Aug 30, 2015

Get set for China’s wild ride

Illustration: Eric Lobbecke
A revolution, Mao Zedong warned grimly, “is not a dinner party, or writing an essay, or painting a picture, or doing embroidery. It cannot be so refined, so leisurely and gentle, so temperate, kind, courteous, restrained and magnanimous.”
Mao, especially, knew the truth of this. He shaped China’s Communist Party in his own very different image.
During the past week, we have seen the lineaments of a new Chinese revolution — which had been shaping up to change the world’s economies for three decades — finally bursting out intemperately to trouble and perplex global markets and investors.
The trail of recent events — sharemarket collapses, shock currency devaluations, the slump in manufacturing performance, government attempts to stanch the bleeding — challenged the previous widespread benign take on China’s economy, that here was a dinner party, a banquet, with boundless courses for all.
The Shanghai sharemarket fell 23 per cent in five trading sessions to Wednesday, triggering a fall in the Dow Jones index in New York by 9.7 per cent in four days, in the London stock exchange by 7.4 per cent in two days, and the Australian All Ordinaries by 4 per cent on Monday alone — though all began recovering lost ground by week’s end.
The Chinese Purchasing Managers Index, which tracks activity in factories, fell to a 77-month low a week ago. And the yuan was devalued by 3.5 per cent against the US dollar over two days, in mid-August.
But these are indicators of a change that China itself has been anticipating, indeed, seeking to engineer, for several years.
The global financial crisis caused it to postpone this policy transition, from a focus on investment and exports towards a more modern economic core based on consumption and services.
Now that process — which is bound to be bumpy — is well under way.
As Ken Courtis, former Asia vice-chairman of Goldman Sachs, told the ABC this week, “The real story is: is China going to be able to pull off this transition or not? If it does, then it will pull the rest of the world with it.”
The world is expecting China to do a massive amount of heavy lifting, Courtis says, by driving 35 per cent to 40 per cent of the world’s growth.
China’s transition, ­although thoroughly aired and explained, is still taking global markets by surprise. This is so particularly in the West, where many previously have subscribed to the simplistic formula: Chinese foreign and military affairs bad, economic affairs good.
The world is finally waking up to the fact China is a more complex beast. And China matters, because of its global economic enmeshment, in a way the old Soviet Union never did.
The trail of recent events does not comprise a one-off diversion but a harbinger of continuing, intensifying impacts.
This frustrates many European and US market managers, who struggled even to connect with culturally distinct Japan when its economic star was in the ascendant. And today’s China matters even more than Japan did.
China’s decision-makers operate in a very different world from Wall Street and the City of London. Based in the sealed away courtyards of Zhongnanhai, the Communist Party leaders’ low-rise compound in Beijing, they are not susceptible to the usual Western political and public pressure points.
Arthur Kroeber, Beijing-based founding partner of Gavekal Dragonomics, says: “Clearly, China cannot give the rest of the world what it wants today — more infrastructure spending, more leverage and an exchange rate that goes only higher — without grievously damaging its own prospects for tomorrow.”
President Xi Jinping can be excused for thinking that China has done more than enough to sustain global demand, as Europe and Japan “merrily tried to devalue their way back to prosperity”, Kroeber says, and as the world contradictorily wants a more balanced Chinese economy that relies less on infrastructure spending and one that keeps such spending high to sustain commodity prices. But neither has Beijing articulated a clear policy direction, Kroeber says. “Are they for a more open, market-oriented China, or a closed empire of state-owned national champions? Impossible to say.”
Australia seems especially spooked by the confusing turn of events. China underwrote our growth, our terrific terms of trade, for more than a decade, with a seemingly insatiable appetite for our resources, while paying ever higher prices for them. Last year, China bought more than one-third of all our exported goods, paying us $90 billion.
China’s appetite for our products remains strong. BHP Billiton chief financial officer Peter Beaven said on Wednesday: “We’re selling everything that we make.” China is the firm’s biggest buyer.
But the prices have dipped. Iron ore is down to a third from a year ago and oil — which also guides the price for Australia’s biggest commodity play, gas — is at its lowest for six years.
What has been the response to this decline in resource prices?
