Never has China exerted such an influence on global markets than in the past two years: driving demand for commodities and influencing equity markets throughout Asia and beyond.
China remains one of the best performing equity markets this year, but while the Shanghai Composite fell more than 20 per cent in August, many other stock indices have posted gains.
Mauro Guillén, director of the Lauder Institute and professor of international management at the University of Pennsylvania’s Wharton School, will answer readers’ questions on China’s continuing influence over global markets on Monday September 7.
We have seen the Shanghai Composite have more and more of a bearing on European equities markets. Is this emblematic of the rise of China toward superpower status, or does it say more about the uncertain nature of the rally in Europe? What factors lie behind the underperformance of Chinese stocks just lately?
Bernard Thomas, London
Mauro Guillén: In spite of the theory of “decoupling,” we have seen in the last two years that stock markets around the world are moving in unison (an important exception being Shanghai’s last month).
When uncertainty is high, market participants tend to observe each other in search of clues. It is not surprising that people are looking towards China for signs of what’s to come. China has implemented the most successful economic stimulus program to date, and the economy is growing quickly.
But please note that there is uncertainty not just about the sustainability of the US and European stock rallies. It also extends to the Chinese markets. It is unclear to me that Chinese equity markets can provide the impetus for global financial markets. They are small, not fully transparent, and subject to very sharp ups and downs.
To what extent is the Chinese economy reliant upon the US consumer? Can China’s exporters do well without a rebound in US consumer spending?
Nic Doig, unknown
MG: The answer is a resounding yes. China can do well without a rebound in U.S. consumer spending.
In 2000, the United States displaced Japan as the leading customer for Chinese-made goods.
Presently, about 18 per cent of Chinese exports are destined to the US market. Thus, the Chinese economy continues to be vulnerable to reductions in US consumption. However, the economic downturn has accelerated a prevailing trend towards greater geographical diversification in Chinese exports.
During 2008 Chinese exports to the United States grew by “just” 8 per cent relative to 2007. By contrast, exports to Germany grew by 22 percent, and those to South Korea and India grew by 31 percent.
If present trends continue, the US may account for less than 5 per cent of total Chinese exports within half a decade or so. In 15-to-20 years, India could well be China’s most important trading partner, given that the two economies are growing fast and produce complementary goods and services.
How can China sustain its growth if it does not rebalance its domestic economy?
MG: I think Chinese authorities and companies are keenly aware of the fact that Chinese economic growth needs to shift away, in relative terms, from exports to domestic consumption. As the disposable income of ever greater segments of the population increases, consumption will rise, even if the savings rate remains the same. Note that development is as much a cultural phenomenon as an economic one.
Economic growth both fuels cultural change and results in cultural change. As the generation of Chinese in their 50s and 60s approaches retirement, they will save less and consume more. The younger generation is bound to place more emphasis on consumption, both for economic and cultural reasons.
I think that the very dynamics of the Chinese economy will generate the kind of rebalancing that will likely sustain growth in the near future.
In some regions of China, real estate prices are skyrocketing. IS This is likely to drive inflation sharply higher, and if so, what are the best investment options for Chinese people to protect their money?
MG: One lesson from the period preceding the present crisis is that consumer price inflation can remain low while asset prices skyrocket.
In fact, the fact that consumer prices were subdued gave the Fed reasons to believe that the enormous equity and real-estate bubbles were inconsequential. In China, consumer price inflation stems more from a rapidly-growing economy, bottlenecks in distribution, and other institutional obstacles. It is important for Chinese savers to think comprehensively about different investment options and to consider long-term versus short-term investment goals carefully.
One peculiar aspect of individual investing in China is that people tend to chase short-term gains more than in other countries. To do so in a volatile market mired by uncertainty is very risky. Chinese investors need to change their inclination to see investing as a short-term game, and embrace long-term strategies. On a sector-by-sector basis, real estate seems to be a bad bet right now, except for supply-constrained markets, i.e. specific locations where new construction is difficult or impossible.
Equities in general (including Chinese) are volatile, though some sectors will do better than others, especially companies that can grow in the domestic market (both consumer-goods and infrastructure). The other factor to watch is currencies. The key variables to watch in this respect are the evolution of the US budget deficit and the Chinese trade surplus.
