time Chinese banks approached
that amount of lending was 2009, when Beijing was deploying 4 trillion renminbi in stimulus to stem the
damage from the global financial crisis.
A depreciating renminbi also has implications for China’s pledges to open its economy and financial
markets wider, including efforts in recent years to lift the currency’s global prominence.
The central bank has been lobbying the International Monetary Fund to include the renminbi among freely
traded benchmarks like the dollar, euro and yen, so that other countries can include it as an official reserve
currency.
While acknowledging these efforts, the fund issued a report last week saying that “significant work remains
outstanding” before it could decide whether to include the renminbi as a global benchmark, adding that no
changes were likely to be made before September of next year.
The fund also singled out China’s official daily fixing of the renminbi’s exchange rate, saying this “is not
based on actual market trades.”
Tuesday’s devaluation “is likely intended to improve the ‘market-driven’ quality” of the exchange rate to
appeal to the I.M.F., Wang Tao, the chief China economist at UBS, wrote Tuesday in a research note.
“However, we think it unlikely that the Chinese government will let only market momentum drive the
renminbi exchange rate from now on,” Ms. Wang added, “as that can be quite destabilizing.”
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5 ways China's devaluation could shake
the markets
By Tim Mullaney, special to CNBC.com 4 hours ago
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View photo
STR | AFP | Getty Images. The 2 percent drop in the yuan's value has broad
implications for the commodities market and global trade. Here are the potential
spillover effects.
Markets are buzzing about the Chinese government's surprise decision to devalue their currency, known as
the yuan, leading to a 2 percent drop in the yuan's value in Tuesday trading, the largest one-day decline
ever.
Related Stories
1.
2.
3.
4.
Yuan cut clobbers markets, rekindles fear of forex war Reuters
Commodities hit by China's currency devaluation CNBC
Is China's Yuan Move the Start of a Currency War? Bloomberg
Q&A: What yuan devaluation means for China, other countries Associated
Press
5. China's move to cut currency reverberates in global economy Associated
Press
The question is, what does it mean?
The markets-all of the markets-supplied some preliminary answers almost immediately.
1. It gives the Federal Reserve another reason to delay raising interest rates.
The yield on benchmark 10-year Treasuries fell more than 5 percent in U.S. trading today, moving down to
2.12 percent in early afternoon. So the most immediate practical impact of China's move in the U.S. may be
that mortgage rates stay lower for longer.
The idea is that the Federal Reserve may stand pat because weaker growth in one of the U.S. major trading
partners might help convince the Fed that conditions are still soft enough to keep the Fed funds rate at the
near-zero level it has occupied since 2008. Whether that's enough to offset strengthening domestic labor
markets, which are expected to prompt the Fed to raise rates in either September or December, remains to
be seen.
Read More Currency war? How China devaluation may impact Fed
2. It's bad for commodities-and good for commodity buyers.
Immediately, the move means China will pay for oil, copper, coal and other commodities with cheaper
yuan. It may also imply that authorities are worried about the Chinese economy weakening more than the
already disclosed dip in gross domestic product growth to an annual 7 percent clip in the first half of the
year, leading to lower demand for commodities.
The second part of that equation is one reason why oil dropped 4 percent on the news. Copper dropped 8
percent. That's great if you're filling your tank in the U.S.-or making pennies. (Chinese airline stocks got hit
hard, as investors factored in the effect of paying more yuan for fuel but discounted the effect of cheaper
crude). But less-valuable Chinese currency is not so good for exporters who want to sell manufactured
goods that include copper, for example, or that are made in factories powered by Australian coal.
The impact on their costs will cut into any benefit they get from selling their goods more cheaply to dollarusing buyers.
3. The falling yuan may force other countries to devalue their currencies.
Currencies of Australia, Malaysia and South Korea fell in tandem after China's move. But an analysis by
Morgan Stanley in March predicted that a 15 percent drop in the yuan, much larger than today's move,
would cause a 5 percent to 7 percent drop in other Asian currencies.
4. China's overall impact on U.S. growth will be small.
The move today isn't big enough to offset the yuan's appreciation over the last year, so it's not likely that it
will immediately affect China's growth rate by itself, Goldman Sachs analyst MK Tang said in a note to
clients. Because the People's Bank of China's policy shift changes the government's formula for valuing the
currency to give greater weight to market prices in a system that is a hybrid of state and market control, it's
too soon to tell whether the 2 percent drop will be all that's in the pipeline, Tang explained. But even a 5
percent drop wouldn't meaningfully affect China's exports, Morgan Stanley's Helen Qiao said in a March 6
report.
Read More No China blame; 'Flat is the new up': Goldman's Kostin
If China's growth did slow more sharply, the impact on the U.S. would be minor. Goldman Sachs analyst
David Kostin says a 1 percentage point drop in China's annual economic growth would shave 0.06 percent
off U.S. gross domestic product. That impact is already showing up in second-quarter reports by companies
such as Caterpillar (NYSE: CAT), 3M (NYSE: MMM) and United Technologies (NYSE: UTX),
suggesting it would be concentrated among industrial companies.
That suggests the 2 percent decline in U.S. stock market averages today is overdone.
Read More Trump: China devaluation will devastate US
5. China's real goal may be prestige-and some longer-term stability.
China has been making an all-out push to make the yuan the fifth currency recognized by the International
Monetary Fund as an international reserve currency, a designation that could be formalized as soon as next
month.
To win so-called Special Drawing Rights status, China has to demonstrate that its currency is "freely
usable," a conclusion the IMF has refused to draw as recently as 2010. The push for special drawing rights
is pressing China to reduce capital controls in general and may, in particular, be driving the move toward a
more market-based way of valuing the yuan, according to a Bloomberg analysis in March.
The results could include convincing more central banks across the world to hold reserves in yuan,
stabilizing its value, or to be able to buy commodities and other goods priced in yuan, according to several
Asia-based experts cited in Bloomberg's piece. Special drawing rights might also cut borrowing costs for
Chinese exporters.
Looked at that way, China's move may be trading some short-term pain for the promise of longer-term
gain.
The Economist
Markets and economics
The curious case of China's currency
Aug 11th 2015, 9:00 by Buttonwood
THERE have been some dramatic devaluations in history—think of sterling in 1967 and 1992, or Argentina
in 2001/2. When currencies decline, they do so in a big way. China's devaluation of the yuan today is less
than 2%, but it is also being treated as a major story. Robert Peston of the BBC says it is more significant
than either the Greek crisis or if the Federal Reserve raised interest rates. The combination of falling
commodity prices and weaker emerging markets is certainly a worry.
Bears have predicted that a Chinese devaluation would send a new wave of deflation* round the globe. It
would force Asian competitors to respond with their own devaluations, reducing import prices in the
developed world. This might lead to job losses in the west or reduced profit margins. Charles Dumas of
Lombard Street Research, a consultancy, recently wrote that it:
would export the deflationary impact to its trade competitors in the rest of the world. In addition, countries
that became notably overvalued, such as the US and UK, could be weakened as cheap imports cut into
margins. This is how the current bullish cycle in stock markets could end.
image: http://cdn.static-economist.com/sites/default/files/imagecache/originalsize/images/2015/08/blogs/buttonwoods-notebook/20150815_woc368.png
But a 2% devaluation is neither here nor there. It will hardly be a massive boost to Chinese exports, which
fell 8.3% in July. The Bank for International Settlements calculates real trade-weighted indices for different
currencies; as of June, China's index was 126, up from 111 a year earlier and 105 in September 2012. This
shift is just a marginal retracement of that gain.
So this move looks more like a signal than anything else. In particular, it may be a response to IMF
concerns about whether to grant the yuan reserve currency status and inclusion in the special drawing right
(SDR) basket. China would very much like to get that status, partly for prestige reasons and partly to help
its financial sector. So a little bit of currency flexibility might help, yet the move is not big enough to really
annoy the country's Asian neighbours or the Americans.
But can China manage the process effectively? A limited devaluation may encourage traders to expect
more, whether the People's Bank of China (PBoC) says so or not. And that will require the PBoC to use
reserves to defend the new rate. It has lots of reserves, of course, but still the recent $300 billion reduction
might give the authorities pause.
China is trying to juggle several balls at once; to move from an investment-led economy to a consumptionled model without letting growth slip too far, to rein in speculation in property and equities without
damaging industry, to engage with markets without being hit by volatility, and to expand its financial sector
without suffering the hot money flows that destabilised Asia in the late 1990s. It would be surprising if it
didn't drop at least one ball. And its task is so complicated that it is bound to send out confusing signals
every now and then.
* The counter-argument is that currency wars are good news as they are usually accompanied by monetary
easing. Even if all currencies end up where they started (not everyone can devalue, of course), the world
will have easier monetary policy as a result. The big question here is whether monetary policy has lost its
effectiveness and the only positive result from quantitative easing and other policies is the currency impact.
In that case, it is a zero-sum game.
Read more at http://www.economist.com/blogs/buttonwood/2015/08/marketsand-economics#oxjzho8L07hJkypE.99
NYT
China Weakens Its Currency Further
By NEIL GOUGHAUG. 11, 2015
Photo
China's central bank set the official exchange rate for the renminbi at 6.33 per dollar
on Wednesday, or 1.6 percent lower than the previous day. Credit Agence FrancePresse — Getty Images
HONG KONG — China weakened its currency, the renminbi, for a second straight day on Wednesday,
jolting markets across Asia and raising concerns about the path of the giant economy.
The central bank, the People’s Bank of China, set the official rate for the renminbi’s exchange at 6.33 per
dollar on Wednesday morning, or 1.6 percent lower than the previous day.
It was the currency’s second-largest one day drop since 1994, when China’s modern foreign exchange
system began. The largest drop was on Tuesday, when the renminbi was devalued nearly 2 percent.
The move sent other Asian currencies lower for a second consecutive day on Wednesday. Stock markets
also fell across the region. Hong Kong’s main index fell 2.4 percent while in Japan the Nikkei 225 stock
average closed down 1.6 percent. The sell-off was steeper in Southeast Asia, where the main share index in
Singapore fell 2.9 percent, while Indonesia’s Jakarta composite index closed 3.1 percent lower.
The Euro Stoxx 50 index, a barometer of euro zone blue chips, was down 2.5 percent at midday, while the
FTSE 100 index in London was down 1.3 percent by late morning. The euro rose almost 1 percent, to
$1.11.
The renminbi fell sharply in offshore markets, where it is freely traded. The offshore renminbi weakened to
around 6.5 per dollar in late Asian trading, displaying a record level of bearishness on the Chinese
currency, as investors bet on further depreciation to come.
In onshore trading in mainland China, where the renminbi is subject to a daily rise or fall of a maximum 2
percent, the currency at one point pushed up against the weak end of the trading band. But it recovered
sharply late in the trading day on heavy buying volumes to close at 6.38 per dollar, weaker by 1 percent
than Tuesday’s market close.
The onshore market closing level has taken on new significance since Tuesday, when China’s central bank
said the closing price would be used as the reference point for setting the renminbi’s official exchange rate
on the following morning.
Citing unidentified people, Reuters and Bloomberg reported on Wednesday that the central bank intervened
in the market, selling dollars and buying renminbi through state banks in order to support the Chinese
currency. The reports could not be independently verified. Phone calls to the People’s Bank of China’s
headquarters in Beijing rang unanswered after regular office hours.
In a statement on Wednesday morning, China’s central bank reiterated its pledge to give the market a
bigger role in setting the exchange rate. But it sought to allay any concerns that the value of the renminbi
would continue to spiral downward.
“Based on international and domestic economic and financial conditions, there is currently no basis for a
continued depreciation of the renminbi exchange rate,” the statement said.
China appears to have two main goals in allowing its closely managed currency to weaken.
For one, it could help offset the country’s slowing economy. Exports have been particularly hard hit,
contracting by 8 percent in July, and a cheaper renminbi makes China-made goods relatively more
affordable for consumers in the United States and Europe.
At the same time, China is also seeking a greater role for its currency on the global stage. In recent months,
policy makers have been lobbying the International Monetary Fund to include the renminbi in its basket of
global reserve currencies, which includes the dollar, euro, yen and pound.
That means convincing the fund that the renminbi is a freely traded currency.
The I.M.F. reacted positively to Tuesday’s statement by China’s central bank that it would tweak the way it
sets the exchange rate, saying in a statement that the move “appears a welcome step as it should allow
market forces to have a greater role in determining the exchange rate.”
It added, however, “The exact impact will depend on how the new mechanism is implemented in practice.”
Global Selling Shows Concerns About
China’s Weakness
By PETER EAVISAUG. 11, 2015
After China shocked investors on Tuesday by devaluing the country’s currency, a wave of selling swept the
globe. The price of oil plunged, the currencies of other countries tumbled and stock markets skidded on
every continent.
For once, the markets may not have overreacted.
Investors have been able to live with the problems brewing in China’s economy for years. The country’s
authorities always seemed to have the financial firepower and the will to rev up China’s $10 trillion
economy when it sputtered.
But the devaluation, along with the authorities’ aggressive efforts earlier in the summer to shore up the
country’s stock market, has rekindled long-running concerns that China’s economy is substantially weaker
than official figures suggest — and that its leadership is running out of ways to bolster growth.
James W. Paulsen, chief investment strategist at Wells Capital Management, said investors’ perceptions of
China dimmed after the authorities intervened to stem the selling of Chinese stocks. “Now, this devaluation
has just made it worse,” he said. “It’s almost an admission that they’ve been unable to arrest the
slowdown.”
The devaluation of the renminbi, nearly 2 percent against the dollar, may help revive the economy. When a
country devalues, its goods cost less in other currencies, like the dollar, which can lead to an increase in
demand for those goods around the world.
Still, investors can view devaluations warily.
Some analysts had recently speculated that China would adjust its exchange rate. But the change, when it
came, was far greater than expected, prompting analysts to ask whether the Chinese authorities were acting
from a position of weakness.
“This is the second time in two or three months that they surprised us with what seemed like abrupt policy
changes,” said Jorge O. Mariscal, chief investment officer for emerging markets at UBS. “They were
almost panicky measures — that is the concern.”
Mr. Mariscal added that investors might have expected the adjustment to be a 2 percent decline in a year,
not 2 percent in a day.
The move rippled through the markets on Tuesday.
The Dow Jones industrial average fell 212.33 points, or 1.21 percent, to close at 17,402.84. The Standard &
Poor’s 500, a broader index favored by investors, declined by 0.96 percent to close at 2,084.07.
Oil, as measured by the benchmark United States crude contract in New York, declined by 3.75 percent to
$43.35 a barrel. The 10-year Treasury note, a safe haven on troubled days in the market, rose in price,
pushing its yield down to 2.137 percent. The currencies of Asian countries, including South Korea,
Thailand and the Philippines, declined on Tuesday.
As investors grope for explanations for the devaluation, they point to the need for stemming capital
outflows from the country, which have picked up in recent months. It is an indication, at least somewhat,
that Chinese investors — fearing their currency was overvalued and a devaluation was coming — are
looking for better opportunities elsewhere.
“All this hot money outflow was people in China realizing they had an overvalued currency — and
spending when they could,” said Atul Lele, chief investment officer at Deltec International, an investment
firm. But there is a danger that the capital outflows may now speed up, if the Chinese investors believe the
renminbi could be devalued again.
The sharp reaction among investors also reflects the mistrust toward economic data coming out of China.
While the country’s goal is to grow 7 percent this year, a report last week from Bank of America Merrill
Lynch caused a particular stir in the markets. It cited data that suggested China’s economy may already be
in a ditch, including figures showing that power generation was flattening, cement production contracting
and steel output slowing.
The murkiness of China’s numbers means that global investors could remain jittery in coming weeks as
they pore over every report about the country’s economy. If more signs of slowing emerge, investors might
expect a further devaluation.
That, in turn, could prompt other countries to devalue, to prevent Chinese exporters from gaining an outsize
advantage in world markets. If that happens, fears of a full-on currency war would soon grip the markets.
In a sign of how fears about China can have negative consequences far afield, stock markets and currencies
fell in Latin America on Tuesday. Countries in the region are big exporters to China and in recent years
they have also received substantial investments from the country. Seeing trouble in China might cause
other investors in Latin America to pull back.
“Everyone has to back up and at least put their projects on pause when China has to tweak more than the
stock market to get its economy growing as quickly as it did in the past,” said Jim Vogel, a strategist at
FTN Financial.
Russia, too, is watching closely. Any further slowdown in China — its largest trading partner — could
weigh on Russia, at a time when it is already dealing with the dual headwinds of Western sanctions and low
oil prices. On Tuesday, the Russian ruble was off roughly 2 percent.
The United States economy would most likely get hit if China and many other countries continued to
devalue. American companies would find it harder to export, depressing their earnings. “We thought we
were at the end of the stronger dollar cycle — and clearly this could extend it,” Mr. Mariscal said.
Still, some analysts say the fretting has gone too far. In devaluing, China’s authorities, they assert, acted
mostly out of a long-term desire to allow the market to have a greater role in setting the level of its
currency.
“We take China policy makers at their word that this is meant to introduce greater market forces into
determining the exchange rate,” Brown Brothers Harriman said in a research note on Tuesday, adding that
any further declines are likely to be restrained. The country also has billions of dollars in reserves that it
can use to influence the exchange rate and put out financial fires.
Others said that the devaluation was sensible because the currency was becoming quite overvalued, and
was merely a catch-up move that would have benefits for the economy. “China’s wages haven’t increased
and their cost base hasn’t gone up,” Mr. Lele said, “but they have been slowly becoming less competitive.”
And by loosening the way it manages its currency, China in effect will gain more flexibility in conducting
its domestic monetary policy, leeway it will need as it tries to stimulate the economy, Mr. Lele contended.
Even so, China will most likely remain a big worry among investors until it posts strong and convincing
growth figures. Some investors are wondering whether China is just another emerging market, vulnerable
to global money flows.
As the Federal Reserve now prepares to raise interest rates, the supply of dollars around the world has
slowed, causing financial havoc in many developing countries. That tightening could make life harder for
China — and the authorities there may already have seen that.
“The growth scare is what is affecting the markets right now,” Mr. Mariscal said. “They are worried that
Chinese growth is much, much weaker than people expected.”
NYT
China’s Economic Stabilization Policies
http://www.nytimes.com/interactive/2015/08/11/business/international/china-yuandevaluation-in-exports-economy-stock-market.html
August 11th 2015
Print Share
Central bank allows the renminbi to
weaken
Event
On August 11th the People's Bank of China (PBC, the central bank) moved the renminbi's central parity
rate against the US dollar lower by almost 1.9% compared with the previous day's rate.
Analysis
The move, which The Economist Intelligence Unit had not anticipated, has been seen by many as part of
the government's policy response to the disappointing economic data of recent months, including the poor
export figures published on August 10th. The weaker currency will support China's export competitiveness.
Nevertheless, China's exports have held up better than many rivals so far in 2015 and the boost to exporters
will be relatively modest. The scale of the decline unveiled on August 11th is small, especially compared
with the depreciation of many other emerging-market currencies against the renminbi over the past two
years or so.
The PBC's actions do not represent a departure from its ambition to liberalise China's exchange rate, or a
return to direct government setting of the exchange rate. The renminbi has been under downward pressure
in recent weeks, with PBC adjustments to the central parity rate not fully reflecting movements of the
currency within the 2% daily band about the parity rate within which the renminbi is permitted to trade.
The PBC's move thus arguably represents an acknowledgement of market forces, although it will doubtless
also please many of those within the government who are pressing for more concerted policy action to
support the economy.
Nevertheless, the latest move is likely to have some negative repercussions. A weaker currency will
increase inflationary pressures within China, which had in any case been rising for consumers. The
struggling heavy-industry sector will not welcome higher imported commodity prices, and some firms with
foreign debts will face a tougher repayment burden. The depreciation could also complicate China's efforts
to get the IMF to allow the renminbi to join the basket of currencies that make up its special drawing rights
(SDR) currency unit. Although there is no reason why the PBC's announcement should contravene the key
requirement that SDR currencies be "freely usable", suggestions that China is engaging in a currency war
may reduce political goodwill towards it. Perhaps the greatest risk, however, is that the depreciation may
encourage perceptions that further declines in the renminbi's value are imminent, increasing the danger of
destabilising capital outflows.
Impact on the forecast
We will adjust our exchange-rate forecasts for 2015–16 lower in the light of the PBC's announcement.
EIU
Simon Baptist
Chief Economist
Are Chinese Leaders Losing Control of the Economy?
China shocked markets this week by allowing a substantial devaluation of the
renminbi's central parity rate against the US dollar. Following hot on the heels of the
stockmarket turmoil that also spurred surprise intervention, it would be reasonable to
wonder if China's government is losing control of the economy. But, as with all
headlines that end in a question mark, the answer to mine is "no". China is
undergoing an economic transition on an incredible scale: a continent-sized
economy is moving rapidly to higher income status, from investment to
consumption, and coming down from 10% levels of growth, while simultaneously
opening its financial markets. It's a tough balancing act, and it won't all be smooth
sailing.
I think there are two key reasons why this week's action is not a sign of crisis. First,
the renminbi has appreciated markedly against almost every currency over the last
18 months: it is still up around 20% against the Euro and Mexican Peso, 15%
against the Yen and 10% against the South Korean Won. The story is really one of
US dollar strength: the renminbi just could not keep appreciating against most
currencies as the economy was weakening. Second, this volatility fits in with the
broader trend of liberalisation with some bumps. It is in line with market forces and is
something that we should expect to see more of as China liberalises its exchangerate regime. With the recent interventions in the stock market, I wasn't expecting
now to be the moment to add more "market forces" to the currency, but it is a good
reminder that there are a range of voices in Chinese policy circles. There is, of
course, a limit to how much volatility the central bank will be willing to accept and so
don't expect to see the renminbi going south of seven per US dollar.
Do you think this heralds the start of currency wars and capital flight from China, or
are you more relaxed? Let me know on Twitter @Baptist_Simon or via email on
[email protected].
Best regards,
Simon Baptist
Chief Economist
NYT
China Seeks to Calm Markets as It Devalues Currency for 3rd Consecutive
Day
By NEIL GOUGHAUG. 13, 2015
Photo
Studying stock charts on Thursday at a brokerage firm in Shanghai. After
two days of declines, the Shanghai composite index rose 1.8 percent on
Thursday. Credit Johannes Eisele/Getty Images — Agence France-Presse
HONG KONG — China on Thursday sought to ease the turbulence its depreciating currency, the
renminbi, has set off in global markets, even as it pushed the renminbi lower for the third day in a
row.
China’s central bank, the People’s Bank of China, set the renminbi’s official exchange rate to the
dollar lower by 1.1 percent on Thursday, bringing the total devaluation since Tuesday to 4.4
percent, the biggest drop in decades.
The renminbi is falling because the government is loosening its tight grip on the currency, but
only by a bit.
China’s slowing economy has created pressure on the renminbi to weaken for more than a year,
but instead the government held to its longstanding practice and kept it closely linked to the
dollar, which has risen as the United States economy rebounded.
By devaluing the renminbi now, China has delivered a boost to its exporters, whose goods
become relatively cheaper for overseas buyers. But the sharp and sudden fall has also raised
concerns that the economy is weaker than the official growth rate suggests and prompted
questions over the Chinese leadership’s management of the slowdown.
What’s the Latest
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For the third day in a row, China’s central bank on Thursday
devalued the currency, the renminbi, this time by 1.1 percent
against the dollar.
The total devaluation since Tuesday is 4.4 percent, the biggest drop
in decades.
Government officials, in an unexpected news conference on
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Thursday, stressed that the currency was not in free fall.
Global markets appeared to respond to the assurances. The
Shanghai composite index ended the day higher.
The devaluation reflects weakness in the Chinese economy.
A weaker currency would make goods more affordable for
overseas buyers, but it risks tensions with trading partners like the
United States.
NYT
China’s Economic Stabilization Policies
http://www.nytimes.com/interactive/2015/08/11/business/international/chinayuan-devaluation-in-exports-economy-stock-market.html
At an unusual ad hoc news conference on Thursday, officials from the central bank were at pains
to explain that the currency had not entered a free fall.
“The central bank has withdrawn from the normal mode of intervention,” Yi Gang, the deputy
governor of the bank and the head of the unit that runs China’s foreign exchange system, told
reporters in Beijing. “But if you say the market has commonly recognized rules of the game, then
those are still the rules that we lay out.”
Mr. Yi was referring to changes to China’s currency system that were announced on Tuesday, as
the bank devalued the renminbi by nearly 2 percent. It was the biggest daily drop since 1994,
when China’s modern currency system began.
Previously, the central bank would assign a value to the currency each morning, and would allow
it to trade up or down by a maximum of 2 percent against the dollar. In practice, it barely budged
more than a fraction of percentage point each day.
Now, policy makers have said they are giving the market a bigger say by basing the setting of the
official exchange rate on the currency’s trading performance, not just on a government decree.
Still, central bank officials made clear on Thursday that while they intended to ease their grip
somewhat, they would not end it.
On Wednesday, when the renminbi showed signs of weakening by the maximum 2 percent limit,
the central bank was widely reported to have jumped into the currency market, selling dollars to
push up the value of the renminbi — which rapidly recovered to close only 1 percent lower.
“They intervened massively and drove the exchange rate up,” said Arthur Kroeber, the managing
director of Gavekal Dragonomics, a financial consultancy. Still, he added that the new system “is
clearly on the spectrum of a much more market-exchange-rate environment.”
On Thursday, trading was more subdued, though heavy trading volume returned again in the final
minutes of activity. The renminbi weakened only very slightly, by 0.2 percent. This suggested
that, based on the new system, the central bank would not be under pressure to make another
drastic shift in the renminbi’s value when it sets the official exchange rate on Friday.
Stock markets across the region recovered modestly on Thursday after the recent sell-off, led by
Shanghai, where the main index finished 1.8 percent higher after two days of declines. Other
currency markets outside China also stabilized, led by the South Korean won, which rose against
the dollar in late Asian trading.
Mr. Yi did not directly comment on any intervention when asked about it on Thursday, but hinted
it was a tool still at the central bank’s disposal. “When there’s excessive volatility in the market,
it can still be effectively managed,” he said.
NYT
The More China’s Currency Falls, the
More It Looks Like a ‘Currency War’
AUG. 12, 2015
Neil Irwin
There were two stories for why China allowed the value of its currency to fall beginning on Tuesday, one
of which makes the government look shortsighted and the other farsighted: It is looking to boost its export
sector to combat a weakening economy or it is trying to liberalize its financial system as it ascends the
global financial stage.
After Wednesday’s events, the shortsighted, export-boost story is looking like the more powerful
explanation of what China is up to.
The renminbi fell 1.6 percent against the dollar Wednesday after a 1.8 percent drop Tuesday. That amounts
to an exceptionally steep two-day move in the exchange rate between the world’s largest economies.
There were signs the sell-off went beyond even what the Chinese officials themselves had hoped for. The
People’s Bank of China issued a statement that “currently there is no basis for persistent depreciation” of
the currency. Some traders report they see evidence the central bank is buying yuan to stem the declines.
Photo
A currency dealer in Seoul, South Korea, sat in front of electronic boards showing
the Korea Composite Stock Price Index and the exchange rate between Chinese and
South Korean currency. Credit Kim Hong-Ji/Reuters
The initial reaction out of the United States to the original liberalization of exchange rates Tuesday went in
two directions. One was to shout “currency war,” arguing that China was engaging in a desperate measure
to try to achieve some temporary economic gain at the expense of its rivals through currency devaluation.
See, for example, the comments of Senator Chuck Schumer, a longtime critic of China’s currency practices.
In some of the halls of power in Washington, the reaction was more one of cautious optimism. The
International Monetary Fund and United States Treasury adopted a wait-and-see view of the move. They
have both been pushing China to liberalize its exchange rate policy so that it adapts more to market forces,
and they were, it seemed, getting what they wanted.
(For a particularly sophisticated version of this argument, read this article by Nicholas Lardy, the China
expert at the Peterson Institute for International Economics, who made arguments in line with the I.M.F.
view; the Twitter feed of his boss, Adam Posen, is more skeptical.)
The fact that the sharp drop continued for a second day makes more plausible the idea that China is
primarily motivated by a desire to advantage its exporters against competitors across Asia and beyond.
Continue reading the main story
Graphic
How China Is Trying to Stabilize Its Economy
China’s devaluation of the renminbi was the latest in a series of moves over the past two months to help
boost the slowing Chinese economy.
OPEN Graphic
The more abrupt a move the government allows, the more the devaluation looks of a piece with China’s
frantic efforts to prop up its stock market earlier this summer — a short-term, desperation solution to a
pressing problem.
Contrast that with the moves the Federal Reserve, the Bank of Japan and the European Central Bank took at
various points in the last few years to loosen monetary policy and spur higher domestic inflation and
growth. They have been controversial, and no doubt resulted in devaluations of their respective currencies,
but the actions were carefully telegraphed, thoughtfully explained and explicitly aimed at domestic
conditions rather than manipulating exchange rates.
The Chinese central bank’s move, by contrast, came as a complete surprise. It was accompanied by only
vague official communication and appears to be narrowly targeted at the exchange rate. And because the
Chinese central bank is not independent from its government, it’s impossible to know whether politicians
or technocrats are really pulling the strings on the policy.
The book is not written on China’s new currency policies; after all, they’re only two days old. But if the
sell-off continues the way it did Wednesday, the blowback to China’s actions and talk of “currency wars”
will only get louder, and the voices of praise for its move toward liberalization softer.
Taking place against a backdrop of sluggish global growth, a United States presidential campaign season
that is getting underway and a Chinese economy that just might be in real trouble, that will make for an
interesting autumn in international finance.
NYT
Devaluation Hints at China’s Rising
Distress Over Economy
点击查看本文中文版 Read in Chinese
By NEIL GOUGHAUG. 12, 2015
Photo
Diners at a table lifted by a crane to a height of about 100 feet, with a view of a
residential construction site in Kunming, China. Credit Wong Campion/Reuters
HONG KONG — Whenever China’s economy swooned in recent downturns, its currency never buckled. It
held steady, or strengthened, even as China’s neighbors or trading partners scrambled to cut the value of
their own currencies to deal with the fallout.
With the Chinese renminbi now taking its biggest plunge in decades, the worry is that the country’s already
slowing economy is even worse off than reported and that the government is panicking. On Thursday,
China allowed the renminbi to weaken significantly for a third consecutive day.
The situation is shaking the aura of supremacy surrounding President Xi Jinping and the Communist Party,
which has portrayed a sense of ultimate authority. But the Chinese government’s response to the country’s
financial woes is creating concerns about its ability to manage a slowdown.
“People are used to growth and rising living standards,” said Jonathan Fenby, an author and co-founder of
the research firm Trusted Sources. “But now they are in a ‘real’ world, and the leadership has to convince
them both that slower growth is in their long-term interests and that it is in control.”
Continue reading the main story
What’s the Latest
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For the third day in a row, China’s central bank on Thursday devalued the
currency, the renminbi, this time by 1.1 percent against the dollar.
The total devaluation since Tuesday is 4.4 percent, the biggest drop in
decades.
Government officials, in an unexpected news conference on Thursday,
stressed that the currency was not in free fall.
Global markets appeared to respond to the assurances. The Shanghai
composite index ended the day higher.
The devaluation reflects weakness in the Chinese economy.
A weaker currency would make goods more affordable for overseas
buyers, but it risks tensions with trading partners like the United States.
By the official measures, the economy is growing at 7 percent, right in line with government targets. It is a
steady pace that the leadership has indicated can support decent job growth and put more money into
consumers’ pockets.
But a look below the surface shows a different, more worrisome picture. Core parts of the economy, like
construction, are weaker than ever as the real estate industry struggles. Consumer spending, which was
supposed to pick up the slack, is not that strong. And financial services, a major driver of economic growth
when the stock market was booming, are slipping.
The data coming out of China, too, is somewhat suspect. Economists now wonder whether, despite official
figures showing growth, some provinces and regions could be dealing with outright recessions.
“To be honest, no one has a clue where the economy is, and I don’t think that it’s properly measured,” said
Viktor E. Szabo, a senior investment manager at Aberdeen Asset Management.
“Definitely there is a slowdown,” he added. “You can have an argument about what level it is, but it’s not 7
percent,” he said, referring to the rate of growth.
The government’s aggressive action on the currency has brought the economy into sharp focus.
The currency’s official rate, at 6.4 renminbi per dollar, is down 4.4 percent over the last three days. On a
typical day, the renminbi rises or falls just a small fraction of a percentage point.
While the government said the decision was intended to make the currency more market-oriented, the
devaluation also was largely a gift to exporters. In relative terms, it makes China’s shipments of clothing or
electronics to consumers in the United States or Europe more affordable.
Photo
China has invested 667 million renminbi, or over $100 million, building a giant
telescope in the southern province of Guizhou. Credit Reuters
“I don’t see this mini-devaluation as some kind of outrageous act,” said George Magnus, an economic
adviser to the bank UBS and an associate at Oxford University’s China center. “But it is part of an array of
other economic and financial stimulus measures designed to shore up the flagging growth rate.”
The government has taken the usual steps by cutting interest rates and freeing up more money for banks to
lend. But the leadership has also turned to more unconventional means in recent months to try to cushion
the blow as the economy’s once-runaway expansion sinks back to earth.
It relaxed a rule that banned investment companies tied to local governments from piling on debt. When the
stock market slumped, it aggressively moved to halt the slide, by encouraging borrowing to buy stock and
pouring money into the system. It has also pledged tens of billions of dollars in support to state-controlled
policy banks for loans to favored projects.
China’s plan has been to wean itself off a debt-driven growth model that has led to wasteful, governmentled investment. Instead, policy makers want consumers to become the main engine for the economy, but
that will take time.
They had hoped to maintain growth by keeping credit flowing to favored projects, a nationwide program
that amounts to trillions of renminbi worth of investment in new infrastructure. The money is going to
redevelop shantytowns and to build wastewater treatment facilities, as well as expand road and rail
networks.
In the city of Liupanshui in Guizhou, one of China’s least affluent provinces, the local government is
building its first subway line. Officials hope to bring in private investment to help finance the project, a 49kilometer line expected to cost 10 billion renminbi, or about $1.6 billion.
But such efforts have not been enough. While infrastructure investment is rising, it has failed to offset the
nationwide pullback in spending on new factories and apartment block towers. In July, overall investment
in fixed assets rose 11.2 percent, the slowest increase in 15 years.
The troubles can be seen in mid-tier cities like Zhanjiang, on the southern coast, which is home to the navy
fleet that patrols the South China Sea. While property prices in major metropolises like Shenzhen or
Beijing have rebounded, those are exceptions. Prices of new homes in Zhanjiang fell 9.8 percent in June
from a year earlier, the most recent data available.
China’s builders just are not building as much. For years, double-digit growth was the norm in construction
materials, as cities across the country went on a building spree. That situation has reversed sharply, and
output of many crucial materials has been declining this year.
Cement output fell 5 percent by volume last month, while plate glass production declined 13.5 percent.
Steel output fell 1.8 percent in July, the most on record. Exports of steel soared as mills, many of them
operating at a loss and unable to find buyers at home, shipped their excess stock overseas.
Consumers aren’t yet able to shoulder the burden of driving the economy. While incomes are still rising,
the job market has started to show signs of stress. Vacancies are declining across the market as companies
reduce hiring in response to slowing business growth.
The stock market slump has also taken a toll, with the main Shanghai index down about a quarter from its
peak two months ago. Ordinary investors have poured money into the markets over the last year, and many
are now sitting on losses.
The overall result is that consumers are spending less. Retail sales grew 10.5 percent in July from a year
earlier, near the slowest pace in a decade. Share prices of big multinationals that sell heavily into the China
market, like LVMH, the spirits and luxury goods retailer, or Yum Brands, which operates the KFC and
Pizza Hut fast food chains, have suffered since the renminbi’s devaluation.
Even homegrown e-commerce companies, held up by China’s leaders as builders of a new economy, have
not escaped the rout. Shares in Alibaba, in New York, and Tencent, traded in Hong Kong, have both
declined over the last two days.
The stock market slump is a double blow. In the first half of the year, the flurry of new share sales, strong
brokerage business and other market-related activities helped mask some underlying issues.
Without that boost, China’s gross domestic product would have risen notably less than the 7 percent
reported rate. Instead, it would have been about 6.2 percent in the second quarter and 6.5 percent in the
first, economists at Standard Chartered estimated in a report last month.
As the government pumps money into the market and the broader economy, it will help, along with moves
like the devaluation. It is just not clear how solid the economy will actually be.
“It’s all about the quality of growth,” said Victor Shih, a China scholar at the University of California, San
Diego. “If they want to, they can always achieve the right rate of growth.”
The Chinese government, he added, just needs to find a group of people and “tell them to go dig a ditch.”
The Economist
China, the Fed and emerging markets
Yuan thing after another
A cheaper yuan and America’s looming
rate rise rattle the world economy
Aug 15th 2015 | From the print edition
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THE cloud hanging over emerging markets seemed to darken in the past week. As it was, fears that the
Federal Reserve is about to raise rates, pushing up debt-servicing costs and sucking capital out of emerging
markets, had been weighing on currencies and stockmarkets from Brazil to Turkey (see chart). Now a fresh
worry is blotting the horizon. On August 11th China engineered a small devaluation of the yuan, prompting
concerns that, with growth sputtering, its government was ready to risk a global currency war.
The angst about the state of the world’s two biggest economies is understandable. China’s economy has
slowed markedly: it is likely to grow by 7% this year, its most languid rate in a quarter-century. In addition
the government has been trying to reorient the economy from investment to consumption. For emerging
markets that had been catering to China’s investment binge—those selling it coal and iron ore, copper and
bauxite—the past few years have been little short of brutal. The economy’s slowing and rebalancing
explain much of the 40% fall in commodity prices since their peak in 2011 and, by extension, the travails of
countries which make their fortunes digging stuff out of the ground, from Peru to South Africa.
For other emerging markets, the importance of China as a source of direct demand is less pronounced.
Exports to China account for less than 9% of total shipments from developing countries, calculates
Jonathan Anderson of Emerging Advisors, a consultancy, whereas exports to the rich world account for
55%. For countries exporting food and fuel—the majority of the global resource trade—China’s slowdown
has had a limited impact. Except for a small group of countries heavily concentrated on exports of ores and
minerals, “China has hardly mattered at all,” he says.
