China is wagging a theatrical finger

Some time last month, China held its National People?s Congress, which culminates in the China Develop-ment Forum. Stephen Roach of Morgan Stanley attended this. At the end of the forum, Wen Jiabao, the Chinese Premier, looked Mr Roach in the eye and told him to take the message to the American people that it was wrong on the part of America to scapegoat China for its structural problems. Mr Roach?s report suggests that he was impressed (http://www.morganstanley.com/GEFdata/digests/20060322-wed.html). But, this leaves yours truly unconvinced.

A country that reportedly grows at 9% (with remarkably little volatility quarter after quarter) and whose energy requirement is met mostly by imports runs a current account surplus. Its non-oil current surplus would be even larger.

It has the world?s largest foreign exchange reserves, thanks to its efforts to keep the local currency from appreciating against the US dollar. For most economists, these should be conclusive evidence of the Chinese structural problem, but there is more clinching evidence that the Chinese Premier was wrong.

According to HSBC Research, foreign firms? share in Chinese exports and imports is 60% and that in the Chinese trade surplus has shot up from near zero in 2000 to over $50 billion in 2005 (12-month rolling sum), even as the Chinese trade surplus itself has galloped. One does not have details of the foreign companies based on their countries of origin. However, it is a reasonable guess that American companies have a large share. That throws a very different light on the rising Chinese trade surplus with the US.

There is a lot of difference between the US having a trade deficit with China and, say, Motorola US having a trade deficit with Motorola China. Data show that the latter is mostly driving the US-China bilateral trade deficit. Consequently, the US trade deficit is more of an internal transfer pricing issue between American corporations rather than a structural problem of the US?its economy packs far more resilience than the babel of the consensus suggests.

This partially explains why the American senators backed off from their threat to retaliate against Chin-ese exports. Not for nothing is America the sole superpower today. They have realised that the same tactics that worked against Japan in the 80s are not necessary against China. Indeed, the best way to ensure that China does not revalue the currency meaningfully is to keep demanding it publicly. That is what the US is doing because the status quo is in the interests of the US.

What about China? If trade deficit is not a problem for the US, then is trade surplus a problem for China? My answer to the question is a rather straightforward yes. A growing and large country depending on exports is bad enough. But, it is worse that such export in turn depends on foreign corporations.

Writing in Foreign Affairs July/August 2004, George Gilboy (?The myth behind China?s miracle?) says that other smaller East Asian nations at a similar growth stage had a much smaller foreign share in their foreign trade. China?s export dependence betrays lack of confidence and a lack of core domestic economic strength. Allowing foreign corporations a lion?s share of exports doesn?t help build domestic capability or know-how. China may be a military power but it is unlikely to beco-me an economic superpower with its over-reliance on foreign investment and export prowess.

Then, where does all the investment spending go? After all, a country with an alleged nominal GDP growth of over 13% has a long-term interest rate lower than 5%. This abysmally low cost of capital has led to excessive borrowing and wasteful investment in showcase infrastructure projects. Hence, it is not a surprise that a recent IMF working paper (Progress in China?s banking sector reform: Has bank behaviour changed? Richard Podpiera, March 2006), analys-ing bank data up to the end of 2004, strikes a note of caution on the health of the balance-sheets of even major Chinese banks. The paper states solemnly that the State Commercial Banks (SCBs) have slowed down credit expansion, but that the pricing of credit risk remained undifferentiated and that banks did not appear to take enterprise profitability into account when making lending decisions.

Dr Jim Walker of CLSA, after a two-week intense tour of China had this to say on Chinese ?enterprise profitability? (or the lack of it): ?…there is one aspect of China where developmental time is not compressed, it is extended. That aspect is the willingness to operate without margins and without return. That is what is prolonging the boom at the moment (one car company we spoke to said that between half to one third of Chinese car manufacturers were losing money). It is not a positive for the country as it eats into everyone?s viability and further distorts the industrial structure.? (CLSA Infofax, March 24, 2006)

Therefore, it should come as no surprise that market capitalisation of stocks listed in the Shanghai Exchange has come down from $360 billion in 2003 to $317 billion in February 2006. The figures are $153 billion and $128 billion, respectively for the Shenzhen Exchange. This is the verdict of investors on the Chinese brand of profitless and export-led hypergrowth.

Therefore, when it comes to domestic demand-led growth, Chinese leaders may say enough to convince the world that it was serious about it. However, the truth is that if a ?thousand millionaires bloom?, it would spoil the ?Communist? party and its hold on power. Hence, China, for the foreseeable future, would continue its strategy of investment-led-export-led growth.

Apologists for China might enthral the Chinese leadership by bashing the US and thus playing to the Chinese gallery while real structural problems keep growing silently (is that the plot?). Wagging the finger at America might be impressive theatre, but there is little substance behind it.

?The writer is the founder-director of Libran Asset Management (Pte) Ltd, Singapore. These are his personal views