Think­ing big about China

Financial Mirror (Cyprus) - - FRONT PAGE - Mar­cuard’s Mar­ket up­date by GaveKal Drago­nomics

There are two big facts about China to­day. One: its econ­omy is slow­ing, and will al­most cer­tainly con­tinue to do so for the next cou­ple of years. Two: un­der its force­ful pres­i­dent Xi Jin­ping, it is mak­ing a big push on many fronts to in­crease its in­flu­ence around the world. The ques­tion is which of th­ese facts de­serves more at­ten­tion.

For those used to treat­ing China as an eco­nomic growth story, the slow­down seems ob­vi­ously more im­por­tant. GDP is grow­ing at its most slug­gish rate since the late 1990s and is clearly headed lower. Lever­age con­tin­ues to rise; get­ting it un­der con­trol will mean even slower growth. The heavy industrial sec­tors that have led the econ­omy since the early 2000s are mired in ex­cess ca­pac­ity, and pro­ducer price de­fla­tion is en­trenched. Clearly, the boom times are over, and much more pain lies ahead.

For work­ers in Chi­nese heavy in­dus­try, and for the coun­tries that prof­ited by sell­ing com­modi­ties to China, this story is in­deed bad news. For the rest of the world, China’s bid for greater global power is far more con­se­quen­tial.

China’s out­ward push has two ma­jor com­po­nents. One is the “Belt and Road Ini­tia­tive,” which aims to cre­ate Chi­nese-fi­nanced trans­port in­fra­struc­ture links across Cen­tral Asia to Europe via a “Silk Road Eco­nomic Belt”, and across Southeast Asia to the Mid­dle East and Africa via a “Mar­itime Silk Road.” The other is the pro­mo­tion of the ren­minbi as a ma­jor global cur­rency.

Both moves will have a larger im­pact over the next decade than can be cal­cu­lated to­day. The Belt and Road pro­gramme could greatly en­large the eco­nomic ecosys­tem within which China op­er­ates, cre­at­ing in­vest­ment and trade op­por­tu­ni­ties well be­yond the ini­tial in­fra­struc­ture projects. It is a ri­val to the Trans-Pa­cific Part­ner­ship trade and in­vest­ment agree­ment that the US hopes to com­plete — with­out China — later this year. West­ern econ­o­mists tend to as­sume that trade lib­er­al­i­sa­tion pro­duces more eco­nomic ben­e­fit than in­fra­struc­ture, so their as­sess­ments of the Belt and Road have been mainly skep­ti­cal. Skep­ti­cism is fully war­ranted if we con­fine our­selves to nar­row ques­tions such as whether de­mand from Asian in­fra­struc­ture projects can soak up the ex­cess ca­pac­ity in China’s steel in­dus­try (It can’t). Yet, good trans­port and com­mu­ni­ca­tions in­fra­struc­ture does the same thing that good trade agree­ments do: it low­ers the cost of mov­ing goods, peo­ple and ideas around. This boosts eco­nomic ac­tiv­ity. It also turns smaller coun­tries into clients of the cen­tral power that built it. China’s po­lit­i­cal goal is to ex­ploit in­fra­struc­ture to be­come the cen­tre of a re­gional econ­omy, just as the US ex­ploited the power of trade to put it­self at the cen­tre of the global econ­omy.

Ren­minbi in­ter­na­tion­al­i­sa­tion serves the same goals, and is also tied to do­mes­tic eco­nomic re­struc­tur­ing. If China can fi­nance its trade and out­ward in­vest­ments in its own cur­rency, it can gain a taste of the “ex­or­bi­tant priv­i­lege” that the US has long en­joyed. And since an in­ter­na­tional cur­rency re­quires a more open fi­nan­cial sys­tem than China now has, the in­ter­na­tional ren­minbi pol­icy pro­vides an ar­gu­ment for do­mes­tic fi­nan­cial re­form ar­moured with solid na­tion­al­ist cre­den­tials.

Ren­minbi pol­icy and fi­nan­cial re­form help ex­plain why China’s eco­nomic slow­down has been ac­com­pa­nied by an epic stock mar­ket run-up that shows no sign of flag­ging. Do­mes­tic in­vestors know the days of easy money in prop­erty are over, and are mov­ing their spare cash to the stock mar­ket. They feel safer do­ing so in the be­lief that cap­i­tal ac­count open­ing will bring in a flood of for­eign money, and that fi­nan­cial re­forms will even­tu­ally im­prove cap­i­tal al­lo­ca­tion, sta­bil­is­ing growth and push­ing up eq­uity prices.

For­eign port­fo­lio in­vestors, mean­while, barely fig­ure. Cap­i­tal con­trols con­strain their in­vest­ments, and China’s weight in the MSCI All Coun­try World In­dex is just 2.7%, less than Switzer­land. Over the next sev­eral years, as cap­i­tal con­trols erode, China’s in­dex weight will rise to­ward Ja­pan’s (7.7%), and for­eign in­flows will swell ac­cord­ingly. Hav­ing a big, buoy­ant stock mar­ket is as much a part of Bei­jing’s mas­ter plan as the roads, ports and pipe­lines of the New Silk Road. It is easy to be skep­ti­cal. Yet prophe­cies of doom for China’s idio­syn­cratic econ­omy and au­thor­i­tar­ian state have a dis­mal record. Last Thurs­day’s an­niver­sary — 26 years since the bloody sup­pres­sion of cit­i­zen demon­stra­tions in Tianan­men Square — re­minds us first of the en­dur­ing val­ues gap be­tween China and the cap­i­tal­ist democ­ra­cies, but also of the Chi­nese sys­tem’s ex­tra­or­di­nary re­silience. Our bet is that this re­silience will con­tinue.

In the com­ing decade the world will have to reckon with China not as a fast-grow­ing trad­ing econ­omy, but as a bur­geon­ing geopo­lit­i­cal and fi­nan­cial power.

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