China can make itself felt in other ways, however. A slowdown in the world’s second-largest economy, for
instance, is bound to have second-order effects on demand. Deflation in China puts pressure on firms in
other emerging markets to cut prices. And some worry that the yuan’s fall may initiate a series of
competitive devaluations, with other exporters racing to weaken their exchange rates or, perhaps, resorting
to trade barriers as a last resort. Fortunately, the changes to China’s exchange-rate regime do not seem
nearly big enough to set such a vicious cycle in motion. Even after its devaluation, the yuan remains
stronger than it was a year ago in trade-weighted terms. Moreover, the authorities are now intervening to
slow its decline. In other words, the depreciation is a small, belated step to keep the yuan’s value in line
with those of its peers, not a dramatic shift in exchange-rate policy.
China’s slowdown continues to amplify jitters about the Fed’s impending “lift-off”. The sensitivity of
developing countries to changes in policy at the Fed was amply illustrated by the “taper tantrum” of 2013,
when the announcement that it would slow and eventually stop its huge purchases of government bonds led
to turmoil in emerging markets.
An American rate rise, which may come as soon as September, could put pressure on emerging markets in
a variety of ways. Rising rates will add to the allure of American assets, potentially making the dollar even
stronger. For the governments, households and firms in the developing world that have borrowed trillions
of dollars in recent years, interest and repayment costs will climb in terms of local currency. If fears about
their debts lead to more outflows of capital, central banks in the weakest countries will face an invidious
choice between letting their currencies plummet and ratcheting up interest rates to defend them. The former
will only aggravate the burden of their foreign-debt load; the latter will stifle growth. Bill Gross, the
world’s best-known bond manager, has spoken of a “currency debacle” for emerging markets.
Not all agree that higher American interest rates need spell doom. That the Fed has been edging towards
lift-off is no secret. Anticipation of this is one reason for the dollar’s recent strength. If its tightening is
gradual, as expected, emerging markets may fare better than feared.
The presumption that the dollar strengthens when the Fed raises rates is not borne out by evidence. In the
first 100 days of its four big tightening cycles of the past 30 years, the dollar has actually weakened every
time, according to David Bloom of HSBC, a bank. The notion that Western central banks’ efforts to keep
interest rates low sent a torrent of money into emerging markets that is now about to drain away may also
be wrong. Average quarterly flows from America to emerging markets were actually higher before the
crisis, according to Fitch, a ratings agency. If so, monetary policy in America may not be the be-all and
end-all for emerging markets. That, at any rate, will be their hope.
NYT
China’s Devaluation of Its Currency Was
a Call to Action
By KEITH BRADSHERAUG. 17, 2015
Photo
Across China, millions of workers and thousands of companies are feeling the pain
of the country’s slowing economy, as sales slip and incomes drop. Credit Adam Dean
for The New York Times
Continue reading the main story Share This Page
HONG KONG — When Prime Minister Li Keqiang convened the Chinese cabinet last month, the troubled
economy was the main topic on the agenda.
The stock market had stumbled after a yearlong boom. Money was flooding out of the country. Most
ominously, the country’s export machine had stalled, prompting a wave of labor strikes.
In a little-noted advisory to government agencies, the cabinet said it was essential to fix the export problem,
and the currency had to be part of the solution.
With the government keeping a tight grip on the value of the renminbi, Chinese goods were more
expensive than rivals’ products overseas. The currencies of other emerging markets had fallen, and China’s
exporters could not easily compete.
Soon after, the top leadership of the Communist Party issued a statement also urging action on exports.
It all set the stage for the currency devaluation last week that resulted in the biggest drop in the renminbi
since 1994.
The cabinet’s call to action: The country needed to give the currency more flexibility and to reinvigorate
exports. If officials did not act, China risked deeper turmoil at home, threatening the stability of the
government.
Graphic
How China Is Trying to Stabilize Its Economy
China’s devaluation of the renminbi was the latest in a series of moves over the past two months to help
boost the slowing Chinese economy.
OPEN Graphic
But the sharp focus on the domestic agenda also complicates China’s global ambitions. By devaluing the
currency, Chinese authorities, who have been pushing a big expansion of overseas investments, are eroding
some of the country’s buying power overseas.
China appears willing to make those trade-offs. Manufacturing, the core engine of growth in the world’s
second-largest economy, is just too critical. And the pressures have been mounting, with exports last month
plunging 8 percent compared with a year earlier.
The weakness is only creating problems elsewhere in an economy already rattled by a real estate slump.
Across the country, millions of workers and thousands of companies are feeling the pain, as sales slip and
incomes drop.
Zhang Wei, a carpenter at a construction materials market in Guangzhou, says customers’ orders are
shrinking drastically. Hu Sheng, a seller of metal siding, had to cut prices to the bone, and even then his
sales dropped by a third.
At a covered market in Guangzhou, Zhang Xiaojun sat dejectedly behind a counter where a half dozen
gutted, plucked chicken carcasses lay. “I was selling 30 to 40 chickens a day last year,” he said. “Now at
best I sell only 10 chickens in a day, and I can’t make a living.”
After the top-level meetings in July, officials moved quickly. On Aug. 11, the central bank announced a
new policy for determining the value of the renminbi, saying it would allow market forces to play a greater
role.
Business By JONAH M. KESSEL 4:59 To Understand Renminbi, Follow the Bacon
Continue reading the main story Video
To Understand Renminbi, Follow the Bacon
From market to table, pork can explain a lot about what’s going on with China’s turbulent currency
markets.
Although the central bank denied the decision was motivated by the export issue, officials were assured a
quick, economic benefit. Once market forces were unleashed, they resulted in the sharp and swift decline of
the currency, which dropped by 4.4 percent last week.
But the devaluation creates uncertainty, potentially undermining confidence in what had been the world’s
steadiest and most enduring economy. It will also test President Xi Jinping and the leadership, as they try to
balance their domestic needs and global expansion. A deteriorating economy could force them to pick
between the two agendas.
“For Xi Jinping, domestic stability is the top priority,” said Willy Lam, a specialist in Beijing politics at
the Chinese University of Hong Kong. “It’s going to be a higher priority than China’s international
responsibilities.”
A Shaky Foundation
The biggest casualties of China’s recent economic woes are the workers.
Zhou Ping, 23, moved from central China to Guangzhou in Guangdong province three years ago and got a
position cutting fabric at a garment factory. He lost his job three months ago and has been unable to find
any work.
Growing Unrest
Labor unrest in China has increased as the country’s economy has faltered, especially in the provinces that
produce goods for export. One focus now is on unpaid wages, a sign of struggling businesses in a troubled
economy. Previous labor actions were largely about pay increases, reflecting a strong job market.
About 200 workers of the Shandong Haijin Group, a paper maker in Jining City in Shandong province,
strike and create roadblocks in May over eight months of i.o.u.s for unpaid wages.
Sporadically in May, several thousand workers of the Ashley Furniture factory in Kunshan City in Jiangsu
province wage strikes and demonstrations over stagnant pay and arbitrary deductions.
About 700 workers at Zhanheng Toys Electronics Company in Dongguan in Guangdong province
demonstrate and create roadblocks in August over unpaid wages.
About 500 workers of Henan Dingsen Clothing, a cloth maker in Shangqiu City in Henan province, strike
and march to a government building in July over receiving i.o.u.s for unpaid wages for three months.
Over 1,000 workers at Compart Technologies, a hard-disk drive maker in Chongqing province, strike in
July for receiving i.o.u.s for unpaid wages and housing funds for eight months.
More than 1,000 workers strike in July at the Guangdong Elecpro Electric Appliance manufacturer in
Foshan in Guangdong province demanding severance pay after a large layoff.
*Labor protests peaked in January 2015 because workers pressed for back wages
and made other demands before returning to their hometowns for Chinese New
Year.
Sources: China Labor Bulletin; New York Times reporting
By The New York Times
“Competition is too intense; there are so many people fighting for each job,” he said. “However, I have no
plans to return to my home province just yet. My friend is letting me take turns in his bunk bed.”
While China lacks reliable unemployment statistics, the labor market is under significant pressure. Pay is
barely climbing faster than consumer prices. Millions of Chinese are looking for work.
It is a sensitive issue. The leadership has indicated that slower economic growth is acceptable, provided the
labor market remains strong. Any instability could prompt an internal debate about whether the government
can manage a slowdown and still meet its global goals.
If President Xi cannot deliver rising living standards, “that will undermine the long-term sustainability of
the regime,” said Li Daokui, an economist at Tsinghua University in Beijing.
When Deng Xiaoping began opening the country’s economy to capitalism and foreign investment in 1979,
he started in a series of duck-farming villages in southeastern China’s Guangdong province, next to Hong
Kong. His successors subsequently built on the plan, turning the experiment into the world’s biggest hub of
light industry manufacturing, producing items like microwave ovens and laptop computers.
The area is a crucial backbone of China’s economic story. Guangdong’s main cities — Shenzhen,
Dongguan and Guangzhou — developed into a vast urban sprawl, each with a population the size of Los
Angeles.
Photo
Butchers cut meat at a market in Guangzhou, one of the cities in the Guangdong
province that developed around light industry manufacturing that now has a
population the size of Los Angeles. Credit Adam Dean for The New York Times
As exports surged, the country produced double-digit growth for decades. The newfound wealth prompted
China to find opportunities overseas, which helped expand its international influence and support its
domestic needs.
But the export business is now suffering.
Furniture companies, for example, have watched sales slump as demand overseas has flagged, particularly
in Europe. Families in China are also buying less, as sagging home sales and real estate prices mean fewer
people need to decorate new apartments.
“Many furniture factories in the Guangzhou area have closed over the past year,” said Rachel Wang, the
sales manager at Hongyuan Furniture Manufacturing, a Guangzhou maker of home saunas. Hongyuan
Furniture has helped offset a slowdown in Europe by expanding to Australia.
Charles M. Hubbs, the owner of Premier Guard, which makes medical equipment in Guangdong province,
said the devaluation will help, estimating the currency drop will add $300,000 a year in profit. But it’s not
enough, he said, to make the company more competitive.
Despite the problems in the job market, monthly factory wages, which have increased tenfold at Premier
Guard over the last decade, remain high and eat into profit. Mr. Hubbs is considering moving part of his
manufacturing operation to Texas, as a way to reduce freight costs and to avoid American import taxes.
Photo
A worker at Premier Guard, which makes medical equipment in Guangdong
province. The owner of the company is considering moving part of his
manufacturing operation to Texas, as a way to reduce freight costs and to avoid
American import taxes. Credit Adam Dean for The New York Times
Even if the currency drops by 8 to 9 percent, it is “not going to bring any business back to China,” he said.
“Nobody’s going to come back to China,” for fear the renminbi might strengthen again later.
As sales fall and factories close, strikes and other labor actions have been increasing, to nearly 200 a
month, according to the China Labor Bulletin, a nonprofit group based in Hong Kong that calls for
collective bargaining rights. Four years ago, it was around a dozen a month.
At the Zhanheng Toys Electronics Company in Dongguan, 700 workers raucously demonstrated on Aug. 4,
demanding back wages. Management had suddenly left and stopped paying workers.
Such disappearances are common in China. If they stick around, managers of failed companies may be
detained by the police, who search for signs of embezzlement and try to force executives to dig into their
savings to pay creditors.
“The Hong Kong boss ran away,” said a security guard at Zhanheng’s front gate on Thursday afternoon
who declined to give his name. No managers were left to answer questions, the guard added.
The local government ended up paying the back wages a day later. It is a routine practice after business
failures in China, where local governments are responsible for maintaining social stability.
Photo
At the Zhanheng Toys Electronics Company in Dongguan, 700 workers raucously
demonstrated on Aug. 4, demanding back wages. Management had suddenly left and
stopped paying workers. Credit Adam Dean for The New York Times
Wu Yukan, a plastics distributor who is also the vice chairman of the local chamber of commerce, showed
up at the factory gate in a black Audi with two aides.
“This factory owes me hundreds of thousands of renminbi for raw materials,” he said. “The economy is not
doing well. I have other clients who also owe me a lot of money, and from whom I have not been able to
collect as well.”
Balancing Needs
More than a thousand miles away from the turmoil in Guangdong, at a monolithic building in Beijing, Zhou
Xiaochuan, the governor of the People’s Bank of China, has the task of guiding the currency at a
complicated time, at home and abroad.
Tall, cerebral and urbane, he has written a series of books and long academic articles in Chinese on
economics. He taught himself English.
He has been steeped in Communist Party politics from childhood. His father, a deputy minister in the early
1960s, mentored a young Jiang Zemin, who later served as China’s leader for a decade.
Continue reading the main story
Graphic: The Yen, Won and Renminbi: A Triangular
Guide to the East Asian Currency Wars
Mr. Zhou needs those economic and political strengths, as the country tries to rev up exports and keep its
international expansion on track.
While he needs to let the renminbi respond to the market, he must also maintain control over the currency.
Mr. Zhou also wants to convince the world that the renminbi deserves a place among the elite group of
global reserve currencies, which includes the dollar, euro, yen and pound.
In March, Mr. Zhou welcomed Christine Lagarde, the managing director of the International Monetary
Fund, to a conference in Beijing. He told Ms. Lagarde and top global bankers that he would dismantle the
many currency restrictions.
“A set of pilot policies and regulations will be released this year, to basically achieve the requirements for a
currency that can be used more easily,” he said.
Mr. Zhou was making the case that China could meet the I.M.F. requirements for joining the basket of
global reserve currencies known as the special drawing rights. The biggest test was whether the renminbi
was considered “freely usable.”
For years, China set an initial price for the renminbi in dollars each morning and then allowed the currency
to trade in a narrow band. The initial price was somewhat arbitrary. A week before the devaluation, an
I.M.F. report expressed concerns, suggesting a more market-oriented approach.
Starting last Tuesday, the central bank said it would give the market more sway, basing the initial level on
the previous closing price. The I.M.F. gave its cautious approval, saying it “appears a welcome step.” But
the execution, the fund said, would be critical.
Mr. Zhou faces a delicate task.
He used to be able to set monetary policy without worrying that money would rush out of the country if
interest rates were too low or the currency too high. With the loosening of controls on moving large sums
of money, he must now navigate the pressures of the market.
He also has to appease many constituencies.
The commerce ministry has long lobbied for a weak renminbi to help the country’s exporters earn more
profits from their overseas sales. But Mr. Zhou can’t let the currency drop too much, lest he antagonize the
Chinese companies investing abroad and the Chinese families sending students overseas.
“You see it as more than 100 million Chinese travel abroad, and there are more than 800,000 Chinese
students studying overseas,” said Yu Yongding, a former member of the central bank’s monetary policy
committee. “They want a strong renminbi.”
Erica Law, a 27-year-old Chinese investment banker, sat in a Starbucks in Guangzhou on Thursday, talking
about her plans to buy an apartment in Europe.
As a student, Ms. Law studied and traveled in Europe. She has since returned on vacations, maintaining a
love affair with a continent that, with its clean air and well-preserved historic monuments, still seems so
different from China.
The renminbi is now factoring into her plans.
“The recent days of renminbi devaluation are not of that much concern,” she said. “However, if the
devaluation trend continues and reaches for example 10 to 20 percent, then it will really affect my travel
and investment decisions — perhaps at that time, I will consider more vacation and investing options closer
to home.”
NYT
China’s Turbulent Markets Keep
Investors Guessing
By ALEXANDRA STEVENSONAUG. 18, 2015
Photo
A dancer for the Hong Kong Economic and Trade Office performed on the floor of
the New York Stock Exchange last month. Credit Spencer Platt/Getty Images
As China’s once-staid currency suddenly dropped sharply last week, Wall Street began sniffing around for
a way to profit.
A trader on Goldman Sachs’s Hong Kong trading desk sent out a memo to hedge fund clients highlighting
one opportunity: Taking advantage of a price difference between China’s onshore renminbi and its offshore
version. The currency is not freely tradable, and it was trading in Hong Kong as much as 1.5 percent lower
than in China.
That is “assuming you can move money between Hong Kong and the mainland,” the trader wrote, referring
to China’s capital controls.
“Good luck,” he signed off.
In China, there is always a catch, something that even some of the world’s smartest investors are just
starting to learn.
The high-flying economy was destined for high-octane growth for years. Until China’s leaders revised their
growth target.
The bull run was heralded as a new golden age of stocks by the state media. Until it hit a free fall that
erased over $3 trillion in market value, volatility that continued on Tuesday.
Continue reading the main story
Graphic
The Yen, Won and Renminbi: A Triangular Guide to
the East Asian Currency Wars
These charts show the relative currency strength of East Asia’s three largest economies over the last 15
years.
OPEN Graphic
The currency for years was set at a relatively stable rate. Until the government devalued the currency,
prompting its steepest fall in decades.
“China really has always been an enigma,” said Troy Gayeski, a senior portfolio manager at SkyBridge
Capital, an investment firm that has $9.4 billion invested in hedge funds. “You could be dead right in the
thesis and you won’t make money.”
At the start of the year, some of the Wall Street’s best known investors — including Stanley Druckenmiller
— sang China’s praises. Mr. Druckenmiller told Bloomberg television in April that he was “very intrigued”
by the Chinese stock market’s steep ascent, despite the slowdown in the economy.
He proclaimed he had seen this movie before. “Like day follows night, six to 12 months down the road
you’re out of recession, and you’re into a full-blown recovery,” Mr. Druckenmiller said.
Still, he pared his growth expectations slightly, “because it’s China, and we don’t know the nature of what
we’re dealing with here relative to normal, mature developed markets.”
Mr. Druckenmiller declined to comment for this article.
The Chinese stock market’s rise into the stratosphere, fueled in part by the government’s encouragement,
had attracted droves of hedge funds.
In July and August of last year, some China-focused managers increased their exposure to mainland stocks
by as much as 50 percent of their entire portfolio, according to Mark W. Yusko, the chief investment
officer of Morgan Creek Capital Management. The investment advisory firm, which has $4 billion invested
in private equity, hedge funds and venture capital funds, has money in a handful of China-based hedge
funds.
“In the short term, we are buying the dip,” Mr. Yusko said. “One of the crazy things is that — in investing
— when things go on sale, people run out the door.”
Betting on China is anything but straightforward. Many like Morgan Creek opted to invest in Chinese
hedge funds.
Investors seeking to buy local equities directly have to get approval from Chinese regulators, by obtaining a
qualified foreign institutional investor license. Big players like Goldman Sachs and Stanford University
have taken this route. Several years ago, the government began to expand the program, as part of an effort
to overhaul its financial system.
As the market soared, many hedge funds rode the bull run, raking in profits and posting double-digit
returns. At the end of the second quarter, Asia-focused hedge funds had $126.3 billion in capital invested, a
record amount of money according to the research firm HFR.
The situation took a sharp turn in late June.
Chinese markets began to tumble, with stocks 30 percent off their highs at one point. By the end of July,
the capital devoted to Asia-focused hedge funds had dropped by $10 billion as investors ran for the exits
and losses mounted, according to HFR. Since then, it has continued to be shaky, with stocks in Shanghai
down more than 6 percent on Tuesday.
Casting doubt on the market reform efforts, Chinese authorities have aggressively intervened to help stop
the slide. Investors got blindsided by some of the measures, including a ban on “malicious short-selling”
and forcing big investors to hold their shares for six months.
Photo
Workers in Baifeng Iron and Steel's warehouse in Tangshan, China. Some Chinese
steel producers are scaling back or closing, struggling from weak demand and facing
new environmental rules. Credit Damir Sagolj/Reuters
Stuck in limbo, hedge fund managers said they were unsure how they fared in the chaos. Stock market
regulators suspended more than 30 different trading accounts, including one owned by Citadel, the $26
billion firm founded by Kenneth C. Griffin.
Then last week the People’s Bank of China abruptly devalued its currency, veering off script and raising
fresh concerns about the economy. The central bank typically sets a daily midpoint for the currency,
allowing the renminbi to trade within a narrow band. On Aug. 11, the initial price was roughly 2 percent
lower, dropping 4.4 percent by the end of the week. The currency usually moves just a fraction of a percent.
“You’re seeing a little bit of smoke from the devaluation,” Mr. Gayeski said. “And where there is smoke,
there is fire,” he added.
Despite the recent tumult, the China story continues to enchant Wall Street.
The billionaire hedge fund manager Julian H. Robertson announced last week that he was putting money
into Yulan Capital Management, a firm that focuses on companies in the greater China region. While Mr.
Robertson declined to comment directly on how much he invested, his firm, Tiger Management, typically
makes seed investments of $25 million and takes an equity stake.
“Asia, in general, and China, in particular, offer great opportunities for hedge funds, both on the long and
short sides,” Mr. Robertson said in an emailed statement.
CDIB Capital International Corporation, the private equity arm of China Development Financial, raised
$405 million last month for a fund focused on private equity opportunities in China and other Asian
markets. It is the fourth Asia-focused fund that the firm has started this year.
The fund will focus on Chinese consumption, as well as companies with innovative models and advanced
manufacturing operations, said Chris Lerner, a Shanghai partner at Eaton Partners, the firm that helped
CDIB Capital raise money for the fund. For example, the fund could focus on Taiwan, where the economy
is intertwined with China; seven of the top 10 exporters in China are run by Taiwanese entrepreneurs, Mr.
Lerner said.
Wall Street investors are also finding new ways to play the turmoil in China. Penso Advisors, a hedge fund
adviser that manages money for investors like pension funds, scoped out currencies that were affected by
the renminbi devaluation in an attempt to profit from the shock waves. The firm bet on the Taiwan dollar,
which dropped more than the renminbi, said Ari Bergmann, founder of Penso Advisors.
“People want to play China, but it’s much harder to play China because you don’t know the rules and they
change all the time,” Mr. Bergmann said, referring to capital controls there.
“Do you realize how volatile these things are?” he added. “You could lose your shirt.”
Investors ultimately know they cannot ignore China, given its size and influence.
Ray Dalio, the founder of the world’s biggest hedge fund, the $160 billion Bridgewater Associates, recently
tempered his enthusiasm for China, saying the firm did not properly anticipate how quickly the stock
bubble would deflate.
“Even those who haven’t lost money in stocks will be affected psychologically by events, and those effects
will have a depressive effect on economic activity,” Bridgewater said in its July note to investors.
Bridgewater remains cautious about the domestic equity markets because the terms and regulatory
framework continue to be uncertain, according to a person with direct knowledge of the firm.
Yet Mr. Dalio, who has traveled to China for business since 1984, maintains a positive outlook over the
longer term. Bridgewater has applied for a foreign investment license from Chinese regulators, so that it
can invest directly in the country’s stocks.
China's economy
All latest updates
Why Chinese economic worries look overdone
Despite financial nervousness,
rebalancing continues
Aug 21st 2015 | China
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WITH investors already in a febrile state of mind about China’s slowdown, the latest bits of gloomy news
only seemed to confirm their worst fears. A survey showed that its manufacturing sector is on track in
August for its weakest month since the dark days of the global financial crisis more than six years ago.
Adding to the sense of panic, Chinese stocks plunged another 4% on Friday, closing off one of their worst
weeks in years. The sell-off, which has already scorched emerging markets, enveloped developed markets
as well; European, Japanese and Australian stocks all fell. Investors, though, are hardly known for taking
measured views when markets get topsy-turvy. There is good reason to be anxious about China, but the
pessimism is almost certainly overdone.
No one doubts that China’s factories are struggling. Industrial growth was 6% year-on-year in July, well
below the double-digit rates of the not-too-distant past. The manufacturing survey published on Friday
suggests that it is likely to slow yet further. New orders, exports and production are all down in August.
One-off factors might have added to the troubles: last week’s deadly explosion in Tianjin wreaked havoc at
one of the world’s busiest ports and, on top of that, thousands of factories are winding down their
operations, ordered to close for a major military parade next month. But the malaise runs far deeper than
these problems. Excess capacity built up over years weighs on manufacturers of everything from solar
panels to office chairs. Private companies have started to deleverage but state-owned firms are only going
deeper into debt.
Chinese growth is losing altitude. Will it be a soft or hard landing?
In other areas, though, things are—shock, horror—looking up. For the past two years, the main fears about
China have centred on its property market, the heart of its economy. In recent months, prices have
stabilised across much of the country and started to rebound in major cities. Developers have vast backlogs
of unsold homes, so new housing starts are still falling and a big upturn in construction seems improbable.
Exporters of commodities thus have little to cheer. But the bigger concern about the housing downturn was
that it would undermine China’s financial stability and, in that respect, the recovery in property sales is
welcome.
What’s more, China is not just about heavy industry. At the same time as growth is slowing, the structure
of the economy is also changing. The services sector supplanted manufacturing a couple of years ago as the
biggest part of China’s economy, and that trend has only accelerated this year. The alarm on Friday
stemmed from an unexpected fall in the purchasing managers’ index (PMI) for manufacturing sponsored by
Caixin, a respected Chinese financial magazine. That gauge has been lilting southward for a while. By
contrast, Caixin’s PMI for the services sector jumped to an 11-month high in July.
Brazilian iron-ore producers or Indonesian coal miners can take little solace from this. Whether the services
are provided by accountants or restaurants, they consume far less energy and raw materials than heavy
construction. But for China as a whole, there is more to the country than the building of highways and
skyscrapers.
China and the world economy
Taking a tumble
Stockmarket turmoil in China need not
spell economic doom. But it does raise
questions far beyond the country’s shores
Aug 29th 2015 | SHANGHAI | From the print edition
THE ability to make stockmarkets boomerang is usually reserved for central bankers. But on August 24th,
hours into a global market rout that had started in Asia and was sweeping its way through Europe and then
America, Tim Cook, the boss of Apple, turned his hand to it. “I can tell you that we have continued to
experience strong growth for our business in China through July and August,” he wrote in an e-mail to
CNBC, a financial-news channel. “I continue to believe that China represents an unprecedented opportunity
over the long term.”
By the time Mr Cook felt it necessary to opine on the state of the world’s second-biggest economy, plenty
had started to question its prospects. Following weeks of wobbling, the Shanghai stock exchange had just
cratered. A government once credited with near-magical powers to browbeat its economy into growth
looked to have misplaced its wand. Suspicions abounded that a decades-long era of superlative—if recently
softening—economic expansion might be coming to an end. So the news that Chinese consumers were still
in the mood for new iPhones and whizzy watches did more to assuage nerves than reams of official
pronouncements from Beijing ever could.
Apple shares reclaimed the $66 billion they had lost; the Dow Jones blue-chip index, having opened down
a calamitous 1,000 points, rebounded. But that was a precursor for days of volatility. Many markets around
the world crossed the line into “correction” territory, having fallen more than 10% from recent peaks,
though some were rallying as The Economist went to press. Shanghai remained down by some 40%, a
drubbing to rival the 2001 dotcom crash, if not (yet) the 2008 miasma.
The effect has been felt beyond stockmarkets. A basket of commodities, including everything from steel to
wheat, has fallen to its lowest level this century; oil is at six-and-a-half year lows. Emerging-market
currencies have been hammered. The VIX index, a measure of fear in markets, jumped this week to its
highest level since 2011. The see-sawing in stocks may even have put cracks in the architecture of markets:
many exchange-traded funds, which investors use to buy baskets of stocks or other assets, decoupled from
their underlying components, trading at nerve-wracking discounts. (Others blamed this on an ill-timed
computer glitch.)
Investors are now trying to delve beyond iPhone shipments and gauge where China’s economy—and so the
world’s—stands. In terms of global impact, a “hard landing” in China would now rival an American
depression. Countries from Australia to Angola have grown richer from digging stuff out of the ground and
shipping it to China. Industries from carmaking to luxury goods look to China for new business. It has been
the most stable contributor to world economic growth. Will that continue?
Certainly, there are reasons to think it is in trouble. Exports are stumbling, bad loans rising and the
industrial sector at its weakest since the depths of the global financial crisis. Never entirely credible, the
government’s claims that the economy is chugging along at 7% now elicit derision.
Even more alarming is the way these stresses appear to be showing through in its markets. On August 11th
the central bank stunned investors by devaluing the yuan, whose rate it “guides” through regular
interventions. The currency moved more in a day than it does in most months. The devaluation looks to
have been a technical change to the way the exchange rate is managed. But thanks to poor communication,
many saw it as China’s first fusillade in a global currency war. Markets around the world have been on
tenterhooks ever since. Capital outflows from China have shot up as investors have soured on the economy.
And then there is the daily carnage in the stockmarket. The government has thrown at least 1 trillion yuan
($156 billion) at buying shares in order to stabilise them, only to see prices plunge even more violently.
The fear is that all this market turmoil speaks to deeper fractures in the foundations of the Chinese
economy, with the entire edifice at risk of toppling over.
So is this the hour of China’s crisis? Highly unlikely. Though the economy faces grave problems, the
financial tumult is misleading. China’s stockmarket has long been derided as a casino, and for good reason.
The bourse is small relative to the economy, with a tradable value of a third of GDP, compared with more
than 100% in developed economies. Stocks and economic fundamentals have little in common. When share
prices nearly tripled in the year to June, they no more reflected a stunning improvement in China’s growth
prospects than their collapse since then has foreshadowed a sudden deterioration.
Less than a fifth of China’s household wealth is invested in shares; their boom did little to boost
consumption and their crash will do little to slow it. Punters borrowed lots of money to buy stocks in good
times, to be sure, and some of that debt will default. But it amounts to just 1% of total banking assets, a
potential hit that, although unpleasant, is hardly systemic.
The property market matters far more for China’s economy than equities do. Housing and land account for
the vast majority of collateral in the financial system and play a much bigger role in spurring on growth.
Yet the barrage of bearish headlines about share prices has obscured news of a property rebound. House
prices have perked up nationwide for three straight months. Two months after the stockmarket first crashed,
this upturn continues.
On the downside, there is little chance this rebound will translate into a big acceleration in building activity,
because Chinese developers still have to work through a glut of unsold homes, the legacy of their building
frenzy of recent years. But the stabilisation of prices reduces the risk of a property-market crash—an event
that would be for China what a stockmarket crash would be in America or Japan.
Some think China has, in fact, already suffered the hard landing dreaded by economists. They point to
weakness across a broad range of physical indicators used as proxies for Chinese growth because the
government’s official data are seen as iffy. Cargo moved by rail has declined, electricity consumption is
anaemic and producer prices are mired in deflation. Add it all up, the sceptics say, and China’s annual
growth looks to be just 2-3%.
This downbeat assessment oversimplifies the economy. Heavy industry is, without question, struggling.
The north-eastern rust belt is on the brink of recession. But China is a continent-sized economy, fuelled by
more than just the construction of homes and railways. The service sector, which now accounts for a bigger
share of national output than industry, is growing quickly. Retail sales remain strong, as Apple’s Mr Cook
was so keen to point out. Economic growth is almost certainly lower than the rate reported by the
government. But it appears to be within the range of a soft landing.
Further turbulence would be manageable. On August 25th the central bank cut interest rates and reduced
the portion of deposits that banks must lock up as reserves. Even with these cuts, the latest in a months-long
easing cycle, benchmark one-year lending rates still sit at 4.6%, while required reserve ratios are 18% for
big banks. The central bank looks set to continue cutting both, reducing funding costs for borrowers and
freeing up more money for banks to lend. These are the sorts of levers most Western economies do not
have.
On the fiscal side, for all the talk of mini-stimulus measures, the government has in fact exercised
remarkable restraint. It aimed for a budget deficit of 2.3% of GDP this year, a bit more than in previous
years. But as of July it was still in surplus, having raised more in taxes than it had spent. This suggests it
still has plenty of petrol in the tank if it wants to rev up growth.
A mess to mop up
Even if China holds up well enough now, there is still the worry that a sharper slowdown lies ahead. The
government faces daunting challenges in managing the economy. It is trying to clean up the debt mess left
over by the stimulus of 2009, when it unleashed a mammoth investment spree to fight off the global
financial crisis.
Debt, by some counts, has reached more than 250% of GDP, almost doubling over the past seven years.
Increases of that magnitude have presaged crises in other countries, from Japan to Spain. At the same time
structural trends are turning against China. Its working-age population is now shrinking.
A range of reforms could help China tap new sources of growth: allowing private companies to compete
properly with state firms; fostering the rule of law to give entrepreneurs more confidence to invest; and
relaxing residency controls that stunt the free flow of its people. For the time being, however, these run
against the Communist Party’s reflexive need for control.
The turmoil of the past two months has sowed doubts about whether the government has either the
inclination or the skill to push through reforms. For all the flaws of China’s political system, many outside
the country had viewed its leaders as economically adroit, capable of bringing about rapid growth and
snuffing out risks. Now they are not so sure.
The government’s ill-fated response to tumbling markets has severely tarnished that aura of competence.
The markets regulator banned short-selling and halted IPOs; traders and a journalist are being probed for
spreading rumours. State-owned companies bought back their own shares. The central bank lent cash to an
agency that vowed to push the market back up. State media boasted that the “national team” would
triumph. It did not. The market sank lower, eroding the government’s reserves as well as its credibility.
China’s stockmarket should eventually find its feet and the devaluation debacle may recede into memory,
but the political damage will be lasting. These episodes have raised unsettling questions about the
commitment of Chinese policymakers to the market reforms needed to shore up the long-term health of the
economy. An unusual editorial in the People’s Daily, mouthpiece of the Communist Party, said last week
that Xi Jinping, China’s president, wanted to make deep reforms but had encountered resistance “beyond
what could have been imagined”. Some guess that former leaders are pushing back against Mr Xi, who has
led an anti-corruption drive that has made him China’s most powerful leader since Deng Xiaoping. Others
say that civil servants, fearful of this campaign, are sitting on their hands, afraid of doing much of anything.
Senior government and party officials have said almost nothing about the turmoil, which has fuelled
speculation of divisions at the top. The prime minister, Li Keqiang, who oversaw the failed attempt to prop
up the stockmarket, is likely to come in for particular criticism.
But Mr Xi himself can hardly escape scrutiny. Unlike most of his predecessors, who left the economy to
their prime ministers, the president has immersed himself in economic decisions. He chairs new
policymaking bodies on reform and finance. This makes it harder for him to escape blame when things go
wrong.
If China does, after a bumbling few months, press on with its reform agenda, it could yet pull off the
amazing trick of opening up and modernising its economy without suffering a serious crisis. But even if it
succeeds, there will be negative consequences for others. The economy is rebalancing, albeit slowly, away
from investment and towards consumption (see chart 3). China still has many more homes, highways and
airports to build, but the trend away from them is unmistakable.
Rebalancing act
As a result, its appetite for commodities has probably peaked. That is bad news for companies and
countries that prospered over the past decade by selling it mountains of iron ore, copper and coal. A decline
in Chinese consumption would be of huge consequence: it absorbs about half the world’s aluminium,
nickel and steel, and nearly a third of its cotton and rice.
Arguably worse for some emerging economies than the prospect of a Chinese slowdown is the reality of
resurgent American growth. The rich world’s anaemic post-crisis recovery has ensured that global interest
rates remain at rock-bottom. The monetary stimulus has been boosted by “quantitative easing” (QE), bondbuying designed to make policy even looser. With bond yields depressed in America, investors piled into
emerging-market bonds in the search for decent returns.
The days of cheap American money appear to be numbered. The Federal Reserve’s QE programme was
wound down last year and it is now contemplating raising interest rates for the first time since 2006. That
prospect has driven up the dollar, which has risen by a weighted average of 17% against the currencies of
its trading partners in the past two years and by considerably more than that against emerging-market
currencies.
This is a dramatic shift given that expectations of future rate rises in America are modest. But much of the
money that flowed into emerging markets was pushed there by the falling yields on offer in America and
pulled by the lure of racier returns. Capital has already started to flow out of emerging markets. If and when
the Fed increases rates, investors will promptly repatriate more money to America.
The countries most vulnerable to such a reversal are those with biggish current-account deficits—in other
words those that relied on foreign capital to bridge the gap between what they spent and what they earned
from trade. The countries most exposed to shifts in China’s economy, meanwhile, are the commodity
exporters who supply the raw materials for the steel girders and copper piping that have underpinned the
construction boom.
Brazil suffers on both counts. Its currency, the real, has fallen by more than a third against the dollar in the
past year and by almost half since May 2013, when the Fed first hinted that its bond-buying would taper
off—prompting a wobble across emerging markets dubbed the “taper tantrum”. Brazil’s central bank has
raised rates to 14.25% to tackle the inflation caused by the real’s dive. The economy is in recession.
Investment in mining and in offshore oil has collapsed.
The currencies of other commodity-intensive countries nearby, such as Argentina and Mexico, have also
fallen heavily against the dollar. Among emerging-market currencies only the Russian rouble—slammed by
the collapse in oil prices and by sanctions related to Ukraine—has fared worse than Latin America’s
miners. Malaysia and Indonesia, the two commodity exporters closest to China, have also been caught up in
the sell-off.
After two years of persistent selling, such currencies have begun to look cheap when set against
conventional benchmarks. But that has not stopped them falling further in recent weeks as concerns about
China’s economy have intensified. The Colombian peso, the Malaysian ringgit and the rouble have been
among the hardest-hit currencies in the past week.
The unenviable third bucket
Despite being a commodity exporter, South Africa largely missed out on the China-led raw-materials
boom, because of weaknesses in its transport and power industries (see article). It belongs more readily
with Turkey in a separate category of emerging markets that have suffered badly because of an overreliance on hot money to finance a large current-account deficit. Both economies are inflation-prone and
have low domestic savings. They also share a tendency to do well when global capital flows freely and to
do badly when, as now, investors are choosier about where they park their money.
Ironically, some of the most resilient countries have been those with the closest trade links to China, such
as South Korea, Singapore and Taiwan. All have solid current-account surpluses and healthy foreignexchange reserves and so have little to fear from capital flight in response to rising interest rates in
America. And as net importers of raw materials, they benefit from falling commodity prices.
Even so, their currencies fell in the wake of China’s devaluation in mid-August and cracks have recently
started to show in their economies. GDP growth in Singapore has dropped below 2%, the lowest rate for
three years. Surveys of purchasing managers point to falling manufacturing output in Taiwan and South
Korea.
Factory-gate prices are falling across Asia, too, reflecting excess capacity in industry. In China they have
declined for 41 consecutive months; in South Korea and Taiwan for 35 months; and in Singapore for 31
months, notes Chetan Ahya of Morgan Stanley. Falling prices make it harder for companies to service the
debts they run up to pay for new capacity in the boom years.
