Quick fixes in China
A Chinese official recently paid a discreet visit to South Korea’s financial authority, the Financial Services Commission. He wanted to get some lessons from Seoul’s experience of a catastrophic failure while trying to prop up the Korean stock market during a downward spiral in 1989. He took home an armful of documents for research.
The Chinese yuan saw its biggest recent fall last week, dropping 4.65 percent for three consecutive days after the People’s Bank of China’s surprise devaluation of the currency by about 2 percent.
Chinese authorities claimed the move was engineered to bring the currency closer to the market rate. But its intervention only heightened concerns that the Chinese economy may be doing more poorly than the official data suggests, particularly as the move followed disappointing trade data, and authorities had to interfere to boost exports. It also could suggest that Beijing may be veering away from an earlier stance that it wouldn’t artificially stimulate growth to concentrate more on structural reforms and expand domestic demand.
The series of heavy-handed interferences with the market - an interest rate cut, additional fiscal spending, a series of measures to boost stocks and stop a stock market free fall, and now intervention to depreciate the currency - all suggest that Beijing was using all the tools at its disposal to bolster growth. The actions over the last few months are all opposite of what Chinese Premier Li Keqiang had promised investors earlier in the year: that Beijing was confident of keeping growth at a level of around 7 percent and would place higher priority on pursuing structural reforms than stimulating growth.
What Li and the Communist Party think could be different.
The Communist Party is paranoid about any threat to its single-party dominance. The masses tend to get restive if their lives turn harder due to a poor economy. Chiang Kai-shek and his government had to flee to Taiwan in 1949 due to hyperinflation. During the civil war between Nationalist leader Chiang and Communist leader Mao Zedong between 1927 and 1949, consumer prices rose by 2 million percent. Only in Taiwan, which was under Japanese colonial rule from 1894 to 1945, was inflation in a manageable range. Price instability from fast progress after a decade of market opening also led to student and nationwide protests that ended with the Tiananmen Square massacre in 1989. Inflation hit 20 percent from 1987 to 1988.
The safest way to inflate an economy is through housing price gains. Real estate properties take up 74 percent of Chinese household assets. But real estate prices have plummeted in a typical sign of a bursting of a bubble. The working population aged between 15 and 64 that is eligible to own homes has been declining since 2013. Mortgages make up 76 percent of household debt, raising concerns of them turning sour. Being house-poor - not being able to afford anything but the mortgage payments - has become a serious problem.
The government also cannot go on pumping out infrastructure spending as the country is already saddled with overcapacity and too much debt. Public debt by local governments and state enterprises has snowballed to astronomical figures and the number of people who cannot pay their credit card bills is surging. The government maintains the combined debt of private enterprises and governments equals 230 percent of gross domestic product, but few believe the data. Kaisa, a former poster child for China’s booming real estate market, became one of the biggest Chinese developers to go bankrupt. Its case raised concerns about the real condition of the Chinese economy as the company, which initially reported it was defaulting on a $52 million loan, later admitted it had more than $10 billion in debt.
China is suffering the typical pains that come from rapid growth. It is laden with debt and excess industrial capacity. Economic growth that slows to a 6 percent pace along with snowballing debt is a dangerous mix. Korea got out of that trap through a sweeping restructuring of heavy industries in the 1980s. So far Chinese authorities seem to be concentrating on makeshift measures instead of attempting fundamental fixes. Their actions can buy China time, but could explode at any time to wreck havoc on the Chinese and world economy.
China has been the locomotive of the global economy for the last 25 years and Korea has benefited greatly from a free ride. The wind, however, may be changing direction. Hyundai and Kia Motors’ market share in China dropped sharply this year and local makers like Huawei and Xiaomi are rivaling Samsung Electronics in the local smartphone market.
China has become our burden instead of our windfall. The yuan has stabilized, but the direction is set to go south. The market expects the currency to devalue by an additional 5 percent. Global powers like the U.S. and China often use foreign exchange or interest rate policies to stimulate their own economies despite beggar-thy-neighbor criticism. Since China sits on foreign exchange reserves of $3.7 trillion, there is little danger of a liquidity crisis. But the ramifications on its neighbors could be big. Korea was hit hard when China appreciated its currency by 51 percent in 1994.
Korea, still intoxicated by its membership in the Organization for Economic Cooperation and Development in 1996, faced a liquidity crisis due to a sharp appreciation of the won. The Korean economy is like a candle in the winds coming from the U.S. and China. We must not let our guard down.
JoongAng Ilbo, Aug. 18, Page 34
*The author is a senior editorial writer of the JoongAng Ilbo.
by Lee Chul-ho