Are all the conditions in place for a Chinese real estate bubble similar to the one seen in the US? Could a Chinese property bubble cause similar havoc on world markets to the troubles created by the one seen in the US?
Andrew Cowell, Derby
MG: Even if the Chinese bubble were greater than the U.S. one, the effects on the global economy would be far smaller.
The reason is that the effects of the American bubble were magnified many times over by securitization, which wreaked havoc on the financial system, and this in turn affected the real economy. Still, if Chinese banks were to suffer from problems in the real estate sector, a crisis of confidence in China’s ability to manage its economy and financial sector could develop.
For those who believe that China is or will be the main engine of economic recovery, that would be bad news.
Do you think the Chinese authorities will seek to move money out of their dollar holdings? What’s your opinion on the rumours that have gone round linking China with plans to increase its gold holdings?
Ian Mitchell, London
MG: The Chinese government would be wise to continue its reexamination of foreign exchange holdings. The global economy is changing quickly. I do not see a massive reallocation of foreign reserve holdings across currencies simply because it is not clear (yet) what the optimal basket should be. The price of gold is up 20 percent from a year ago, likely the result of perceived uncertainty.
I think the debate about the future of the dollar is key. Note that in the next 2-3 years, the value of the greenback will depend on a number of variables that remain uncertain: will U.S. consumer price inflation increase? When will the Fed raise interest rates? Will an economic recovery lower the budget deficit quickly? These are unknowns as of now.
Do you agree that the emergence of a Chinese middle class could be the most important driver of its long term economic rise? What are the prospects for China to feature ”Indian-style” growth of a middle class, and what would it mean for the Chinese economy if such a development did not occur?
Alan Gilbert, Surrey.
The rise of the middle class is a key stabilizing factor in economic development and one that contributes to its sustainability.
Statistics clearly indicate that the ranks of the middle class are growing quickly in Brazil, Mexico, India and China. I think this is important in the Chinese case not only numerically but also qualitatively. Note that all socio-demographic changes take place across generations (or age groups) as well as within generations.
While the economic consequences of middle-class growth within the generation of Chinese in their 50s or 60s are important, I consider the effect of the new generations, those born into the middle class, as potentially more important.
I say this because their cultural preferences, attitudes towards consumption (versus saving), and even political behavior are likely to be very different from their parents’. You also asked what might happen if the middle class did not grow in China. I do not think we need to worry about that possibility.
As China’s economic power grows, what are the likely consequences for Japan? Will the benefits of greater demand in China outweigh the potential emergence of rival exporters on the mainland?
Sue Kennedy, unknown
MG: Japan stands to benefit from China’s continued growth, and in a number of ways.
First, Japanese companies are, together with German corporations, the world’s largest and very best in key industries such as machinery, precision equipment, construction equipment, and robotics. Sustained economic growth in China will spur demand for Japanese and German-made capital goods.
Second, Japanese firms have taken advantage of China’s growth by investing there, especially in manufacturing, though also in services. Thus, Japanese firms have remained competitive by shifting production capacity to lower-cost locations like China.
Lastly, as China’s domestic consumer market grows, Japanese durable-goods firms will surely benefit, both because they have famous brands and because they manufacture their products in China.
As you point out, however, Japanese companies should fear their Chinese counterparts’ technological upgrading. Companies such as Haier, Lenovo and Huawei, among many others, are quickly developing technical and branding skills. Japanese firms need to continue innovating. Similarly, South Korean firms will also feel the pinch, perhaps sooner than the Japanese. North East Asia is a rapidly changing set of inter-connected economies.
As long as they continue to engage in trade with each other, their interaction could be mutually beneficial. It is quite clear that a dynamic China-Japan-Korea economic triangle will produce winners and losers, but the overall effect is likely to be positive. Take a look at the statistics: Japan and South Korea are China’s most important suppliers, way ahead of the US. Moreover, both countries run a large, although shrinking, trade surplus with China. The countries that has suffered the most from China’s competition is Mexico, certainly not Japan.
Do you think Hong Kong will ever overtake New York and London to become a clearly predominant financial centre, and if so, when do you think that could happen?
Marcus Carberry, unknown
MG: I consider this to be unlikely.
Hong Kong has a tremendous reputation as a business and financial hub. But there is competition. Shanghai aspires to become the leading financial center in East Asia, and Tokyo is far from finished.