Producer prices are falling even in inflation-prone India, which is one of the relative bright spots in
emerging markets. India is less tied to China than other economies in Asia and, as a net oil importer,
benefits from low crude prices (caused, mostly, by abundant supply in Saudi Arabia and America rather
than Chinese wobbles). Its junior finance minister even speaks of taking up the baton of fast growth from
China. The worry is that such boasts reveal complacency about reforms that are needed in India but have
nevertheless stalled.
With large chunks of the emerging world in trouble, parallels are being drawn with the Asian crisis of
1997-98. Yet many of the factors that contributed to the intensity of that debacle—and the brutality of the
recession in emerging Asia that followed—are missing today. The chief absentee is exchange-rate pegs,
which were common in the mid-1990s. The illusion of currency stability that such pegs fostered led to a
build up of dollar-denominated debts in emerging Asia. When capital inflows dried up, the pegs broke.
Currencies quickly plunged in value, pushing up the cost of dollar debts.
These days far more emerging markets allow their currencies to float. By contrast with what happened in
1997, the recent flood of capital from the rich world into emerging markets went largely into local-currency
bonds. Foreigners own between 25% and 50% of the stock of government bonds in Brazil, Turkey, South
Africa, Indonesia, Malaysia and Mexico, according to Morgan Stanley. For a while the momentum behind
capital flows meant rich-world investors enjoyed a virtuous circle of higher bond prices and stronger
currencies. Now that cycle has turned vicious but it is the currency (and thus the lender, not the borrower)
that has adjusted most. Emerging markets typically have far larger arsenals of foreign-exchange reserves—
and healthier current-account balances—than they did in the 1990s.
For these reasons the latest emerging-market dust-up lacks the severity of the 1997-98 crisis. But in at least
one regard it is more worrying. The weight of emerging markets in global GDP is now much heavier,
mostly because of China’s greater mass (see chart 4). Slower growth there is felt more keenly in rich
countries. Worryingly, world trade suffered its biggest fall since 2009 in the first half of this year.
There is one other contrast with the late 1990s. More recently the search for yield in exotic places took
rich-world pension funds to the farthest edge of the investing universe: “frontier” markets, which are
typically poorer and have less developed financial systems than most emerging markets. Resource-rich
Africa was one of the busiest parts of the frontier. Countries that had not long ago been freed from punitive
debt burdens were suddenly able to borrow cheaply, albeit in dollars. Sixteen countries in sub-Saharan
Africa have now issued such foreign-currency bonds, says Stuart Culverhouse of Exotix, a broker. With
commodity revenues falling, repayment could get tricky. Firms that borrowed in dollars could face similar
troubles—including some in China that have done so through opaque offshore arrangements.
Quite when the turmoil associated with the end of easy money comes to pass largely depends on the Fed.
Before the tumult, markets priced the chance of a September rate rise at over 50%; now the probability is
closer to 25%. Grandees such as Larry Summers, a former treasury secretary, and Bill Dudley, head of the
New York Fed, have expressed scepticism about a rate rise next month.
Yet the Fed may plough on regardless. America’s economy is well insulated from the Chinese shock: just
8% of American exports, worth 0.7% of GDP, go to China. When discussing the timing of interest-rate
rises, Janet Yellen, the Fed’s chairman, usually focuses on the domestic labour market rather than the fate
of distant economies. If a jobs report on September 4th shows strong employment growth, the Fed could
well raise rates despite market volatility.
After the “taper tantrum” of 2013, a “rate-rise rumble” was always a possibility as the prospect of Fed
action neared. That has affected all emerging markets—including China. The crash in Shanghai was not
evidence of a Chinese economy on the brink. Nevertheless, policymakers in Beijing have chosen a bad time
to lose so much of their credibility as the world economy’s safest hands.
NYT
International Business
Zombie Factories Stalk the Sputtering
Chinese Economy
By MICHAEL SCHUMANAUG. 28, 2015
Continue reading the main story Slide Show
Slide Show|8 Photos
‘Zombie’ Factories in China, Running on Fumes
CreditAdam Dean for The New York Times
Miao Leijie loses money on each ton of cement his company produces. But stopping production is not an
option.
When the plant opened in 2011 to supply the real estate and infrastructure industries in the northern
Chinese city of Changzhi, the company raised most of the initial money from banks. Now, Mr. Miao, the
factory’s general director, needs to keep churning out cement simply so the company can pay the interest
on its loans.
It will be tough for the business, Lucheng Zhuoyue Cement Plant, to get out of the hole. Customers and
investments are drying up, and the company is borrowing even more money to stay afloat.
“If we ceased production, the losses would be crushing,” Mr. Miao said, as he chain-smoked in the
company’s quiet, spartan office. “We are working for the bank.”
Changzhi and its environs are littered with half-dead cement factories and silent, mothballed plants, an
eerie backdrop to the struggling Chinese economy.
Like many industrial cities across China, Changzhi, which expanded aggressively during the country’s long
investment boom, has too many factories and too little demand. That excess capacity, many economists
indicate, will have to be eliminated for the Chinese economy to return to healthy growth.
But rather than shut down, Lucheng Zhuoyue and other Changzhi companies are limping along in a kind of
march of the undead.
To protect jobs and plants, the government and its state-owned banks sometimes keep money-losing
businesses on life support by rolling over or restructuring loans, providing fresh credit or offering other aid.
While this may seem like an odd business tactic, it is part of a broader strategy to help maintain social
stability, a major goal of China’s leadership. Authorities in China’s provinces and cities also back
struggling factories just because they are deemed important to the local economy.
Similar strategies have been tried before, with little success. In Japan, such businesses, known as “zombie
companies,” are blamed for contributing to that country’s two decades of economic stagnation.
As China allows its own “zombies” to stalk the economy, the situation is clouding the country’s outlook,
making it difficult to predict where growth is headed. If the leadership doesn’t address the underlying
problem, the economic weakness could be prolonged.
Concerns have already been rising that China’s slowdown is worsening and its problems are becoming
harder to overcome. Such fears helped ignite a dramatic sell-off on stock markets around the world. Shares
on the Shanghai stock exchange have tumbled by more than third since the June high.
“Global investors have now come to realize that China’s travails are beginning to affect everyone,” said
Frederic Neumann, co-head of Asian economic research at HSBC in Hong Kong.
A Threat to Prosperity
Far from the sparkle of Shanghai or the export zones of Shenzhen, Changzhi is a modest city of three
million people who live in low-rise apartment complexes and work in boxy factory compounds. The local
economy depends on steel manufacturing and other heavy industries that girded the country’s decades-long
era of high growth. As the property market grew and the government plowed money into roads and other
infrastructure, cement factories sprouted on the city’s outskirts to capitalize on the bonanza, creating
hundreds of well-paying jobs. In recent years, the busy local shops and crammed fast-food restaurants
along Changzhi’s narrow downtown streets bustled with new prosperity.
But the country’s economy is slowing down, threatening that wealth. Gross domestic product expanded 7
percent in the second quarter of 2015. While that would be a stellar performance by the standards of most
countries, it is the slowest pace for China in a quarter-century.
Photo
An empty security office in an idle section of the Changzhi Cement Group factory, a
partially abandoned state-owned enterprise, near Changzhi, China. Credit Adam
Dean for The New York Times
Some industries are plummeting, wreaking havoc in less economically diverse cities and towns. Empty
apartments built during the boom are now weighing down the property sector. Businessmen in Changzhi
complain that construction projects supported by the local government have also been scaled back.
As a result, Changzhi’s cement plants are saddled by excess capacity. Companies in the province can
produce three times as much cement as what was actually needed in 2014, according to the Shanxi
Provincial Association of Building Material Industries. Two-thirds of them lost money in that year.
Such conditions have turned once promising companies into zombies. While trucks are still parked outside
the sprawling industrial compound of Changzhi’s Huatai Cement Clinker Company, there are far fewer
than just a couple of years ago, and they have less to haul. The money-losing company has produced a mere
200,000 metric tons of cement this year, even though it is able to make one million.
As a state-owned enterprise, Huatai has been kept running with the help of special assistance. Huatai gets
coal on credit and access to cheap loans from its parent company, which is owned by the provincial
government. That has allowed management to keep all its 300 workers on the payroll — the company’s top
priority. “Our employees need to eat, they need to live,” said one manager, who declined to give his name.
Such measures may help sustain employment, but they also delay the much needed overhaul of Chinese
industry. A study of China’s labor market by the International Monetary Fund released in July noted that
state-owned enterprises tended to keep workers that they did not need. From an economic perspective, it
would be better for such businesses to downsize or even close, releasing their trained staff to work at
companies or in sectors with stronger prospects. That would shift resources away from less productive parts
of the economy, helping get growth back on track.
Without such a shift, the economy could suffer in the future. Raphael Lam, deputy resident representative
at the I.M.F. in Beijing, says Chinese policy makers should move more forcefully to enact pro-market
reforms and allow state-owned enterprises to restructure. If not, he says, “Over the long term, there would
be an increasing likelihood of a sharper slowdown.”
‘Eternal, Unpaid Vacation’
The situation is also complicating matters for workers not lucky enough to keep their jobs. Though
unemployment has remained low nationally, workers in troubled Changzhi complain that good jobs are
hard to find.
At the Changzhi Cement Group, where the only sound is a barking dog, a former company electrician,
Zhao Liwei, 43, watches TV inside a decrepit room for janitors at the compound’s entrance. Two years ago,
as production at the state-owned plant ground to a halt, her paychecks stopped coming. Most employees
were left to fend for themselves.
Photo
A former worker of the Changzhi Cement Group factory exiting his apartment
building on Monday. He complained that he had paid for his flat but had not
received the homeownership documents from the state-owned factory. Credit Adam
Dean for The New York Times
Since the factory was never formally shuttered, they have not received severance payments or other
compensation, Ms. Zhao said. Though a private company took on a handful of employees to produce
cement in a portion of the plant’s facilities in August, the work is only temporary.
Ms. Zhao has not worked at all. The only jobs in the area, she says, are sweeping floors and waiting tables,
for as little as 500 renminbi, or $78, a month. She earned twice that working at the factory. “We were
promised an iron rice bowl” — the Chinese term for lifetime employment — she said. But now “it is like
we’ve been left on an eternal, unpaid vacation.”
Some of these idled workers have faced biting hardship. Sitting outside a nearby deteriorating residential
complex, Du Jianping, 45, says that she has to rely on handouts from her parents to put food on the table
for her 12-year-old daughter. She and her husband lost their jobs at the Changzhi Cement Group, and ever
since, Ms. Du has been earning a pittance selling women’s clothes and children’s toys at a stall outside a
train station.
She feels trapped, fearing she would be unable to get better work elsewhere. “We are too old to find jobs in
the cities,” she said. “I hope the government could help lift up the cement industry so that it can recover.”
Beijing is sensitive to such pleas. Fearing that joblessness could lead to social instability, the government
has made maintaining employment a primary goal of its economic policy. Premier Li Keqiang said during a
news conference last year that the lowest growth rate acceptable to the regime “needs to ensure fairly full
employment and realize reasonable increase of people’s income.”
That helps explain why Beijing is taking stronger action to prop up the economy. On Aug. 25, the central
bank cut its benchmark interest rate for the fifth time since November. Almost two weeks earlier, it
suddenly devalued the renminbi, which some analysts see as an attempt to lift China’s sagging exports by
making them cheaper in international markets.
The government is also planning to use state banks to finance another round of infrastructure spending
aimed at aiding beleaguered industries like cement. Managers in Changzhi argue that the authorities should
be doing even more to help, by setting a minimum price for cement or supporting local construction
projects.
Still, such steps may do little more than keep zombie companies alive — to the detriment of the overall
economy. By pumping up growth with fresh credit and stimulus, the government might temporarily revive
some factories, but also exacerbate the economy’s problems of excess capacity and high debt.
The consulting firm IHS Global Insight estimates that debt relative to China’s output will reach 254 percent
in 2015, nearly double the level of 2008. Such debt levels can pose substantial risks to an economy if
borrowers are unable to repay them and a wave of defaults follows. “The size of debt only accumulates,”
said Grace Wu, a senior director at the rating agency Fitch in Hong Kong. “That doesn’t help with the
underlying economy. It doesn’t help create jobs.”
Over the long term, Chinese policy makers are trying to decrease the economy’s dependence on excessive
investment for growth and allow household consumption to play a bigger role. That means the factories in
many heavy industries, like cement, may never run again at full tilt.
Wang Xiaohu has not completely given up hope. Over the years, Mr. Wang, a 40-year-old businessman,
put 20 million renminbi, or $3.1 million, into Changzhi Ruili Building Materials Ltd., which can produce
300,000 metric tons of cement annually. But now the factory site is watched over by a lone, elderly security
guard in an ill-fitting uniform. Mr. Wang was forced to idle the plant about 18 months ago, laying off
nearly all of his 100 employees.
Mr. Wang, though, has refused to liquidate the factory. Instead, he maintains the machinery, waiting for the
day when the economy revives and he can produce cement once again — a day that even he acknowledges
may never come. “Many of the small and medium cement plants here are like this,” Mr. Wang says. “The
chances are slim that they will ever reopen.”
NYT
As Economy Falters, Military Parade
Offers Chance to Burnish China’s Image
By ANDREW JACOBSSEPT. 1, 2015
Photo
Soldiers from the People's Liberation Army training last week for the military
parade. Credit Damir Sagolj/Reuters
BEIJING — Few things distract an anxious nation in economic trouble quite like a jaw-dropping military
parade featuring a cavalcade of gleaming high-tech weaponry, 12,000 goose-stepping soldiers and fighter
jets filling the skies with synchronized plumes of candy-colored smoke.
China celebrates a new national holiday on Thursday to honor the 70th anniversary of the end of World
War II, with events across the country, a three-day holiday and a martial spectacle that will rumble through
the ceremonial heart of the capital. President Xi Jinping ordered up the festivities long before the latest
round of economic news, but the timing could hardly be better for the Communist Party as it grapples with
a slumping stock market and fears that a slowdown could spur social unrest.
The event allows Mr. Xi to push a much bolder nationalist agenda just as the Chinese public is beginning to
question the party’s main source of legitimacy: its ability to deliver economic growth.
“As social conflicts continue to sharpen, the party needs to divert attention, and of course a parade is a good
way to do that by whipping up nationalist fervor,” said Zhang Lifan, a historian in Beijing.
The martial spectacle that will rumble through the capital on Thursday could not
come at a better time as the Communist Party grapples with a slumping stock
market and fears that a slowdown could spur social unrest. Credit Rolex Dela
Pena/European Pressphoto Agency
Though billed as a commemoration of the war’s end, the holiday has been carefully conceived to project
Mr. Xi’s vision for a “rejuvenated” China: a rising military power that will stand up to rivals — most
notably Japan and its main ally, the United States. But the turn to the past has left the party open to
criticism that it is manipulating the history of the war to overstate the Communist role in ending Japan’s
14-year occupation of parts of China.
The guest list for the parade on Thursday is also a potential embarrassment, as the leaders of many of the
nations that fought Japan or suffered Japanese aggression turned down invitations. President Vladimir V.
Putin of Russia and President Park Geun-hye of South Korea will be in the viewing stands at Tiananmen
Square, but top officials from the United States, Australia, Indonesia and several other countries in the
region will not.
The turnout robs Mr. Xi of international prestige to make the event more credible, and suggests he may
have misjudged the anxiety across Asia over rising Chinese nationalism. Washington has expressed unease
with the parade’s demonization of Japan, saying it would prefer that China hold a forward-looking event
that promotes reconciliation and healing.
Inside China, critics have questioned Mr. Xi’s decision to break a tradition that calls for a military parade
only once every decade to celebrate the founding of the People’s Republic of China. The next anniversary,
in 2019, will signal 70 years since Mao’s rebels vanquished the Nationalists after a bloody civil war, and
Chinese officials have not said whether they will hold another parade just four years after this one.
“Every emperor has his weakness, and Xi wants to demonstrate his might and prestige,” said Hu Jia, a
prominent Chinese dissident. “The parade is a chance for the Communist Party to show its gleaming knives
and shiny boots so the people will submit to the fear and the charm,” he added.
Perhaps the most stinging criticism has come from historians in China and abroad, who have accused the
party of distorting the narrative of China’s fight against Japan.
Historians generally agree that the Nationalist armies of Chiang Kai-shek, not Mao’s Communist guerrillas,
did the bulk of the fighting against the Japanese. The majority of the estimated three million Chinese
soldiers who died from 1937 to 1945 wore the Nationalist uniform, while the Communists, nearly
vanquished by Chiang at the time of Tokyo’s invasion, spent most of the war rebuilding behind enemy
lines and only occasionally ambushing Japanese troops.
Sometimes the party’s attempts to recast history have veered into the absurd. In August, many Chinese
ridiculed posters for a state-backed film about the Cairo Declaration, the 1943 statement by Allied leaders
that set out the goal of defeating Japan. Chiang attended the conference with Franklin D. Roosevelt and
Winston Churchill, but the posters featured an actor playing Mao.
For decades, the Communist Party portrayed their Nationalist foes as too corrupt to battle the Japanese
effectively. But that narrative has shifted in recent years as China, eager to improve ties with Taiwan and
deflate pro-independence sentiment on the island where Chiang and his troops fled, has acknowledged and
even celebrated the Nationalists’ role in fighting Japan.
“There’s been a stealth rehabilitation of the Nationalists,” said Rana Mitter, a professor of Chinese history
at Oxford University and author of “Forgotten Ally: China’s World War II, 1937-1945,” noting that
wartime soap operas on the mainland now often include an honorable Nationalist officer as a stock
character.
Organizers have even invited Nationalist veterans to participate in Thursday’s parade, but the move has
proved controversial in Taiwan. Among those planning to attend is Lien Chan, a former Taiwanese vice
president who once led the Nationalist Party. Some have called his decision to go a betrayal, saying it lends
credence to the Communists’ self-promoting version of history.
Party propagandists frequently sidestep another crucial detail about World War II: Though Chinese troops
tied down a million Japanese soldiers who might have otherwise been free to fight Allied forces in the
Pacific, Tokyo’s surrender is generally attributed to the American atomic bombs that destroyed Hiroshima
and Nagasaki, as well as the Soviet Union’s invasion of Manchuria, the northern Chinese region that was
then a Japanese puppet state.
Over the decades, the party has all but ignored the anniversary of Japan’s surrender aboard the U.S.S.
Missouri. In fact, historians say, Mao repeatedly played down Japanese wartime atrocities, even rebuffing
Tokyo’s offer for reparations. Fixated on class struggle and his Nationalist nemeses on Taiwan, he was
willing to let bygones be bygones partly because he was eager to court Japanese investment.
The decision to cast Japan as an unrepentant enemy of the Chinese people was made after 1989, when the
party’s violent suppression of student-led demonstrations in Tiananmen Square prompted a crisis of faith
among the educated elite. In the years that followed, Chinese leaders introduced a patriotic education
campaign that emphasized Japanese wartime atrocities and the indignities wrought by a century of foreign
invasions.
Zheng Wang, director of the Center for Peace and Conflict Studies at Seton Hall University, said the
ideological re-education campaign had largely succeeded in forging a national identity based on a narrative
that is part myth, part trauma.
Mr. Xi has taken that narrative further in promoting “the Chinese Dream,” an emotional appeal for national
rejuvenation and military greatness.
“The humiliation narrative is a very important part of China’s identity formation, but I didn’t expect
President Xi to continue on the same track, as his China has already risen to be a major world power,”
Professor Wang said. “In fact, the current administration has been giving even more emphasis to that
narrative.”
Party propagandists have been in overdrive in recent months. In the run-up to the parade, the government
has commissioned more than a hundred war-themed performances, and broadcasters have been ordered to
fill prime-time television with period dramas that set valiant Communist troops against odious Japanese
invaders.
Three months later, China will celebrate a second new holiday on Dec. 13 to memorialize Japanese
atrocities in the eastern city of Nanjing, where tens of thousands of unarmed civilians were massacred over
several weeks in 1937.
Some warn that the party has fanned anti-Japanese sentiment to dangerous levels.
During a recent visit to the Chinese People’s Anti-Japanese War Memorial Hall, a museum on the outskirts
of southern Beijing, young people voiced anger over what they described as Japan’s reluctance to
acknowledge its wartime behavior as others snapped selfies standing atop Japanese flags and other Imperial
army relics displayed under a glass floor.
“I would shed my blood in the face of Japanese aggression,” declared Feng Hao, 19, a college student from
Shaanxi Province who was spending the afternoon at the museum with dozens of classmates wearing
matching red Windbreakers.
Mr. Hao, a journalism major, eagerly recited the details about Mao’s struggle against the Japanese that
dominated the museum’s exhibits. But he drew a blank when asked about the episode in 1989 when
Chinese troops opened fire on unarmed protesters or the famine, social chaos and three decades of
economic stagnation that resulted from Mao’s misguided policies.
“We don’t learn that much about those things at school,” he said apologetically. But then he brightened
with another thought. “We mostly study ancient history,” he explained. “China has a long history and the
things you mention are just a tiny portion of our past.”
NYT
Slowdown at Chinese Factories
Accelerates
By REUTERSSEPT. 1, 2015
BEIJING — Activity at China’s factories shrank at the fastest rate in at least three years in August, as
domestic and export orders tumbled, increasing investors’ fears that the economy may be lurching toward a
hard landing.
Even more worrying, China’s service sector, which has been one of the bright spots in the sputtering
economy, also showed signs of cooling, a similar business survey said.
Hurt by soft demand, overcapacity and falling investment, the economy has also been buffeted by plunging
shares and a shock devaluation in China’s currency, the renminbi, in a confluence of factors that is rattling
global markets and could strain relations with China’s major trading partners.
The purchasing managers’ index for manufacturers released on Tuesday by China’s National Bureau of
Statistics fell to 49.7 in August from 50 in July. That was the lowest level since August 2012, although
expected by analysts in a Reuters poll. Readings above 50 points indicate growth; reading below indicate
contraction.
New orders — a measure of domestic and foreign demand — fell to 49.7 in August from 49.9 in July. New
export orders contracted for an 11th straight month.
A nongovernment survey conducted by the research firm Markit and released by Caixin, a Chinese news
media company, pointed to an even sharper cooldown, with the purchasing managers’ index dropping to
47.3, the worst reading since March 2009. The Caixin survey focuses on smaller companies than the
government survey.
Both surveys showed that manufacturers were laying off workers at a faster rate as their orders declined.
The closing of factories in northern China to clear Beijing’s skies for a huge military parade this week
probably also hurt output, as did giant explosions in the port city of Tianjin.
Analysts said the bleak readings affirmed bets that China, which has lowered interest rates five times since
November, will loosen monetary policy again soon to avert a sharper economic downturn that could weigh
on global growth, even as the Federal Reserve in the United States moves toward increasing interest rates.
News of deteriorating business conditions set off fresh selling in mainland Chinese shares, dragging down
stocks across Asia as well as American stock futures. “Capital market turmoil has made Chinese businesses
and consumers turn more cautious,” Bill Adams, a senior economist at PNC Financial Services in
Pittsburgh, said in reference to a plunge of nearly 40 percent in Chinese shares since mid-June.
He estimated that the Chinese economy would grow at an annual pace of about 6.5 percent in the second
half of 2015, easing to 6.2 percent in 2016.
Some analysts believe growth levels are already well below that, contrasting with Beijing’s official goal of
7 percent.
The Japanese finance minister, Taro Aso, said on Tuesday that it would be beneficial for this week’s
meeting of representatives of the Group of 20 major economies to discuss what was going on in China’s
economy.
Service companies in China are showing clear signs of fatigue, to the point where growth in that sector may
no longer be enough to offset persistent weakness at factories. The government’s survey of purchasing
managers at service companies showed a slight cooling to 53.4, although that remained well in expansion
territory.
The corresponding Caixin survey fell sharply to 51.5, its lowest level since July 2014. Caixin’s composite
purchasing managers’ index, combining factory and services readings, went below 50 for the first time
since April 2014.
In another sign that economic weakness was spreading to the service sector, the Caixin index showed that
the labor market had deteriorated for the 22nd straight month in August.
“We believe further aggressive monetary easing and proactive fiscal policy, along with financial
liberalization, are needed to maintain growth at around 7 percent,” economists at the Australia and New
Zealand Banking Group said.
He Fan, the chief economist at the Caixin Insight Group, said, “Recent volatility in global financial markets
could weigh on the real economy, and a pessimistic outlook may become self-fulfilling.”
Knowledge@Wharton
Public Policy
What’s Behind Chinese Leaders’
Response to the Market Crisis?
Sep 01, 2015

Opinion

China
While China’s economic fundamentals are solid, the recent market crisis could threaten the country’s
reform agenda, writes Christopher Mark, Sr., in this opinion piece.
China’s plummeting stock market and uncertainty about Beijing’s policy intentions and capabilities are
forcing global businesses to reassess their exposure to the Chinese economy. At the same time, renewed
focus on China’s economic slowdown has prompted deepening gloom about broader growth prospects,
given the country’s outsize role in the world economy. These factors contributed to the late-August rout in
global equity markets.
The current China conundrum lies in both economic and political dimensions, although much of the alarm
about China’s economic downturn appears to be misplaced or overstated. China’s economic fundamentals
essentially are solid. Multiple indicators point to a growth slowdown that remains broadly in line with the
leadership’s game plan, and the authorities can draw upon enormous financial resources and economic
resilience. Particularly if planned reforms go forward, the Chinese economy should be able to continue
functioning as a reliable driver of global economic growth.
The recent market turmoil has serious political implications, however. The opacity of maneuvering within
the Chinese leadership makes it exceptionally difficult for foreign business and government leaders to
gauge risks or prospects. While President Xi Jinping has eschewed a high-profile role during the latest
market turbulence, he appears to be engaged in a high-stakes internal power play, trying to drive policy via
a top-down power structure while flouting the consensus-based leadership dynamic of the last two decades.
In the process, he has consolidated more power in his own hands than any leader since Deng Xiaoping. Xi
has taken command of the Communist Party’s primary policy committees and set up new ones under his
control to oversee economic restructuring, foreign relations and national security, military reforms, and
cyber censorship.
Abetted by a propaganda apparatus bent on burnishing his leadership aura, Xi is now indelibly identified
with all major policies. However, over the next seven years of his presumed time at the helm, much could
go wrong – involving not only wrenching economic changes and further market gyrations but also
environmental degradation, ethnic violence, pushback from attempts to root out Party corruption and
reform the military, or any number of foreign-relations wildcards. And conspicuous failure in any of these
areas is bound to be identified with him.
“China’s economic fundamentals essentially are solid.”
There is little doubt that Xi’s hardball tactics have earned him powerful adversaries within the Party. Some
coalition of these might find it expedient to make him the scapegoat if the current downturn worsens or a
major crisis erupts, threatening to cut short his tenure. Still, in any such dire scenario, Xi may be able to
make the case that his personal brand of “strong hand at the top” would be the Party’s only hope of
forestalling chaos and maintaining its hold on power. A more likely scenario is that Premier Li Keqiang –
to whom Xi has left responsibility for day-to-day handling of the economy and associated challenges –
could become a lightning rod for public anger over the government’s handling of the market crisis. If so, it
could deflect some of the political fallout, giving Xi a freer hand to pursue his main agenda of revitalizing
and rehabilitating the Party and thereby preserving its hold on power.
Blowback in Beijing
Following largely ineffectual efforts since June to halt the slide in China’s stock market with a spate of
emergency measures –- including a ban on large shareholders selling their stakes and encouraging state
banks to buy shares –- Beijing is turning once again to monetary stimulus measures to reassure investors
and bolster the economy. In effect, the Xi administration is trying to buy time until China’s economic
prospects stabilize. On August 25, the central bank cut interest rates by one-quarter of a percentage point; it
simultaneously reduced bank reserve requirements by half of a percentage point, effectively adding roughly
$106 billion to the economy.
China’s wildly gyrating stock market has tested both public confidence and the country’s leadership
capacity. Following Beijing’s full-court press in July to arrest a precipitous slide in stock prices, the market
by late August was down more than 40% from its high point in June. Resumption of efforts to stem the
[market] fall could delay a necessary correction and further distort market forces, while longer-term
damage to leaders’ credibility will be more difficult to assuage. President Xi and Premier Li were silent
throughout the market selloff, despite widespread perceptions that the regime had backed the market’s
upsurge during the spring and would stand behind investors on the downside.
The effect of the market collapse on China’s real economy is still relatively muted. Over the past year,
investors flooded the Shanghai and Shenzhen stock markets looking for better returns than those in the
stagnant real estate market, and since late spring, small retail investors responding to state-media
exhortations joined in the surge. Despite the recent prevalence of share purchases based on loans, market
analysts judge that the amount of leverage in the Chinese market has been relatively small, limiting the
prospects for emergence of a debt crisis.
While its potential magnitude is difficult to gauge, one result of the market selloff is likely to be a reduction
in spending by households that sustained significant wealth losses. The market sell-off at one point had
wiped out nearly $3 trillion in value, affecting millions of middle-class investors. As a consequence,
broader consumer sentiment and spending could be depressed, threatening to upend Beijing’s plans to
rebalance the economy by focusing on domestic consumption as a growth driver.
Shaken Credibility
The market turmoil severely damaged public confidence that Party and government leaders can effectively
manipulate market forces or meet future economic challenges. Popular anger is simmering over perceptions
that Party officials and state-controlled media had pumped up the market this spring with talk of high
returns offered by stocks, and fostered a surge in margin lending that drew in millions of individual
investors with relatively small accounts, but then appeared inept in addressing the downturn.
It remains to be seen how popular views of Xi will be affected by the stock-market turmoil and the
government’s response. While he faces no immediate threats to his authority, Xi’s pledges to limit
bureaucratic meddling and to give markets greater scope have been tarnished by the government’s
apparently panicked and scattershot approach to the market free-fall.
“Resumption of efforts to stem the [market] fall could delay a necessary correction and further distort
market forces, while longer-term damage to leaders’ credibility will be more difficult to assuage.”
Leadership Differences
While Beijing’s effort to stem the stock-market rout has shaken domestic and foreign investor confidence,
the leadership remains convinced that China’s longstanding growth model is no longer sustainable and that
rebalancing the economy is essential. In the nearly two years since the Party’s economic rebalancing
blueprint was promulgated, China’s economic slowdown – the most severe in a quarter-century – has
intensified its concerns that lower growth could spark massive unemployment and threaten domestic
stability. Faced with intensifying deflationary forces in the industrial sector, Chinese leaders have been
looking for ways to contain downward momentum as they seek to shift the economy to a slower but more
sustainable growth path while simultaneously working down a looming credit overhang.
Beijing jolted international markets on August 11 by moving to liberalize its exchange-rate management,
initially engineering a 1.9% depreciation in the renminbi’s value against the U.S. dollar and even more
against the euro and Japanese yen. Although relatively modest in comparison to recent movements in other
emerging-market currencies, it was the biggest one-day drop in China’s tightly-managed currency since
1993. And while the move will give a near-term boost to China’s faltering exports – inevitably prompting
protests of currency manipulation from trading partners — it could signal a shift to a more market-driven
exchange rate needed for broader financial-sector reforms.
Beijing’s use of public funds to prop up the overvalued stock market and its change of tack in currency
policy came amidst mounting economic difficulties that could undermine leaders’ efforts to keep overall
growth at about 7% for 2015. The threats to growth have revived internal debates over timeworn remedies
involving fiscal spending on infrastructure and other projects, while leading to backtracking on reforms
aimed at curtailing local-government debt and restructuring state-owned enterprises.
Since last November, Beijing has tried to bolster flagging growth through five interest-rate cuts; several
reductions in banks’ required reserves levels and other measures to stimulate bank lending; freeing up local
governments to issue bonds, with financing to enable commercial banks to purchase those bonds; and a
continuing rollout of announced infrastructure projects. Despite the prospect that such measures could lead
to more bond defaults and nonperforming loans, Beijing is once again pushing more money into the real
economy through central government backing of infrastructure investment.
“Xi almost certainly will regard the recent market turmoil as confirmation that chronic inefficiencies and
distortions in the Chinese economy need to be expunged through fundamental reforms.”
Internal disagreements over economic and financial policy have begun to surface more visibly in recent
weeks:



As recounted by various Chinese officials, Central bank governor Zhou
Xiaochuan and finance minister Lou Jiwei – advocating scaled-back stock
market intervention – were overruled by Premier Li and his associates, who
demanded forceful actions to prop up the market and assuage public ire.
Also reflecting likely policy discord, Chinese state media in recent days have
conveyed sharply differing views about future state intervention in the
markets. While the official Securities Daily defended interventionist policies
to forestall destruction of investor confidence, commentary in the official
Economic Information Daily called for retreat from stock-market bailout
policies.
In a development with possibly profound political overtones, the annual
leadership “summer summit” at the seaside resort of Beidaihe – traditionally
a venue for Chinese leaders and Party elders to air views and forge
consensus on key policy issues – was abruptly scrubbed in mid-August, and
commentary in the Communist Party’s flagship People’s Daily subsequently
criticized unnamed retired leaders for interfering in government policy and
sowing discord.
Implications for Reforms
Beijing’s measures to prop up share prices undermine Xi’s push to allow market forces to drive the
economy, but he probably will stay the course on his overall reform agenda. The market crisis has
nevertheless exposed vulnerabilities:



Internal opposition to Xi’s reforms of the financial sector is likely to stiffen,
increasing the vulnerability of the reformists such as central bank governor
Zhou Xiaochuan.
Further opening of Chinese financial markets to foreign investors – a key
element of Xi’s reform agenda – could be jeopardized if those investors’
confidence is shaken by further stock-market intervention.
Whereas reforms of state-owned enterprises (SOEs) have been premised on
selling shares to the public and converting SOE debt to equity, these plans are
likely to be set back by government efforts to stabilize the markets.
Xi almost certainly will regard the recent market turmoil as confirmation that chronic inefficiencies and
distortions in the Chinese economy need to be expunged through fundamental reforms. Still, his reliance on
authoritarian command-and-control mechanisms, and the concomitant crackdown on dissent within the
Party and among the public at large, could ultimately derail his reform ambitions.
Christopher Mark, Sr., is chairman of The Signal Group, a consultancy focused on Chinese economic and
political developments.
NYT
China, Trying to Bolster Currency, Taps
Foreign Reserves
By NEIL GOUGHSEPT. 7, 2015
Photo
A display showing the Shanghai composite index at a brokerage firm in Beijing in
August. Credit Ng Han Guan/Associated Press
HONG KONG — China is burning through its huge stockpile of foreign exchange reserves at the fastest
pace yet as it seeks to prop up its currency and stem a rising tide of money flowing out of the country.
Even after a record monthly decrease of nearly $100 billion, China still has the world’s biggest cache of
foreign reserves, standing at $3.56 trillion at the end of last month, government data showed on Monday.
The total has declined steadily from a peak of nearly $4 trillion in June of last year, as slowing economic
growth caused investors to move money out of the country in search of better returns elsewhere. As a
result, the Chinese central bank has had to sell huge amounts from its foreign reserves to maintain the
strength of the nation’s currency, the renminbi.
The exodus of investors’ money accelerated last month after China made the surprise decision on Aug. 11
to devalue the renminbi by the most in over two decades. China’s foreign reserves fell $94 billion in the
month, according to Monday’s report, as the central bank mounted an aggressive defense of the renminbi.
Photo
Workers preparing panels for saunas at the Hongyaun Furniture Manufacturing
Company's factory in Panyu, near Guangzhou, China, in August. China's
manufacturing sector grew faster last year than previously estimated, but the
service sector grew more slowly than originally reported. Credit Adam Dean for The
New York Times
Investors have been jolted in recent months by the sudden change in China’s exchange rate policy and by
the government’s bungled handling of a stock market bailout. The sell-off in shares in Shanghai has
become steeper in recent weeks, sending ripples through markets around the world and heightening worries
that apparent confusion in Beijing could be a sign of more trouble to come.
On Monday, the sell-off continued in a volatile day. The benchmark stock index in Shanghai closed down
nearly 2.5 percent despite assurances by a Chinese official at a meeting of Group of 20 finance ministers in
Ankara, Turkey, on Saturday that the worst of the correction was almost over.
The downward pressure on the renminbi reflects the bleaker prospects for China’s economy as growth
appears to be slowing faster than previously reported. Also on Monday, China’s statistics agency lowered
its estimate for gross domestic product in 2014, saying the economy had grown by 7.3 percent last year
compared with the 7.4 percent previously reported.
The manufacturing sector grew faster last year than previously estimated, the agency said, but the service
sector — specifically financial services companies like securities firms and banks, which benefited from a
booming stock market — grew slower last year than originally reported.
Pockets of weakness can be seen across China’s economy.
“Business this year has been tough, and getting more tough as each month goes by,” said Du Shengdu, a
manager in the sales department of Hebei Hongchi Bicycles, a bicycle manufacturer in central China.
“Fewer customers are asking for quotes, and even for those who ask for quotes, a lot of times, no order
ultimately materialized.”
But at least some exporters report seeing a recent uptick in business on expectations of a weaker renminbi.
A weaker currency makes China’s products relatively cheaper for overseas buyers.
Economists have said the initial drop in the currency’s value of around 3 percent against the dollar would
have only a limited impact, but the effect could be intensified if the currency yields to market pressure for
further depreciation.
Photo
The headquarters of the People's Bank of China in central Beijing. Credit Peter
Trebitsch/European Pressphoto Agency
Kellen Chan, a sales manager in the export department at Guangzhou Xinxiu Fashion Bags, a handbag
maker in the southern city of Guangzhou, said that business was slow earlier in the summer but had started
picking up more recently.
“We are getting a lot more inquiries starting from last month,” Ms. Chan said. “It is probably due to the
devaluation of the renminbi.”
Since the devaluation, China’s central bank has kept the currency more or less steady at roughly 6.4
renminbi to the dollar. But the move raised expectations that the renminbi would weaken further, leading to
the central bank’s sales of foreign reserves to counter depreciation pressures.
China amassed its huge pile of reserves in previous years, when the pressure had been for the renminbi to
appreciate in value. Because China closely manages the value of its currency against the dollar, it had to
buy dollars and sell renminbi to counter this appreciation.
Now, the tables have turned and the pressure is on the renminbi to depreciate. But China retains a firm grip
on its value, and this time it has been selling dollars and buying renminbi to prop up the Chinese currency’s
value.
Some analysts interpreted the drop of nearly $100 billion as relatively good news, compared with estimates
that the decrease could have been double that amount.
China’s central bank “is not burning through its reserves as quickly as many had believed,” Julian EvansPritchard, a China economist at Capital Economics, wrote in a report Monday evening after the data was
released.
