China: A Continent of Stability?

By Alexander Salitski and Igor Tomberg, 11.08.2011

http://www.strategic-culture.org/news/2011/08/11/china-a-continent-of-stability-i.html

US national default was narrowly averted in the short-term after weeks of permanent headaches for the global economy, but, with the higher US debt ceiling supposed to sustain financial stability through 2012, serious problems continue to loom on the horizon. The US, still a single superpower and the world's biggest economy, is sure to stay on the downward trajectory, and the last-minute deal which lifted the country's borrowing limit did not prevent an unprecedented downgrade of the US credit rating from the formerly axiomatic AAA to AA+. China as the top holder of US bonds harshly reacted to the shift by calls for replacing the US dollar as the global reserve currencyŠ

At the moment China's yuan is a clear forerunner among candidates for the mission of a new world currency. Beijing's reiterating that the yuan should be admitted to the privileged club of reserve currencies in part reflects fears that the global financial system is entering a protracted period of volatility and turbulence. In the meantime, China's increasingly important status is propped up not only by its unsurpassed currency holdings and sway over the world's spheres of financial transactions from commodity exchanges to bonds trading, but also by the stabilizing character of the influence it contributes to the global economy. The stabilizing role played by China during and in the wake of the crisis grows naturally out of the Chinese economic system which differs fundamentally from the Western economy with its bloated and largely virtual financial sector.

China's title of the global factory shows to what extent the country has succeeded in creating powerful and as of today fairly integrated industrial capacities. The policy of building industrial might - along with engaging with the global market - was adopted in Beijing back in the mid-1980ies, and today's Chinese industry is both extremely competitive and sufficiently diversified. The supply and demand posed by China largely define the readings of the global market barometers and, moreover, factor considerably into the state of global politics, making China the key driver of the new globalization and worldwide changes.

Having outpaced the US in terms of export and import growth by factors of around 1.5 and 2 in 2010, already this year China may emerge as the world trade champion. China's postings for the first half of 2011 are also impressive. Notably, at the moment the Chinese volume of export only slightly trails that of the EU: in 2010, the share foreign trade of the EU as a whole in the world's total was 15% vs. China's 13.3%. In fact, China's share may be even higher considering that a fraction of its cross-border exports are delivered to the markets in neighboring countries by individual vendors without customs declarations.

China's export activity appears generally sustainable and is relatively immune to the oscillatory character of the world trade. In 2009, at the peak of the crisis, the Chinese export dropped by 16% compared to the 23% global average. Importantly, China's overall export volume is not overly sensitive to fluctuations of demand for individual types of products. In 2006-2010 the convincing 15.7% average export growth was achieved regardless of the unfavorable pricing climate as over the period of time the prices of electronic appliances stagnated and those of labor-intensive products decreased.

Under all circumstances, China remains one of the top-stable consumer markets. Its import grows steadily ahead of export and, moreover, even in 2009, a disastrous year for the world trade, the physical volume of China's import rose by 2.9% compared to the 12.8% contraction of the global average.

Pricing competition across the global market gathers momentum as China inches towards the leadership in the world trade. Formerly limited to products of labor-intensive traditional sectors like the textile and clothing industries, the race over offering better prices now spill to the markets of industrial equipment, electronic appliances and devices, durable consumer products, etc.

The truth highlighted by the crisis is that China's competitive edge is not attributable preeminently to discount prices or the undervalued yuan as US critics permanently charge. In the difficult [year] 2009, China's export did not plummet as deeply as that of its Asian peers while the yuan/dollar rate remained fixed and their currencies shed weight. The underlying cause unrelated to the currency value is that China with its increasingly integrated industrial capacities is making vast progress in replacing formerly imported product components with those manufactured domestically.

On top of being healthily insulated from the world's financial instabilities, the Chinese economy demonstrates an ability to carry on with strong growth regardless of the shrinking export. In 1997 China's ratio of foreign trade volume to GDP (both expressed in US dollars) equaled 42%. Following a slight decrease in the next couple of years, the index eventually climbed to 57% in 2008. In 2009 the striking nearly 14% export dip could be expected to undercut China's economic growth which in fact slowed down minimally and promptly picked up in 2010 (the toll on China's export taken by the 1998-1999 Asian crisis - a 0.4% foreign trade decrease - seems insignificant in comparison but bore a much stronger impact on the Chinese economy).

In China's case, there is loose correlation between export dynamics and GDP, and the export growth adds little to the overall state of the economy. At first glance, the conclusion seems to contradict the widely accepted notion that the share of added value and local production in China's exports are rising.

Assembly based on imported components along with processing trade are known to account for much of China's export sector. Beijing is staunchly implementing the strategy aimed at boosting the share of the value added within China in the country's export, the result being an increase of the ratio of costs of export and import in foreign trade from 1.2 in 1994 to slightly under 1.8 in 2010. As a parallel process, the share of processing trade in China's export was reduced from 48.6% to 38.9% during the 11th five-year period in line with the strategy.