Australian organisations such as the unions, the Labor Party and the Greens may have seen the logic in supporting a doubling of Australia’s efforts to engage on a more broad front with the vast Chinese economy, now the world’s second biggest, and with India, whose growth is again picking up speed. But no. Instead, the change in the Chinese wind has emboldened those urging us to reduce our involvement and to raise our protection.
As China was disintegrating a little more than a century ago, its Qing dynastic court resisting modernisation, the Australian labour movement and its political arm rallied around the flag of “White Australia” to lock out Chinese seeking a better life.
Now China is on the way up, for all the present turmoil — still growing at more than 6 per cent a year, still the world’s factory — and is seeking increased foreign opportunities and foreign partnerships for its ambitious companies, both state-owned and private.
In response, the Australian ­labour movement and its political arm are back where they started in the late 19th century, campaigning against Chinese labour and capital, and against a free trade agreement with China.
It may take some time for the West in general, and many Australians in particular, to come to terms with what’s happening in our world. They — we — need to get out more.
Through the 18 centuries after Christ, Asia was responsible for about 75 per cent of the world’s gross domestic product, its vast population a core component. For four centuries up to the first millennium, China’s capital Chang’an — the present Xi’an, home of the terracotta warriors — was by far the world’s biggest city, with more than a million inhabitants.
But China was left behind by the Industrial Revolution, from which its dynastic leaders wilfully refused to learn — unlike their Japanese counterparts in the late 19th century. The accelerated productivity that resulted in Europe and North America thrust these regions to the fore. At their peak in 1950, they reached 80 per cent of global output.
As Asia began to industrialise, the pendulum started swinging back. In 1980, after three miserable Mao decades, China’s GDP per head was just 24 per cent of the world’s average.
After the following reformist 30 years, its GDP per head exceeded the world’s average.
Colleague Peter Cai of Business Spectator says the average real wage in China has been growing at an annualised rate of 11.4 per cent this century so far. Growing numbers of skilled Chinese factory workers are now paid more than their US counterparts.
It naturally takes time for such change to sink in. After years of enjoying cheap Chinese products, suddenly it’s dawning on Western countries that China has also quietly become the great hope for its own exports; that it has acquired such market heft that any change of economic gear triggers a profound global impact.
When Beijing ploughed billions into sustaining its economy in the face of the global financial crisis in 2007-08, leading to disastrous misallocation and waste of funds that were denied its own workers, the world applauded.
This week, the world has been howling because China hasn’t done what market commentators have demanded, except for a belated interest rate cut.
So China scared us on the way down, as the Qing empire failed and emigrants sought new lives elsewhere including Australia, and now China seems to be unnerving some of us again as it seeks a greater involvement with Australia on the way back up towards global leadership.
The Australia in the Asian Century white paper, launched under Julia Gillard only three years ago, was intended to educate us about all this. It said that by 2025, four of the 10 largest economies in the world would be in the region — China (first), India (third), Japan (fourth) and Indonesia (10th).
“Asia is likely to account for ­almost half of the world’s economic output, with China accounting for about half of that,” the white paper said.
Gillard, introducing it, said: “Our economy is strong because over the past 30 years we have been prepared to do the things that are necessary to build for ­tomorrow.”
That readiness to change has since reversed, as speakers at this week’s National Reform Summit in Sydney serially underlined. The resource sector has hit a ceiling and alternative routes to increase national productivity and wealth are floundering.
Australia celebrates Asia’s and especially China’s capacity to change in order to seize opportunities for a better life. But today powerful elements resist calls for corresponding change to Australia’s own remaining spheres of protection, including in labour organisation.
Paths to higher productivity, wealth creation and international co-operation are being blocked.
The Victorian Labor government, having cancelled the East West link, the state’s first big new infrastructure project in years, this week has talked of going into debt to seek to fund other projects, while conjuring a new public holiday, on the day before the AFL grand final.
The successful “lawfare” campaign against Indian company Adani’s $16 billion coal project in Queensland is inspiring further anti-coal measures.
Australia is the dominant global supplier. It provides 54 per cent of metallurgical coal, which is irreplaceable for steelmaking, and from which the country earns considerably more than from thermal coal exports for power generation. China, the world’s biggest steel producer, is naturally the biggest buyer.
