What do the Chinese think of the Great Recession and the Euro Crisis?

Visiting Shanghai in 2010 is the ultimate experience in Modern urban infrastructure.  At the nearly-new international airport, you can take a MagLev (magnetic levitation) train that whisks you into Pudong at a top speed of 430 km/h.  You then transfer to a modern subway system with 400 kilometers of track, 200 of which opened within the last year.  Or, if you prefer, you can grab a cheap, new taxi from Pudong and travel into Shanghai across modern six-lane expressways and impressive new bridges that cross the river, one every few kilometers.  This is the kind of town that big money, government money, buys for its citizenry when the state is wealthy and wants to show off to the world for the 2010 Shanghai Expo, the world’s fair now underway.  The fairgrounds straddle the Pudong and Shanghai riverbanks and cover a surface area equal to that of downtown Montreal.  When this is how you live, why would you worry about what’s going on in the rest of the world?

Many Chinese do not worry about the US banking crisis, the Greek-induced Euro instability or the capacity of the West to correct its fiscal imbalances.  However, they are not entirely ignorant of the situation, and during my recent visit to Shanghai I had the opportunity to solicit opinions from the Chinese mercantile class as to how they regard their export client’s economic problems and how China is likely to behave going forward.    The following is a distillation of comments shared with me during my stay.

When it comes to the Chinese economic model, most think that they have the right balance between state control and unbridled free enterprise.  The excessive speculative lending of the US banks, the ensuing real estate collapse and the massive government bailout demonstrated to them that free-market capitalism results in an uncontrollable boom and bust cycle that the Chinese do not wish to emulate.  They are comfortable with the Chinese government having extensive ownership stakes in their banking entities since they perceive it as adding stability and predictability to the banking system.  Indeed the Chinese government just announced new rules requiring their banks to increase their capital base to 17% of loans outstanding AND in order to curb real estate speculation all second-property purchases now require downpayments of 40 to 50 percent.  When the government is your regulator as well as your major shareholder, banking compliance is swift and complete.  The merchant class also benefits enormously from the government’s ability to impose large infrastructure projects on their population without the public manifestations against bulldozing neighborhoods and relocating people and businesses.  When the Chinese and Shanghai governments were looking for a suitable site to house the world exposition, they just asked a large steel manufacturer and an assortment of other industrial companies along the river to relocate to a new, preferred economic development zone out of town.  The Chinese are willing to accept these impositions and inconveniences as the price as progress, with the recognition that their government has the capacity to impose its will in any case.  This acquiescence to the collective needs of the state in exchange for economic freedoms within well-defined limits reminds me of a conversation I had in Chile with a businessperson who had lived under the Pinochet regime.  When I asked him what it was like doing business during the general’s dictatorship, he replied, “Well, it was predictable – when I needed an import or foreign currency permit, I always got it, no problem.”  In Chile, it was a case of taking some good with a lot of bad – in the eyes of the Chinese business community, there is far more good than bad in their economic relationship with the government.

Several months ago, the Chinese government mused openly about the need for a new world reserve currency to replace the US dollar and discussed holding more of its foreign reserves in Euros in an effort to diversify away from the USD.  With the fallout from the Greek debt crisis rocking foreign exchange markets, the Euro has fallen from above 1.40 Euros/USD to the 1.27 level as of mid-May.  Even with the 700 billion Euro bailout package for Greece and any other weakening European economies (Portugal, Italy, Ireland and Spain complete the PIIGS list) there remains significant doubt that Europe is willing to make the difficult fiscal and lifestyle changes necessary to grow out of its debt problems.  Interestingly, the Chinese I spoke with take a longer-term view and believe that the Chinese government will still invest in Euro-denominated debt instruments as a means to increase their political leverage on the continent.  As well, a falling Euro may be bad for Chinese exports, but it does make acquisition targets in Europe far more interesting for Chinese firms, especially if those firms control the raw materials that China craves.  The Euro crisis is seen as presenting China with an opportunity to repeat on that continent the type of strategic investments and joint ventures it has undertaken in Canada and Africa.

Another important lesson from the Euro crisis is that you have large groups of people with vastly different languages, cultures and economic profiles all sharing one currency, and fiscal imbalances are bound to put a strain on the common economic relationship governed by one central banking authority.  You thought I was referring to Europe again?  No, I was thinking of China – where 70% of the population still lives in rural poverty and life for these hundreds of millions has barely changed under the economic revolution launched in 1980 by Deng Xiaoping.  China has only been unified twice in its long history, once under Sun Yat Sen barely 100 years ago and again under Mao and the Communist Party.  The Communist Party holds together a county where those in the western provinces have much more in common with Afghanistan and Pakistan than they do with the cosmopolites of Shanghai, Shenzhen and Hong Kong.  Further political liberalization would lead to the kind of political discord that is currently eating at Europe, except in China it would be far more volatile.  Do not expect the business community in China to become leaders of a democratization movement – the current one party state works well for them, thanks.  Once again, this is compromise in the name of economic mobility and, to a certain extent, expediency.  The Chinese can get rich without US or European-style multi-party politics, and indeed that messy experience would be a distraction from the important goal of making money.

As much as the Chinese feel that they have avoided the economic crisis experienced in the west, their economy is exhibiting some bubble-like warning signs similar to those experienced in the US from 2005-2008.  The great rush to own real-estate has resulted in condo prices rising 40% per year in some cities and buyers panicking to close on apartments before the next round of price hikes.  Chinese banks responded to the export market slump by making massive loans to consumers to spur on local consumption, and Chinese bank lending is up 100% year over year.  When that level of debt hits the market so rapidly, bad loans are bound to result and the government is going to end up recapitalizing their banks the way the US government did in 2008-9.  China can probably afford a 25% default rate on these loans because they enjoy 10% annual economic growth, and the wealth that produces for the state can paper over a lot of poor lending decisions.

According to the China Economic Review, state and local governments have been setting up “development companies” to borrow money and invest in stimulating their local economies.  These governments are not allowed to incur this type of debt on their own, but the can guarantee the loans – which they did, to the tune of $1.9 trillion dollars.  Officially, China’s debt stands at 22% of GDP – but if these “off balance sheet” loans of state and local governments were included in the calculations, then China’s gross debt would be close to 100% of GDP.  Chinese with whom I shared this frightening statistic repeated that this is why China must keep growing – they are aware that mistakes and excesses have been committed in the quest for progress and that wealth (and foreign reserves) must continue to be generated in order to pay for them.  In short, don’t rock the boat, don’t derail the train – stoke the fire in the boiler rather than stoke the flames of democratic reform.