Note that it took several decades for New York to displace London, only to see the latter stage a comeback as a global financial center during the 1980s and 90s. I think we will likely see the emergence of three main financial centers, one in Europe, one in the Americas, and one in Asia. Hong Kong could be the one, but I would not bet on it.
How important will it be for China to retain the best of its talent pool if it is to fulfil its potential? Is the trend of out-migration a danger to its potential success?
MG: Retaining top talent is key to any economy.
The Chinese are making a great effort to attract US and European-trained Chinese, and to boost the quality of their own universities so that fewer bright young people leave the country to study in the first place. I think, though, that the best policy is actually to encourage foreign study coupled with a program to facilitate the return of some of the foreign-trained students, though not necessarily all.
In the cases of South Korea, Taiwan, Israel and Ireland, foreign-trained students played a key role in the rise of high-technology industries. Something similar has happened in India. The fact that many Indian engineers work in Silicon Valley has greatly facilitated the rise of the Bangalore-based software industry. Thus, China does not need to discourage out-migration of talent across the board; but it should try to keep the Chinese technology diaspora linked to the homeland.
What is your option of the possibilities of the renminbi replacing the dollar as reserve currency?
Yao , unknown
MG: It’s very unlikely in the foreseeable future.
The currency of world trade continues to be the dollar. The US is not only the largest economy, but also the most transparent from an institutional point of view.
Moreover, the Fed has a good reputation and people understand how they make decisions. I think the dollar will not be as dominant in the next 20 years as it used to be, but I do not see any other currency replacing it.
I am aware of a few famous economists who argue otherwise, but even they doubt that the Chinese currency could replace the greenback.
What lessons are we to learn from China’s experience in dealing with fiscal deficits against the risks of high levels of unemployment?
Augustin Dufatanye, Reykjavik
MG: China’s economy must continue to grow in order to not only reduce unemployment (presently at 9 per cent) but also to fulfill the dreams of young, educated people who would like to have good paying jobs, and the aspirations of the people living in the countryside, who would like more stable incomes than agriculture can offer.
It is a gigantic task, given the size of the country population-wise.
Given China’s reliance on exports for economic growth, the present downturn posed a serious challenge to the achievement of these long-term goals, and could have possibly derailed two decades of economic transformation. This is why China launched this year the world’s most ambitious fiscal stimulus, equivalent to 6.5 per cent of GDP in 2009 and 5.5 per cent of GDP in 2010, compared to about 2 per cent in the case of the US stimulus.
China is also running a budget deficit, but it is much smaller than the US deficit or the average for the eurozone.
China has two advantages at this point: it has money to spend, and it has a quick, effective, and sensible way to spend it.
It has a large number of already planned infrastructure projects that the stimulus can fund. In fact, 90 percent of the stimulus money is going into infrastructure, compared to just 10 percent in the US (the rest is going to tax credits for families, education, science & technology, renewable energy, Medicaid, unemployment benefits, and healthcare information technologies).
Investments in infrastructure are likely to improve the long-term competitiveness of the Chinese economy. The lessons are simple, but powerful. First, increasing your deficits and indebtedness during good economic times reduces your options during bad times. Second, plan now, spend later, if need be.
What weapons do the see the People’s Bank of China using in tackling inflation, if and when indeed it is a threat?And how will this change the environment for both foreign and domestic investment, especially in the growing financial sector?
Michael Soon, Beijing
MG: I think the People’s Bank of China, the central bank, is facing in many ways a similar dilemma as other central banks around the world.
During the last two years, monetary policy has been unusually loose. It aimed at rescuing the financial sector from oblivion and ensuring that there is enough liquidity in the system to revive credit. Inflation is low or negative in many countries, including China.
As the economy improves, however, prices will likely rise, and central banks will have to drain liquidity. The issue confronting central banks, including China’s, is when exactly to switch gears. It is mostly a timing problem.
Regarding investment, the distinction between foreign and domestic investment is important. In the case of business investment, interest rates in China will affect private domestic investment, but not so much inward foreign investment. On the contrary, in the case of portfolio investment (in equities, for instance), expectations as to domestic interest rates will surely affect the performance of the stock market. Again, it is hard to predict the timing.
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