The impression is that currently the Chinese economy depends on export much less than it used to back at the time of the Asian crisis. The potential explanation is that, in part thanks to the quality anti-crisis package, China's development is being mainly energized by domestic demand for investments and consumer products. In the situation, export volume figures became misleading and the projections that the fall of the global demand would plunge the Chinese economy into crisis have proved naive. Liquidity injections and spiking accumulation rates (which, conversely, used to go down in the 1990ies) tend to offset the impact of global demand contraction on the Chinese economy. As for the export sector, the recent crisis effectively filtered out its weakest players, the end result being the sanation of the Chinese economy.

The 1997-1998 financial crisis highlighted the advantages of China's gradualist approach to integration into the world economy and to liberalization of foreign-trade policies. Recovery from the current crisis which spread globally from the West was accompanied by expectations that China would eventually take the role of the world's economic locomotive, but a more realistic scenario is that the beneficial impact of China's continuing rise will be highly selective.

China is becoming increasingly independent from external financial infusions, and it currently appears that the country will not be absorbing foreign investments at the same rate as it used to. The 11.9% annualized growth of direct investments in China in 2006-2010 - a handsome total of $426b - should not obscure the wider picture: the share of direct foreign investments in China's investment portfolio is steadily on a downward trend and shrank from 4-6% to 2-3% over the period. The share of direct foreign investments does continue to grow in China's central and eastern regions and in the country's services sector, plus the average figures of foreign investments per company are clearly rising.

In contrast to direct foreign investments in China, the volumes of financial outpourings from the country grew at a breakneck pace - by nearly 40% annually - over the 11th five-year cycle. As of late 2010, the total of China's investments abroad reached $246b, with $59b handed out to foreign partners in 2010 alone.

Generally, the Chinese economy is already saturated with financial resources, and the patterns of interactions between foreign and national investments within China are changing accordingly. In fact the same holds true with regard to the interplay between Chinese and other investments across the global economy. On the whole, at the moment the dynamics of China's inherently secure economy overshadows the advanced West's sluggish recovery in shaping the globalization process. The Chinese entrenchment in the international services sector is also worth noting. The combined output of China's and Hong Kong's de facto integrated services sectors puts the virtual economic conglomerate on the second position in the list of global championsŠ

The healthy accumulation of financial resources stabilizes China's domestic demand. Liquidity injections in China are efficiently channeled into the manufacturing sector, with seizable benefits eventually being drawn by the global economy. The positive impact of the Chinese economic rise is not limited to the country's heavily industrialized partners such as East Asian countries and Germany. Commodity suppliers also gain massively from China's contribution to global demand. The share of natural resources in the Chinese import climbed throughout the 11th five-year cycle from 20.3% in 2005 to 28.7% in 2010. Expressed in physical terms, China's commodity import over the period almost doubled. The import of ferrous ore, for example, rose by a factor of 2.2 and topped 600 billion tons.

Over the past economically tight several years, China's demand for commodities seriously helped to sustain a tolerable pricing climate on the corresponding markets. In particular, the recent coal and ferrous ore price hikes are clearly attributable to China's appetites.

In the settings of the global economic nosedive, China's relatively robust energy demand was the key to the vitality of the oil and gas markets. At the peak of the crisis in 2009, the cost of China's fuel import dropped by 27% (to $124b, or 12.3% of China's import total) compared to the 44% US energy import contraction (to $279b, or 17.5% of the US import total).

It should be taken into account in the context that, contrary to widespread criticism, China is not a black hole in terms of energy consumption. While the country was posting impressive growth figures in the second half of the 2000ies, its energy generation and consumption grew at a relatively moderate rate. In 2005-2010, energy generation in China reportedly increased by 6.7% annually while the country's coal, oil, and natural gas production respectively added 6.6%, 2.3%, and 14.4% a year. The electric power output in China grew by 11% annually on the average. The statistics reflect China's serious energy efficiency progress, with the sectoral energy efficiency data being even more impressive. In 2006-2010 the energy efficiency   improvements in the production of copper, caustic soda, steel, aluminum, and ethylene reached 36%, 35%, 12%, 12%, and 11.5%. The coal-burning efficiency for electric power generation rose by 16%. China's results for the 11th five-year cycle are therefore comparable to those attained by Japan, a country with a reputation for energy efficiency, over three decades. In Japan, the improvements in 1973-2006 made 20% in steel production, 24% - in concrete production, and 24% in the chemicals sector.

China's monetary policies exert influence over the global financial situation as profound as China's commodity needs - over the market of natural resources. In October, 2010, the announcement of higher interest rates by the People's Bank of China triggered - for the first time on record - appreciable corrections across the financial markets. Since the moment, Beijing's steps in the financial sphere visibly affected the prices of cold, copper, and the Brent and WTE crude.