Mr. Evans-Pritchard calculated that the net amount of money leaving China probably rose to a record $130
billion last month, up from about $75 billion in July.
“It seems that the depreciation of the renminbi has not sparked as rapid an acceleration of outflows as many
had feared,” he wrote.
NYT
In China, a Forceful Crackdown in
Response to Stock Market Crisis
By EDWARD WONG, NEIL GOUGH and ALEXANDRA STEVENSONSEPT. 9, 2015
Photo
Day traders at a brokerage house in Beijing. The main stock index in Shanghai has
fallen 37 percent since the market sell-off began in June. Credit Kevin Frayer/Getty
Images
BEIJING — The police have been dropping in on investment firms and downloading their transaction
records. Senior executives at China’s biggest investment bank have been arrested on suspicion of illegal
trading. A business journalist has been detained and shown apologizing on national television for writing
an article that could have hurt the market.
The Communist Party’s response to China’s monthslong stock market crisis has been swift and forceful. In
addition to spending as much as $235 billion to buy shares and bolster prices, the authorities have imposed
a range of extraordinary restrictions on the sale of stocks — and backed them with the full weight of a
security apparatus usually more focused on political dissent than equity trades.
The strategy appears to have succeeded, at least for now, in softening the impact of the Chinese market’s
biggest rout since the global financial crisis of 2008. But the new limits on trading and the efforts by the
police and regulators to enforce them have unsettled investors at home and abroad who are unsure exactly
what types of transactions are being banned or criminalized.
Photo
Li Yifei, the China chief of the world’s largest publicly traded hedge fund, has denied
she was detained by the Chinese authorities. Credit Reuters
After decades of watching China make slow but steady progress in building Western-style financial
markets, many are now asking whether the party is reversing course — and whether Chinese officials are
willing to tolerate the sometimes turbulent waves of selling that are inherent to such markets.
“What’s happening in China is definitively spooking people,” said Dawn Fitzpatrick, the chief investment
officer of O’Connor, a $5.6 billion hedge fund owned by UBS. “They’ve set themselves back a couple of
years” in terms of attracting investment, she added.
Anxiety in the industry surged last week after Li Yifei, the prominent China chief of the world’s largest
publicly traded hedge fund, disappeared and Bloomberg News reported that she had been taken into
custody to assist a police inquiry into market volatility. Her employer, the London-based Man Group, did
little to dispel fears, declining to comment on her whereabouts.
Ms. Li resurfaced on Sunday and denied that she had been detained, saying that she had been in “an
industry meeting” and “meditating” at a Taoist retreat. But many in the finance sector are unconvinced.
“There is, generally, a very nervous atmosphere, as people wait to see the outcome of some of these
investigations and how deep the rabbit hole goes,” said Effie Vasilopoulos, a partner at the Hong Kong
office of the Sidley Austin law firm who works with hedge funds that invest in mainland China. “How wide
a net is the government going to cast in terms of looking at foreign firms and their operations — not just
onshore, but also offshore as well?”
The authorities are canvassing industry players in several cities, including Beijing and Shanghai. Police
officers under the Chinese Ministry of Public Security specializing in economic crimes have joined agents
from the nation’s securities regulator on inspections of investment funds and brokerage firms. The
authorities are combing records and questioning transactions that appear to profit from or contribute to a
falling market, according to employees of investment firms who, like others who spoke anonymously, said
they feared reprisals.
Police officers have downloaded extensive trading data and asked fund managers why they sold shares
when the market was going down, prompting discussions about basic investment strategy. Officers have
bluntly told some fund managers to just stop selling.
While regulators and law enforcement elsewhere in the world routinely meet with investment companies to
monitor trading for potential abuse and illegal activity, they seldom do so with the aim of steering the
direction of the markets.
The government has offered few details about the various investigations, contributing to the atmosphere of
uncertainty. In late August, it announced the arrests of eight executives at state-owned Citic Securities, the
country’s largest brokerage firm and investment bank, including four members of its senior management,
on suspicion of insider trading.
At least four other brokerage firms said last month that they were being investigated by regulators for
failing to properly identify their clients.
Photo
A Chinese day trader buying shares at a local brokerage house in Beijing. The new
limits on trading and the efforts by the police and regulators to enforce them have
unsettled investors, who are unsure exactly what types of transactions are being
banned or criminalized. Credit Kevin Frayer/Getty Images
While insider trading is common in China’s relatively opaque markets, the investigations also serve the
government’s short-term goal of discouraging sales and stabilizing prices, said Chris Powers, a senior
consultant at Z-Ben Advisors, a financial consulting firm in Shanghai. “Is this more about limiting
supposed market manipulation, or is it about sending a message to the market as a whole and using these
cases as examples?” he asked.
Starting in the middle of last year, China’s markets enjoyed a breathtaking rally driven by record levels of
margin financing, or borrowing to invest in stocks, and strong signals of government support, including
cheery reports on the bull market in official news outlets like People’s Daily. But the Shanghai composite
index has fallen 37 percent since the sell-off began in June, and the government has intervened directly and
repeatedly in an attempt to support prices.
The measures include restrictions on short-selling, or betting that stocks will fall. Regulators in the United
States took similar action for a month at the height of the 2008 financial crisis, but the Chinese authorities
have been vague about what kinds of transactions have been prohibited and for how long. The police have
said they are investigating “malicious” short-selling but have not said what that entails.
The crackdown on short-selling and other trading strategies has been particularly disruptive for hedge
funds, which depend on such trades to balance risks and limit losses.
“They seem to be harassing anybody that they thought was selling or was short,” said one hedge fund
manager in Hong Kong who does not have investments on the mainland. “Hello, it’s a hedge fund — they
are long and short — but China is only looking at the short side.”
The government has also suspended initial public offerings and prohibited investors who own more than 5
percent of a company from selling shares.
While central banks in the United States, Europe and Japan have used unconventional monetary policy in
recent years to stimulate growth and lift markets, China’s intervention has been more direct, with the
government ordering brokerage firms to contribute to a bailout fund. In a report this week, analysts at
Goldman Sachs estimated that entities directed by the Chinese government have spent about 1.5 trillion
renminbi, or $235 billion, buying shares to support the market.
While opening its wallet, the state is also wielding a cudgel. At the end of August, Wang Xiaolu, a
journalist for the respected financial newsmagazine Caijing, was detained by the police and shown on state
television apologizing for an article suggesting the government might scale back its bailout of the market.
Nearly 200 others have been punished in a special police campaign against “spreading rumors,” including
some detained for discussing the stock market.
Censors have ordered the Chinese news media to avoid any reporting that might result in a market sell-off.
With the economy growing at its slowest pace in a quarter-century and the party leadership worried about
social unrest, discussion of the markets can draw official scrutiny almost as quickly as political speech.
“Like many other bad ideas, the Chinese have finally adopted the Western practice of silencing financial
critics — and banning short-selling — when markets turn down,” said James S. Chanos, the prominent
American short-seller who has bet on a downturn in China for more than five years. “It has never worked
here and does not appear to be working there either.”
Graphic: Why China Is Rattling the World
One hedge-fund manager based in Hong Kong said that he was cashing out most of the nearly $500 million
he has invested in the mainland because of fears that his money could get tied up by new rules, with no
legal recourse.
“I’m worried about more systemic risks” and “the witch hunt that is going on,” he said.
Another fund manager, in Singapore, said his colleagues in China were finding ways to take vacations
outside of China because of a perception in the industry that the environment was becoming increasingly
hostile.
The state news media has stoked the flames in the campaign against short-sellers, hedge funds and other
investors, especially foreign ones. In July, the official newspaper of China’s state banks, Financial News,
ran an editorial that accused Morgan Stanley, Goldman Sachs and other foreign investment banks of trying
to cause a market “stampede” and said that outsiders wanted to prevent China from becoming a strong
financial power.
Another article, on the popular Chinese website Sina, criticized Citadel Securities, a Chicago-based
investment firm. One of the firm’s accounts in China was among a group of 34 that officials suspended in
July and August for suspicious automated trading activity.
Though foreign investors are being singled out, only about 1 percent of China’s $6.4 trillion domestic
market value is owned by such investors, according to estimates by UBS, the investment bank.
In recent years, some financial officials and regulators have started developing more sophisticated
investment tools for the Chinese stock market, such as futures and derivatives. But regulators are unlikely
in the current environment to continue with such experiments, analysts said. On Sept. 2, China’s futures
exchange, an important platform for hedging, announced new restrictions that quickly led to a severe drop
in trading volume.
“Now we’re seeing the regulators trying to stuff the genie back into the bottle,” said Victor Shih, a political
economist at the University of California, San Diego, who has worked for a hedge fund.
“For investors, if you can’t hedge, it makes it hard to mitigate any sort of risk,” he added, arguing that
would “ultimately limit the wealth of the equities market” in China.
Anne Stevenson-Yang, co-founder of J Capital Research, which analyzes the Chinese economy for
investors, said the restrictions on selling had turned the Chinese stock market into “a roach motel for
capital.”
“You can enter,” she said, “but if you want to leave, you have to be really fleet about it, because you’re
mostly not going to get out.”
NYT
China’s Export Data Points to a
Deepening Industrial Downturn
点击查看本文中文版 Read in Chinese
By NEIL GOUGHSEPT. 8, 2015
HONG KONG — China’s industrial slowdown is showing signs of worsening, as the country’s trade slump
deepened further in August in the face of weaker demand from overseas buyers.
Once seemingly indomitable as the world’s workshop, China is now facing its most protracted decline
since the global financial crisis. Overseas shipments fell 5.5 percent last month compared with a year
earlier. That has dragged total exports 1.4 percent lower in dollar terms in the first eight months of the year.
It is a sign that the country’s sprawling manufacturing sector is losing competitiveness: Labor costs are
rising relentlessly and the currency, the renminbi, remains relatively strong despite its devaluation last
month. Despite the currency move, Chinese goods are notably more expensive for foreign buyers than they
were even a year ago.
At the same time, China’s imports are falling even more sharply, declining last month for the 10th month in
a row, with a drop of 14 percent by value.
Economists say sharp drops in global prices for commodities like oil and industrial metals have propelled
the decline in import value. But the sheer volume of imports of crucial industrial raw materials like coal,
iron ore, copper, aluminum and steel has also fallen this year. The declines are a clear sign of weakening
domestic demand in China as a slump in manufacturing and new housing construction drag on economic
growth.
Photo
An idle section of a Chinese steel plant. As the country's economy slows, demand for
the raw materials of steel producers and other industries has declined, affecting the
economies of countries supplying raw materials to China. Credit CHINATOPIX, via
Associated Press
Beck Cai, a sales manager at the Shanghai Steel Fashion Industrial Company, a manufacturer and exporter
of prefabricated steel structures, said his company’s business in August dipped as much as 40 percent
compared with a year earlier.
“I don’t think it has anything to do with the way we operate; it is mainly that the overall environment is
slowing down,” Mr. Cai said. “As far as the recent devaluation of the renminbi, it is still too early to tell
how it will impact our business.”
China’s leadership last month made the surprise decision to devalue the currency by about 3 percent, the
renminbi’s sharpest drop in two decades. But China’s central bank has since intervened on a huge scale,
propping up the currency further by selling dollars for renminbi.
As a result of this intervention, China is burning through its stockpile of foreign exchange reserves at the
fastest pace on record. Reserves fell by nearly $100 billion in August alone, although that still leaves $3.56
trillion, the central bank reported on Monday.
Still, analysts say the recent devaluation was probably too small to help China’s exports.
“The renminbi has appreciated substantially in real effective terms against a basket of currencies in the past
year, which in relative terms makes China’s exports less competitive than in the past,” Ding Shuang, the
head of greater China economic research at Standard Chartered, wrote in an email. “But China still
registered a huge trade surplus and there is no reason for significant devaluation against most currencies.”
Photo
A market in Beijing. China hoped to emphasize consumer consumption, over
exports, as a driver of its economy. But a devaluation of its currency and a sell-off in
its stock markets has raised doubts about those efforts. Credit Kevin Frayer/Getty
Images
China’s trade surplus with the rest of the world has surged, rising to $365 billion in the first eight months of
the year. This is because imports are declining more sharply than exports.
But the trade surplus also helps soften the blow of investors’ withdrawing money from China with
expectations that the renminbi will weaken further.
Analysts at Nomura calculate the pressure on China’s currency to weaken is stronger now than at any time
since 1994, when the country adopted its modern exchange rate system and devalued the currency by a
third.
“Given the Chinese economy’s weak growth and deep-seated structural challenges, we expect renminbi
depreciation pressure to remain,” the Nomura analysts wrote in a research note on Tuesday. “However,
unlike in the late 1980s and early 1990s, we expect this pressure to be moderate and prolonged, rather than
sudden and severe.”
One potential complication in the August trade figures may be the exchange rate used by the customs
administration. The administration said exports totaled $196.883 billion in dollar terms and 1.204 trillion
renminbi in local currency terms.
That implied an exchange rate for August of 6.116 renminbi per dollar, the same implied rate used in the
July trade figures. But China devalued its currency on Aug. 11, and the average exchange rate in August,
according to the central bank’s official fixing, was 6.3056 renminbi per dollar.
The reason for the discrepancy was unclear. But it raised the possibility that China’s actual decline in
exports in renminbi terms was not as bad as the 6.1 percent decrease reported — or that the real decline in
dollar terms might have been worse than the 5.5 percent drop reported.
Representatives of the customs administration’s press office could not be reached for comment after normal
working hours.
NYT
Who's Running China's Economy?
Mixed policy signals from China – on the stock market, currency and financial reform – have unnerved
global investors and prompted central bankers to shift strategies. Here are five officials who are calling the
shots in Beijing.
1. Photo
Credit Ruben Sprich/Reuters
Governor of the People’s Bank of China
Zhou Xiaochuan
Portfolio: Interest rates, currency policy, supporter of financial reform
The head of the central bank in China since 2002, Mr. Zhou is the world’s longest serving
governor of a major central bank. Fluent in English and an admirer of Western classical music, he
has long been a public face of Chinese financial reform to the outside world; that status has helped
him stay in office despite having surpassed the retirement age for officials of 65 (he’s now 67).
As a princeling, or son of a senior Communist Party figure, his voice also carries added weight
within China. Mr. Zhou has been busy pushing for a more freely traded renminbi, which if
successful would have huge implications for China and its main trade partners, including the
United States.
2. Photo
Credit Bobby Yip/Reuters
Chairman of the China Securities Regulatory Commission
Xiao Gang
Portfolio: Securities regulation and enforcement, market reform and stock
market bailout
A former banking chief, Mr. Xiao is an outspoken critic of nontraditional finance. He once
famously described the rapid growth of China’s loosely regulated shadow finance sector as
“fundamentally a Ponzi scheme.” At the central bank, Mr. Xiao and Mr. Zhou both served under
Zhu Rongji, the prime minister in the late 1990s and early 2000s who led sweeping overhauls of
the country’s banking sector and state-owned companies.
Mr. Xiao, who took over the securities agency in 2013, has faced criticism in China for not acting
fast enough to curb the speculative excesses that helped drive the run-up in share prices. His
agency has since responded with an aggressive crackdown on short sellers. At the same time
China’s anti-corruption agency has also taken aim at securities officials.
3. Photo
Credit Reuters
Minister of Finance
Lou Jiwei
Portfolio: Economic stimulus, tax reforms and other fiscal policy
Another protege of the former prime minister, Mr. Lou in 2007 became the first chairman of the
newly established China Investment Corporation, the country’s first sovereign wealth fund. With
Mr. Lou at the helm, the fund bought stakes in American financial companies like Morgan Stanley
and Blackstone. The purchases came under fire in the Chinese press when their value dropped
because of the financial crisis.
After becoming head of the finance ministry in 2013, he has focused on technical fiscal reforms as
well as the high levels of local government debt. Earlier this year, he warned that China faced a 50
percent chance of falling into the middle-income trap – where growth and incomes stagnate –
unless it pursues further financial reform.
4.
5. Photo
Credit Mark Schiefelbein/Associated Press
Prime Minister
Li Keqiang
China’s prime minister, also know as the premier, traditionally has been the point person for
economic policy. As the head of the state council, Mr. Li oversees the work of the central bank,
securities regulator, the finance ministry, as well as dozens of other government agencies.
He is also the No. 2 in the seven-member Politburo Standing Committee, the Communist Party’s
most powerful decision-making body. Since coming to power in 2002, Mr. Li has focused on
cutting administrative red tape, promoting technology and innovation, as well as increasing state
investment in infrastructure.
6. Photo
Credit Jason Lee/Reuters
President
Xi Jinping
Since rising to power three years ago, Xi Jinping, a lifelong politician who was educated as a
chemical engineer, has emerged as one of China’s most influential leaders. He has asserted
himself as the prime decision maker in economic policy, partly overshadowing the typical role of
the premier.
Along with introducing sweeping financial reforms in late 2013, Mr. Xi created a new “central
leading group on deepening overall reform.” He has rejected recent criticism that the country is
backpedaling in its efforts, saying in a speech in September that “the key to China’s development
lies in reform.”
China’s Growth Slows to 6.9%
点击查看本文中文版 Read in Chinese
By NEIL GOUGHOCT. 18, 2015
Photo
A construction site in Beijing. Credit Kim Kyung-Hoon/Reuters
HONG KONG — China’s economy grew 6.9 percent in the third quarter from a year ago, as a deepening
industrial rout and slumping stock market pushed growth to its slowest quarterly pace since the global
financial crisis of 2009.

The weak result in the July-to-September period compares with growth of 7 percent in each of the first two
quarters of the year, but was slightly better than the 6.8 percent rate that economists had forecast. The
government’s official target for the year is growth of around 7 percent.
“China was facing increasing downward pressure of domestic economic development” in the first nine
months of the year, the official statistics agency said in a statement accompanying the data released
Monday morning in Beijing. Still, it added, “the overall performance of the national economy was stable
and moving in a positive direction.”
Uncertainties over China’s decelerating growth have shaken global stock markets in recent months as
investors have raised doubts about the quality of Chinese economic data and the transparency of the
country’s policy decision-making process. Concerns have been heightened by China’s botched attempt to
prop up its stock markets in July and the surprise move in August to devalue its currency, the renminbi, by
the most in nearly two decades.
Continue reading the main story
China is struggling with an industrial slump that in recent months has appeared to be worse than the
country’s leaders had anticipated. The country’s traditional growth drivers — manufacturing and housing
construction — have recently become among the biggest drags on its economy, the world’s second largest
after the United States.
Data released Monday showed continued pressure, with industrial production rising 5.7 percent in
September, near its slowest pace since the financial crisis. Overall investment rose 10.3 percent in the first
nine months of the year, its slowest rate of increase in 15 years.
In response, China’s central bank has cut interest rates five times since last November, and has taken other
steps to free banks to lend more. The government has also pledged to spend hundreds of billions of dollars
this year on new infrastructure projects, including rail lines and water treatment plants, to help lift growth.
Continue reading the main story
To offset the industrial slowdown, China is relying on a rise in consumer demand driven through
continuing urbanization and a growing middle class. Evidence of this emerging economic driver can be
seen in recent months in double-digit growth rates in areas like box office revenues and online merchandise
sales. Overall retail sales rose 10.9 percent in September from a year earlier, data released Monday showed.
But so far, rising spending by Chinese consumers has failed to offset the slump in the economy’s traditional
industrial engine.
“We don’t really trust the overall growth figures,” said Julian Evans-Pritchard, an economist following
China at Capital Economics. “There’s plenty of evidence to suggest the economy is growing significantly
slower than that, but that doesn’t mean that the G.D.P. data, particularly the breakdown, doesn’t tell us
anything.”
He pointed to the rising share of services and consumption in the overall economy, which continued to gain
prominence in the third quarter despite the slump in activity related to the stock market.
For example, while a continued contraction in housing construction weighed further on the industrial
sector, sales of newly completed or existing homes have been rebounding sharply — helping lift business at
services companies like property agencies.
Compared with the April to June quarter, the third quarter “had some additional weakness in industry, but
that’s been made up by some strength in services,” Mr. Evans-Pritchard said. “Things look to have been
pretty stable overall.”
NYT
Discordant Financial Messages From
China Spur Global Unease
By NEIL GOUGHOCT. 19, 2015
Workers direct a crane lifting newly made steel bars at a factory of Dongbei Special
Steel Group in Liaoning Province. Credit China Daily/Reuters
HONG KONG — China’s bungled stock market bailout was a significant setback to its decades-long
efforts to build a modern financial system.
Its currency devaluation shocked global investors and altered the policy calculus at central banks from
Hanoi to Washington.
A highly anticipated package of overhauls to sprawling state-owned companies was a crushing rebuke to
hopes that China would move to privatize such businesses. Instead of reducing their stakes, the Communist
Party said it would increase its control over such companies.
To many global policy makers and investors, China’s spate of surprises is driven by the government’s need
to get the economy back on track.
Growth is slipping. The latest data on Monday showed that the economy grew at 6.9 percent in the third
quarter, its lowest level since 2009. And Beijing is scrambling to respond to the pressures.
While President Xi Jinping says the country is committed to financial reform, the resulting measures send
the message that China is backpedaling on those efforts. It is a new and shifting landscape that is proving
difficult for the rest of the world to navigate.
Continue reading the main story
Who’s Running China’s Economy?
Mixed policy signals from China have roiled global investors. Here are five officials who are calling the
shots in Beijing.
“People say reform is coming, but you’re giving back your reforms,” Fraser Howie, a longtime banker in
Asia and co-author of “Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise,”
said of the recent actions by Chinese authorities.
“That defeats the whole purpose; you either embrace markets or not,” he said.
For years, the technocrats who control the levers of China’s economy have been heralded as farsighted
planners. What they promised, they generally delivered, and any doubts could be dispelled by the nation’s
torrid economic growth.
But that image has been shattered in recent months, as an expanding cast of agencies and officials regularly
roll out ambitious plans with little warning and explanation. In China, some economic decisions are treated
like state secrets, forcing global investors and policy makers to adjust quickly.
The People’s Bank of China routinely surprises the market with major policy announcements on evenings
and weekends. Its counterpart, the United States Federal Reserve, tries to telegraph its moves long in
advance.
It is all complicated by the competition and the lack of coordination among the many agencies charged with
managing China’s economy. The central bank, securities regulator, Finance Ministry and economic
planning agency, among others, have different agendas and goals.
The collective result is that it is difficult to discern exactly what is happening in China. From the outside,
officials appear to be changing course on long-held reform plans that are broadly considered critical for the
health of the economy.
In June, China’s chief securities regulator outlined sweeping plans to help turn millions of cash-starved
start-up companies into innovative corporate champions by making it easier to raise money and go public.
The initiative would “strengthen the vitality of the entire economy,” Xiao Gang, the head of the China
Securities Regulatory Commission, said at a financial forum in Shanghai.
With China’s stock markets tumbling a week later, he appeared to sacrifice his free-market agenda. Mr.
Xiao’s agency banned new listings, barred big shareholders from selling and ordered brokerages to buy
aggressively.
Graphic
Why China Is Rattling the World
China’s economy is faltering, prompting concerns that are now shaking global stock markets.
OPEN Graphic
“The stock-market rescue revived questions regarding the leadership’s commitment to economic
liberalization and whether that is even what the administration means by reform,” said Matthew P.
Goodman, a senior adviser for Asian economics at the Center for Strategic and International Studies who
was an author of a two-year study on economic decision-making in China that was published in March. “It
is now pretty clear that things are not going according to plan.”
The current pressures in China signal a shift from the rosier outlook two years ago, when President Xi
introduced a platform of financial overhauls intended to give the market a “decisive” role in the direction of
economic growth. At the same time, Mr. Xi has aggressively asserted his primacy in driving China’s
economic policy and reforms, an area that was traditionally overseen by the prime minister.
“The focus on centralizing authority has been a big theme of Xi’s, and also this more politicized and
nationalist environment that Xi has inaugurated has had very clear effects on the progress of economic
reform,” said Andrew Batson, the China research director at Gavekal Dragonomics, a financial consultancy
in Beijing.
“That’s not necessarily 100 percent negative,” Mr. Batson added. “But it’s certainly not the universally promarket reform agenda that some people were expecting.”
The confusion over the country’s commitment to financial reform has increased volatility far beyond
China’s borders.
China’s central bank has explained the devaluation on Aug. 11 as a one-time adjustment that was meant to
make the currency, whose value had been tightly controlled by the government for years, more marketdriven. But the suddenness of the move spurred competitive devaluations in Vietnam and Kazakhstan. The
tumult even prompted the Fed to hold off raising interest rates at its Sept. 17 meeting.
“I think developments that we saw in financial markets in August in part reflected concerns that there was
downside risk to Chinese economic performance, and perhaps concerns about the deftness with which
policy makers were addressing those concerns,” Janet L. Yellen, the Fed’s chairwoman, told reporters after
that meeting.
Zhou Xiaochuan, the long-serving head of China’s central bank, has not commented directly on the
devaluation. In a recent essay, he argued that China had made impressive progress in financial overhauls
over recent decades, but he also acknowledged that the global financial crisis and other factors had delayed
some changes.
“Today the conditions are there to advance reforms for market changes, internationalization and
diversification,” Mr. Zhou wrote in China Finance magazine. “But in this process, there are some things
that require catching up, because there have been planned reforms that, owing to the crisis and other
factors, were pigeonholed.”
Photo
A vendor waits for customers at a market in Beijing. Inflation is edging higher,
mainly because of higher food prices. Credit Kevin Frayer/Getty Images
For China, the risk in delaying promised financial overhauls is that longstanding economic issues, like the
country’s ballooning corporate and government debt problem, might get worse.
The fact that China has more billionaires (USD) than the US yet family incomes are barely over 10
thousand (USD) a year is a HUGE reason...
State-controlled media reported on Monday that Prime Minister Li Keqiang had met with the leaders of
some of China’s biggest banks on Friday and issued a broad promise to prop up companies in financial
trouble. According to the Beijing Times, Mr. Li declared that China “will not cut or withdraw loans to
those companies with difficulties but good market prospects,” and will “give necessary capital support to
companies undergoing bankruptcies or regrouping.”
In October 2014, Lou Jiwei, the finance minister, announced a bold plan to clean up trillions of dollars of
local government debts, spending that has traditionally played a major role in China’s efforts to stimulate
the economy. But policy makers have appeared partly to backtrack, allowing local governments to continue
adding new debt through riskier methods like borrowing through unregulated holding companies.
“Relative to the plan announced last year, the pace of reform now is slower,” Nicholas Zhu, a vice
president at Moody’s Investors Service based in Beijing, said of the local government debt efforts. “The
reason is because the sharper-than-expected slowdown of economic growth since earlier this year has
changed the policy focus more towards stabilization of the economy.”
The most recent development to set off doubts about China’s commitment to economic reforms came last
month, when the government released a much-anticipated policy document on the overhaul of its gigantic
state-owned sector.
A few days after the proposal was published, the Communist Party’s powerful Central Committee followed
up with a document that bluntly ruled out loosening the party’s grip on state firms.
Party leadership “can only be strengthened rather than undermined, as state-owned enterprise reforms have
entered the deepwater zone,” the Central Committee document said, according to a report by Xinhua,
China’s official news agency.
The party leadership over state firms “is vital in ensuring the socialist direction of their development” and
would “enhance their competitiveness and competence,” Xinhua added.
Despite signs of stasis on the ground, Chinese officials continue to talk up a pro-reform agenda in public,
which adds to the murkiness.
On his visit to the United States last month, Mr. Xi, China’s president, repeatedly drove home his
commitment to pushing through economic overhauls.
“The key to China’s development lies in reform,” Mr. Xi said in a speech in Seattle.
“When it comes to the toughest reforms, only those with courage will carry the day,” he added. “We have
the resolve and the guts to press ahead.”
The Economist
Debt in China
Deleveraging delayed
Credit growth is still outstripping
economic growth
Oct 24th 2015 | SHANGHAI | From the print edition

IN MOST respects, double-digit growth is a relic of the past for China. In the third quarter the economy
grew by just 6.9% year-on-year according to official data, and probably by a percentage point or two less in
reality. Yet bank loans increased by 15.4% in the third quarter compared with the same period in 2014.
Having released a torrent of credit to buoy the economy during the financial crisis, China was supposed to
have started deleveraging by now. Instead, banks are continuing to pump debt into the economy, while the
authorities, apparently worried about the damage a contraction in credit might do, coax them on.
Growth in credit has at least slowed in recent years. A broad measure is “total social financing” (TSF),
which encompasses bank loans, corporate bonds and a range of shadowy loan-like products. TSF growth
soared to 35% in 2009 when the government called on banks to open the taps and support the then-faltering
economy. It has since decelerated: it rose by 13% in the third quarter from a year earlier. The problem,
though, is that nominal GDP growth has fallen much lower, to 6.2%.
This means that China’s overall debt-to-GDP ratio is continuing its steady upward march (see chart). Debt
was about 160% of annual output in 2007. Now, China’s debt ratio stands at more than 240%, or 161
trillion yuan ($25 trillion), according to calculations by The Economist. It has risen by nearly 50 percentage
points over the past four years alone, with slowing growth only serving to magnify indebtedness.
A rapid increase in debt in a short space of time has historically been a good predictor of financial trouble,
from Japan in the 1990s to southern Europe in the 2000s. But there is no level that automatically triggers
crises. Since most of China’s debts are held within the government-controlled bits of its economy (stateowned firms are the biggest debtors and state-owned banks their biggest creditors), the country has the
means to avoid an acute crisis. It can, in effect, roll over bad loans as they come due or abstain from calling
them in. However, although that spares the economy short-term pain, it leaves it with a chronic ailment.
Ever more credit is needed to sustain growth. Loans that should have gone to sprightly companies with
promising new ideas go instead to corporate zombies.
There are worrying signs that China is heading in this direction. In the six years before the global financial
crisis, each yuan of new credit brought about five yuan of national output. In the six years since the crisis,
that has fallen to just over three yuan. It is not hard to find examples of companies on life support that in
other countries might have perished by now. In September China National Erzhong Group, which makes
smelting equipment, received a bail-out from its parent. Investors in Sinosteel, a metals conglomerate, are
now hoping for the same after it delayed payment on a bond this week.
It is not too late for China to bring its debts under control. Regulators have taken steps in the right
direction. They have obliged local governments to provide better data on their debts and have forced banks
to bring more of their shadow loans onto their balance-sheets, providing a clearer picture of liabilities. One
reason that banks have been issuing loans so quickly this year—faster than overall credit growth—is that
they are replacing shadowier forms of financing. China has also used both monetary easing and a giant
bond-swap programme for local governments to reduce the cost of servicing debts. The weighted interest
rate on existing liabilities has fallen from roughly 6% to 4.5% this year.
But some worry that these measures are just pushing risks elsewhere. A bond-market boom is the newest
concern. Net bond issuance in the first nine months of 2015 reached 8.7 trillion yuan, up 67% from the
same period a year earlier. At the same time, the gap between funding costs for companies and the
government has narrowed sharply. The one-year yield on government bonds has fallen by nearly a
percentage point over the past year, whereas corporate yields have fallen by 1.5 percentage points. In other
words, investors are lending to companies as if they were becoming safer borrowers, even as their liabilities
increase. Yang Chen of Bank of America Merrill Lynch notes that some investors are buying bonds with
borrowed cash, believing that the government will wade in to spare them from any big defaults—as it has
done in the past. If that impression persists, China’s debt mountain could grow bigger still.
NYT
China Aims for 6.5% Economic Growth Over Next 5 Years, Xi Says
By EDWARD WONGNOV. 3, 2015
President Xi Jinping of China on Tuesday. Credit Pool photo by Jason Lee
BEIJING — President Xi Jinping of China announced on Tuesday that the Communist Party and the
national government had set a 6.5 percent target for annual economic growth from 2016 to 2020.
The announcement was an apparent attempt to temper expectations that China’s slowing economy will
rebound to anything near the double-digit growth of recent decades. The party also released the broad
outlines of proposals for its next five-year plan. That blueprint of its economic development was discussed
at a recent party plenary session in Beijing and is expected to be completed next spring by the National
People’s Congress, a legislature that grants pro forma approval to party policy.
In declaring the target of 6.5 percent, Mr. Xi was reiterating a figure that Prime Minister Li Keqiang had
used in a speech on Sunday in South Korea. The leaders say the target must be met for China’s gross
domestic product and per capita income in 2020 to be double what they were in 2010.
“China aims to narrow the income gap and raise the proportion of the middle-class income population in
the next five years,” according to a report by Xinhua, the state news agency, on the proposals for the next
five-year plan, which will be the 13th in the party’s history.
China’s gross domestic product per capita is about $7,800, the Xinhua report said, citing figures released on
Tuesday. With nearly 1.4 billion people, China is the world’s most populous country. The current
development plan, which runs from 2011 to the end of this year, set an annual growth target of about 7
percent.
The party said the proposals for the new plan aimed to, among other things, eradicate rural poverty (an
“arduous task”); promote inclusion of the Chinese currency, the renminbi, in the International Monetary
Fund’s basket of currencies; and attract foreign investment while encouraging more Chinese businesses to
invest overseas. The party also said that China would set up a Green Development Fund to promote clean
industry and sustainable growth.
The proposals emphasized the need to strengthen conservative party ideology in public realms, an
important goal under Mr. Xi. For example, they called for cultivating a positive culture on the Internet and
cleansing the online environment. At the same time, the plan said China wanted to improve Internet speeds
— a task seemingly incompatible, at least on a global level, with the country’s Great Firewall system of
web censorship.
The proposals were approved after about 200 full members of the party’s Central Committee held a
meeting for four days last month in a heavily guarded hotel in western Beijing. Last Thursday, during the
session, the party announced that it was changing its one-child policy of family planning to a two-child
policy in an attempt to stimulate economic growth.
The new policy is also expected to be approved by the National People’s Congress next spring and will go
into effect afterward, although economists and demographers say they do not expect a big spike in the
national birthrate.
On Tuesday, some critics expressed skepticism about whether any five-year plan could address the
evolving complexity of China.
“Rarely do people compare the plan and the eventual reality,” said Mao Yushi, chairman of the Unirule
Institute of Economics in Beijing. “Not one five-year plan has unfolded as planned. Why? Because you
can’t predict the problems five years from now.”
The Chinese economy grew 6.9 percent in the third quarter, relative to a year earlier, according to data
released in October. That figure, while robust compared with those of advanced economies, was the
slowest for China since the global financial crisis of 2009, and some economists say the economy is
actually much weaker.
Mr. Xi and Mr. Li have said they want to shift China away from heavy industry and high investment
toward a larger service sector and more consumer spending. But recent economic shakiness has fed doubts
about whether they can smoothly manage that transition.
The annual plenary sessions of the Central Committee are part of the ritualized cycle of Chinese politics,
giving top leaders a platform to win elite endorsement for their policies and to settle disagreements. Most
famously, a plenum in late 1978 sealed Deng Xiaoping’s re-emergence as a dominant leader and opened
the way to market overhauls that transformed the economy over the next decade.
Before the latest meeting, party propaganda depicted Mr. Xi, who is also the general secretary of the party,
as a visionary in the mold of Deng.
“It is consistent with the broader trend of the C.C.P. general secretary acting as the ‘chairman of
everything’ and ensuring his personal stamp is on every policy,” said Scott Kennedy, a researcher on
Chinese economic policy at the Center for Strategic and International Studies in Washington who has
followed the drafting of the new five-year plan.
Although China has shed many of the top-down economic controls of the Maoist era, the five-year plan still
plays an important role in setting long-term goals, Mr. Kennedy said. After the National People’s Congress
endorses the plan next spring, ministries and agencies will issue more detailed strategies for making
changes regarding energy, the environment, trade and other areas.
“The plan serves as the most authoritative statement on the state’s priorities,” Mr. Kennedy said. “The
party, government agencies, financial institutions and companies then spend a great deal of effort aligning
themselves with these priorities.”
NYT
China’s Slowdown Raises Questions
About Long-Term Growth
By NEIL GOUGHNOV. 4, 2015
HONG KONG — The short-term economic signals out of China have not been reassuring.
Policy makers bungled a stock market bailout over the summer. The central bank made a surprise
devaluation of the currency. Growth slipped to its slowest pace since 2009.
These developments rattled global markets and unnerved investors. But the bigger question is, what, if
anything, has changed in the long-term outlook for China’s growth?
Some experts on emerging markets look at China’s sputtering growth rate and see signs of deeper problems
ahead. Others are undeterred, taking China’s current economic deceleration in stride. To them, it is a
natural and necessary part of the switch to a more sustainable development path.
“The last couple of decades were all about ever-faster growth in everything in China, and the next couple of
decades will be about slower growth rates in almost everything,” said Andy Rothman, a San Franciscobased strategist at Matthews Asia, one of the biggest investment firms in the United States dedicated to
Asia.
“We need to get comfortable with that,” he added. “The Communist Party is comfortable with that, but
over here, we’re freaking out about it.”
Indeed, the once-torrid growth in industrial and manufacturing output has been cooling off for several
years, falling under 7 percent. China’s leaders have just set an annual growth target of 6.5 percent in the
next five-year plan, running through 2020. But after decades of debt-driven investment, economists are
trying to size up whether China can shift to a new model in which consumer demand becomes the main
engine of economic growth, as in most developed countries.
Bob Browne, the chief investment officer at Northern Trust in Chicago, describes the question of the
Chinese consumer as “one of the fundamental long-term decisions an investor has to make about China.”
“You can’t be agnostic or neutral on it: Is that transition to a services-based economy, as the middle class
expands, going to continue inexorably — with bumps along the way — or not?”
Given the volatile short-term outlook, investors have been cashing out of Chinese-related stocks in recent
months, part of a broader sell-off that has affected most emerging markets.
Selling pressure appears to have stabilized in recent weeks, but as of late October, the one-year estimated
flow out of emerging market stocks totaled nearly $70 billion, according to data from EPFR Global, a fund
tracker, as cited by Citigroup. Of that global total, money flowing out of funds in China and Hong Kong
was more than $30 billion.
In the near term, investors are worried about China’s growth. In recent monthly surveys of fund managers
conducted by Bank of America’s Merrill Lynch unit, a potential recession in China was cited as the biggest
outlying risk to the global economy. In the bank’s October survey, 39 percent of respondents said China
was the biggest such risk, though that was down from 54 percent in September.
Mr. Browne is among those who see China’s slowdown as a near-term risk, but his longer-term faith in its
ability to make the transition to a consumption-led growth model is unchanged.