But Declan Clausen, a Labor councillor in Newcastle elected in February, told ABC Radio on Thursday how he had successfully moved a motion in the coal-driven NSW city’s council to shed shares in banks that did not abandon companies that produced coal.
Instead, he proposed investing in “environmentally friendly products”, in aged care, in “equal opportunity employers” and in affordable housing.
Moves against China are set to be elevated to the Senate, as Labor and the Greens prepare to vote down the groundbreaking free trade agreement negotiated over a decade with China.
Trade and Investment Minister Andrew Robb says the slowing of China’s “real economy” as it ­restructures from a focus on ­investment and exports towards consumption and services will encourage more Chinese funding into “safe havens” such as Australia, “when we’re looking for foreign capital”.
Yet at the same time, the xenophobia on display in Australia’s union campaigns is confusing the Chinese, Robb says, and “souring the whole run-up to entry into this huge FTA deal”.
The services sector, which comprises 75 per cent of the Australian economy, makes up only 17 per cent of exports, so we have to internationalise those capabilities, Robb says, including through working with big Asian companies. This requires change. Something that much of Australia, and other Western nations, have resisted thus far, believing that relations with China and Asia can be quarantined, held at a distance, engaged only when it suits us.
The past week has shattered such smugness. As Commonwealth Bank chief executive Ian Narev says: “We’ve got to get used to the fact that over the next few years there is just going to be more volatility” — which will affect everyone including, of course, those relying on superannuation.
In China, too, change is being opposed. A recent commentary in the People’s Dailylamented that “the uncanny, complex, ferocious and stubborn forces opposing reforms exceeded what people imagined”.
The profitability of China’s own largest companies has declined during the past five years, ratings agency Standard & Poor’s says, and China itself is exporting volatility.
Like Mao, Xi prefers to occupy himself with entrenching the party’s political strength, in his case through an open-ended anti-corruption campaign, than with “doing embroidery”.
Kerry Brown, director of the China Studies Centre at the University of Sydney and author of The New Emperors: Power and the Princelings in Modern China, tells Inquirer that today’s Chinese elite largely shares “a notion of China undergoing a very tough transition, but with the endgame — the restoration of status, of great power dignity — being worth going for’’.
“This aspiration is a huge political asset for Xi, and I think ­accounts for the more fervent, emotional tone in which he speaks, and the way he is, in fact, spoken about in China.
“There is a remarkable level of tolerance publicly for the sort of state-sponsored idolatry of him because the public buys into the idea that his ambition is to achieve this grand national mission.”
Despite all the fixations about China’s economy, Brown says, “its greatest challenges are political ones — in the sense of how to ­arrange the distribution of power. In that context, the current leadership has shown a remarkable paucity of thought or vision.
“They have asserted brute control, and demanded obedience, particularly from party members and the elite. The question of how far they can outline a political ­vision to accompany the economic one of almost four decades is going to become increasingly crucial.
“A huge new social contract is being written in China, where the party is expecting more from citizens, and they are demanding more from it. The question of the real political achievements of this leadership is constantly nagging away, and banging up a few elite former leaders for corruption doesn’t quite cut the mustard, especially stacked against falling stocks, falling growth, stagnant house prices and a weakening yuan.”
Next Thursday, Xi will seek to enhance that “great power dignity” — taking the salute at Beijing’s biggest military parade for years to celebrate the defeat of Japan 70 years ago. Alongside him will be the leaders of Russia, Venezuela, South Africa, Sudan and South Korea, as well as Tony Blair.
The economy is not Xi’s top priority, as Brown says. He will not have lost sleep over the slump in the Shanghai stockmarket or paid much interest to the cries from Wall Street and Europe for China to “do something”.
China’s economy will continue to grow almost by gravity, but at the slower pace, the “new normal” Xi anticipated and publicly sought soon after taking office three years ago — which Western markets ­bizarrely overlooked because they have yet to learn to take Beijing’s statements sufficiently seriously.
Fraser Howie, co-author of Red Capitalism: The Fragile Financial Foundation of China’s Extraordinary Rise, tells Inquirer: “Xi’s reform agenda is considerable and comprehensive, no one doubts that. He has also accumulated power to push through those reforms.
“But that does not mean the implementation will be easy. China is too big and messy for one man to push it all through.”