The Chinese economy copes fairly easily with the growing prices for some of its imports and with the surge of domestic costs and tariffs. In part, China owes its economic stability to being less dependent on energy import than the US, the EU, or Japan. The Chinese economy is not burdened with ample sovereign or corporate debt, is free of financial sector hypertrophy, and must be credited with success in switching to a higher efficiency mode and cultivating a native services sector. The above combines into generally positive economic outlook for the country. For the rest of the world, gains to be derived from the strengthening of China will be proportional to its partners' ability to optimize the strategies of cooperating with the country at the government, corporate, and regional levels.

The abstract concept of world economy adopted by the West as the theoretical foundation of its financial globalization campaign is obviously getting out of sync with reality. The West's plan obviously was to create a global financial market under its own control, charged with the mission of distributing assets across the world. The grip on the market was supposed to enable the key players to send destructive signals to national economies, to feed to them various toxic financial assets, or to occasionally bloc the accounts of defiant leaders, companies, and banks.At the moment, China's national financial system remains insulated from this type of "coordination" and capable of playing internationally a big game of its own. It should be noted that recently Dagong Global Credit Rating, China's top rating agency, similarly to Standard and Poor's downgraded the US credit rating in response to Washington's enactment of a higher national borrowings ceiling.

The West's crisis and the unhealthy state of the global financial system automatically cast new light on the advantages of the Chinese system of financial control. Under the circumstances, the part of the world economy powered by the yuan balances its part which fell into untamed dependence on the volatile Western financial markets.

There is consensus among experts that the internationalization of the yuan proceeds considerably faster than expected. The calculations performed by Standard and Poor's show that over the coming 2-3 years the share of yuan payments in China's foreign trade will likely reach 20%-30%. Under the circumstances, it will depend on the readiness of China's trade partners to accept de facto overdue changes to what extent they will benefit from the currency diversification. Measuring the feasibility of switching the trade with China, including Russia's energy export, to the yuan therefore appears to be a timely idea. It should be also taken into account that, in contrast to what is happening across Western markets, China's domestic commodity prices currently stay on a steady upward trend.

China's growing importance to commodity markets must not be ignored by Russia whose economy is propped up by the export of natural resources. A diversification of Russia's east-bound energy export was officially installed into the national agenda, but so far the volume of fuel export from Russia to China remains stuck at a fairly low mark compared with that to Europe.

The widening of the zone of economies tightly interwoven with China's economy translates into a serious modification of the traditional North-South interaction models, one of the scenarios on the horizon even being the partition of the global economy into two distinct spheres with their independent centers of gravity. For companies and governments, the dynamics should highlight the importance of developing strategies aimed at optimizing in advance the models of engagement with the Chinese economy.

In particular, it should be realized that the Chinese economy is increasingly exporting investments and that, in contrast to the Western capitals, those from China came into being in the settings of the national modernization and linked to the manufacturing sector rather than to financial markets. The potential impact of Chinese investments on Russia's economy is yet to be understood considering that the amount of those attracted by Russia up to date is fairly modest. Russian state-run companies, for example, should pay closer attention to the Chinese financial market as getting Chinese and other Asian investors involved into their anticipated partial privatization could prove to be an excellent idea. Among other benefits, Chinese investments can help to shield Russian assets from speculative attacks and the Western investors' mood swings. Notably, the Chinese stock market fared better than Western ones during last week's panic caused by the US debt ceiling problem. Even when the Chinese stock market shows clear signs of overheating or suffers occasional asset value drains, China's economic growth holds on thanks to the clever architecture of the national financial system originally designed to sustain the development of the manufacturing sector. In this regard, China differers radically from the countries whose bloated financial sectors dominate their economies.

As the credit ratings of the countries where the huge financial sector debts weigh on national budgets continue to slide, countries solidly free of external deficit are exposed to the threat of sharp revaluations of their currencies, which, in the cases of China and Russia, would undermine their export capabilities. In contrast, the impact of the potential revaluations on the countries' bilateral ties would be positive, especially if some level of coordination of the revaluation processes is achieved.

The strengthening of the yuan, Beijing's gradual loss of interest in pumping up its currency holdings, and China's vigorous search for untapped investment niches altogether boost the importance of the China-Russia partnership for both countries. China's potential in the investment sphere is adequate to Russia's task of cultivating its enormous and extremely resource-rich territories, meaning that the cooperation between Russia and China has a serious future.

It should be taken into account as well that, in contrast to Western countries, China is not overreacting to the tide of panic currently sweeping across the world's financial markets. Assessing the damage the Chinese currency holdings may face as the dollar is shedding value, Chinese economists suggest using the reserves to reinforce the country's positions internationally, to reign in inflation, to launch new investment programs, and, above all, to strengthen China's domestic market based on higher population incomes. There is concern in China that the country can be overwhelmed by foreign investments, with rocketing inflation as the likely result. For China, being a continent of stability takes more than just the abundance of financial resources - preserving the worldview which helps the Chinese solve problems and retain optimism regardless of how their situation is seen from the outside is similarly important.

Given the current volatility of Western finances, deeper engagement with China appears to be Russia's natural approach to providing its national economy with some kind of defense. For Beijing, Russia's standing would improve if the course it steers in the international economy meets the expectations of the Chinese regulators and business community who surely know what modernization is about.