“Clearly with China, it’s more of a top-down-driven economy, but so were Korea and Japan for much of
their postwar development,” he said. “That transition from a manufacturing- and investment-dependent
economy to a services and consumer-led economy is fairly consistent.”
China has a long way to go. Its state-directed economic model has overemphasized investment for years,
and this has made growth increasingly unbalanced. The result is that private consumption today accounts
for only around 38 percent of China’s gross domestic product. That is a sharp contrast to the industrialized
nations of the Organization for Economic Cooperation and Development, where consumption on average
accounts for more than 60 percent of G.D.P.
Addressing this imbalance poses pressing risks for China. Because of a reliance on state investment —
often in wasteful projects or loss-making industries — the country accrued record levels of debt, which
stands at nearly 300 percent of G.D.P.
That debt burden looks increasingly precarious as economic growth slows, raising the risk of deflation, or
falling prices, which can lead companies to curtail investing and individuals to spend less. Deflation also
makes debt relatively more expensive to repay — even at a time when revenue and profit at many
businesses are crumpling.
“Given the economy is slowing down and deflation is a major risk, if the government cannot push through
necessary reforms, China may well follow the Japanese path of having a balance-sheet recession,” said LiGang Liu, the chief economist for greater China at the Australia and New Zealand Banking Corporation in
Hong Kong. He was referring to a type of recession in which spending on debt repayment takes priority
over making new purchases or investments.
Mr. Liu forecasts that private consumption will rise to about 44 percent of G.D.P. in the next five years —
a slow but significant shift because consumption is expected to outpace the economy’s general growth rate,
replacing investment as the key engine.
This forecast, like others that see China making the gradual shift to a consumption-led growth model, rests
in part on changes underway in how ordinary citizens manage their finances.
On average, Chinese households save roughly 30 percent of their disposable income, the most of any major
country. By comparison, the net saving rate is nearly 6 percent in the United States, 7 percent in Europe
and just over 2 percent in Japan.
But there are signs that a younger, urbanized generation — one that has not experienced the privation of the
past — is taking a less conservative approach to spending than their parents or grandparents did.
That includes people like Yu Ying, 22, who dyes her hair blond and works as a hostess and greeter for
corporate functions and other events, making as much as 6,000 renminbi, or about $940, a month.
Asked about her saving and spending habits while on a recent shopping trip to Sanlitun, a popular Beijing
neighborhood of cafes and shops, Ms. Yu said: “I don’t save. I can’t save any.”
Ms. Yu moved to Beijing from the northeastern province of Jilin three years ago, and says she spends about
half of her income on cosmetics and clothes. She spends a further 1,800 renminbi a month on rent in an
apartment that she shares with friends.
“I also spend money on going out with friends and having dinner with them,” she added.
But even if younger Chinese are more free-spending, analysts say getting most Chinese to open their
wallets more will require financial and other regulatory overhauls that Beijing has so far shied from
undertaking. Among the priorities are easing or abolishing the nationwide system of household registration,
or hukou.
The system as it stands generally prevents new migrants from the countryside from gaining access to urban
school placements, health care and other social services, which can be provided only in one’s official place
of residence. Analysts say liberalizing this system would deliver a tremendous stimulus to labor mobility
and also help reduce the need for migrants to save so much to meet health care and other costs.
“China needs to let people live where they can make the most money, which obviously they don’t do now,”
said Derek M. Scissors, a resident scholar at the American Enterprise Institute in Washington.
The risk of failing to execute on these and other reforms, he said, is falling into a phenomenon known as
the middle-income trap, where growth and earnings reach a plateau before a country can become broadly
wealthy and achieve developed-nation status.
“That’s what I mean by stagnation: China doesn’t continue to climb the ladder of prosperity; it stalls,” he
said.
“Of course, the Chinese have the capacity to reinvigorate the economy,” he added. “But they’re not
implementing those kinds of reforms, and you cannot be a heavily indebted, aging middle-income country
and continue to do well.”
China’s leaders reject suggestions that the economy could stagnate, pledging to remain watchful against an
even faster downturn by undertaking interest rate cuts, infrastructure spending and targeted loans to favored
projects.
“The fundamentals underpinning a stable Chinese economy have not changed,” Li Keqiang, the prime
minister, told a gathering of the World Economic Forum in September in Dalian, a city in northeastern
China.
“We will be fully capable to deal with the situation once signs indicate that the economy is sliding out of
the reasonable range,” he added. “I’m not making an empty promise when I say that the Chinese economy
will not head for a ‘hard landing.’”
NYT
International Business
China’s Renminbi Is Approved as a Main
World Currency
By KEITH BRADSHERNOV. 30, 2015
Photo
Inclusion of the renminbi in the I.M.F.’s elite reserve currency group was so
important to China’s leaders that they named it in October as one of their highest
economic policy priorities in the coming years. Credit Agence France-Presse —
Getty Images
HONG KONG — The International Monetary Fund on Monday approved the Chinese renminbi as one of
the world’s main central bank reserve currencies, a major acknowledgement of the country’s rising
financial and economic heft.
The I.M.F. decision will help pave the way for broader use of the renminbi in trade and finance, securing
China’s standing as a global economic power. But it also introduces new uncertainty into China’s economy
and financial system, as the country was forced to relax many currency controls to meet the I.M.F.
requirements.
The changes could inject volatility into the Chinese economy, since large flows of money surge into the
country and recede based on its prospects. This could make it difficult for China to maintain its record of
strong, steady growth, especially at at a time when it economy is already slowing.
The I.M.F. will start including the renminbi in the fund’s unit of accounting, the so-called special drawing
rights, at the end of September. Many central banks follow this benchmark in building their reserves, so
countries could start holding more renminbi as a result. China will also gain more influence in international
bailouts denominated in the fund’s accounting unit, like Greece’s debt deal.
China’s leadership has made it a priority to join this group of currencies, naming it in October as one of
their highest economic policy priorities in the coming years. The renminbi’s new status “will improve the
international monetary system and safeguard global financial stability,” President Xi Jinping of China said
in mid November.
In the months before the I.M.F. decision, China took several actions to make sure that the renminbi was
more widely embraced. China did so partly to meet the I.M.F.’s rule that a currency must be “freely usable”
before it can be included in this benchmark.
China and Britain have sold renminbi-denominated sovereign bonds for the first time in London, which has
emerged as Europe’s hub for the currency. Even Hungary has announced plans to issue its own renminbidenominated bonds as well, while the Ceinex exchange in Frankfurt has begun trading funds this month
based on renminbi bonds. Preparations began to trade renminbi-denominated oil contracts in Shanghai,
where copper and aluminum contracts are already sold.
Most important, China began changing the way it sets the value of the renminbi each morning. In doing so,
it abruptly devalued the currency.
The entry itself into the special drawing right is mainly symbolic. But such broader moves toward greater
financial transparency and easier trading — part of the process to meet the I.M.F. requirements — will
have long term effects on the renminbi’s usage.
“There’s this obsession with the S.D.R., and it’s completely out of proportion to its economic impact,
which is likely to be trivial,” said Randall Kroszner, a former Federal Reserve Board governor who is now
an economics professor at the University of Chicago. “It may be that in the drive to get into the S.D.R.,
they may make changes that make the renminbi more attractive for international market participants.”
NYT
The Choice Facing China as Its Currency
Becomes More Global
NOV. 30, 2015
Photo
Credit Nicky Loh/Reuters
Neil Irwin
@Neil_Irwin
There is surely some clinking of Champagne glasses, or perhaps a Chinese celebratory equivalent, taking
place in the hallways of China’s finance ministry and central bank. Those officials will now be the proud
guardians of a “global reserve currency,” after a long-sought decision Monday by the International
Monetary Fund.
But they will soon find that the step raises more questions than it answers about China’s role among nations
and that the hardest decisions lie ahead. Being a world financial hegemon comes with meaningful costs, in
addition to benefits.
The direct implications of the I.M.F. decision are narrow. The renminbi (also known as the yuan) will join
the dollar, euro, yen and pound in an elite group of currencies. But if you’re not a reserve manager for some
national treasury, seeking to build emergency savings to buffer the vicissitudes of global finance, the direct
impact of China’s inclusion in “special drawing rights” is limited.
The big question for the future is whether this is akin to what happened about a century ago, when the
United States dollar was gradually supplanting the British pound as the predominant currency for global
trade and finance. This development was a crucial piece of the nation’s rise to superpower status.
Conversely, China’s leaders in the years ahead could decide that being a world financial hegemon carries
too many costs, in which case the renminbi will be more like the British pound or Japanese yen —
important currencies, certainly, but not so important as to create continuing political and economic burdens
on their nations.
The decision for China is whether it is content to have a global reserve currency, or if it aspires for the
renminbi to one day be as important to trade and finance as the dollar is now. There are both benefits and
costs in being the leading global reserve currency — the default currency for world trade and financial
transactions, the most widely used unit for savings, and so on. Understanding these pluses and minuses is
essential to understanding the tensions China faces as it decides how far it wishes to go down the road of
financial liberalization and leadership in the world economy.
The Benefits: Stability and Geopolitical Sway
Remember when the global financial system nearly melted down in 2008 because of problems centered in
the United States housing market and banking system? That’s the kind of crisis that in most countries
would prompt a currency crisis and sharp outflow of capital, making a dire situation worse.
In that miserable fall of 2008, though, the dollar actually soared. Treasury bonds were in such hot demand
that American interest rates plummeted. The United States’ role as the bedrock of the global financial
system was a crucial reason that a terrible situation didn’t become worse; when things went bad, the United
States — and especially its government debt — were a beacon of safety.
Even in times of noncrisis, the country that is the leading global reserve currency will tend to have a
stronger currency and lower interest rates than it would otherwise, thanks to continuing purchases of its
assets by individuals, companies and other nations.
Then there’s geopolitics. Ownership of the premier global reserve currency gives a country sway in global
politics and security that are hard to obtain any other way. In the last few years, the United States has
enforced economic sanctions on countries including Russia, Iran and North Korea, and has waged outright
financial war against what it considered to be terrorist groups.
In effect, any bank that facilitates the transfer of money in violation of those sanctions risks being cut off
from a global transfer of dollars — which in turn means being cut off from much of the global economy.
Analysts at Eurasia Group have called this the “weaponization of finance,” and it is one of the important
ways that financial supremacy and geopolitical supremacy go hand in hand for the United States.
Surely China might like to have a similar scale of influence in global affairs, but to do so it would need the
renminbi to be as fundamental to finance as the dollar. Which raises the reasons not to do that.
The Costs: Loss of Control
It may be a cliché to observe that with great power comes great responsibility, but here it applies. The
United States enjoys what’s been called an “exorbitant privilege” from the dollar’s central role in global
finance, but researchers have also taken to calling it an “exorbitant duty.”
Essentially, the price the United States pays for that role is having fewer tools to manage its domestic
economy.
China has long restricted the ability of businesses and individuals to transfer funds in and out of the
country, helping it prevent huge economic swings as investors’ interest in investing in China waxes and
wanes. It has made exports central to its economic development strategy, using market interventions and
those capital controls to keep its currency undervalued relative to fundamentals, at least until recently.
Contrast that with the United States. Pretty much anyone, anywhere can buy a United States Treasury bond,
for any reason. The dollar rises or falls based on market forces, and on net is probably stronger than it
otherwise would be because of the reserve currency role. That leaves American exporters at a perpetual
disadvantage.
Chinese officials seemed caught by surprise this summer when decisions to liberalize trading in their
currency and prop up their domestic stock market caused widespread ripples through global markets. This
is one of the more subtle costs of becoming a major player on the global financial scene: Your actions don’t
affect just you.
Part of the reason the United States dollar is so important is that the United States has legal, political and
monetary institutions that make international investors and business people feel confident they can always
get easy access to money traded in dollars. The United States government has control in some areas
(economic sanctions for geopolitical foes, for example) because it gives up control in many others
(exchange rate, capital flows, legal protections for foreign investors).
The question for China’s political leaders is whether that trade-off is worth it.
“The renminbi will not be seen as a safe haven currency unless economic reforms are accompanied by
broader legal, political and institutional reforms that are necessary to inspire the trust of foreign investors,”
said Eswar Prasad, an economist at Cornell and author of “The Dollar Trap,” in an email. “China’s
government has made it abundantly clear that such reforms are not on the cards.”
Still, financial history moves slowly, and Monday’s action from the I.M.F. is one more baby step toward
China’s financial pre-eminence.
Lew Says U.S. to Ensure Dollar Remains
Top Reserve Currency
By Michelle Jamrisko 12/1/15

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View photo
Jacob "Jack" Lew, U.S. Treasury secretary, left, speaks with Jamie Dimon, chief
executive officer of …
Treasury Secretary Jacob J. Lew said the U.S. intends to ensure the dollar stays the world’s leading reserve
currency a day after the International Monetary Fund elevated the Chinese yuan into a basket alongside the
dollar, euro, yen and pound.
The dollar “remains the reserve currency of the world for a good reason,” Lew said in a Bloomberg
Television interview Tuesday in Washington when asked if the U.S. would consider converting any of its
foreign-exchange reserves to yuan. “We’re determined to run a U.S. economy that continues to be a strong,
safe and secure economy that makes that the case in the future.”
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While the U.S. supported the IMF decision, “we’ve also had long, ongoing discussions with China about
their currency practices,” he said. “They’ve made commitments to us that they will not intervene in ways
that are unfair. And those are important commitments, and they know we’re going to hold them to those
commitments.”
The remarks suggest that the Obama administration isn’t yet convinced that China has completely allowed
markets to determine the yuan’s value, despite Monday’s approval by the IMF, which puts the currency in
the Special Drawing Rights basket. The fund’s decision “reflected a long study by the IMF technical team”
and the yuan met the requirements for inclusion, Lew said.
More from Bloomberg.com: Cruz Excoriates Rubio on Foreign Policy, Links Him to Clinton
The addition will take effect Oct. 1, with the yuan having a 10.9 percent weight in the basket, the IMF said.
Weightings will be 41.7 percent for the dollar, 30.9 percent for the euro, 8.3 percent for the yen and 8.1
percent for the British pound.
The yuan has a long way to go to dethrone the dollar. In the second quarter this year, about 64 percent of
central banks’ allocated reserves were in dollars, more than triple the 20.5 percent share in euros, the next
most widely held currency, according to IMF data.
More from Bloomberg.com: IMF Approves Reserve-Currency Status for China's Yuan
Lew also said that the Dodd-Frank law of 2010 has made the financial system “safer and sounder.” The
Treasury has encouraged financial regulators to apply flexibility in enforcement “to the greatest extent that
they can, so that they can be sensitive to the differences in risk” among varying sizes of institutions.
He urged caution in rolling back “some of the core protections that have made our system safer and
sounder.”
The Economist
The yuan joins the SDR
Maiden voyage
Reserve-currency status might make for a weaker yuan
Dec 5th 2015 | From the print edition
PASSING through the Suez Canal became easier earlier this year, thanks to an expansion completed in
August. Now it is about to become a little bit more complicated. Transit fees for the canal are denominated
in Special Drawing Rights, a basket of currencies used by the International Monetary Fund (IMF) as its unit
of account. This week the IMF decided to include the yuan in the basket from next year, joining the dollar,
the euro, the pound and the yen.
If lots of things were priced in SDRs, the IMF’s decision would have forced companies around the world to
buy yuan-denominated assets as soon as possible, to hedge their exposure. That would have prompted
China’s currency to strengthen dramatically. But few goods or services are priced in SDRs. Instead,
admission to the currency club is significant mainly for its symbolism: the IMF is lending its imprimatur to
the yuan as a reserve currency—a safe, liquid asset in which governments can park their wealth. Indeed, far
from setting off a groundswell of demand for the yuan, the IMF’s decision may pave the way for its
depreciation.
The reason is that the People’s Bank of China (PBOC) will now find itself under more pressure to manage
the yuan as central banks in most rich economies do their currencies—by letting market forces determine
their value. In bringing the yuan into the SDR, the IMF had to determine that it is “freely usable”. Before
coming to this decision, the IMF asked China to make changes to its currency regime.
Most importantly, China has now tied the yuan’s exchange rate at the start of daily trading to the previous
day’s close; in the past the starting quote was in effect set at the whim of the PBOC, often creating a big
gap with the value at which it last traded. It was the elimination of this gap that lay behind the yuan’s 2%
devaluation in August, a move that rattled global markets. Though the yuan is still far from being a freefloating currency—the central bank has intervened since August to prop it up—the cost of such
intervention is now higher. The PBOC must spend real money during the trading day to guide the yuan to
its desired level.
Inclusion in the SDR will only deepen the expectations that China will let market forces decide the yuan’s
exchange rate. The point of the SDR is to weave disparate currencies together into a single, diversified unit;
some have suggested, for example, that commodities be quoted in SDRs to reduce the volatility of pricing
them in dollars. But if China maintains its de facto peg to the dollar, the result of adding the yuan to the
SDR will be to boost the dollar’s weight in the basket, defeating the point.
What would happen if China really did give the market the last word on the yuan? For some time it has
been under downward pressure. The simplest yardstick is the decline in China’s foreign-exchange reserves,
from a peak of nearly $4 trillion last year to just over $3.5 trillion now—a reflection, in part, of the PBOC’s
selling of dollars to support the yuan. Were it not for tighter capital controls since the summer, outflows
might have been even bigger.
And the yuan does look overvalued. Despite China’s slowing economy, its continued link to the surging
dollar has put it near an all-time high in trade-weighted terms, up by more than 13% in the past 18 months
(see chart). With the Federal Reserve gearing up to start raising interest rates at the same time as China is
loosening its monetary policy, the yuan looks likely to come under more downward pressure, at least
against the dollar.
It would be foolhardy to predict that China will suddenly give the market free rein. That would go against
its deep-seated preference for gradual reform. But while basking in the glow of its SDR status, China must
also be aware of the responsibility to minimise intervention that comes with it. A weaker yuan may well be
the result.
China's capital outflows set to hit record:
Expert
By Neelabh Chaturvedi 12/7/15

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View photo
China Daily | Reuters. Capital outflows from China that have bedeviled global
financial markets likely reached a record in November, according to an economist.
The constant stream of capital outflows from China that have bedeviled global financial markets look set to
reach a record in November, according to estimates from Capital Economics.
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Julian Evans-Pritchard, China economist at the Singapore office of Capital Economics, has estimated that
net capital outflows totaled $113 billion last month, accelerating from $37 billion in October.
But getting an accurate picture of how much money is actually fleeing China is somewhat tricky.
Data released Monday showed China's foreign exchange reserves fell by $87.2 billion in November to
$3.44 trillion. Evans-Pritchard's calculations suggest that fluctuations in exchange rates accounted for $30
billion of that reduction, leaving $57 billion in foreign exchange sales by the central bank.
Combining the foreign exchange sales with Capital Economics' trade surplus estimate of around $55 billion
for November (official data are out Tuesday) leaves net capital outflows at $113 billion.
It is worth noting that these estimates can vary. Capital Economics reckons that net capital outflows stood
at $86.3 billion in August, the month when China rocked financial markets by devaluing the yuan. In
contrast, the U.S. Treasury believes capital outflows were closer to $200 billion during the month.
Despite the differences, observers note that the outflows reflect expectations for the yuan to weaken further
as China's economy slows. Yuan traded offshore is currently at its weakest level against the more tightly
controlled onshore counterpart, suggesting traders expect further declines.
"A rise in offshore interest rates due to the increased likelihood of a December Fed rate hike will also have
added to outflow pressures," said Evans-Pritchard.
The inclusion of the yuan as a reserve currency in the International Monetary Fund's (IMF) Special
Drawing Rights basket last week represented a nod from the IMF that Beijing's reforms were moving in the
right direction.
But a disappointing result from the official manufacturing Purchasing Managers Index (PMI), a measure of
factory activity, for November sent investor confidence tumbling once again.
NYT
China’s Renminbi Declines After Being
Named a Global Currency, Posing
Challenges
By KEITH BRADSHERDEC. 18, 2015
Photo
Uighur herders in China count renminbi at a livestock trading market. A weakening
economy is taking a toll on the currency’s value as money leaves the country. Credit
China Daily/Reuters
HONG KONG — At the end of last month, the Chinese renminbi was anointed as one of the world’s elite
currencies, a first for an emerging market and a widely hailed acknowledgment of China’s rising financial
influence and economic might.

But soon after reaching that milestone, the renminbi started slowly and steadily falling as Chinese
companies and individuals moved huge sums of money out of the country’s weakening economy.
The falling currency sets a fresh challenge for Beijing’s leaders as the Chinese renminbi is increasingly
woven into the global marketplace. While a weaker currency helps the country’s exporters, the government
must also control the slide, or risk fanning market worries and trade tensions.
So far, the Chinese government has stepped into currency markets repeatedly to control the tempo of the
drop, but not enough to stop it.
Over the last two weeks, the renminbi has dropped 1.3 percent against the dollar. The move follows a 4
percent devaluation in August. And while China’s central bank has stayed studiously silent, most banking
industry economists now expect the renminbi to continue slipping in the weeks and months to come.
Continue reading the main story
Falling Back
China has allowed its currency to depreciate this year against the dollar as its economy weakens and
investors move money elsewhere.
renminbi to the dollar
6.0
6.2
6.4
6.6
6.8
Scale is inverted to show the weakening of the renminbi.
7.0
’10
’11
’12
’13
’14
’15
Source: China’s State Administration of Foreign Exchange, via CEIC Data
By The New York Times
“We are looking for larger depreciation in the first half of next year, and then a stabilization,” said Ryan
Lam, the head of research at Shanghai Commercial Bank, a Hong Kong institution.
The currency is partly a barometer of global forces, a sign of the Chinese economy’s weakness and the
dollar’s strength. It also reflects the market’s bet that the currency will continue to fall as the Chinese
government looks to help the country’s economy by making exporters more competitive.
Every morning this last week, the central bank has weakened by an additional 0.1 or 0.2 percent its daily
fixing of the value of the renminbi, which sets the midpoint for the currency’s daily trading range.
The People’s Bank of China, the country’s central bank, faces a tricky balancing act.
If the renminbi falls too steeply, the volatility could prompt traders to place large bets on further
depreciation, making the decline harder to control. The International Monetary Fund added the renminbi on
Nov. 30 to its group of global reserve currencies, alongside the dollar, euro, yen and pound. In an effort to
meet the I.M.F. requirements, China had to loosen some of its currency controls, making it somewhat more
susceptible to market forces.
While a weaker currency helps Chinese exporters, it also adds to the country’s already widening trade
surplus with the United States.
A continued drop in the currency could start trade issues in the midst of the American presidential
elections. Candidates mentioned China nearly two dozen times in Tuesday’s Republican presidential
debate, none of them favorably. Carly Fiorina described China as a “rising adversary” and asserted that like
North Korea, “they, too, recognize one thing: strength and their own economic interest.”
Some longtime American critics of China’s currency policies had tried to persuade the Obama
administration to try to block the I.M.F. decision, contending that the renminbi continues to be heavily
controlled by the Chinese government. Those critics of China’s currency policies point to the recent
weakness as evidence.
“It’s not at all surprising to me that once they got what they wanted, the renminbi is sliding further
downhill,” said Senator Chuck Schumer, Democrat of New York. “We have to take much tougher action
against the Chinese government if we’re going to have success combating currency manipulation.”
The I.M.F. has a policy of not commenting on short-term currency fluctuations, while the People’s Bank of
China and the United States Treasury very seldom do so. All three declined to issue statements on the
renminbi’s drop since the I.M.F. decision three weeks ago.
The I.M.F. had said that China has adopted substantial reforms aimed at making the renminbi more “freely
usable.” The Treasury accepted this in lending American support to the decision by the I.M.F.’s board to
accept the renminbi. The I.M.F. and the Treasury have both urged China to let markets play a greater role
in setting the value of the renminbi, which makes it harder for them to object now when market forces push
down the currency.
Those market forces are tougher to manage, although China still has formidable resources to do so.
It has the world’s largest trade surplus. And until the last couple of years, that kept the renminbi on a path
of gradual appreciation. But money is sluicing out of the country now, and it is more than offsetting the
money that comes in from China’s selling of more goods overseas.
Photo
A visitor looks at crafted embroidery works based on old Chinese bank notes at an
exhibit at the Singapore Art Museum. Credit Tim Chong/Reuters
The Chinese government has responded to faltering investment spending in the country by cutting interest
rates. While lower lending rates have helped housing prices and construction by making mortgages
cheaper, lower rates on bank deposits have also given an extra incentive for Chinese investors to look
overseas for opportunities. At the same time, the Federal Reserve is now raising interest rates, making it
more attractive to keep money in dollars.
The People’s Bank also has far less autonomy than central banks in the West. Major currency policy
decisions, including the decision to let the renminbi sink steadily lower against the dollar, are made by
Communist Party leaders, leaving the central bank to manage day-to-day interventions in the markets.
Still, China has more ability than most countries to prevent a plunge. The nation has the world’s largest
foreign exchange reserves, $3.5 trillion worth of dollars, euros and other currencies.
China also retains some regulatory restrictions on large outflows of money. China is enforcing its
remaining regulations much more stringently this autumn, in an attempt to choke off more speculative
outflows into overseas real estate and other investments.
An official news outlet, People’s Daily, reported last month that the authorities had closed an underground
bank that had handled illegal foreign exchange transactions totaling $64 billion, mainly money leaving the
country, since the start of 2013. The authorities needed 35,000 sheets of paper to print records from the
underground bank, People’s Daily reported.
Chinese exporters — and importers in the United States and Europe — are celebrating the renminbi’s
weakness.
Betty Chong, a director of the J.C. & Winsons Company, which manufactures gloves, hats and scarfs in
Wuxi for export, said that she no longer added a premium to her prices as a buffer against appreciation of
the renminbi. “The devaluation of the renminbi against the U.S. dollar of course helps my exports — my
goods are comparatively more competitive than those from nearby manufacturers in Bangladesh, Vietnam
and India,” she said.
China’s exporters to Europe are benefiting, as well as those selling to the United States. China’s central
bank made headlines a week ago by saying that it would publish an index of the renminbi’s value in terms
of a basket of currencies, not just the dollar. Such an index would highlight that the renminbi actually
strengthened against some currencies in the first 11 months of this year, like the euro, even as it weakened
against the strong dollar.
But because the dollar has faltered in the past two weeks, the drop in the renminbi lately has been even
sharper against other currencies. The renminbi has fallen 3.7 percent against the euro in the past two weeks,
for example.
A weaker renminbi is not a complete boon to Chinese companies.
Zhang Zepeng, the sales manager at the Qingdao Reliance Refrigeration Equipment Company, which
makes cold-storage rooms and refrigerator compressors in Qingdao, has profited from a weaker renminbi
on its exports. But he is concerned about rising costs for supplies bought overseas, since his company also
sells within China.
“Since we need to import some of our raw materials, I do not want to see the RMB further devalue to, say,
6.7 or 6.8 against the U.S. dollar, since that will mean we will have to pay more for our raw material
imports as well,” he said. It is now around 6.5 to the dollar.
If China does allow the renminbi to decline further in the coming months, it would not be the first emerging
market to achieve a breakthrough in international economic relations only to see its currency soon tumble.
A little more than two decades ago, Mexico concluded the North American Free Trade Agreement with the
United States and Canada, cementing its position as an emerging market closely tied to the global
economy. But less than a year later, as Fed rate increases prompted investors to move money to the United
States, Mexico found itself struggling to protect the peso. It ended up letting the peso drop nearly 30
percent in less than a week.
The Economist
Economic ideology
Reagan’s Chinese echo
The mystery of Xi Jinping’s supply-side
strategy
Jan 2nd 2016 | SHANGHAI | From the print edition



RONALD REAGAN, a sworn enemy of communism, and Xi Jinping, a doughty defender of Communist
rule in China, ought to have little in common. Lately, though, Mr Xi has seemed to channel the late
American president. He has been speaking openly for the first time of a need for “supply-side reforms”—a
term echoing one made popular during Reagan’s presidency in the 1980s. It is now China’s hottest
economic catchphrase (even featuring in a state-approved rap song, released on December 26th: “Reform
the supply side and upgrade the economy,” goes one catchy line).
Reagan’s supply-side strategy was notable, at least at the outset, for its controversial focus on cutting taxes
as a way of encouraging companies to produce and invest more. In Xiconomics, the thrust of supply-side
policy is less clear, despite the term’s prominence at recent economic-planning meetings and its dissection
in numerous articles published by state media. Investors, hoping the phrase might herald a renewed effort
by the leadership to boost the economy, are eager for detail.
Mr Xi’s first mentions of the supply side, or gongjice, in two separate speeches in November, were not
entirely a surprise. For a couple of years think-tanks affiliated with government ministries had been
promoting the concept (helped by a new institute called the China Academy of New Supply-Side
Economics). Their hope is that such reforms will involve deep structural changes aimed at putting the
economy on a sounder footing, rather than yet more stimulus. Since Mr Xi gave the term his public
blessing, officials have been scrambling to fall in line with supply-side doctrine, designing policies that
seem to fit it or, just as energetically, working to squeeze existing ones into its rubric.
Mr Xi’s aim may be to reinvigorate reforms that were endorsed by the Communist Party’s 370-member
Central Committee in 2013, a year after he took over as China’s leader. They called for a “decisive” role to
be given to market forces, with the state and private sectors placed on an equal footing. But Mr Xi lacked a
catchy phrase to sum up his economic vision. The one he most commonly used was simply that the
economy had entered a “new normal” of slower, more mature, growth. That phrase had its detractors, for it
seemed to imply passive acceptance of a more sluggish future. “Supply-side reform” is being made to
sound like a call to action. Xinhua, a state news agency, neatly tied the two phrases together: “supply-side
structural reform is the new growth driver under the new normal.”
But what does it mean? Those who first pushed supply-side reform onto China’s political agenda want a
clean break with the credit-driven past. Jia Kang, an outspoken researcher in the finance ministry who cofounded the new supply-side academy, defines the term in opposition to the short-term demand
management that has often characterised China’s economic policy—the boosting of consumption and
investment with the help of cheap money and dollops of government spending.
The result of the old approach has been a steep rise in debt (about 250% of GDP and counting) and
declining returns on investment. Supply-siders worry that it is creating a growing risk of stagnation, or even
a full-blown economic crisis. Mr Jia says the government should focus instead on simplifying regulations
to make labour, land and capital more productive. Making it easier for private companies to invest in
sectors currently reserved for bloated state-run corporations would be a good place to start, some of his
colleagues argue.
There are plenty of differences between China’s supply-siders and those who shaped Mr Reagan’s
programme, not least in their diagnosis of their respective economies’ ills. The Americans thought that
production bottlenecks were fuelling inflation and stifling growth. Their Chinese counterparts worry about
the opposite: excessive production causing deflation and unsustainably rapid growth. Still, the language
used in China can sound just as radical. “We can no longer delay the clean-up of zombie corporations,”
Chen Changsheng of the Development Research Centre, a government think-tank, wrote recently. “Taking
painkillers and performing blood transfusions is not enough. We need the determination to carry out
surgery.”
There may be another similarity as well: a revolution that falls short of its hype. Reagan had to work with a
Congress controlled by his political opponents, and the policies he enacted were more moderate and
muddled than supply-side purists had hoped. Mr Xi faces no such democratic checks, but China’s ruling
party is split between rival interest groups, and economic policy is often implemented in fits and starts as
party leaders try to reconcile their competing demands.
Supply us with a slogan
Mr Xi’s adoption of the supply-side mantra marks the start of protracted tiptoeing. Over the past two
months, party propagandists have asked economists at top universities and research institutions to expound
on their views of what supply-side reforms should entail, according to insiders. It is a slogan in search of
content.
In the recent proliferation of articles and speeches about supply-side reforms, there are clearly differences
over what the emphasis should be. The National Development and Reform Commission, a powerful
planning agency, argues that China needs to become more innovative and efficient in making the kinds of
things its consumers want to buy. But its version of “supply-side reform” would look more like stimulus
than surgery. Tax cuts since 2014 on purchases of electric cars offer a taste of what may lie ahead; sales of
these vehicles have surged nearly fourfold this year.
Some fret that the supply-side talk is a dangerous distraction. As Yao Yang of Peking University puts it, the
economy’s main ailment now is a lack of demand, not a problem with supply. The cure for that, he
believes, is a short-term burst of monetary easing, the very thing that ardent supply-siders have been hoping
to banish.
For all the recent debate, early signs are that the supply-side shift may not amount to a serious change of
course. Measures proposed by the government in late December include lower corporate borrowing costs,
an easing of entry barriers in underdeveloped sectors such as health care and a reduction of excess capacity
in sectors such as property. It just so happens that all these policies have already been in place for months
or even years. If nothing else, Mr Xi’s supply-side reforms will prove that China is among the world’s most
accomplished suppliers of slogans.
Why China’s growth could be over
By Steven Kopits, managing director, Princeton Energy Advisors
1/4/16
Independent analyses by both the University of California macroeconomist James Hamilton and the Bank
of England have fingered weak demand as the chief cause of low oil prices. Given that China is the driver
of incremental demand for most commodities, weak prices must therefore be principally attributed to
weakness in the Chinese economy.
But what sort of weakness is this? The thinking splits two ways. Many analysts anticipate a gradual
slowdown in China's underlying growth rate as it migrates from an investment-led to a consumer-led
economy. By this view, China is facing a structural re-alignment, with the shift requiring another two to
four years. Things are slowing down, but it's nothing serious.
A darker view sees a credit bubble emanating from years of misguided over-investment in China's
infrastructure, housing and manufacturing. China has created an unsustainable credit bubble, and this will
come crashing down, taking the Chinese—and by implication, East Asian—economy with it. This view
does not deny the need to restructure the Chinese economy, but anticipates a cyclical downturn, a financial
crisis along the lines of 1998. The Chinese economy will not see a "soft landing," but rather a full-blown
crash.
We have proposed the third hypothesis. The collapse of commodity prices from mid-2014 corresponded to
an oil supply surge and the failure of China to devalue the yuan in line with the yen, won and euro. By this
line of thinking, China made a simple policy mistake which killed its exports, and with it, the incremental
demand for commodity imports. Thus, if China devalues, then all should be well and commodity prices
should recover about half their losses since summer 2014. If this is true, China is not in such bad shape. All
the country needs is a quick, if painful and politically awkward, devaluation.
However, a fourth theory also merits consideration: leadership has taken the country in a new direction, and
this is dampening China's growth. From Deng Xiaoping until the current Xi administration, China has been
ruled by an economically liberal philosophy emphasizing economic growth, global integration, and
harmonious relations with other countries. With the Xi administration, however, the social compact has
become conservative. Nationalism, not economic liberalism, now seems the driver of policy decisions.
Other post-communist nations have taken this path already. In Hungary, for example, the Orbán
government has repeatedly thumbed its nose at European norms, nationalizing pensions, reducing the
independence of the judiciary, decreasing fiscal transparency, and restricting media rights. It has proved
popular, with Orbán's FIDESZ party winning a qualified majority in Hungary's 2014 parliamentary
elections.
But nationalism comes at a price. Hungary's GDP is barely above its 2005 level, even as those of Poland
and Slovakia have soared. From 2005 to 2015, Hungary's GDP growth averaged 0.8 percent, versus 3.4
percent for Slovakia and 3.9 percent for Poland. Not all of this is due to the Orbán regime, which took
power in 2010. But the Orbán government has exacerbated a turn inward which had started in the early
2000s. As such, Orbán is both a cause and effect of rising Hungarian nationalism. The resulting policies
have knocked nearly 3 percentage points from Hungary's GDP growth annually.
How would comparable policies affect China? If China followed Hungary's script, China's growth rate
would decline from the desired 7 percent to around 3-4 percent, about $300 billion per year in foregone
GDP growth. Interestingly, this puts China's GDP growth on the level recently estimated by a number of
independent consultancies. Thus, the impacts of a switchover to a nationalist ideology may already be
manifest in the Chinese economy.
The question, however, is whether an economy accustomed to growing above 7 percent—and leveraged
accordingly—can be decelerated to a lower growth rate without prompting an outright recession. Some
think a recession is inevitable. For example, Tyler Cowen, professor of economics at George Mason
University, believes China's GDP is "headed rapidly to zero." He is often right in these matters.
On top of generally reduced growth prospects, nationalism can lead to specific territorial conflicts which
have distinct economic impacts. Both Russia and China have adopted acquisitive and confrontational
policies regarding territorial claims. Russia has annexed Crimea, and China is pressing territorial claims in
the South China Sea by building a military base at Fiery Cross Reef.
Such moves are invariably popular domestically, at least in the beginning. In Russia, President Vladimir
Putin boasts approval ratings approaching 80 percent, even when measured by independent observers.
Much of it is due to war. By at least some measures, Putin's approval ratings jumped more than 20
percentage points with Russia's invasion of Crimea. And there is nothing uniquely Russian about this. U.S.
President George W. Bush saw his popularity jump 13 percentage points with the start of the Iraq War in
2003.
But wars are expensive. A Brown University study estimates that the Iraq War cost the U.S. taxpayer $1.7
trillion and as much as $2.2 trillion if future costs of veterans' care are included. For Russia, the costs are
comparatively steeper. Even discounting the effect of low oil prices, we estimate that sanctions look to
reduce Russia's GDP by 17 percent per year, compared to a no sanctions scenario, by 2020. That's
phenomenally expensive.
And Putin has no exit strategy. The histories of Cuba , Iran and Saddam Hussein's Iraq show that
sanctions remain in place for many years, often decades. Will Putin relinquish Crimea in return for the
lifting of sanctions? It would be political suicide on the domestic front. Consequently, Putin can neither
advance nor retreat. He has trapped Russia in a sanctions regime—exiled from the family of G7 nations—
for not only years, but for decades to come.
China has prepared a similar trap for itself by asserting territorial claims with the building of a base at Fiery
Cross Reef—600 miles from the Chinese mainland. Consider: An aircraft flying from Manila to Singapore
would transit over Fiery Cross. Were China to shoot down an aircraft on such a path, it could prove the
single most expensive aircraft downing ever. Sanctions comparable to those on Russia would cost China $2
trillion per year in foregone GDP. Just how much is Fiery Cross—indeed, the whole South China Sea—
worth to the Chinese? For purposes of comparison, the U.S. Gulf of Mexico produces $25 billion of oil and
gas revenues per year and is thought superior to the potential of the South China Sea. Put another way,
Russian-scale sanctions could equal 100 times the potential gain from the South China Sea. Has Beijing
considered this possibility?
And this brings us to the PMIs, the Purchasing Managers' Indices recently suspended in China. These are
prepared on a monthly and "flash" basis. The flash numbers are issued early based on a partial sample of
business surveys, providing a quick read of economic conditions.
The loss of the flash PMIs is troubling on three fronts.
First, I think most analysts assume that China's leadership has better, more timely and more trustworthy
data than is released to the public. Consequently, withholding the PMIs gives the impression that the
incoming economic data is much worse than expected—the missing PMIs are themselves leading indicators
of a noteworthy economic downturn.
Second, the loss of the PMIs could also reflect a lack of confidence by China's leadership in their ability to
manage a downturn. Not only are the incoming data worse than expected, leadership does not know if it
can manage the challenge.
Finally, the suppression of the PMIs takes China firmly in the wrong direction, away from progress,
development and transparency. It suggests leadership wants to reverse the country's historical course and
revert back to a more closed, less dynamic economy. National strength, in the form of centralized decisionmaking and control, is to be valued over economic progress.
Taken together, these factors suggest the time has arrived to question whether slow growth in China is
solely attributable to structural factors. What responsibility does the Xi government bear? We seem to be
witnessing error compounding error. An over-valued yuan leads to poor manufacturing numbers, reflected
in weak PMI readings, and leading to political pressure to pull the related PMIs. This in turn undermines
the credibility of and confidence in the government, prompting a crash of the Chinese stock market.
Moreover, China seems to want to distance itself from the G7 and align its fortunes with poorly managed
countries like Russia and Hungary. The country looks headed on a downward spiral, with the government
lacking the right stuff to make appropriate adjustments.
Behind it all, I see the marks of a shift to nationalism and away from economic liberalism. "Strong" is
preferred to "smart." For a country with comparative advantage in "smart," this looks to be a bad decision.
But nationalist policies can persist for a long time. They have in Hungary and Russia, and they have done
so with public approval. We'll see how events play out in China, but for now, investors need to consider
that the China of the last thirty years may no longer correspond to the China of today — or tomorrow.
China's era of growth may be over.
Commentary by Steven Kopits, managing director, Princeton Energy Advisors.
NYT
A New Economic Era for China Goes Off
the Rails
By KEITH BRADSHERJAN. 7, 2016
http://www.nytimes.com/2016/01/08/business/international/a-new-economic-era-for-china-goes-off-therails.html?hp&action=click&pgtype=Homepage&clickSource=story-heading&module=first-columnregion&region=top-news&WT.nav=top-news
An investor uses his cellphone to check stock prices at a brokerage house in
Chengdu, China, after a so-called circuit breaker measure halted trading on
Thursday. Credit Color China Photo, via Associated Press
HONG KONG — When President Xi Jinping of China convened a group of top officials to discuss the
economy last month, the highly publicized meeting was seen as a moment of triumph.
A stock market plunge last summer, and a messy currency devaluation that followed, had faded from global
view. In the relative calm, he seemed to usher in a new era of economic management, promising policy
coordination at the highest levels to prevent another bout of turmoil.
Less than three weeks later, his plans have been derailed as China’s stock market and currency once again
rattle investors around the world. The latest rout sets up a challenge for Mr. Xi, who has positioned himself
as the master of the country’s economy.
At every turn, the president’s efforts to manage the economy, market and currency have been undercut by
global headwinds and haphazard policy making, and initiatives this week have been particularly discordant.
He also cannot move forward on the bolder actions needed to head off a more serious economic slump,
such as forcing hopelessly indebted state-owned enterprises to stop borrowing money and shut down.
Otherwise, he risks further eroding short-term confidence and growth, which have depended heavily on this
borrow-and-spend mentality, and mass layoffs could follow.
Mr. Xi’s options are also more limited than in the past. He and his aides engineered the elevation of the
renminbi to the ranks of the world’s leading currencies, a status bestowed by the International Monetary
Fund in November. But in doing so, he gave up some control, allowing market forces to play a bigger role.
In the last couple of years, China had begun allowing, even encouraging, companies and people to invest
more of their wealth overseas. Doing so helped reduce deflationary pressures at home from chronic
overinvestment and overcapacity, and increased China’s influence around the world.
But a trickle of money leaving China to buy houses and other overseas investments has become a flood this
winter. The central bank has responded by trying for the last three weeks to slowly guide the currency
down as a way to help bolster exports and also make overseas investments seem more expensive and less
appealing.
The result has been chaotic. With the renminbi worth less by the day in the international markets, Chinese
families and companies worry that their renminbi wealth will buy less tomorrow, spurring faster capital
flight and worsening the currency turmoil.
This week, regulators also put in place a so-called circuit breaker for the stock market, a mechanism that
halts trading when shares fall too steeply. The new measure, which followed last summer’s market slide,
was aimed at stabilizing stocks. But in practice, it has amplified anxiety.
Another measure, which banned large shareholders from selling stock, was supposed to expire on Friday.
The looming deadline prompted smaller investors to dump shares.
“These very high-level bodies were supposed to coordinate policy, and in this case there really was a
failure of coordination,” said Victor Shih, a specialist in Chinese financial policy at the University of
California, San Diego.
The resulting stress has driven share prices in China down 12 percent so far this week. The fall would have
been even steeper if the new rules had not shut down the market repeatedly.
The combination — a troubled stock market and currency — has proved worrisome for global investors.
The Standard & Poor’s 500-stock index, the main benchmark in the United States, was off 2 percent on
Thursday, and European and Asian shares were down broadly.
In a stark about-face, the Chinese stock market regulator said Thursday night it would suspend the new
measure, “in order to preserve market stability.” It is also extending the selling ban for another three
months.
Few analysts had expected such a quick retreat. “Removing the circuit breakers now means they have to
admit they made a mistake,” Hao Hong, the chief strategist at Bank of Communications International, the
overseas arm of a big Chinese bank, said earlier in the day.
For years, the response to economic weakness has been the same in China: spend, spend, spend.
When the global financial crisis hit in 2008, the Chinese authorities developed a $585 billion stimulus
package. The money, funneled into infrastructure, high-speed rail lines and intercity highways, helped
protect China against the problems plaguing the United States and much of the world.
In some way, China is reverting to its old tactics.
Over the last few months, the government has cut interest rates and introduced numerous measures to help
stimulate growth. The central bank’s response to the latest stock market fall has been to inject more money
into the financial system, so that banks can keep lending.
In the face of Monday’s tumult, Prime Minister Li Keqiang visited one of the country’s largest and most
troubled state-owned steel companies, Taiyuan Iron and Steel Group. There, Mr. Li reassured workers,
urging them to “revive your strength and power.”
The strategy, though, risks deeper problems down the road.
By not shutting down struggling companies, China is putting off a much-needed shakeout. The country is
also piling on debt to keep such businesses on life support.
That makes it difficult to discern the underlying health of the economy, and runs counter to Mr. Xi’s tough
promise that China will clean up its corporate mess.
Photo
Investors gather near darkened stock-price display boards after trading was halted
at a brokerage in Beijing. Credit Ng Han Guan/Associated Press
Mr. Xi also cannot easily ask the central bank to print huge sums of money to bail out the stock market and
struggling companies. Doing so now would risk flooding the economy with cash, causing a further decline
in China’s currency against the dollar.
Some economists see ominous signs of a broader slowing.
A quarterly survey of 2,000 Chinese manufacturers and other industrial companies shows that almost none
are currently investing in new equipment and factories. “In the past four quarters, it’s only 2 to 3 percent
that are making expansionary investments,” said Gan Jie, the director of the Center on Finance and
Economic Growth at the Cheung Kong Graduate School of Business in Beijing, who oversees the quarterly
survey.
Controlling the currency is already a problem. China has found itself in the difficult position of setting the
value of the renminbi lower and lower each day, culminating in a fall of 0.51 percent Thursday morning
alone. But the central bank tried to halt the renminbi’s slide on Friday morning by fixing it 0.015 percent
higher than the day before in mainland trading.
China faces a similar steady drip of stock declines.
China’s stock markets have tended to be less correlated with the local economy than most countries’
markets. That is because trading tends to be a speculative activity in China, mainly undertaken by retail
investors who frequently have a herd instinct.
The problem was on full display this week, as the new circuit breaker mechanism kicked in. The rule
imposed a cooling-off period, halting trading for 15 minutes when losses reached 5 percent. After trading
resumed, the steep slide continued, prompting the markets to close early twice this week when they reached
a second circuit breaker of 7 percent.
To some analysts, it was unnecessary. China already has a rule that each stock cannot drop more than 10
percent in a day.
Even China tacitly admitted it had made a mistake. When the country’s regulator abandoned the policy on
Thursday night, it noted in a statement that it had imposed the policy despite having “no experience” in
using a circuit breaker.
Liberal economists
Three wise men
Ageing reformists diagnose the economy’s
ills
Jan 9th 2016 | SHANGHAI | From the print edition


WHATEVER image you may have of the reformists hoping to shake up China’s creaking economic
system, it is probably not one of octogenarians who fiddle with their hearing aids and take afternoon naps.
But that is a fair description of three of the country’s loudest voices for change: Mr Market, Mr
Shareholding and the most radical of all, the liberal. With growth slowing, the stockmarket once again in
trouble and financial risks looking more ominous, their diagnoses of the economy, born of decades of
experience, are sobering.
Wu Jinglian, Li Yining and Mao Yushi—their real names—were born within two years of each other in
1929 and 1930 in Nanjing, then China’s capital. Whether it was that or pure coincidence, all three grew up
to demand an end to Soviet-style central planning and to propose, to varying degrees, capitalism in its
place. Their influence has waned with age, but their powers of analysis remain sharp. And they do not
much like what they see.
Mr Wu is in some ways the most important of the group. He advised the government from the earliest years
of China’s “reform and opening” in the 1980s, through the 1990s when the great China boom got under
way (see timeline). He proposed that the Communist Party should declare China a “socialist market
economy”, a twist of words (and a hugely controversial one—conservatives abhorred any positive mention
of markets) that opened the door to private enterprise.
But Mr Market, as he came to be called, thinks this kind of linguistic ruse has outlived its usefulness.
Imprecise concepts have led to flawed actions, he warns. Though the private sector has flourished over the
past couple of decades, the state still looms large, controlling financial flows and acting as gatekeeper for
virtually all important decisions, from land deals to mergers. “Even a low-level bureaucrat can decide the
life or death of a company. You need to listen to the party,” says Mr Wu, who now teaches at the China
Europe International Business School in Beijing.
Mr Wu notes contradictions in the official blueprint for reforming state-owned firms. The party promises to
empower their boards, but still wants to retain authority over the appointment of top executives. “If you
can’t solve this problem, it will be very difficult to develop effective corporate governance,” he says. Mr
Wu argues that political change is now needed to shore up the economy: the government must stop
meddling in markets and instead focus on developing the rule of law. Holding up a copy of his recent book,
he chuckles softly. “All my ideas are in here. No one pays them much attention.”
Getting heard is less of a problem these days for Li Yining, who has spent his entire academic career at
Peking University. His former pupils include Li Keqiang, China’s prime minister. His big idea in the 1980s
was that selling partial stakes in state-owned companies to the public would improve their performance—
hence his nickname, Mr Shareholding. The party eventually took his advice, though the companies remain
hugely inefficient.
In diagnosing the problems of today, Li Yining is blunt: the previous few years of ultra-high-speed growth
“did not accord with economic laws”. China wasted natural resources, damaged its environment, piled up
excess capacity and missed opportunities to fix its economic model. Yet perhaps because of his connections
to those in power, Mr Li is by far the most sanguine of the old guard of reformers. “The new normal”—
President Xi Jinping’s favourite economic slogan—is shifting the economy in the right direction, by aiming
for lower growth and structural changes.
China's growth is slowing. A detailed look at what is behind the slowdown
Mao Yushi disagrees. And unlike many economists cowed by a frostier political climate, he is unafraid to
say so. Mr Mao started his career in the railway system, including a spell driving trains, before retraining as
an economist in the 1970s. Always on the margins of Chinese academia, he founded the Beijing-based
Unirule Institute of Economics in 1993, an independent think-tank (a rarity in China). He champions
deregulation and courts controversy in his criticism of Mao Zedong’s disastrous rule. Some diehard
Maoists call the softly spoken economist “Mao Yu-shit” online, playing on a homonym of his name.
In Mr Mao’s view it is already too late for the economy. China has too many empty homes and its banks
have too much bad debt. “A crisis cannot be averted,” he says. Mr Mao allows himself some optimism,
however. The young generation is educated and open-minded. The waste of capital and resources of recent
years implies that China still has good potential for growth, if it can operate more efficiently. But he
believes that Mr Xi, while espousing reform, is strengthening the state’s economic grip. “He has the power
and the determination to fix problems, but in many cases he does not properly understand the problems,”
says Mr Mao.
Such unvarnished, open criticism of Mr Xi is rare in China these days. Speaking in the living room of his
apartment, its walls stacked high with books and yellowing newspapers, Mr Mao says that his age and
experience give him, and the other elderly reformists, a bit of leeway. “If it was someone else speaking,
they would probably be arrested. But to me, the government is polite.” If only it would pay more heed to
the elders’ advice, too.
NYT
China’s Obsolete Economic Strategy
By THE EDITORIAL BOARDJAN. 8, 2016
It was inevitable that China’s economy would slow from its once turbocharged growth rates. But its leaders
have made so many mistakes in recent months that they have turned what should have been a benign,
natural slowdown into a chaotic descent.
China’s main stock index fell nearly 10 percent for the week, depressing stock and commodity prices
elsewhere. These drops are not in themselves a big economic problem. The larger question is whether
China’s leaders, their credibility already damaged, will see this moment for what it is: a dramatic warning
that it’s time to make fundamental changes in the way they manage the economy.
The Chinese economy, the world’s second largest, is growing at nearly 7 percent a year — down from 10.6
percent in 2010 but still a healthy pace for a country at its stage of development. The problem is that the
boom was fueled by lavish investment and spending as well as profligate borrowing, a lot of which will
probably not be paid back. China’s central government orchestrated that binge by pumping billions of
dollars into the economy in the aftermath of the 2008 global financial crisis and by failing to enact needed
reforms that would make it easier for private and foreign companies to compete with inefficient stateowned enterprises.
Beginning last year, Chinese officials also used state-owned media to encourage individual investors to
pour their savings and borrowed money into the stock market, leading to a massive bubble. When the
market started to tumble over the summer, the government blamed rumormongers and speculators, and
ordered securities firms and state-owned companies to keep buying, which simply disguised the underlying
problems.
The lesson here is clear: Instead of trying to micromanage stock prices, Chinese officials ought to be
strengthening the economy, foremost by shifting its emphasis from investment to consumer spending and
services. This is important because China can no longer grow by taking people off the farm and putting
them to work in factories. It needs to move people into white-collar jobs. To take one example, officials
could help create more such jobs and make the economy more competitive by easing the way for private
companies to get into industries like telecommunications and insurance that are currently dominated by a
handful of state-owned corporations.
China also has to clean up its financial system. Many businesses and local governments have borrowed
billions of dollars to build high-speed rail lines, real estate developments and other projects, many of which
are not going to produce the returns needed to pay off those debts. The government should encourage
lenders and borrowers to quickly restructure loans that paid for those projects so that banks are not crippled
by bad debts and can continue making new loans. Officials also need to shut down highly inefficient stateowned businesses.
How China deals with its problems will have far-reaching implications because the country has become
such a big part of the world economy. It is one of the biggest consumers of commodities like oil, soybeans
and iron ore, and when demand falters, economies in Brazil, Saudi Arabia and South Africa suffer. The
price of crude oil fell to about $33 a barrel this week, down from about $50 a year earlier.
Even industrialized countries like Germany, Japan and the United States are vulnerable, though less so than
commodity exporters, because they sell manufactured goods to China and many multinational companies
have invested a lot of money in the country. Some analysts are concerned that Beijing will simply fall back
on a familiar tool to aid the domestic economy: devaluing the currency, the renminbi. That would raise
China’s exports and reduce its imports, but it would do so at the expense of the rest of the global economy,
which is itself not very healthy.
Since early August, the renminbi has already fallen about 5 percent against the dollar. It has also been
under pressure because as the Chinese economy weakens many people and companies in China are
clamoring to convert their savings into dollars to buy property and invest in businesses overseas.
Ultimately, however, China’s leaders must realize that they need to modernize their policies by
encouraging more private initiatives and greater competition. Their nation has changed dramatically over
the last three decades, and a command-and-control approach to economic management will not produce the
results of the past.
NYT
China’s Hunger for Commodities Wanes,
and Pain Spreads Among Producers
By CLIFFORD KRAUSSJAN. 9, 2016
Photo
India continues to invest in mining despite a coal surplus. Credit Dhiraj
Singh/Bloomberg
Chile is expanding its largest open-pit copper mine below the northern desert to dig up 1.7 billion
additional tons of minerals, even as metal prices plummet around the globe.
India is building railroad lines that crisscross the country to connect underused coal mines with growing
urban populations, threatening to dump more resources into an already glutted market.
Australia is increasing natural gas production by roughly 150 percent over the next four years, as energy
companies build half a dozen export terminals to serve dwindling demand.
Across the commodities landscape, this worrisome mismatch mainly traces back to the same source: China.
For years, China voraciously gobbled up all manner of metals, crops and fuels as its economy rapidly
expanded. Countries and companies, fueled by cheap debt, aggressively broadened their operations, betting
that China’s appetite would grow unabated.
Now everything has changed.
China’s economy is slumping. American companies, struggling to pay their debts as interest rates rise, must
keep producing. All the excess is crushing prices, hurting commodity-dependent economies across
emerging markets like Brazil and Venezuela and developed countries like Australia and Canada.
For data see: http://www.nytimes.com/2016/01/10/business/international/chinas-hungerfor-commodities-wanes-and-pain-spreads-amongproducers.html?hp&action=click&pgtype=Homepage&clickSource=storyheading&module=first-column-region&region=top-news&WT.nav=top-news&_r=0
A worker at a copper refinery in Chile. Despite slowing growth in China and falling
prices, Chile is increasing its mineral output. Credit Rodrigo Garrido/Reuters
The geopolitical and financial consequences of this shift have shaken investor confidence. Concerns over
global growth intensified in recent days, when weakness in China prompted a stock sell-off around the
world.
The commodities hangover, the dark side of a decade-long boom, could last for a while.
Multibillion-dollar investment decisions made years ago on big projects, like the oil sands fields in Canada
and iron ore mines in West Africa, are just getting up and running. Facing huge costs, companies cannot
simply shut off projects. So the excess could take years to work through.
The flood of raw materials is pressuring prices, prompting a painful shakeout. Oil companies have laid off
an estimated 250,000 workers worldwide. Alpha Natural Resources and other American coal mining
companies have filed for bankruptcy protection.
Saudi Arabia, a giant energy economy, has had to tap the credit markets as its financial reserves dwindle.
Venezuela, an oil-rich nation that went on a spending spree, is struggling to meet $10 billion in debt
obligations this year, since 95 percent of export earnings depend on crude.
Michael Levi, an energy expert at the Council on Foreign Relations, likened the reversal to a rainfall that
first relieved a drought but then created a flood. “Producers ended up being their own worst enemies,” he
said. “No one ever worried they would produce too much, but that is exactly what has happened and gotten
them into this mess.”
Lower energy and material prices are often welcomed by consumers. An energy glut has allowed American
households to save hundreds of dollars a year on gasoline and heating oil.
But economists worry that the commodity mess reflects a weakening global economy, lowering the value
of trade worldwide and perhaps even pushing some countries into the same kind of deflationary spiral that
has hampered the Japanese economy for decades. Global turmoil last summer, stemming from China,
prompted the United States to delay raising interest rates until the end of last year.
“Lower oil prices have not proven to be as stimulative as economic theory once had it,” said Daniel
Yergin, the energy historian and vice chairman of the IHS consultancy. “The question is what are weak
commodity prices telling us: Is it overinvestment in the past, or signaling a weaker global economy
forward? My own feeling is the answer is both.”
Commodities have always been subject to booms and busts, rising and falling with the global economy. But
China and the cheap debt have changed the equation in some ways.
Continue reading the main story
Multimedia Feature
Oil Prices: What’s Behind the Drop? Simple Economics
The oil industry, with its history of booms and busts, is in a new downturn.
OPEN Multimedia Feature
China’s rapid growth led to an increase in crude oil consumption to 7.5 million barrels a day in 2007, from
5.5 million barrels a day in 2003. It is now the world’s biggest importer of crude, having surpassed the
United States. Other commodities have followed a similar pattern.
The increased demand fueled a surge in prices; copper tripled and zinc doubled over the five-year period
ending in 2007. Americans and Europeans found themselves in what amounted to a bidding war for
products as diversified as gasoline and coffee.
Then the financial crisis hit in 2008. While the global economy faltered, China continued to grow, buying
ever more commodities from developing countries. Those economies, in turn, flourished from the infusion
of money.
Peru, with its big bounty of copper and other metals, used its newfound riches to expand its middle class,
creating a boom in shopping centers and apartment houses in its capital, Lima. Lagos, Nigeria, experienced
the same, benefiting from the high price of oil.
The low interest rates, which had been cut to the bone because of the crisis, fueled the boom. The Brazilian
energy company Petrobras accumulated $128 billion in debt, doubling its annual borrowing costs over the
last three years.
Continue reading the main story
Graphic
Why China Is Rattling the World
China’s economy is faltering, prompting concerns that are now shaking global stock markets.
OPEN Graphic
Then the commodity story started to change when Chinese growth slipped.
In 2015, commodity prices had their worst year since the financial crisis and global slowdown. Nickel, iron
ore, palladium, platinum and copper all declined by 25 percent or more. Oil prices have declined by more
than 60 percent over the last 18 months. Even corn, oat and wheat prices have sunk.
And the commodity slide has continued into this year. At just over $30 a barrel, oil has reached levels not
seen in over a decade.
The bust is made all the more pernicious by rising interest rates, as the Federal Reserve changes gears.
Companies that took advantage of the cheap debt to increase production are now stuck with a big bill that
will be difficult to cover.
Freeport-McMoRan is putting the finishing touches on a $4.6 billion expansion of the Cerro Verde copper
mine in Peru, which will triple production. The project is so big that it could consume nearly 10 percent of
Peru’s electricity.
With copper prices at their lowest level in seven years, Freeport-McMoRan reported a $3.8 billion loss for
the third quarter. The company’s shares have dropped by more than 70 percent over the last year. At the
behest of the board, the executive chairman James R. Moffett stepped down at the end of 2015, and the
company’s next moves are uncertain.
Although companies are retrenching, they cannot completely retreat. Many new mines, for example, are
designed to function at full capacity to keep them operating efficiently. And the sales are necessary to pay
the debts incurred to build them.
At particular risk are coal mines in the United States, Australia, Indonesia and elsewhere. Not only is
Chinese demand declining, but rising environmental concerns are also hurting their prospects.
“Raw material producers invest according to current prices without realizing how those prices might affect
future demand,” said Michael C. Lynch, president of Strategic Energy and Economic Research, a
consultancy. “Now that the demand is declining because of high prices, they have too much capacity, and
once it’s built, you can’t unbuild it.”
NYT
Currency Devaluations by Asian Tigers
Could Hinder Global Growth
By LANDON THOMAS Jr.JAN. 8, 2016
Photo
A container terminal in Singapore. A currency war in Asia could add to the already
substantial concerns about the global economy this year and next. Credit Edgar
Su/Reuters
China’s decision to push the value of its currency lower has opened a new front of worry for global
investors: a potential wave of currency devaluations among the so-called Asian tigers — South Korea,
Singapore and Taiwan.
Such an outcome, a number of foreign exchange specialists say, would put a further damper on global
growth expectations, which already are being revised downward as China’s once-booming economy
retrenches.
The dollar’s strong run recently — together with the plunge in the price of oil and other commodities —
has damaged fragile emerging-market economies like Brazil, Turkey and South Africa; the dollar has risen
130 percent against the Brazilian real and the South African rand since mid-2011.
The currencies of fast-growing Asian countries, including India, have largely been insulated, thanks to their
better-performing economies and their ability to stockpile large foreign currency reserve positions.
But having a strong currency at a time when manufacturing competitors like Japan and China have weaker
currencies leads to a sharp fall in exports, which have been the economic lifeblood of these countries for
decades.
SEE CURRENCY @ http://www.nytimes.com/2016/01/09/business/dealbook/asia-china-renminbicurrencydevaluation.html?mabReward=CTM&action=click&pgtype=Homepage&region=CColumn&module=Reco
mmendation&src=rechp&WT.nav=RecEngine
Source: China’s State Administration of Foreign Exchange and Hong Kong Treasury
Markets Association, via CEIC Data
By The New York Times
“These countries have some of the most overvalued exchange rates on the planet,” said Julian Brigden of
Macro Intelligence 2 Partners, an independent research firm based in Vail, Colo., that advises large money
management firms on global investment themes.
When economies have high exchange rates, their exports tend to lose market share compared with countries
with cheaper currencies. And when that happens, countries that depend on foreign trade will frequently take
steps to push their currencies lower.
Echoing these fears, the finance minister of Mexico, Luis Videgaray, warned on Thursday that the Chinese
currency actions could lead to a new round of competitive devaluations.
The fear is that a currency war in Southeast Asia — where the Asian financial crisis erupted in 1997 —
could result in lower growth and add to the already substantial concerns about the global economy this year
and next.
Earlier this week, the World Bank lowered its estimate for global growth to 2.9 percent from 3.3 percent,
with expectations for just about all major economies being revised downward.
Already, global money managers have begun to pull money out of some of these Asian markets.
The Korean won and the Singapore dollar are down 5 percent, while the Taiwan dollar has lost 7 percent
over the last six months. Even in India, perhaps the most popular emerging market among global investors,
the currency has given ground, about 7 percent, against the United States dollar.
Continue reading the main story
Graphic
Why China Is Rattling the World
China’s economy is faltering, prompting concerns that are now shaking global stock markets.
OPEN Graphic
Underpinning the fears about a currency war have been the disappointing export figures from the region.
For example, Korean exports fell 14 percent in December compared with the same month in 2014. For the
year, exports shrank 8 percent — the worst result for the country since the global financial crisis in 2009.
In Taiwan, government officials say they expect exports for last year to have fallen 10 percent; and in
Singapore, the manufacturing sector at the heart of the country’s export-based model slumped 6 percent in
the most recent quarter.
These export figures are disturbing because they reflect that something deeper is ailing the global economy
than simply a slowing China that is buying less oil from Nigeria, iron ore from Brazil or copper from Chile.
Strong currencies in the Asian tiger countries have made their high-end electronic products, like Samsung
phones from South Korea and computer parts from Taiwan, more expensive in Europe and the United
States, their biggest markets.
And with China, their main export competitor, expected to to let the renminbi weaken further, these
countries will face further pressure to let their currencies fall.
The sudden export drop-off for manufacturing powerhouses like South Korea and Singapore troubles
analysts who see it as a sign that the slowdown in the global economy is worse than people expect.
Photo
A display showing the security features of the new 100-renminbi note in Beijing.
China’s decision to push the value of its currency lower has investors worried about
the possibility of a wave of currency devaluations in Asia. Credit Ng Han
Guan/Associated Press
“I expect these currencies to fall by another 20 or 30 percent,” said Raoul Pal, an independent financial
analyst and the founder of Real Vision TV, a media venture where sophisticated investors discuss their
views on the market. “These export figures are a big deal — it’s a huge shrinkage in the dollar-based
economy, as not enough people are buying goods.”
For quite some time, Mr. Pal has been promoting an investment thesis that the relentless rise of the dollar
— since mid-2011, the dollar is up 35 percent against a broad basket of currencies — will have a
deflationary effect on the global economy as export-driven economies enter into a series of competitive
devaluations to protect crucial export sectors.
“This is not just a commodity story,” he said. “It’s a global trade story.”
Exchange-rate volatility in this part of the world will not take the heat off other weak currencies. In
addition to usual examples like Turkey, Brazil and South Africa, investors expect commodity exporters like
Indonesia, Chile and Colombia to take a big hit, as the prices for their products continue to fall.
The final frontier in this respect would be the pegged currencies in the Middle East, especially the Saudi
Arabian riyal, which is tightly linked to the dollar.
Although Saudi Arabia has been running budget deficits of close to 20 percent of gross domestic product
because of the fall in oil prices, it still has a war chest of $635 billion in foreign exchange reserves that it
can tap to defend the riyal.
The other problem with downward trending currencies in South Korea, Taiwan and Singapore is that these
countries, like just about all emerging market economies, have taken advantage of a rock-bottom interest
rate environment to issue billions of dollars in dollar-denominated corporate debt to finance capital
investments.
Foreign investors were attracted to the high yields and especially the stable currencies and bought them in
huge quantities. Now, with the currencies starting to wobble, dollar-based investors have less incentive to
hold on to them, and they will do what they have been doing with their Brazilian, Turkish and South
African bonds — get rid of them as quickly as possible.
“There is a lot of underlying investor exposure in these markets,” said Mr. Brigden, the independent
research analyst. “I think if things continue to get worse, we are going to move to liquidation stage.”
The Economist
China’s economy
The yuan and the markets
Strains on the currency suggest that
something is very wrong with China’s
politics
Jan 16th 2016 | From the print edition

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“WHAT if we could just be China for a day?” mused Thomas Friedman, an American columnist, in 2010.
“…We could actually, you know, authorise the right solutions.” Five years on, few are so ready to sing the
praises of China’s technocrats. Global markets have fallen by 7.1% since January 1st, their worst start to
the year since at least 1970. A large part of the problem is China’s management of its economy.
For well over a decade, China has been the engine of global growth. But the blistering pace of economic
expansion has slowed. The stockmarket has been in turmoil, again. Although share prices in China matter
little to the real economy, seesawing stocks feed fears among investors that the Communist Party does not
have the wisdom to manage the move from Mao to market. The rest of the world looks at the debts and
growing labour unrest inside China (see article), and it shudders. Nowhere are those worries more
apparent—or more consequential—than in the handling of its currency, the yuan.
Faulty forex
China’s economy is not on the verge of collapse. Next week the government will announce last year’s rate
of economic growth. It is likely to be close to 7%. That figure may be an overestimate, but it is not entirely
divorced from reality. Nevertheless, demand is slowing, inflation is uncomfortably low and debts are rising.
The bullish case for China depends partly upon the belief that the government can always lean against the
slowdown by stimulating consumption and investment with looser monetary policy—just as in any normal
economy.
Yet China is not normal. It is caught in a dangerous no-man’s-land between the market and state control.
And the yuan is the prime example of what a perilous place this is. After a series of mini-steps towards
liberalisation, China has a semi-fixed currency and semi-porous capital controls. Partly because a stronger
dollar has been dragging up the yuan, the People’s Bank of China (PBOC) has tried to abandon its loose
peg against the greenback since August; but it is still targeting a basket of currencies. A gradual loosening
of capital controls means savers have plenty of ways to get their money out.
A weakening economy, a quasi-fixed exchange rate and more porous capital controls are a volatile
combination. Looser monetary policy would boost demand. But it would also weaken the currency; and
that prospect is already prompting savers to shovel their money offshore.
In the last six months of 2015 capital left China at an annualised rate of about $1 trillion. The persistent gap
between the official value of the yuan and its price in offshore markets suggests investors expect the
government to allow the currency to fall even further in future. And, despite a record trade surplus of $595
billion in 2015, there are good reasons for it to do so, at least against the dollar, which is still being
propelled upwards by tighter monetary policy in America.
The problem is that the expectation of depreciation risks becoming a self-fulfilling loss of confidence. That
is a risk even for a country with foreign-exchange reserves of more than $3 trillion. A sharply weaker
currency is also a threat to China’s companies, which have taken on $10 trillion of debt in the past eight
years, roughly a tenth of it in dollars. Either those companies will fail, or China’s state-owned banks will
allow them to limp on. Neither is good for growth.
The government has reacted by trying to rig markets. The PBOC has squeezed the fledgling offshore
market in Hong Kong by buying up yuan so zealously that the overnight interest rate spiked on January
12th at 67%. Likewise, in the stockmarket it has instructed the “national team” of state funds to stick to the
policy of buying and holding shares.
One step back, two forwards
Yet such measures do nothing to resolve a fundamental tension. On the one hand, the state understands that
the lack of financial options for Chinese savers is unpopular, wasteful and bad for the economy. On the
other, it is threatened by the ructions that liberalisation creates. For Xi Jinping, the president, now in his
fourth year in charge, that dilemma seems to crop up time and again (see Briefing). He needs middle-class
support, but feels threatened by the capacity of the middle class to make trouble. He wants state-owned
enterprises to become more efficient, but also for them to give jobs to the soldiers he is booting out of the
People’s Liberation Army (see article). He wants to “cage power” by strengthening the rule of law and by
invoking the constitution, yet he is overseeing a vicious clampdown on dissent and free speech.
Daily dispatches: China's stockmarket mess
It is easy to say so now, but China should have cleaned up its financial system and freed its exchange rate
when money was still flowing in. Now that the economy is slowing, debt has piled up and the dollar is
strong, it has no painless way out.
A sharp devaluation would wrong-foot speculators. But it would also cause mayhem in China and export its
deflationary pressures. The poison would spread across Asia and into rich countries. And because interest
rates are low and many governments indebted, the world is ill-equipped to cope.
Better would be for China to strengthen capital controls temporarily and at the same time to stop stagemanaging the yuan’s value. That would be a loss of face for China, because the IMF only recently marked
the yuan’s progress towards convertibility by including it in the basket of currencies that make up its
Special Drawing Rights. But it would let the country prepare its financial institutions for currency
volatility, not least by starting to scrub their balance-sheets, before flinging their doors open to destabilising
flows. Mr Xi could embrace more complete convertibility later, when they were less vulnerable.
One reason the PBOC is rushing towards convertibility, despite the risks, is that it feels that it must seize
the chance while it has Mr Xi’s blessing. But better to retreat temporarily on one front than to trigger a
global panic. That might also lead to some clearer thinking. There is a contradiction between liberalisation
and party control, between giving markets their say and silencing them when their message is unwelcome.
When the time is right, China’s leaders must choose the markets.
The Economist
China’s labour market
Shocks and absorbers
Unemployment is rising, but is not always
visible
Jan 16th 2016 | YIZHENG | From the print edition



THE crane that looms over Sainty Marine’s shipyard on the lower reaches of the Yangzi river had been
motionless for weeks when a worker climbed it late last year. The struggling company had stopped getting
orders and, rather than deal with the headache of laying off its employees, it simply stopped paying them.
The man on the crane threatened to jump to get the attention of local officials, coming down only when
they promised to help him. Other workers took a somewhat safer, though (in a country where strikes are
illegal) no less provocative measure to demand their missing wages: they marched out and blockaded a
nearby highway.
That Sainty Marine workers have resorted to such actions is perhaps not surprising. The global shipping
industry is depressed, plagued by oversupply at a time when slowing trade means demand for new ships is
shrinking. Chinese firms that rushed to expand are now gasping. Sainty Marine, which overextended itself
by buying another shipbuilder, is veering towards bankruptcy. Withholding wages is a common tactic for
Chinese companies in trouble; in Yizheng, the gritty town that is home to Sainty Marine’s shipyard, the
local government has published statements admonishing employers for doing so.
Many workers at other hard-hit companies, especially in heavy industry, are facing similar frustrations. The
China Labour Bulletin, a watchdog group based in Hong Kong, recorded 2,774 strikes and worker protests
nationwide in 2015, double the 1,379 posted in 2014. Police arrested four labour activists last week in the
southern province of Guangdong, China’s manufacturing heartland—a sign of the authorities’ unease over
the growing protests.
Although the swooning stockmarket and falling currency have captured global attention in recent days, the
effect of slowing growth on employment is a more sensitive problem for the government. The Communist
Party has always treated markets and, by extension, investors with a certain disregard. Workers are
different: the steady improvement in their living standards over the past three decades has helped to
legitimise the party’s rule.
How worried should it be? The stresses have made only a small dent so far in overall employment figures,
at least in the official telling. The jobless rate crept up to 5.2% at the end of September from 5.1% at the
start of last year, according to the latest government survey of 31 big cities. Manufacturing firms are clearly
cutting jobs: the employment index in the closely watched Caixin survey of the sector dipped to 47.3 in
December—its 26th consecutive month below 50, the threshold marking a contraction. But for services, a
bigger share of the economy than manufacturing, Caixin’s employment index hit 51.3 in December, above
last year’s low of 50.1 in August. That points to an expansion.
However, the employment data are flattered by two uniquely Chinese shock-absorbers. First, the hukou
system of household registration means that some 270m migrant workers who have gone to cities for jobs
do not enjoy a permanent right to live in them, let alone collect unemployment insurance there. When they
lose their jobs, they are expected to return to their original homes, often in the countryside, and do not
count as unemployed. In 2008, at the height of the global financial crisis, tens of millions of migrants
simply went back to rural areas, tilling fields or scrabbling for meagre pay in villages. There has been no
similar exodus this time, but the countryside remains a safety valve that can help to absorb the unemployed.
Daily dispatches: China's stockmarket mess
The other buffer is one of the things hobbling the economy in the first place: state-owned enterprises
(SOEs). Private firms are better run and more profitable, but SOEs, with their political backing, have far
easier access to finance and dominate a series of restricted sectors, from energy to transport. These
privileges carry with them political duties, including an obligation to help maintain social stability by
refraining from laying off workers. With the army planning to cut some 300,000 positions as part of a
modernisation plan, the government reminded SOEs last month that they are required to reserve 5% of
vacancies for demobilised soldiers.
In a working paper last year, analysts at the International Monetary Fund noted signs of “increased labour
hoarding in overcapacity sectors”, helping to suppress unemployment at the cost of weaker productivity.
But even SOEs do not have infinite resources. Loss-making companies with little prospect of turning round
their performance are starting to shed workers. Longmay Mining, the largest SOE in the northern province
of Heilongjiang, said in September that it would cut up to 100,000 jobs, nearly half its workforce.
China’s economy should, in theory, be able to accommodate many of the unemployed. The working-age
population peaked in 2012, so all else being equal, there is less competition for jobs. At the same time, the
economy’s tilt towards the services sector, which is more labour-intensive than industry, generates jobs
even as growth slows. Services probably accounted for more than half of China’s GDP last year for the first
time in decades, and their share is growing: in nominal terms, service output grew by 11.6% year-on-year
in the first nine months of 2015, whereas manufacturing grew by just 1.2%.
The central bank estimates that as long as the service sector’s share of GDP increased by one percentage
point in 2015 (in fact, it did better), the economy could have slowed by nearly half a percentage point and
yet still generated the same number of new jobs as it did in 2014. This helps to explain why employment
centres around the country still report a shortage of workers: an average of 1.09 vacancies for every
applicant (see chart). For those hoping to be hired by accounting firms or restaurants, opportunities are
plentiful.
The problem for shipbuilders and coalminers is that many of the service jobs are destined for younger
people with more education, and the jobs they can get, whether as janitors or cooks, often pay less well
than their current work. The government has promised to provide retraining for those who lose jobs in
industry, but that can only help so much. “Most of these guys can’t just go from making a living by their
brawn to making a living by their brains,” says a recruiter at the human-resources centre in Yizheng.
For the employees of Sainty Marine, the question of what their next job might be is not the most pressing
one. They have been showing up to work without getting paid. Mr Wang, 45, a welder, has a note signed by
a manager stating that he is owed several months’ salary, money that he needs to pay back relatives who
lent him cash to build a house. He joined the group blocking the highway, but that achieved nothing. He
has tried to corner his bosses, but that also got him nowhere. Lately, he says, he has been looking at the
crane, sizing it up for a climb.
NYT
Indebted Chinese Companies Increase
Pressures on Government
By KEITH BRADSHERJAN. 17, 2016
Photo
A welder at a shipbuilding yard in Chongqing. Credit Agence France-Presse — Getty
Images
HONG KONG — Sainty Marine Corporation started small, buying and selling a few ships in the 1980s.
But the state-owned Chinese company went on a debt-fueled binge over the last few years, opening its own
shipyards and signing orders worth hundreds of millions of dollars apiece.
Now, heavily indebted companies like Sainty Marine are at the center of the economic troubles in China
that have unsettled currency, commodity and stock markets of late.
Sainty Marine just found itself in court, as one of China’s biggest banks asked to dismantle the company to
recoup overdue loans. Government regulators are investigating the accuracy of the company’s financial
reports, its bank accounts have recently been frozen and its shares have not traded on the Shenzhen stock
market since August.
“It’s pretty dire,” said Matthew Flynn, a Hong Kong shipping consultant.
Shipbuilding is part of a long list of Chinese industries, including steelmaking, coal mining and auto, that
borrowed heavily from state-run banks to expand during the good years, helping to propel the country’s
three decades of double-digit economic growth. But growth has now slipped to around 7 percent, and many
companies are running low on cash.
For data on Chinese inflation, see:
http://www.nytimes.com/2016/01/18/business/dealbook/indebted-chinese-companies-increase-pressureson-government.html?hpw&rref=business&action=click&pgtype=Homepage&module=wellregion&region=bottom-well&WT.nav=bottom-well&_r=0
Falling prices, particularly those paid at the factory gate, have made it even harder for Chinese companies
to cover their bills.
It is adding to concerns about the direction of the Chinese economy, which has made global investors
nervous and weighs on the price of oil. And troubled companies like Sainty Marine are clouding the
outlook.
For years, state-owned companies could regularly mark up their prices to help them pay their loans. As
customers now pull back and deflationary pressures set in, companies are being forced to cut prices, while
facing the same debt payments.
The corporate crunch is clouding the government’s efforts to manage the economy. To keep growth from
falling off a cliff, authorities are pushing a raft of stimulus measures, like building more high-speed rail
lines and encouraging state-owned banks to keep lending.
But ever more borrowing leaves China vulnerable, as company blowups add to the pressures. Last year,
total debts of all sorts in China — household, corporate and government — increased by an amount equal
to 12 percent of the entire country’s economy. Overall lending expanded in December at the fastest pace
since June, figures released by the central bank on Friday show.
Companies in industrial sectors, which accounted for the bulk of borrowing, are navigating a treacherous
environment.
Low or falling prices mean that companies need to sharply increase their sales volume every year to have
enough revenue to cover their debt payments. But increasing sales is hard in a slowing economy.
China is not the only country with falling producer prices. They are also down in the United States from a
year ago amid weak prices for oil and other commodities.
What makes China unusual is that companies are coping with sharply rising labor costs. Blue-collar wages
are up nearly 10 percent a year, as the work force ages and more young people prefer white-collar jobs.
Overinvestment in many sectors is also resulting in too many factories and other businesses chasing the
same limited sales.
“The combination of rising staff costs and lower prices is a real challenge,” said Sabine Bauer, a senior
director for financial institutions in the Hong Kong office of Fitch Ratings.
Shipbuilders like Sainty Marine illustrate the litany of problems.
Up and down the Chinese coastline, in harbors and along coastal rivers, companies bought big plots of
land, purchased cranes, and hired large numbers of welders. China expanded from one-fifth of global
shipbuilding capacity in 2008 to two-fifths by last year.
Quality control was a problem from the start. “In China, building what are supposed to be two identical
ships in two adjacent slips, you get two different vessels,” said Basil Karatzas, a Manhattan ship broker. “In
Japan, they can build 10 ships and they are all the same.”
With many Chinese shipyards dogged by complaints, competition was fierce. Japanese and South Korean
shipyards demanded 20 percent down payments for orders, plus a guarantee from an international bank to
pay the rest of the cost if the buyer defaulted. Although Chinese shipyards demanded the same deposits,
they did not require the guarantees, and accepted orders from what were effectively shell companies with
weak finances.
That put Chinese shipyards at risk.
Continue reading the main story
Graphic
Why China Is Rattling the World
China’s economy is faltering, prompting concerns that are now shaking global stock markets.
OPEN Graphic
If ship prices fell sharply, buyers could forfeit their deposits and not pay for the rest of the vessel, leaving
the shipyard stuck with the project. As global demand for commodities withered in the last two years, ship
prices dropped more than 20 percent — and in some cases, more.
For the 58,000-ton bulk freighters that Chinese shipyards were churning out, prices have plunged from
nearly $30 million in 2013 to just $16 million now. Buyers who bought at the high end chose to forfeit their
deposits instead of paying for finished vessels worth less.
Chinese shipyards are now littered with half-finished shells, like immense steel earthworms cut in two.
Many shipyards lack the money to complete vessels and sell them at a discount that might allow them to
recover some costs.
Even strong buyers are balking at completing deals. Sainty Marine has four finished vessels that were
rejected by Precious Shipping of Bangkok. Precious Shipping backed away, in a dispute over the quality
that has triggered an arbitration case in London.
The Bank of China, one of the country’s biggest commercial banks, pushed Sainty Marine into court on
Tuesday in the shipyard’s hometown Nanjing, in Jiangsu Province. The bank requested the appointment of
a liquidator, as Sainty Marine is already overdue on $81 million in loans.
A Sainty Marine official who gave only her family name, Ma, said that the court had held hearings this
week, but added that she was not aware of any decisions. The bank and the court had no comment.
It is rare for state-owned banks to pursue debts so aggressively.
Authorities periodically send signals about shutting down such zombie companies. “Zombie enterprises are
not new, but as the economy feels downward pressure, their seriousness and danger becomes evident,”
People’s Daily, the Communist Party’s main newspaper, recently said..
But banks usually keep rolling over debts and lending more, particularly for state-owned companies like
Sainty Marine, where the controlling shareholder is Jiangsu province. The government has been hesitant to
completely shut down companies, over fears that large-scale layoffs might lead to protests.
The shipbuilding industry, though, is in complete disarray, with dozens of Chinese companies lacking any
orders. The government, which has halted export credits for the sector, seems determined to force some
closings.
In other circumstances, a weaker currency might offer relief.
When the currency drops, it makes imported goods more expensive. That helps stave off deflationary
pressures that hurt companies’ ability to raise prices. It also makes labor costs look lower in dollar terms,
which in turn can help attract overseas investment.
Those dynamics are a big reason the Chinese government has been letting the renminbi fall.
But the currency is also challenging.
A weaker renminbi could further dampen Chinese demand for imported commodities, which are typically
priced in dollars. As Chinese appetite wanes, freight stagnates and shipping companies have even less need
for new vessels.
It’s a disastrous situation for Sainty Marine. “Even for what’s in the order books,” said Mr. Flynn, the
shipping consultant, “people don’t want to take delivery of the vessels.”
NYT
Slump in China’s Industrial Sector
Weighs on an Already Slowing Economy
By NEIL GOUGHJAN. 19, 2016
Business By JONAH M. KESSEL 4:58 In China, a Reverse Migration
Continue reading the main story Video
In China, a Reverse Migration
After the sudden closure of a shoe factory, a migrant worker on China’s eastern seaboard heads back to his
home in the countryside. China’s shoe industry has been hit hard by the slowing economy.
By JONAH M. KESSEL on Publish Date January 18, 2016. Photo by Lam Yik Fei for
The New York Times. Watch in Times Video »
DONGGUAN, China — Walking around an abandoned furniture factory, Fang Minghua pointed out the
workshops where several hundred employees once toiled, transforming sheets of raw wood into TV stands
or wardrobes for the aspiring middle class in China and other emerging economies.
The factory is relocating to a new facility two hours away, priced out by rising costs and falling orders. Mr.
Fang estimated that as many as a third of the furniture factories around town had gone out of business,
while many others were struggling.
“The economic slowdown is real,” said Mr. Fang, 46, who over the past 22 years had worked his way up
from $50-a-month laborer to production supervisor.
The downturn in Dongguan, a once-thriving manufacturing hub, is part of the Chinese economic puzzle
that global investors are trying to solve.
While China has been moving away from the type of low-end manufacturing that has been Dongguan’s
specialty, the protracted slump in the country’s vast industrial sector is a major threat to the nation’s
already slowing economy. As the government tries to manage the situation, the risk is that the Chinese
economy is worse off than expected — a concern that has put markets around the world on edge.
Continue reading the main story
Graphic
Why China Is Rattling the World
China’s economy is faltering, prompting concerns that are now shaking global stock markets.
OPEN Graphic
The latest signals from China don’t offer much reassurance, with the economic weakness showing little
sign of abating. On Tuesday, China reported growth of just 6.8 percent for the fourth quarter, its slowest
expansion since the depths of the financial crisis in 2009.
When it comes to the economy, Mr. Fang said, politicians and business leaders talk about industrial
innovation and upgrading, “but I think that is just a slogan. It’s really hard to carry out.”
Dongguan is at the heart of south China’s Pearl River Delta. For decades, the region drove the country’s
global ascent in exports, rolling out furniture, garments, shoes and other goods.
But the world’s workshop has been stumbling as cheaper production bases in Asia have gained ground.
Last year, Chinese exports fell for the first time since the financial crisis — and for only the second time
since the country’s economy began reopening to the outside world in the late 1970s.
That position is likely to be further eroded by the Trans-Pacific Partnership. The United States-led trade
agreement deepens American ties with Asian countries like Vietnam and Malaysia, but it excludes China.
The slump has created a tricky situation for the government.
Officials have encouraged phasing out low-end exports in favor of promoting the service sector and hightech manufacturing. While newer and more dynamic companies are on the rise in China, the risk is that
they won’t develop fast enough to offset the hollowing out of light manufacturing, which remains a
shrinking but significant employer across the country.
Some traditional manufacturers have responded to the downturn by relocating farther inland or overseas,
where costs are generally lower. Others are trying to reduce their reliance on export orders by establishing
their own branded products for domestic sale.
“This is an unfortunate pain being felt in traditional, older sectors,” said Louis Kuijs, the head of Asia
economics at Oxford Economics. However, he added, the shift away from low-end, labor-intensive
manufacturing “is an unavoidable part of the structural change that the economy is undergoing.”
Photo
A abandoned wholesale shoe market in Dongguan. Factories in this town, now
struggling, once accounted for a quarter of global athletic shoe production. Credit
Lam Yik Fei for The New York Times
Zhang Lin, 43, is trying to adapt to the shifting terrain.
As a supervisor, Mr. Zhang, who left his home in western Sichuan Province 25 years ago to work in
Dongguan shoe factories, once oversaw about 7,000 production-line workers at a Taiwanese-owned factory
here. At their peak, before the financial crisis, factories in the city accounted for about one in every four
pairs of athletic shoes sold globally, according to estimates from the Dongguan Shoe Industry Commerce
Association.
But rising costs have weighed heavily on the shoemaking business. The Taiwanese factory where Mr.
Zhang worked closed in 2012. He and several partners went out on their own, setting up a plant making
shoes and leather boots for brands like K-Swiss and Durango. Today, Mr. Zhang’s factory employs about
700 people.
While costs are rising, demand from overseas customers has also been declining. The company’s orders
slipped to about 1.2 million pairs of shoes last year, down about 15 percent from 2014.
“It’s hard to say whether we can keep going for another five years — the outlook isn’t very good,” Mr.
Zhang said.
In response, the company has been reducing hours for its workers. It also considered moving.
While the company plans to keep the existing factory here, it is making a future bet by expanding to a lessdeveloped province, Guizhou. Labor costs there are as much as 40 percent less than those in Dongguan.
Mr. Zhang also went on a scouting trip in August to Bangladesh, where some other large Dongguan shoe
companies have shifted production.
The factory has also started making its own line of leather casual shoes. It sells them online in China, for as
much as $75 a pair, on Taobao, Alibaba’s main online shopping platform.
“In a situation where overseas orders are falling, you need to have a backup plan,” Mr. Zhang said.
Photo
Workers walk past notices advertising factory space for rent in Dongguan, a once
thriving manufacturing hub. Credit Lam Yik Fei for The New York Times
Other sectors have similarly been struggling, including some electronics manufacturers. In October, Fu
Chang Electronic Technology, a supplier to the telecommunications equipment makers Huawei and ZTE,
shut its doors unexpectedly. The closing prompted a protest by thousands of workers in front of a
government building in Shenzhen.
Chinese officials, wary of further labor unrest, have sought to ease pressures on the sector. Earlier this
month, one of China’s main tech regulators said it would team up with a big local bank to set up a $30
billion fund to support troubled small and medium-size electronics suppliers.
While there are still many active factories in Dongguan, the main ones succeeding are increasingly hightech and less reliant on large staffs.
After working 15 years at an automotive plant in Alabama, Michael Recha moved to Dongguan in 2012 to
set up a specialized factory for car parts, one of the first of its kind in China. Owned by Gestamp, a Spanish
automotive component maker, the factory uses a technology called hot stamping to form metal sheets into
precision parts like car bumpers and body panels for both local and foreign carmakers.
But robots do an increasing share of the work. The factory employs just 400 workers working two shifts a
day.
“China is no longer a low-cost country, so we have the same robots and equipment here” as in Europe, Mr.
Recha said.
Mr. Fang, of the furniture factory, estimates that by moving inland and consolidating three factories, the
company saves about $150,000 a month in operating costs — including lower electricity and water bills,
and also taxes. The biggest saving is on rent, because the owner of the company was able to buy low-cost
land to build the new compound.
The move, though, has extracted a different toll.
The new factory is relatively remote, so there isn’t much to do after work. Mr. Fang’s wife, who stayed
behind in Dongguan, “doesn’t feel very happy about being apart,” he said.
Their current plan is for her to join him sometime after next month’s Lunar New Year holiday.
“She will get a new job, probably in the same factory with me,” he said.
NYT
China G.D.P. Growth at Slowest Pace
Since 2009, Data Shows
点击查看本文中文版 Read in Chinese
By NEIL GOUGHJAN. 18, 2016
Photo
An investor at a securities company in Beijing. Investors have been on edge in recent
weeks amid renewed turmoil in China’s stock markets and currency exchange rate.
Credit Wang Zhao/Agence France-Presse — Getty Images
HONG KONG — China’s growth slowed further last year, adding to the troubling economic picture that is
unsettling investors around the world.
The Chinese economy grew at a 6.8 percent pace in the fourth quarter, according to data released on
Tuesday. It was the lowest quarterly expansion since the global financial crisis in 2009.
Uncertainty about the Chinese economy — and whether the government can manage a slowdown — has
been weighing heavily on global markets in recent weeks. Investors, in part, are trying to determine if
China’s slump will spread, dragging down the rest of the world.
The latest data is not likely to reassure investors that all is well in China, the world’s second-largest
economy.
The quarterly growth rate was lower than analysts expected. For the full year, China expanded at 6.9
percent, just below the government’s target of 7 percent.
It is a pace that would be the envy of many developed countries. But the figure represented China’s slowest
expansion since 1990, when foreign investment shriveled in the year after the government’s deadly
crackdown on protesters in Tiananmen Square.
Business By JONAH M. KESSEL 4:58 In China, a Reverse Migration
Continue reading the main story Video
In China, a Reverse Migration
After the sudden closure of a shoe factory, a migrant worker on China’s eastern seaboard heads back to his
home in the countryside. China’s shoe industry has been hit hard by the slowing economy.
By JONAH M. KESSEL on Publish Date January 18, 2016. Photo by Lam Yik Fei for
The New York Times. Watch in Times Video »
China’s growth is decelerating as its traditional industrial businesses struggle with excess capacity and
dwindling demand. A slump in new housing construction is hurting consumption of building materials
including steel, cement and glass, even as home prices show signs of a rebound.
China’s export base in lower-end manufacturing, once a powerhouse that drove growth and created jobs,
has been hollowed out. Factories churning out goods like garments and furniture are losing competitiveness
because of lower wages in Southeast Asia and South Asia.
Although consumer spending and more innovative private sector companies are expected to help China’s
economy expand in the future, analysts worry that their development will be too slow to offset the current
and painful industrial slowdown.
And the government’s response could add to the challenges. The government has rolled out a raft of
stimulus measures to help bolster the economy. But that only threatens to leave already struggling
companies even deeper in debt.
Taken collectively, China’s results could spell more trouble for global growth, even as the economy in the
United States shows resilience.
Continue reading the main story
Graphic
Why China Is Rattling the World
China’s economy is faltering, prompting concerns that are now shaking global stock markets.
OPEN Graphic
Separate monthly data released on Tuesday offered no sign that China’s slowdown was bottoming out. In
December, industrial production rose 5.9 percent from a year ago, retail sales increased 11.1 percent and
investment rose 10 percent — all of which were slightly below economists’ forecasts.
In a news release on Tuesday, China’s state statistics agency said the growth rate last year was challenged
by a “complicated international environment and increasing downward pressure on the economy.”
However, it added that the economy “achieved moderate but stable and sound development.”
The weakness in China has reverberated around the world, as investors try to dissect what’s actually
happening in the country’s economy. The plunge in Chinese stocks, which are now in bear territory, only
clouds the outlook.
Global investors worry about what these dramatic stock swings say about the health of China’s economy.
But analysts note that the frequent gyrations of Chinese stocks are often unrelated to what is happening on
the ground in China.
“There does seem to be a disconnect there between equities in mainland China and how the economy is
actually performing,” said Julian Evans-Pritchard, a China economist at Capital Economics.
He cited the example of a huge rally in the Shanghai and Shenzhen markets in the first half of last year—
which gathered steam even as the economic data emerging from the mainland suggested a sharpening
slowdown.
“A lot of what goes on is driven by perceptions of what policy makers are going to do in terms of market
support, rather than what’s happening in the real economy,” said Mr. Evans-Pritchard.
Asian markets seemed unmoved by the G.D.P. figures, as Shanghai closed up 3.25 percent, and Japan’s
Nikkei 225 index finished the day up about 0.6 percent. In Europe, the FTSE Euronext index rose nearly 2
percent at the open.
The Economist
Chinese politics
A crisis of faith
In their response to wobbly markets,
China’s leaders reveal their fears
Jan 16th 2016 | From the print edition
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THERE should be something comforting, during uncertain times, in the sight of the boss solidly seated
behind his desk, working away at the business of the day. And that was the image China’s official state
media presented when broadcasting Xi Jinping’s annual new-year message to the Chinese people on
December 31st—though it has to be said, if that impressive expanse of wood really is the presidential desk,
Mr Xi must find it hard to reach his impressively red but implausibly far-off telephones.
From this confidence-inspiring position Mr Xi told his audience that 2016 was going to mark “the
beginning of the decisive phase” of the country’s efforts to build a “moderately prosperous society”, a goal
that the Communist Party says it hopes to reach by the end of the decade. Not mentioning that the
economy’s rate of growth was at a quarter-century low, he maintained that the country’s future prospects
were “encouraging”.
Recent events, however, suggest that Mr Xi’s managerial confidence is not widely shared. Jitters emanating
from China’s equity and currency markets have exposed widespread fears that the way ahead will be rocky
indeed—and that Mr Xi and his colleagues are ill-equipped to navigate it. Evidence from their handling of
a broad range of political and economic policy suggests that the worriers may prove right.
Four days after Mr Xi’s broadcast, the Shanghai stockmarket reopened after a new-year break. With 90
minutes to go before the close of business, transactions were halted for the rest of the day: the index had
fallen by 7% and a newly introduced “circuit-breaker” kicked in. The sell-off has deepened since then: the
index is now down by about 15% so far in 2016, its worst-ever start to a new year. At the same time,
China’s once-placid currency has turned stormy. The central bank believed it could nudge the yuan down,
offering a little help to weary exporters without grave repercussions. Instead, it has triggered an exodus of
capital and alarmed investors around the world, who braced themselves for bigger falls. As fears of a
meltdown in China rippled across global markets, the government scrapped the ill-conceived circuitbreaker, and scrambled to shore up the yuan and the markets by telling its banks and brokers to buy.
Panic about China’s ability to maintain steady growth is unwarranted. True, its debt is worrisome:
government and private debt was about 160% of GDP eight years ago and now stands at more than 240%
(about $25 trillion). But the government still expects the economy to grow by an average of 6.5% a year for
the rest of the decade. That may be difficult, and it could entail a lot more wasteful investment. But it
should be achievable.
The problem is thus not an economic one, per se. It is that a government once widely thought of as allpowerful—even over markets—may be losing its grip. The recent ructions, after all, are not the first mess
of this sort; the markets went haywire last August (see chart 1). China’s leaders are now grappling with
hugely complex reforms of their financial system, their currency policy and of their state-owned enterprises
and, apparently uncertain how to proceed, they are thrashing around and making mistakes. At home and
abroad, people risk losing faith in them; such a loss would be felt well beyond the markets.
Mr Xi and his colleagues appear frightened of losing their grip on the economic levers that they have used
to help keep the party in power. Party bosses like state-owned banks: they can be relied on to direct lending
to favoured companies and loyal officials’ projects. They worry about loosening the party’s grip on the
state-owned industries that control vital areas of the economy such as energy, transport and
telecommunications—can anyone but party loyalists be trusted to run them?
If the party drags its feet on reform, though, China will fall back on unsustainable stimulus measures, and
may eventually slide into economic stagnation, as Japan did in the 1990s. That would bring with it the risk
of social and political turbulence. A full-blown economic crisis cannot be ruled out. Once admired by
authoritarian governments elsewhere, not to mention some commentators in the West, for its canny
balancing of free markets and party control, China’s style of leadership may be about to lose its shine.
Though he may lack a sophisticated understanding of how to handle stockmarkets, Mr Xi was quick to
grasp the dangers facing China when he took over in 2012. Some foreign commentators were still, even
then, mesmerised by what they regarded as a winning combination of a technocratic government with a
good sense of the country’s needs and how to fulfil them, and a disdain for the endless debates that can bog
down good policy in democracies. But Mr Xi and his colleagues realised that the foundations of the model
that the late Deng Xiaoping began to develop in the late 1970s, and that in the 1990s came into its own, was
in need of an overhaul.
Trouble at the top
The model’s surge of success had been sustained by two forces: the rapid spread of prosperity and, since
the bloody suppression of the Tiananmen Square protests in 1989, an unusually protracted truce among the
often fractious party elite. Consistent growth underlay both, providing fabulous dividends for the elite as
well as prosperity for hundreds of millions of people. But in 2012 China’s GDP was growing at its slowest
pace in 13 years (see chart 2). To make matters worse, Mr Xi’s assumption of power occurred amid the
most vicious struggle within the leadership that China had seen since Tiananmen. Not content with
enriching his family to a phenomenal degree, Bo Xilai, the party boss of Chongqing, a south-western
region, also made a bid for a job at the very top. Mr Xi resented this; other powerful politicians backed it.
Mr Bo is now serving a life sentence for corruption and abuse of power.
Although economic growth and peace at the pinnacle of the party kept the country stable, they did not keep
it static. Under Mr Xi’s predecessor, Hu Jintao, the middle class grew phenomenally (see chart 3). And its
desire for a stable environment in which to get ever better off was a vital bulwark of party rule. But some of
its members were increasingly fed up with the party’s caprices and its manifest corruption. What was more,
this middle class had a powerful new weapon: information.
The rapid spread of the internet opened up a nationwide forum for dissent. Sina Weibo—China’s
equivalent of Twitter—was founded just three years before Mr Xi took office; but by that time it had 46m
daily users. Social media allowed the party to monitor public opinion and identify problems before they
became threats to the party’s grip on power. But they also spurred the development of a civil society:
NGOs, house churches and independent legal firms ready to take up the cases of the downtrodden and
dispossessed in their battles with officialdom all made extensive use of social media. Groups independent
of party control—albeit small and scattered—sprang up everywhere.
Events abroad seemed to underscore the instability of authoritarian states. The Arab spring began unfolding
in 2011, a year before Mr Xi took over, and though it hardly amounted to a democratic breakthrough—far
from it—it showed that authoritarian governments could prove unexpectedly brittle. The police in China
worked hard to prevent any copycat unrest. At the same time, the Tibetan plateau and Xinjiang, which
cover about 40% of China’s land area, were seething with anti-party sentiment following the government’s
ruthless response to unrest in 2008 and 2009.
A demographic crisis was also beginning to loom. Plunging birth rates were stripping China of the surplus
of working-age people that had constituted its “demographic dividend”: it was fast growing old. Young
people were beginning to worry about a future weighed down by the burden of caring for the elderly—not
to mention sky-high property prices and, among graduates, rising unemployment. To cap it all an
environmental catastrophe was unfolding: the industrialisation that had brought growth was choking cities
with smog; one-fifth of rivers were too toxic for human contact, let alone to drink from. Even party leaders
had taken to describing China’s economic model as “unstable, unbalanced, unco-ordinated and ultimately
unsustainable”.
Faced with a need to reshape, or even fundamentally restructure, China’s economic and political model, Mr
Xi has tried to present himself as a reformer in the mould of Deng Xiaoping. He has acquired more power
than any leader since Deng, putting himself in charge of all the most important portfolios and abandoning
the system of “collective leadership” Deng brought in. Indeed in many ways Mr Xi’s grip on the country’s
mechanisms of control appears stronger than Deng’s was, and second only to that of Mao Zedong.
Thus empowered Mr Xi talks of reform that goes yet further than Deng’s did—as when, in 2013, he asked a
meeting of the party’s 370-member Central Committee to endorse his call for market forces to be given a
“decisive” role in the economy. (It did.) Recently Mr Xi has taken to calling for “supply-side reform”,
implying that structural changes in the economy, rather than massive state-led investment, are to be the new
order of the day. The party’s main mouthpiece, the People’s Daily, calls these reforms the “China Model
2.0 Edition”.
A crucial aim of this approach is to ensure that the middle class remains on side, even as what Mr Xi likes
to call a “new normal” of slower growth sets in. Hence his signature exhortations to build the “Chinese
dream”. It is an ambiguous term, partly designed to evoke thoughts of American-style middle-class
prosperity, and of a life unfettered by interfering government. But the slogan was also designed to foster
patriotic pride, including a “dream of a strong army”. Mr Xi’s revamped China model leans even more
heavily on nationalism than earlier models did.
Constitutionally inept
Mr Xi’s style of rule, though, has proved an impediment to his ambitions. His anti-corruption campaign—
the longest and most far-reaching of its kind since the party seized control in 1949—has been welcomed
not just by the middle class but also among those less well off, who feel that China’s economic miracle has
unfairly rewarded the powerful. But along with specific injunctions not to question party policy the antigraft drive has made officials even more afraid than usual to take the risks needed to carry out reform.
In the political realm Mr Xi talks of making the legal system fairer and more effective. Just a month after
he took over, he took up a cause that had long been dear to liberal intellectuals: that of giving the
constitution more clout. “No organisation or individual has the privilege to overstep the constitution and the
law,” he said. He was trying to instil some discipline into the authoritarian model, reining in abuses of
power and privilege within the party that had enraged the middle class and people aspiring to join it.
Those who saw this as licence to push for deep reform, though, were quickly disabused. When a partycontrolled newspaper in Guangdong province, Southern Weekend, tried to argue the case for constitutional
government in an editorial titled “The Chinese Dream: A Dream of Constitutionalism”, the censors shut it
down. Journalists at the paper went on strike; dissidents gathered outside its offices in Guangzhou.
Tolerated for a couple of days, the sight of crowds on big-city streets listening to speeches calling for
freedom of the press and even a multiparty system proved too much. The police rounded up the dissident
orators. Late last year three of them were sentenced to terms of between two-and-a-half and six years in
jail. The episode ushered in a crackdown on civil society of greater duration and intensity than any since
the dark days that followed the Tiananmen protests.
Mr Xi still talks up the constitution. At a meeting in 2014 the party’s Central Committee decided to make
officials swear loyalty to it, ordered schools to teach students about it and decreed that December 4th would
be celebrated henceforth as Constitution Day. But Mr Xi’s talk of constitutionalism rings hollow to liberals,
just as his talk of reform fails to calm markets. And its impact within the party remains unclear.
One way Mr Xi hopes to prolong the party’s life is by proving that it can govern effectively. His anticorruption chief, Wang Qishan, raised eyebrows in September when he said that “the legitimacy of the
ruling party” rested partly on “the mandate of the people”. It was the first public use of the word legitimacy
by a Chinese leader in connection with the party’s rule, and seemed to imply a recognition that the party
could not take it for granted.
Mr Xi has built on a system, developed by his post-Deng predecessors, of grading officials according to
their fulfilment of “responsibility targets”. In the past the targets that mattered most were those seen as
maintaining social stability and promoting economic growth. Now the environment is getting a much
higher billing. In 2012 the government made the reduction of PM2.5 air particles, the worst kind, a “hard
target” in Beijing and other heavily polluted cities. State media have reported that the mayor of Beijing,
Wang Anshun, has been ordered—metaphorically—to “submit his head” if he fails to meet this target.
Sensing that China’s development has entered uncharted territory, China’s leaders are turning to foreign
gurus. In November Mr Xi met Francis Fukuyama, an American political scientist whose claim to fame is a
thesis that would seem to run against everything Mr Xi wants to protect: that the march to liberal
democracy is an unstoppable one. Mr Fukuyama has tweaked this “end of history” line somewhat since
first espousing it, emphasising that, even in the absence of democracy, a state’s ability to enforce laws and
provide basic services such as education, health and infrastructure can matter a lot.
Harder tasks
Can Mr Xi’s model—with all the flaws in its implementation—continue to keep the end of the party’s
history at bay? David Shambaugh of George Washington University, a career-long observer of China, was
an early champion of the idea that the party had learned useful lessons from the collapse of the Soviet
Union and changed its methods of ruling accordingly. It had, for example, allowed the development of
NGOs that could help fill in the cracks of an overstretched welfare system. It had recruited more
businesspeople into its ranks and experimented on a small scale with elections for party posts.
But in a forthcoming book, Mr Shambaugh says he has changed his mind; he thinks the reforms of which
he spoke have run their course and a new era of “hard authoritarianism” has begun. And he points out that
there has been no example of an authoritarian country making the transition to high-income status that Mr
Xi seeks without at least a partial democratisation.
The 100th anniversary of the party’s founding will come in 2021, just before Mr Xi’s years in power are
due, if he follows the example of his predecessors, to come to an end. If China’s reforms continue to
disappoint over the next few years, it is unlikely to be the joyous celebration Mr Xi must be hoping for.
Nationalist chest-thumping may help to rally some support for the party. But it comes with risks—China’s
history since the 19th century is studded with examples of nationalist fervour turning against the
government because of leaders’ perceived failings.
Mr Xi may feel inclined to step up economic pressure on Taiwan, which is likely to elect an independenceleaning president on January 16th after eight years of rule by one who favoured closer ties with China. But
there is little sign of public appetite for a return to the military tensions of the mid-1990s, when China
lobbed unarmed missiles close to the island.
There is every reason, therefore, for Mr Xi to worry. Job losses in manufacturing will stoke tensions among
blue-collar workers, which is why the party has started rounding up labour activists (see article). The
loyalty of the middle class, long accustomed to unremitting growth, will become increasingly difficult to
secure as growth slackens further. Both the middle class and the equally large cohort of rural migrants that
dreams of joining it are vital to the country’s economic success, and both are capable of mobilising regimethreatening opposition. Mr Xi talks a good reform, but has yet to follow through, and has shown that his
preferred way of dealing with any threat is to resort to time-honoured tactics of cracking down ever harder.
Chinese authoritarianism has been at times surprisingly deft. Just now, it does not look so.
Strategy+Business
s+b Blogs
Published: January 22, 2016
Global Perspective
What Really Ails China’s Economy
John Jullens
John Jullens is the emerging markets leader for the capabilities-driven strategy platform for Strategy&,
PwC’s strategy consulting business. He is a principal with PwC US.
Just a few days into 2016, China’s stock market was back in the headlines. The CSI 300 index plunged 7
percent on January 4, triggering the government’s new circuit breakers, which suspended trading. On
January 7, trading was halted again, this time only a half hour after the market opened. Predictably, Beijing
intervened by injecting billions into the interbank market, directing state-controlled funds to buy shares,
postponing the expiration of its recent selling ban on major investors, and supporting the yuan. And just as
predictably, global markets overreacted almost immediately, sparking a sell-off eerily similar to last
summer’s meltdown.
In reality, China’s markets are largely disconnected from the real economy and are a poor leading indicator.
Their total market value represents only about 40 percent of GDP, and individual retail investors account
for as much as 90 percent of daily transactions. In addition, traded stocks are heavily skewed toward the
manufacturing and construction sectors, and Chinese firms rely far more on the banking system to raise
capital.
Nevertheless, all is obviously not well in China. GDP growth has slowed significantly, debt levels are still
increasing, and capital efficiency is unacceptably low. At the same time, overcapacity has reached
dangerous levels in sectors such as steel, glass, and cement. And although it continues to exercise strong
systemic control over the economy, Beijing is rapidly depleting its cash reserves as it tries to prevent the
yuan from devaluing too quickly. As a result, most mainstream economists believe that China urgently
needs to “rebalance” by implementing structural reforms and moving to a more market-based economy.
An October 2015 presentation by Tepper School of Business professor Marvin Goodfriend to the Federal
Reserve Bank of New York sums up the conventional wisdom: “China is facing a severe macroeconomic
adjustment problem…[and] must reduce its excessive dependence on investment as the main source of
aggregate demand…. The heart of China’s problem is its exceptionally low share of private
consumption…. Unless consumption can pick up the slack in a timely manner, the requisite contraction of
investment would precipitate a recession.”
That is technically true, but also a little misleading. Consumption as a share of GDP is indeed unusually
low, but only because the main economic driver of China’s growth over the past decade has been capital
investments in industrial capacity and physical infrastructure. In fact, retail sales in China are estimated to
grow 10.7 percent this year; certainly not enough to offset the decline in industrial output, but clearly far
from problematic. Even though Chinese families hoard much of their rising incomes (in response to the
absence of a comprehensive social safety net), low consumer demand simply isn’t the problem most
economists believe it to be.
Ultimately, a country’s economic health is a function of the type and strength of its domestic companies. In
other words, a national economy’s institutions and policies should create an environment that stimulates the
formation, development, and global competitiveness of its domestic companies over time. For a desperately
poor, mostly agrarian economy, such as China’s 30 years ago, that initially means implementing various
rural improvement measures to migrate subsistence farm labor into low-cost manufacturing for export
markets.
A country’s economic health is a function of the type and strength of its domestic companies.
But now that even China’s vast supply of surplus farm labor is disappearing and costs are rising, domestic
firms have begun to lose business to cheaper countries, such as Vietnam and Thailand. Thus the real
underlying challenge for China is how to upgrade its industrial base, from manufacturing most of the
world’s shoes, toys, and other labor-intensive, low-skill products into more capital- or technology-intensive
products, such as cars or medical equipment, and services.
Of course, it isn’t easy to elevate a developing economy’s industrial base and compete head-to-head against
the West’s far more experienced and capable world-class firms. In fact, only a handful of countries have
successfully managed this, and none with China’s scale, complexity, and systemic impact on the world’s
economy. What should Beijing’s policymakers do? In addition to addressing endemic corruption and
serious environmental concerns, China needs to take three critical steps to avoid getting ensnared in the
dreaded middle-income trap while simultaneously maintaining economic and political stability:
1. 1. Continue to grow the services sector
2. 2. Remove constraints on the private sector, and redirect investment toward
higher value-added activities
3. 3. Implement reforms of state-owned enterprises (SOEs)
China is actually making progress against the first two objectives. For example, the services sector has
grown steadily and now represents more than 50 percent of GDP. Similarly, China is implementing a series
of initiatives, such as tax reform and better credit access for small businesses, and is making substantial
investments in numerous new and green technologies.
However, much less progress has been made in improving the competitiveness of the thousands of SOEs
that still make up roughly 40 percent of China’s GDP. Most economists prefer privatization, but for various
reasons, Beijing doesn’t want a Western-style, asset-light balance sheet. That’s actually fine; state control
of strategic sectors can be advantageous during a developing economy’s catch-up period. However, those
assets must then be well managed — and that’s where China has fallen short. Instead of simply protecting
SOEs indefinitely, Beijing’s focus should be on administering a healthy dose of tough love.
First, China needs another round of SOE rationalization similar to then Premier Zhu Rongji’s draconian
program in the late 1990s, which spurred China’s entry into the WTO and its subsequent global economic
rise. Such rationalization programs may be even more difficult to implement today, often requiring mergers
instead of outright liquidations, but nevertheless must be completed sooner rather than later.
Second, SOE management itself must be overhauled. Recently announced “supply-side” reforms, including
mixed ownership, are a promising first step. But they don’t go far enough, as many SOEs still lack
advanced managerial skills, for example, in marketing and strategic planning. In addition, executive
incentives need to be more clearly focused on improving firm competitiveness instead of meeting local
political objectives or advancement in the party hierarchy.
