China’s legitimate risks
The People’s Bank of China, boasting the world’s largest financial assets, unabashedly displayed its riches in its currency war last week. Beijing’s authorities scrapped the circuit breaker after the mechanism failed to stop an avalanche of sell-offs in the Shanghai bourse. It subsequently opened its foreign currency hoard to use some of its greenback holdings to shovel up yuan and Hong Kong dollars from the Hong Kong capital market. It clearly showed who was the boss in Shanghai and Hong Kong. Foreign speculators eventually backed off.
But last week would be just the first round. The bet is still on for a strong U.S. dollar and weak yuan. The U.S. Federal Reserve will go on with its tightening cycle, and the Chinese economy is cooling off faster than expected. Beijing ensures it can achieve a growth of 6.5 percent, but given railway freight volume and electric power use, even 5 percent growth appears to be difficult. Hedge funds will likely prepare more raids.
The Hong Kong and Shanghai markets are different. The Hong Kong dollar is strictly pegged against the U.S. dollar because an expensive currency could stoke up interest rates and devastate the island’s property market. That’s why Hong Kong poured out 19 trillion won ($16 billion) and bought 5 percent of the stock market capitalization in 1998 to defend the Maginot line.
Beijing is less desperate. It mostly sides with hedge funds in their bet on the yuan’s devaluation. But it disagrees with the speed. When the yuan appreciated sharply last year, it shifted to a multi-currency basket. It wants to navigate incremental devaluation to sustain exports and keep up steady growth. But its plan was interrupted after speculative foreign capital ebbed out of the country en masse. The local currency jumped too fast and the stock market crashed. The market backfired.
Global markets have been rattled with a “cocktail of risks” from China and plunging oil prices. The Chinese economy indeed is strained. But it is by no means running toward an immediate disaster. It is not out of the ordinary for an economy with per capita income of $10,000 to grow at a pace of 5 to 6 percent. Moreover, China is sitting on foreign exchange reserves of over $3 trillion.
The real risk lies elsewhere — in the people and the systems. Beijing firmly believed in its ability to navigate its colossal economy. It mastered the hybrid economy by moderating intervention and driving the economy at staggering pace. But its capacity is beginning to raise questions. When the stock market began to falter last year, it rolled out one makeshift measure after another — prohibiting stock sales by large shareholders and introducing a circuit breaker. It acted without any respect for market trends. Investors began to lose confidence in Chinese authorities as their plans backfired one after the other.
Beijing also has a formidable contestant to deal with — Uncle Sam. Washington has so far tolerated a subdued yuan. But it clearly drew a line and warned of an impending currency war if Beijing went further. Washington fears the yen’s appreciation relative to the yuan could undermine U.S. global strategy. Beijing cannot go on defending the yuan with Washington accusing it of manipulation, citing China’s trade surplus of $500 billion — the largest in the world. So Beijing must inevitably watch its step.
China, which drove the global economy over the last 30 years, is now regarded as the next epicenter for a major financial crisis. The country is currently paying the price for past excesses and grappling with overcapacity, over-debt and oversupply. Its real estate and equity markets are on the brink of bursting. The stock market rout at the beginning of the year wiped out 5,000 trillion won worth of capitalization off global stock markets. The economy is no runaway train, but it is still undoubtedly losing steam fast.
The neighboring Korean market is feeling the repercussions from China’s roller coaster ride. The Seoul bourse’s coupling ratio against the Shanghai market is the world’s highest at 0.75, and a quarter of the country’s trade hinges on China. We cannot comfortably watch the Chinese markets be eaten up by international speculators. President Park Geun-hye has been raising alarms about the economy, warning of a perfect storm and the possibility of massive layoffs. It may not all be a bluff. We must keep our eyes open if we want to avoid becoming the next casualty.