While Howie believes the world reaction to China’s data “is grossly overdone in many ways”, it shows that China is “very much on the radar screen now, and missteps in China have global impacts and knock on effects. When then premier Zhu Rongji was restructuring the banks 15 years ago, when they were all duds, nobody outside China cared.
“Now China is the top story globally. This means Xi’s job is a lot harder than he ever thought.”
It is made harder because, Howie says, “The Communist Party thinks it is still best placed to price risk, or that it should intervene if the market isn’t pricing as the party sees fit.”
Mobo Gao, professor of Chinese studies at the University of Adelaide, says it does not matter whether China really has the kind of financial clout that global markets believe. “The perception alone indicates a kind of climate change in world affairs,” he says.
Gao believes that “while there was a tendency to over-estimate China’s economy when China was on the rise, now there is a tendency to underestimate China’s strength when problems are surfacing”, and that room remains for underdeveloped areas to catch up.
Pradeep Taneja, an expert on China and India at the University of Melbourne, says that “as the Chinese economy was going gangbusters, it avoided” making important choices. Now it has reached a fork in the road — rather than “hitting the wall” — as China is caught in “a hybrid system, neither a market economy nor a command economy, that defies any logic other than the bottom line requirement of maintaining the Communist Party’s monopoly on power”.
Although India, the next cab ready to leave the rank towards rapid growth in Asia, is politically in a better shape under Narendra Modi, he says “it is not yet ready to benefit from China’s troubles. Modi has so far talked the talk, but he needs to demonstrate his resolve to carry out much-needed reforms.”
Besides restoring popular faith in the party, Xi has aimed primarily to reset foreign policy, in line with his “China dream” of ­entrenching the country at the centre of a revived Asia, including India, as part of “the great revival of the Chinese people”.
Unlike today’s Western leaders, those in China love to read history. They learned how Britain and The Netherlands’ fruitful first forays into Asia came via their East India companies.
So it will be with the suite of “Silk Road” initiatives that have poured from Beijing: China doesn’t want formal colonies, it wants its corporate champions to lead the charge, building the infrastructure the region lacks, so that all roads will lead not to Rome but to Beijing, as the hub of the new, dynamic Asia sweeping from the Caucasus across to the Pacific.
Benjamin Herscovitch, research manager at Beijing-based China Policy, says that “as well as sensitising the domestic audience to the ‘new normal’ of 3 per cent to 6 per cent growth, the Communist Party is busy softening the blow of the slowdown” and the “Silk Road” stimulus program will play a big role.
He says this will “bankroll the sale of Chinese technology and expertise — from Chinese solar plants in Pakistan to high-speed rail in Britain. And the hundreds of billions of dollars the party has at its disposal to fund this is just a fraction of the financial firepower at its disposal”.
Xi announced during his visit here last November that Australia, too, is expected to play an important role within the “maritime Silk Road”.
This is presented as an opportunity made specially available for us by Beijing — as is the FTA.
Malcolm Cook, a senior fellow at Singapore’s Institute of Southeast Asian Studies, says China’s trajectory is particularly important for Australia, for three reasons.
“Australia’s dollar is a market proxy for international investors’ bets on the Chinese economy. Australia has the highest export dependence on China of any major economy. And Australia’s fiscal health is especially sensitive to falling resource prices,’’ he says.
“Australia thus suffers especially from any loss of faith in Chinese economic policies.”
Cook says he hopes the present sense of crisis will enable misconceptions to be corrected: “The longstanding belief, egged on by commentators, that China is an exceptional economy with preternaturally skilled technocrats and political leaders … Shades of Japan.
“The second is that Australia’s comparatively high economic dependence on China is primarily a strategic vulnerability for Australia and Australia-US relations. It is not. Australia’s economic dependence on China is an economic vulnerability.”
But Courtis says: “Don’t panic — yet. The important thing is that (the Chinese) don’t lose their nerve, that they continue the transition.
“If they can maintain this drive to reform over the mid-term, I think we’ll come out of it saying, ‘Wow, that was a pretty good opportunity to buy cheap stocks.’ ”
But this is serious business, not playtime for political or market lightweights. Stock exchanges, economic transitions and even apparently win-win FTAs are — like revolutions — not a dinner party.

No comments: