Perils of export-driven economies: China (Part 2)
China is no exception here when it comes to ever rising exports. The difference here being that its government can make more informed economic decisions. After seeing the experiences of Japan, it does not attempt make the same mistakes. It does not irrationally purchase property from abroad. Instead, it chose to make calculated purchases on overseas strategic assets and decisions crucial to its continued economic growth . Examples including investing in resources in the Africa continent, cooperation with Russia to build a pipeline, resisting calls to revalue its currency and to a smaller but significant extent, buying oil companies of developed countries. Even these actions have their own disadvantages.
Many African countries have poor track records in the human rights area (as deemed by many developed nations). And as such, to punish them, economic sanctions were imposed on them. For example, US petroleum companies are prohibited from prospecting and investing in these nations. If these nations want these sanctions lifted, they will be required to extensively change their laws and practices, something they are unwilling to.
Here is when China makes it move, it is eager to have access to this resources so it will do whatever it takes to get them. Thus, it has this policy of non-intervention. That is to say, it will exploit this resources as a pure commercial interest with no strings attached. This obviously irks the US which sees it as eroding its influence in eliminating their human-right violations. But these African countries have no complaint, they receive their much-needed foreign exchange. Negatively, their governments would feel less pressure to change their mindsets and as such, many of the government's political enemies will continue too suffer. The positive outcome here being that the economic conditions of this part of the continent are now showing signs of improving, all thanks to the much needed currency from China. And this would serve as a wake-up call to the US for neglecting this part of the world for so long.
The second problem is the buying of strategic overseas assets. Here I have two examples, one, a successful venture, and another, a failure. (It is helpful to note that many Chinese companies which ventured overseas are actually majority or minority owned state-owned enterprises or SOEs)
The successful example would be the purchase of IBM PC division by Lenovo. Formerly named Legend when it was incorporated in 1988, it is currently a majority-owned SOE with a government stake of 27.5%. It took control of IBM's PC division in 2005 after several regulatory delays. This was because the US government has several contracts with IBM and were concerned about issues of national security. This is one of the few success stories of Chinese companies flexing their muscles in the global takeover arena.
One of the most famous failures is the attempted takeover of Unocal Corporation by China National Offshore Oil Corporation (CNOOC). Both are oil companies specialising in offshore oil drilling. It is no wonder that CNOOC( majority SOE, 70% government stake) views Unocal as a strategic asset. When the bid was announced in June 2005, this caused an uproar in the US Congress of a Chinese company attempting to take over an American resource-strategic company. This was followed soon after by a bid by rival American company Chevron in the hope of keeping Unocal in US hands. CNOOC upped its bid to US$18.5 billion. Normally this figure would not raise eyebrows, however what raised suspicions was that CNOOC was itself then only worth US$22 billion. To raise such capital with such limited collateral to offer immediately implied that this decision was made and supported by the Chinese government. This did not sit well with Congress and they attempted to stall the purchase though repeated calls to review the CNOOC motives. With such political tensions arising from these issue, CNOOC withdrew its bid paving the way for the merger of Unocal and Chevron.
The last problem is the currency. China is currently facing with a huge dilemma with its huge trade surpluses. As they are dominated in US dollars, it faces the same risks. Similar to Japan a decade ago. However, there is another problem. Its currency, the Chinese renminbi(or yuan). Although its peg on the US dollar was dropped in 2005, it is still only allowed to be traded at a fixed narrow band of 0.05% pegged to a secret basket of currencies(similar to Singapore) This in effect is sort of like a flexible peg. The Japanese yen then was not pegged to anything. Despite the large inflow of foreign exchange into the Chinese economy, the currency will not change much as the Bank of China( BOC, China's Central Bank) strongly holds the yuan at that level. So how does China deal with it keeping its currency low?
The answer, use the same instruments that Japan used, heavy purchasing of US securities and treasuries. This in itself is dangerous for the long term. It means that the hard-earned Chinese money is now being held overseas by the US and it is vulnerable to the declining value of the US dollar. Judging by the size of the the Chinese foreign reserve of US$1.3 trillion(PRC State Administration of Foreign Exchange, June 2007), for every cent the US dollar depreciates in value, the Chinese savings erodes by tens of billions of yuan.
In my opinion, there are three main options to correct this problem. One, convert future foreign earnings into other major currencies such as the euro and yen. Second export more and use the proceeds to buy more treasuries to cover any perceived loss of yuan-equivalent US-denominated assets. Third, reduce imports from China.
For the first option, its purpose is to hedge against the continued fall in the US dollar. However by doing this, the demand for the US treasuries and securities will slide as the Chinese government being the prime purchaser of these instruments will not have the need to purchase them anymore. As there is less demand for the US dollar, its value will fall. Further lowering the value of current US-denominated assets. Which means any current US assets one owns would have loss their value. But the advantage of Euro or yen dominated assets is that they will keep their value.
For the second option, I would view this as more of a short-term solution. By earning more US-dollar to avoid the fall of value of current assets, one will actually be digging his own grave for doing so. This is actually postponing what is inevitably the inevitable. But surprisingly, despite its highly negative nature, China still practices it.
For the third option, this is easier said than done. It is a well known fact that Chinese-made goods are among the lowest-priced in the world. In order to not to import from China, we have to turn to other more expensive alternatives. Problem is, are we the layman consumers be willing to pay more for a “noble” economic cause?
After reading the above, one would guess that China is like a reminisce of Japan in those few years. I personally agree, but one has to note, China's population and available resources are many times that of Japan.
If Japan's problem took this long to show up, how long would China take? The answer in my opinion is ironically, faster. But this would not just hurt China alone, the entire world including the US would be affected seriously as well. The Chinese and US economy are now more intertwined then ever before and are the main engines of the world economy, on the production and consumption side respectively. With the increasingly globalised and technologically advanced interconnected world of today then two decades ago, any problems that might show up will surface much quicker.
By Yeo Kheng Meng