Finally, the remaining SOEs have to develop truly world-class capabilities and integrate them into a
coherent and differentiated capabilities system. They must decide how to progress from relying primarily
on state protection and country-based comparative advantages, such as low-cost labor, to developing their
own firm-specific competitive advantages, and whether to fill existing capability gaps through external
contracting, internal development, or M&A.
China’s greatest challenge may be a lack of consensus on the best way forward. The New Right favors promarket reforms whereas the New Left advocates a return of the state, which may explain recent policy
inconsistencies and the lack of coordination between the interventionist securities commission and the more
market-oriented central bank. Ultimately, much will ride on the political courage and business acumen of
China’s leaders. Let’s hope President Xi is up to the task.
Published: May 11, 2015 / Summer 2015 / Issue 79
Global Perspective
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How Emerging Markets Can Finally
Arrive
Building world-class domestic firms is the overlooked
key to economic development.
by John Jullens
Illustration by Lars Leetaru
Throughout much of human history, economic output was firmly yoked to the size of a country’s labor
force. Because productivity growth was negligible, the countries with the largest populations, such as China
and India, could put the most people to work. They reigned as the world’s largest economies. Things
changed suddenly during the late 1700s. A number of economic, institutional, and other factors coalesced
in England to unleash the Industrial Revolution, which was transformational — at least in the handful of
Western countries that rose to dominance through their economic prowess and resulting military and
political power. Everyone else fell behind.
Incredibly, this great divergence has persisted for more than 250 years. Today, the global economy still
consists of only 30 or so high- income countries, roughly the same number of middle-income countries, and
a very long tail of 140 or so low income countries. This last group is still finding it difficult to industrialize,
and at least 34 of these countries remain fragile and vulnerable to outright collapse.
This circumstance doesn’t really jibe with orthodox economic theory. As access to new technologies and
other know-how opens up, and as domestic savings and investment are complemented with external
financing, theory predicts that growth in low-income countries should accelerate and the gap with wealthier
counterparts should narrow. In fact, many pundits, including the Nobel Prize–winning economist Michael
Spence, believe we are currently living in the middle of a century-long journey, during which the rest of the
world will catch up with the developed economies of the West. By the time what Spence dubs “the great
convergence” is over, around 2050, he says, as much as 75 percent of the world’s population will live in
developed economies — in contrast to a mere 15 percent today.
But it’s not clear that Spence’s optimistic prophecy will come to pass. In reality, developing countries
almost invariably get caught in various types of growth traps that make it difficult to reach high-income
status. Since the 1950s, at least 80 countries, in every major region of the world, have achieved an increase
in annual per capita income of at least 2 percentage points for at least eight consecutive years. Yet during
that same period, only a handful managed to escape the dreaded middle-income trap (classified by the
World Bank as having a median gross national income [GNI] of US$6,750 in 2011 dollars). The few
favored exceptions are largely in East Asia: Hong Kong, Japan, Singapore, South Korea, and Taiwan.
What’s more, the rate of progress recently slowed down again after an unparalleled growth spurt in the
early 21st century. (Between 2000 and 2014, annual growth rates in emerging markets had outpaced those
in developed ones by almost 5 percentage points, as reported in the Economist). It’s no wonder Morgan
Stanley strategist Ruchir Sharma, writing in Foreign Affairs, coined the term ever-emerging markets to
describe the all-too-common cycle of promise and excitement when a country appears to take off — and
the bitter disappointment when its growth stalls long before anything close to economic parity is achieved.
Several interrelated issues explain why emerging economies have found it so difficult to achieve
convergence. But ultimately, the root cause is the lack of integration among the three primary disciplines
that must inform any coherent catch-up strategy: development economics to guide a country from low- to
high-income status, political science to design the enabling institutional environment, and strategic
management to create competitive world-class firms over time. Perhaps most alarming, the third discipline,
strategic management of domestic firms, is often not even part of the conversation. The result is a series of
growth fallacies that have led many policymakers astray.
Emerging markets need a fundamental reversal in approach. The conventional wisdom advocates
implementing large-scale economic and institutional reforms that shape the overall business and political
environment. But it would be more effective to selectively use reform initiatives tailored to each country’s
unique mix of business dynamics and industries, to improve domestic firms’ resources and capabilities at
each stage of a country’s economic development.
Think about it like a professional sports team. For years, we’ve been focusing on the playing field —
making sure the grass is cut, and the lines are clear. But if the individual players don’t have the capabilities
they need to compete, none of that really matters. Those players are an emerging country’s domestic firms.
They need the right training (and nurturing) to compete to win against world-class “teams” from more
mature countries. Without such capable firms, emerging markets will inevitably get stuck somewhere along
the way.
Without capable domestic firms, emerging markets will inevitably get stuck somewhere along the way.
Getting Growth Wrong
Many economists and policymakers still believe that developing countries should simply open up domestic
markets to foreign direct investment, liberalize their financial systems and exchange rate regimes, remove
all barriers to competition, and specialize in those activities in which they have inherited a comparative
advantage. These analysts are influenced by a near-religious belief in free markets, trade, and competition
that goes all the way back to Adam Smith’s invisible hand and David Ricardo’s subsequent musings on
British cloth and Portuguese wine.
But the positive relationship between trade liberalization, competition, and economic development is
ambiguous at best. For instance, trade restrictions can actually benefit a country depending on whether it is
already developed or still developing, whether it is big or small, and whether it has a comparative
advantage in those sectors that are receiving protection. Conversely, premature trade liberalization can hurt
a developing country, as the entry of much more experienced and better-resourced foreign multinationals
can drive fledgling indigenous firms out of business. This can force the developing country to deindustrialize and revert to activities with lower added value. In other words, slavish adherence to the free
market orthodoxy may inadvertently doom a developing country to the production of simple, low-margin
manufactured goods, agriculture, and the extraction of finite natural resources.
Similarly, the conventional wisdom holds that economic development is a function of democratic political
institutions that ensure arm’s-length government–business relationships, deregulated labor markets, and
private ownership and shareholder control. At first blush, that makes sense — the vast majority of today’s
high-income countries are democracies. However, here too, the evidence shows that major institutional
reform, and indeed democracy, is not a prerequisite for economic growth, at least initially. Some of the
most successful development cases in history, including China today and South Korea in the postwar years,
took place under unambiguously autocratic governments.
A related growth fallacy is the assumption that the best theoretical solution is also implementable in
practice. In reality, emerging markets are characterized by numerous institutional voids, as Harvard
Business School professors Tarun Khanna and Krishna Palepu have written extensively about, such as
shoddy infrastructure, nascent capital markets, and endemic corruption, which make pursuing “first-best”
solutions virtually impossible. In addition, these institutional voids vary from country to country, making
effective economic development policies highly situation-specific. In other words, each country’s
development journey will have to be unique, due to initial differences in factor endowments (land, labor,
capital, technology), institutional environments (political system, property rights, financial system, labor
markets), domestic firm capabilities (technology, processes and systems, brand, management), and culture.
The conventional wisdom also falters because it implicitly assumes that economic development is a linear
process, through which higher and higher income levels are reached in a progressive and gradual fashion.
In reality, a poor country’s long and difficult journey from low- to high-income status runs through distinct
development stages. Each stage is characterized by different challenges, policy objectives, and tasks at the
political, economic, and firm levels. Policymakers will encounter new growth traps at every step along the
way. What is needed to lift a country out of poverty may be quite different from what is needed to navigate
across the middle-income trap, which, in turn, may be entirely different from what is required to sustain a
successful high-income country (a GNI of $12,476 or higher).
Policymakers thus face a formidable challenge, as they have to change course several times along the way
— each time having to overcome stiff resistance from those with a vested interest in maintaining the status
quo. To add further complexity, economic development discussions normally take place at the relatively
abstract policy level, as opposed to the firm-level trenches where the battle is ultimately won or lost. As a
result, government policy is typically focused on advancing the overall business environment, and is
seldom designed to address and improve individual firm performance.
Rethinking Development
Given the complexity and ever-changing nature of the intervention required, it is not surprising that so few
countries have been able to transition successfully from one economic development stage to another.
Although a comprehensive theoretical framework has yet to be developed, examples of successful
initiatives from various emerging markets — most recently those in East Asia — suggest a preliminary set
of guiding principles for each of the four major phases of an emerging market’s economic development
journey. A country can evolve this way from relying primarily on country-based comparative advantages
(for example, ultra-low labor costs) to developing a sufficient number of domestic companies that possess
world-class differentiated capabilities of their own.
Phase 1: Breaking free. Many emerging countries remain poor (a GNI of $1,025 or lower) indefinitely not
because local policymakers don’t understand the basics, but rather because their economies are stuck in
subsistence growth traps. In these traps, market forces alone are insufficient catalysts for the
industrialization and development process. Such growth traps result from structural impediments that differ
from country to country, but typically include some combination of economic constraints (such as
inadequate access to affordable financing), political constraints (such as excessive bureaucracy), and firm
strategy constraints (such as the absence of a skilled workforce).
For example, in emerging economies where the vast majority of the workforce is employed in farmingrelated activities, the agricultural sector is typically controlled by a wealthy, landed elite with little
incentive to upset the status quo — and enough power to block or stall reforms. As a result, land reform
programs specifically designed to break the stranglehold of the landed elite are often a prerequisite to longterm economic development. As described by journalist Joe Studwell in How Asia Works: Success and
Failure in the World’s Most Dynamic Region (Grove Press, 2013), Japan, Taiwan, South Korea, and China
all implemented meaningful land reform programs early in their economic development journeys — in
contrast to their less successful counterparts in Southeast Asia, India, and South America.
Phase 2: Catching up. Once the initial set of growth barriers has been broken, policymakers must focus
more broadly on the industrialization process. It is difficult to become a high-income country solely by
producing and exporting agricultural products and other natural resources while importing most
manufactured goods. Industrialization directly raises productivity and income levels. It also prevents the
inevitable deterioration of a country’s terms of trade, which otherwise occurs when the country must pay
for importing increasingly sophisticated and expensive manufactured goods with its own exports of much
cheaper primary products (which often have far less stable demand).
Several East Asian countries have demonstrated that leveraging land reform and other rural productivity
initiatives (for example, investments in fertilization, irrigation, and infrastructure) and migrating the
resulting surplus farm labor into more productive activities, such as manufacturing goods that are currently
imported, can be an effective strategy for jump-starting the industrialization process. Doing so will
typically require some form of direct government intervention, as few local firms will have the capabilities
or scale to compete with their more experienced foreign competitors. Of course, such interventions may
have some initial downsides, such as higher prices for consumers, but they should be seen as an investment
in the country’s future economic development. They are therefore every bit as important as similar
investments in infrastructure and education. From an emerging market policymaker’s perspective, the real
question is not whether to intervene, but what form the intervention should take and which industries
should be targeted.
Some of these initiatives will be horizontal, such as providing financing and reducing bureaucratic red tape
to unlock entrepreneurial activities. But policymakers should also introduce complementary vertical
initiatives to facilitate the flow of surplus farm labor into high-potential target industries. Given the lack of
capable domestic companies at this early stage, the focus should be on whatever comparative advantages
happen to be available locally, be they ultra-cheap labor, access to natural resources, a favorable location,
or a large domestic market. Country leaders should also consider the target industry’s specific technological
and other spillover potential that can be deployed in other industries. For most emerging markets, the initial
focus will likely be on simple, nondurable consumer goods, such as clothing, that are labor intensive, are
relatively simple to produce, and do not require advanced technical and managerial skills.
The type of intervention can take various forms, and will need to be adapted to the requirements of the
target industry and the specific economic, institutional, and cultural environment in each country. Tariffs
are an obvious choice, at least initially, as they directly protect local firms from premature foreign
competition. Importantly, they don’t require funding through public resources — which are likely still quite
limited. Other options include low-cost financing, favorable tax rates, below-market land and utilities
prices, and direct subsidies to selected industries.
Phase 3: Moving out and up. Using the strategies described in the previous phase, a low-income country
can experience a period of economic development that can last several years. But growth rates will
eventually come down again, as the number of imported products suitable for domestic production
dwindles, the supply of surplus farm labor runs dry, and costs begin to rise — all of which make local firms
steadily less competitive.
At this point, domestic firms must enter into more value-added activities and engage in head-to-head
competition with rivals from developed markets. The government will need to help homegrown firms move
from relying primarily on country-based comparative advantages and copying basic production capabilities
to developing firm-specific competitive advantages and acquiring advanced innovation, operations, and goto-market capabilities. Instead of passively relying on whatever static set of resource endowments (natural
resources, a large labor force, and so on) their country may have inherited, emerging market governments
must play an active role in dynamically creating new sources of competitive advantage.
This is a difficult and time-consuming process, because the difference between merely good and worldclass firms is often embedded in capabilities that may have been honed for decades. In addition, worldclass firms naturally have little interest in sharing their trade secrets with anyone, let alone with emerging
market firms that could, over time, become formidable global competitors themselves. And cutting-edge
innovation in high-potential industries, such as green energy and nanotechnology, increasingly requires
massive investments that are far beyond the means of all but the largest firms.
Therefore, it is important to adopt a deliberate approach to upgrading the domestic industrial base over
time, perhaps starting, as James Cypher and James Dietz recommend in The Process of Economic
Development (Routledge, 1997; rev. 2007), with simply exporting the goods that were previously imported
but are now produced locally, and then expanding internationally into more advanced countries and
challenging categories, such as capital goods (for example, factory equipment), intermediate products (such
as batteries), and, eventually, durable consumer goods (such as cars). This step-by-step process would
expose domestic producers to foreign competitors early and encourage them to reach global performance
standards themselves — initially, just for a few relatively simple goods, but over time, also in more
complex and knowledge-intensive product categories. This is precisely the economic development path
followed by Japan, South Korea, and Taiwan.
But simply exposing domestic players to ever-tougher foreign competition is not enough by itself. If
domestic firms are ever to catch up with their far more experienced foreign competitors or, in some cases,
to take advantage of latecomer advantages in sunrise industries where firms from developed markets can be
burdened by their installed customer base and older technology standards, emerging market governments
will need to take an active role. They must engage in a process of incremental capability building and
innovation by encouraging the transfer of technology and know-how from developed markets and the
insertion of local companies into global value chains and innovation networks (for example, through local
investment and partnering requirements). They must also make substantial investments in areas such as
education, training, and applied research. In addition, they will need to create an enabling financial
environment, including credit provision to selected industries. More controversially, they may want to
maintain some combination of capital controls, active currency management, close supervision over the
banking system, and mild financial repression to ensure that scarce capital is disproportionately directed
toward investment, and that domestic firms can meet economic and social developmental goals in a more
stable business environment.
Of course, there are strong arguments against such active government intervention. These include not only
the social costs, such as higher retail prices, lower interest rates on deposits, and fewer individual
investment opportunities. There is also the potential for widespread corruption, and for domestic firms to
become dependent on government protection. But the risk of failure doesn’t negate the necessity of trying,
as no country has ever caught up without significant, albeit temporary, direct government support. To
mitigate the risks of active intervention, governments should focus on enabling, even forcing, domestic
firms to continually upgrade their capabilities and competitiveness, helping to cull the losers rather than
pick the winners, and setting clear and credible timetables for phasing out support initiatives. For example,
in the 1960s and ’70s, South Korea’s government enforced a strong export regime, specific performance
standards, and sunset clauses to expose domestic firms to world-class performance standards early and
weed out those that ultimately couldn’t compete.
To be sure, a more interventionist stance demands a highly capable government sector that is fully
independent, yet sufficiently connected with the private sector to jointly achieve ever-higher levels of
economic and societal development while avoiding excessive degrees of corruption and bribery. However,
these attributes are more a function of the domestic political system — and especially whether certain
groups enjoy privileged access to key government decision makers — than they are a particular economic
development approach, as South Korea, Taiwan, and others have demonstrated.
Phase 4: Staying sharp. As the economy matures and domestic companies become more capable, the
government’s role must change again from active intervention during the initial three catch-up phases to a
more passive enabling stance. However, that doesn’t mean the government’s job is over once the country
has achieved high-income status. The ever-accelerating pace of innovation continually pushes out the
global productivity frontier to higher performance standards, requiring ongoing investments. Countries
whose companies fall behind in this process of industrial upgrading and knowledge acquisition will become
steadily less competitive and ultimately face lower growth rates. Governments need to help local
companies stay sharp through such means as sponsoring research in advanced new technologies, investing
in complementary upstream and downstream industries, creating a supportive regulatory environment, and
providing financial incentives to reduce up-front investment requirements and mitigate startup risk for local
entrepreneurs.
In addition, structural change inevitably produces winners and losers (even when society on the whole
benefits). That hands governments an important related role in smoothing the transition process that goes
well beyond simply ensuring free market competition, low tax rates, and vigorously enforced intellectual
property laws. For example, many governments of developed countries face serious policy challenges as
manufacturing activity migrates to lower-cost countries. Their economies become increasingly reliant on
the tertiary sector: service industries. As a result, many workers are forced into subsistence service jobs
unless they have the education, experience, and aptitude required for high-end professional services sectors
such as healthcare, finance, or management consulting. When few workers are able to make this difficult
transition, individual poverty can become surprisingly common in otherwise highly developed countries.
Finally, even developed countries may simply lack enough firms with world-class capabilities to sustain
their economy as a whole. For example, Italy remains overreliant on its many small, family-owned
businesses. They are capable of high levels of craftsmanship but often don’t have the resources and scale to
compete with low-cost competitors from countries such as China. Unless these companies can become
more capable (and larger), Italy will be effectively forced to turn to old-fashioned protectionism, which in
the long term only undermines its economic competitiveness. The orthodox economist’s solution of simply
letting noncompetitive local firms be replaced by more efficient foreign competitors not only is challenging
politically, but also fails to recognize that local firm ownership still matters to a region’s prosperity. Most
multinationals remain overwhelmingly local in, for example, the makeup of their executive teams and
location of their business activities with the highest added value.
Timing Is Everything
The number of countries that remain mired in poverty today makes all too clear the need to think
differently about development — both to improve human welfare and to reduce the global impact of related
challenges, including pandemics, terrorism, and military conflict. In addition, emerging markets will
remain the best potential source of the economic growth many developed countries will need to meet their
rising social and public debt obligations.
For emerging markets to avoid the growth traps that have long held them back, government leaders need to
apply the right remedies at the right time, with interventions directed at the specific bottlenecks that prevent
domestic firms from steadily improving their capabilities relative to world-class competitors. Such policies
should focus on integrating tailored economic, institutional, and firm policies at each development stage,
and engaging in a continual process of industrial upgrading and rebalancing. The key is to craft a national
development strategy from the bottom up, rather than starting with a general set of policies and principles
and trying to deduce specific recommendations and initiatives from the top down.
To avoid growth traps, emerging market leaders need to apply the right remedies at the right time.
The result of such efforts is a winning team: a crop of highly productive homegrown companies that have
the capabilities to compete on the global stage, and that can create an economic base at home that is broad
and resilient enough to provide plentiful high-paying jobs, encourage a thriving services sector, spawn
advanced technologies and innovation, and invest in local communities.
Of course, all this is not to imply that capitalist free market economics and liberal democracies are
suddenly passé. Indeed, they will probably still be the endgame in most, perhaps even all, cases. But the
likelihood of getting there may actually be much higher if governments and multilateral institutions do not
insist on them early on — and instead give countries the tools and time they need to catch up.
Reprint No. 00331
Author Profile

John Jullens is a partner with Strategy& based in Shanghai. He co-leads the
firm’s engineered products and services practice in Greater China.
NYT
Data FEX reserves
http://www.nytimes.com/interactive/2016/02/13/business/dealbook/china-exodus-flows-currency.html
China’s Foreign Exchange Reserves
Dwindling Rapidly
By KEITH BRADSHER
FEB. 18, 2016
Photo
A worker in Beijing. China’s drop in reserves weakens its control over the value of
its currency, the renminbi. Credit Wang Zhao/Agence France-Presse — Getty Images
HONG KONG — As markets around the world have churned, China has long taken comfort in having
what in the financial world amounts to a life preserver: its vast holdings of other countries’ money.
A year and a half ago, China held as much as $4 trillion in foreign exchange reserves. The reserves
represented a symbolic trophy for China’s leaders, who have described them as the “blood and sweat” of
the workers and upheld them as a sign of national strength.
Now, as China’s economic growth slows, that sign of national strength is slowly ebbing.
China’s foreign exchange reserves are shrinking steadily as money flows out of China and Beijing moves
to shore up its currency. The country’s reserves have shrunk by nearly a fifth since the summer of 2014 —
and more than a third of the shrinkage has been in the last three months. By the end of January, reserves
stood at $3.23 trillion, a level that has prompted speculation about how much lower Beijing will let them
go.
With a smaller pot of reserves, Chinese leaders have less room to maneuver, should the economy undergo a
sudden shock. The reserves situation also weakens China’s control over the value of its currency, the
renminbi.
Continue reading the main story
Graphic
China’s Exodus of Capital
As the economy stumbles, individuals and companies are pulling money out of China en masse, leaving the
government scrambling to limit the outflows.
OPEN Graphic
The drop in reserves could also hurt China’s efforts to raise its global profile, as it doesn’t have as much
money to pump into high-profile projects in developing countries.
“If you use up $700 billion of reserves, how much more is going to follow? That is the basic problem,” said
Guntram Wolff, the director of Bruegel, a nonprofit economic research institute in Brussels.
The dwindling reserves are one of the many factors shaking global investor confidence because of the
impact the slide could have on China’s financial system. A number of investors are now betting that China
may have to let its currency depreciate, rather than dip further into its reserves.
Chinese officials are fighting back. In a rare interview published last weekend by Caixin, a Chinese
magazine, Zhou Xiaochuan, the governor of China’s central bank, said, “China has the largest volume of
foreign exchange reserves in the world, and we will not let speculative forces dominate market sentiment.”
China’s reserve hoard is a byproduct of how it manages it currency.
During China’s biggest boom years, its currency could have risen in value as huge sums in dollars, euros
and yen flowed into the country. Instead, Beijing tightly controlled the value of the renminbi, buying up
much of the inflows and putting them into its reserves instead. That brought angry accusations from the
United States and Europe that it was manipulating its currency to help keep Chinese exports inexpensive
and competitive in foreign countries.
Now that the renminbi faces pressure to fall, China is spending its reserves in an effort to prop up the
currency. But many American lawmakers and presidential candidates still accuse China of keeping its
currency artificially weak.
The reserves are still considerable, more than double Japan’s, which has the world’s second largest amount.
The central bank chief, Mr. Zhou, and others have questioned whether the reserves were too big and the
money could be better invested if left in the private sector. Mr. Zhou led a move over the last two years to
make it easier for Chinese companies and families to invest their own money overseas, only to find in
recent months that the outflows have been disconcertingly fast at times.
China has taken steps to stem further flows out of the country. This winter the Chinese authorities arrested
the leaders of underground banks that were converting billions of renminbi into dollars and euros. They
also made it harder for Chinese citizens to use their renminbi to buy insurance policies in dollars.
More quietly, Beijing bank regulators have halted sales within China of investment funds known as wealth
management products that are denominated in dollars.
Photo
Beachgoers in Sri Lanka near a major port project in Colombo backed by Chinese
investment. The erosion of China’s foreign reserves could leave it with less money
for projects in developing countries. Credit Dinuka Liyanawatte/Reuters
Beijing has also instructed bank branches in Hong Kong to limit their lending of renminbi to make it harder
for traders and investors to place bets against the Chinese currency in financial markets.
“We did receive notice from Beijing in the earlier part of January to be more stringent in approving
renminbi-denominated loans,” said a Hong Kong-based China bank executive, who insisted on anonymity
for fear of employer retaliation. “It is no fun being caught in the middle, with marketing officers wanting to
do more business and the higher-ups telling you to be tougher when reviewing credit proposals.”
The erosion of reserves is also politically awkward, given public perception, and Beijing has taken steps
aimed directly at shoring them up.
One move would keep more of its reserves free of long-term commitments. China’s central bank now
demands that at least some foreign money managers who want to invest part of the reserves pledge to
achieve an annual return of as much as 26 percent or else their management fees will be reduced, said a
person with knowledge of China’s foreign reserves who insisted on anonymity to avoid retaliation.
Chinese markets rose this week, as some investors bet that China could slow the erosion. Expectations have
faded that the Federal Reserve will keep raising interest rates this year, making China look more attractive.
And China is running huge trade surpluses, bringing in a steady inflow of foreign money.
Economists inside and outside China are increasingly trying to guess how far reserves must fall before
China might consider a sharp devaluation of the currency. An International Monetary Fund model suggests
that an economy of China’s size needs $1.5 trillion with strict capital controls and $2.7 trillion without
them.
Brad Setser, a former United States Treasury official now at the Council on Foreign Relations, said that
China could manage with smaller reserves because the model is not designed for a country with domestic
banking deposits as large as China’s.
The Texas hedge fund manager J. Kyle Bass, who has bet on a fall in the renminbi, recently told clients that
his firm believes China doesn’t even have the ability to tap all of its reserves because as much as $1 trillion
is already committed to long-term investments. But most economists disagree, saying that no more than
$300 billion has been committed to various projects and not yet disbursed, while the rest of China’s $3.23
trillion in reserves is readily usable.
Longer term, China looks less likely to commit its reserves to big projects that build up its image abroad,
said Victor Shih, a specialist in Chinese finance at the University of California, San Diego. “When you’re
losing $100 billion a month, you can’t afford to invest in a highway in the middle of nowhere or a railway
in Pakistan that could be blown up,” he said.
In 2014, President Xi Jinping announced that China would provide the bulk of the $50 billion to set up an
Asian Infrastructure Investment Bank and then said a month later that China would also set up a $40 billion
fund to invest in many of the same countries that would borrow from the bank.
Last month, Mr. Xi announced yet another fund for additional infrastructure projects in the world’s poorest
countries. Its total: just $50 million, barely enough to build a few roads in a single impoverished country.
The Economist
Red-ink China
Some ways in which the Chinese economy might evolve
Feb 17th 2016, 14:29 by R.A. | LONDON
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
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THIS week began with the release of a staggering number. In January, new debt issued in China rose to just
over $500 billion, an all-time high. Not all of the "new" debt was actually new; some represented a move
out of foreign-currency loans and into local-currency borrowing (in order to reduce foreign-currency risk).
But the flow of red ink is not a mirage. China's government opened the credit taps early in 2016 in order to
reduce the odds of a sharp economic slowdown. Private borrowing in China has grown rapidly and steadily
since 2008, even as nominal output growth has slowed. As of 2014, according to an estimate by the
McKinsey Global Institute, total debt in China stood at 282% of GDP. China is rapidly becoming one of
the most indebted countries in the world.
So what? There is a cottage industry of analysts out there gaming out the ways in which a crisis of some
sort might unfold within China. But with debts of this magnitude accumulating, you don't need to posit a
looming crisis to draw some reasonably strong, and reasonably gloomy conclusions about the near-term
future of the Chinese economy—and the world as a whole.
At some point, Chinese corporates will need to deleverage. It is hard to say precisely when or why, but a
deleveraging at some point is inevitable. The result of that deleveraging, when it occurs, will be a big drag
on demand growth within China. That, in turn, will translate into much slower GDP growth, unless some
other source of demand can be found.
China could try to boost demand by encouraging more spending and investment by non-corporates. This
probably wouldn't work especially well, if the history of other economies in such circumstances is any
guide. Households have also been adding debt at a good clip. To get them to borrow at an even faster pace,
especially at a time when (presumably, given the corporate deleveraging) animal spirits are not at their
most spirited, the Chinese government would basically have to force new loans down households' throats.
Certainly, we could expect China to hit the zero lower bound on interest rates and to begin QE.
Zero rates and QE would place significant downward pressure on the value of the yuan. That's just as well,
since another thing history tells us is that demand-deficient, deleveraging economies depreciate their
currencies and rely on exernal demand to support growth.
Of course, most countries in the situation we're imagining here aren't already running big trade surpluses. It
is possible, given the importance to China of supply-chain trade, that even a big depreciation wouldn't
boost demand in the economy very much, since it would make imported components more expensive even
as it made exports cheaper. If those arguments are right, they suggest that a Chinese adjustment would
require either a really big depreciation, or would be slower and more painful, or a bit of both.
Conventional wisdom has it, however, that China does not want to depreciate the currency. Depreciation
might not boost net exports by much, but it would make dollar-denominated loans more expensive
(increasing the pressure on some of those deleveraging corporates), it would squeeze Chinese consumers,
and it would represent a big loss of face for the government. If China were to resist depreciation, then the
demand shortfall would be much larger, and the pain of the deleveraging process would be greater. What's
more, if China did not wish to see its reserves vanish with startling speed, its government would need to reimpose stiff capital controls. Even the stiffest of capital controls might prove too leaky to prevent the drip-
drip-dripping away of reserves (and eventual pressure to depreciate) unless the Chinese government
simultaneously imposed stiffer controls on both trade and investment. Yet that would not be a good thing
for the Chinese economy at all. It therefore stands to reason that while the government might resist
depreciation of the currency for a while, it will eventually begin to look the least bad of the available
options.
There is a third potential source of demand: government borrowing. While the Chinese economy as a whole
has lots of debt, the central government's debt load is relatively modest at between 40% and 50% of GDP.
It seems a sure thing that in the event of a sudden deleveraging, China's government would have no qualms
about assuming troubled debts, taking over wobbly firms, and borrowing for massive public-investment
campaigns. It shouldn't have any trouble financing the debt, either by encouraging the patriotic domestic
consumption of government bonds or through QE. But how effective would spending be at boosting
demand? It's hard to say. If the government were simultaneously resisting depreciation, China's experience
might look an awful lot like Japan's, in which big budget deficits were not enough to spark a robust
recovery.
Maybe—maybe—the Chinese government could hit the policy sweet spot. Maybe it could, all in one
smooth go, depreciate, let deadbeat firms fail, protect the creditors that need to be protected to prevent a
panic, maintain the flow of credit to good borrowers, credibly promise to maintain aggregate demand
through monetary easing, and support that promise as necessary through aggressive fiscal stimulus. In
practice, governments always get some big things wrong before getting things right. And so what we are
left with is either a slumping China which exports some of its demand weakness abroad as it depreciates, or
a China that resists depreciation and therefore slumps in much more serious fashion, and which ends up
exporting demand weakness anyway. A Chinese slump would send a sharp disinflationary impulse across
the rest of the world. If the rest of the world is still stuck with low inflation and low interest rates when this
occurs, as seems probable, then this impulse will not easily be offset. And this all assumes that China
manages to avoid a major banking crisis.
Who knows what might happen next. Perhaps the euro zone would slip back into recession and then break
up. Perhaps everyone would simply grit their teeth through another few years of economic difficulty. But
the bigger China's debt pile grows, the bigger a Chinese deleveraging episode looms ahead, somewhere in
the not-so-distant future.
Asia Pathways
FINANCE
Globalizing the RMB? Beijing appoints
three new clearing banks in London,
Frankfurt, and Seoul
By Gregory Chin. Posted July 29, 2014
In the span of three weeks from late June to early July 2014, the central bank of the People’s Republic of
China (PRC) appointed three new RMB clearing banks successively for London (China Construction
Bank), Frankfurt (Bank of China), and Seoul (Bank of Communications). The three new clearing banks
join the existing group of RMB clearing banks of the Industrial & Commercial Bank in Singapore: and the
Bank of China for Hong Kong, China; Macao, China; and Taipei,China.
It has become increasingly apparent that the People’s Bank of China (PBOC) sees the internationalization
of the RMB as unfolding through the creation of a global network of offshore RMB clearing banks,
currency swap agreements, integrated e-infrastructure, and related regulatory underpinnings for backingstopping the RMB transactions by market actors and official reserve managers.
The recent appointments of the clearing banks for Germany, the Republic of Korea (henceforth, Korea),
and the UK received impetus from the delays in official PRC efforts to create the China Integrated
Payments Systems for direct offshore-onshore payments and clearing with the mainland.
Big steps toward RMB internationalization
In the eyes of Beijing, London took two big steps forward in this global network for RMB
internationalization when the PRC named China Construction Bank (CCB) as the RMB clearing bank for
London in June, and subsequently authorized the China Foreign Exchange Trade System to launch direct
trading between the RMB and the British pound on the interbank foreign exchange markets.1
London’s ambition, and that of the UK Treasury, is for the UK capital to be “a” hub for the international
use of the RMB, the so-called “Western hub” for the RMB, including the European market and beyond.
However, London already had access to offshore-onshore RMB clearing through Hong Kong, China, and
many of the leading London-based banks and PRC banks in London have well established RMB clearing
arrangements in their networks that stretch back to the mainland, and so it remains to be seen what will be
the impact of CCB receiving the official status for the UK from PBOC.
Much will also depend on CCB’s capacity to make the business case, especially for European-based traders
and investors, to use CCB’s newly established clearing channel rather than going through existing channels
in Singapore or Hong Kong, China.
Beyond the CCB, the most prominent banks in London—especially those geared to emerging markets, and
have a strong presence in Hong Kong, China, and the Asian region—are looking beyond Europe, and
eyeing how to link from London further westward to North America and South America, southward to
Africa, and with the Gulf states in between—in short, to offer 24 hours a day, 7 days a week, RMB
services. This is no small ambition.
London surely has some structural advantages. It is the largest foreign exchange trading market in the
world, with an average daily turnover in traditional foreign exchange market transactions (spot transactions,
outright forwards and FX swaps) totaling $4.4 trillion in October 2012.2 This accounted for 37% of global
foreign exchange trading at that time. Twice as many dollars are traded on the foreign exchange market in
the UK than in the US, and more than twice as many euros are traded in the UK than in all the euro-area
countries combined. Worldwide, foreign exchange is the most traded financial market, and London has
captured a growing share of this market.
London handled 62% of RMB trading3 conducted outside of the PRC and Hong Kong, China, in October
2013, according to data from SWIFT, the global payments company. At that time, volumes in London were
around $5 billion per day, up from about $2.5 billion in October 2012. SWIFT data also shows, however,
that Singapore regained the lead for RMB payments and offshore clearing (outside of Hong Kong, China)
in February 2014, surpassing London. The value of RMB payments rose by 375% from March 2013 to
March 2014.
Nonetheless, many analysts suggest that London’s standing as the main global center for currency trading
for the dollar and euro—strong asset management skills, highly developed financial e-infrastructure, strong
rule of law, and legal systems, English as the language of business, its strengths in trading generated by
prime brokerage, investment banking, and hedge funds—means that London will have a strong role to play
in internationalizing the RMB outside of the PRC and Hong Kong, China.
The case for Frankfurt is compelling. The Bank of China in Frankfurt is situated in a context where real
economy linkages between Germany and the PRC are deep and broad. A number of the leading German
multinational corporations, including Volkswagen, are using RMB to settle a growing portion of their
exports to the PRC. A large number of small and medium-sized German companies engaged in high valueadded manufacturing and design, are looking to strengthen their partnerships with PRC counterparts—the
RMB will likely feature as the currency for a portion of these transactions. The Bank of China in Frankfurt
can tap into the BOC’s well-established RMB trade financing tools, e-infrastructure and related payments
arrangements, and clearing channels for international use of the RMB, which include the bank’s ties to a
plethora of domestic companies in the PRC.
A key variable for Frankfurt is whether Germany’s most powerful banks will opt to transact in RMB via
Frankfurt, or whether they will prefer to operate through their London branch, or via Hong Kong, China’s
established arrangements. London remains the transaction center for 250 foreign and UK-based banks;
continues to handle the financial services for many European exporters and importers, including traderelated foreign exchange business for banks from other European powerhouses, including Germany.
The case of Seoul is most perplexing. Trade and investment between the PRC and Korea are high and
continue to grow. The two economies are highly integrated. However, although Korean finance officials
have approached RMB internationalization with the requisite political will, central bankers have been
cautious (perhaps understandably) in introducing the technical arrangements to facilitate the growth of a
pool of offshore RMB in the financial sector in Seoul. Perhaps most important, Korean traders and
investors are hesitant about engaging in RMB-based transactions due to concerns about having ready
access to a supply of RMB to settle trade accounts over the medium term. Dollar inertia is strong in the
Korea case, despite the structural rationale for transitioning to a variety of international currency options.
Financial centers compete to create RMB infrastructure
Each financial center is now competing to create RMB-supportive banking infrastructure and regulation in
the hopes of capturing a greater share of the profits as the RMB’s international use continues to grow. From
a systemic perspective, rising competition between the financial centers competing as offshore RMB hubs
could help generate new products and could induce more efficient regulation. At the same time, this
competition could generate either inefficiencies in clearing arrangements, or even global financial stability
concerns if the RMB centers clash over clearing arrangements or regulatory innovation—or end up in a
race toward high risk financial innovation. Market actors have noted that the size of the pool of offshore
RMB is a constraint, a source of liquidity concern for the offshore RMB hubs (except perhaps Hong Kong,
China). The latest statement a few weeks ago in Shanghai from PRC officials was that the total pool of
offshore RMB has grown to about RMB 1.5 trillion (about RMB 900 billion RMB in Hong Kong, China,
and the rest mainly in London, Singapore and Taipei,China). However, the PRC maintains controls over the
cross-border flow of RMB. Competition between the hubs on financial product innovation can go some
way to helping to provide additional liquidity. As long as the various RMB hubs remain as segmented and
discrete pools of RMB, rather than agglomerating into a globalized pool of offshore RMB—and the capital
controls remain in place—then the liquidity concerns persist for many of the hubs.
A greater degree of coordination between the offshore hubs on clearing infrastructure and regulations—and
with the PBOC—would help to facilitate the integration of the pools of offshore RMB into a larger global
pool of RMB. It would also be helpful if the regulators could help steer the competition between the RMB
hubs toward developing longer-term RMB-denominated investment products that can attract Asian
pensions and other large-scale asset managers in need of long-duration products.
To the degree that we see significant advances in RMB transactions in London, Frankfurt, and Seoul—
including the growth of a secondary market—and the continued growth of Singapore, Taipei,China, and
other European financial centers and, of course, Hong Kong, China, as RMB platforms, then we are really
talking about the globalizing of the RMB, in the sense that the geography of offshore and onshore RMB
transactions are becoming increasingly global in scope, rather than merely cross-border (internationalized),
or confined to the Asian region alone (regionalized).
_____
1
The People’s Bank of China. 2014. www.pbc.gov.cn:8080/publish/english/955/index.html
2
TheCityUK. 2013. London increases lead in foreign exchange trading as global turnover drops 7%. 29 January.
3
Financial Times. 2013. Fed Explores Overhaul of Key Rate. 8 October