China Faces Challenges Over Currency Valuation and Wages
Economist Rob Johnson says China is undergoing a major transition from an export-led economy to a domestic demand-led economy
SHARMINI PERIES, EXEC. PRODUCER, TRNN: Welcome to the Real News Network. I’m Sharmini Peries coming to you from Baltimore.
When Nobel Prize-winning economist Joseph Stiglitz was asked in a Bloomberg interview on Monday if what is going on in the Chinese markets is a reflection of the weak Chinese economy, he said:
JOSEPH STIGLITZ: There has always been a gap between what’s happened in the real economy and financial markets. When the American economy was really in bad shape the stock market was doing very well. And what’s happening in China is a slowdown, by all accounts. You know, everybody looking at the data seems to be convinced that the growth is slowing down. But it’s not a cataclysmic–it’s a process of slowing down. So there’s no real news.
What this does remind us is market rules matter. And the way you structure those market rules can either diminish the volatility or increase the volatility. And what’s happened, what we’re seeing here in a sense is a consequence of some market rules that were not as well-designed as they could be.
PERIES: Now joining us to talk about what is happening in the Chinese markets and underpinnings for the recent dramatic fluctuations is Rob Johnson. Rob Johnson is the president of the Institute for New Economic Thinking. He is a senior fellow and director of the Global Finance Project for the Franklin and Eleanor Roosevelt Institute in New York, and he’s also served on the United Nations commission of experts on international monetary reform under the chairmanship of Joseph Stiglitz. Thank you so much for joining us, Rob.
ROB JOHNSON: It’s my pleasure.
PERIES: So Rob, let me start with whether you agree with your friend, colleague, and economist Joseph Stiglitz.
JOHNSON: Well, I think Joe is right, that things are decelerating, decelerating quite markedly in China. They are amidst what I would call a very long-term structural adjustment from an export-led growth manufacturing economy and moving towards a domestic demand-led and increasingly service economy. Joe also spoke about the financial markets and why they were anxious here in the beginning, and about some of the technical matters related to the structure of what are called circuit breakers in the securities market.
PERIES: Now, Rob, I understand that–actually, you sounded like you wanted to explain that a bit further. Let me actually let you continue.
JOHNSON: Okay. With regard to the securities markets, there is a great deal of instability in China right now because people are not trusting that they understand the market regime. There has been ups and downs in the foreign exchange rate. Mostly down, meaning weakening of the RMB. There is very, very primitive market structure that’s in the middle of modernization. And even the head of the Chinese Securities Regulatory Commission a few years ago came out of retirement and gave a blasting speech yesterday about these circuit breakers, saying the crisis isn’t a crisis of this or that circuit breaker, or you know, what have you. It’s a crisis of talent in the regulation of financial and securities markets.
Now, that’s quite understandable in the sense that it’s not a society that has had broad and deep financial markets or mature institutions for a long time, and there are always growing pains as people accumulate experience. But the allegation in the last few days has been the CSRC has been what you might call rather wildly incompetent, and as the former director said, there have been potential rent-seeking opportunities, meaning people are manipulating these markets for political purposes.
PERIES: Now, it’s difficult for the Chinese ruling class to kind of disconnect from the market and regulate it, because there’s so much of the Chinese state corporations, and they themselves working the market. So how is regulation going to really affect and support the stabilization of the market?
JOHNSON: Well, that’s a very difficult question. Those of us in the West work with institutions that have what you might call a balance sheet, an income statement, reporting numbers that are at least allegedly transparent. And if they’re going to go bust, they go bust, or if they need a, a bridge loan or a restructuring loan, these things are identified.
It’s a much murkier environment where what I’ll call the remixing of property rights in China takes place, where state-owned enterprises don’t necessarily have to make a profit, and when they lose money, the question is where are those losses to be distributed. And that’s a political decision. And it’s not always a systematic political decision where one can understand how the regime will behave. It’s on a case-by-case basis.
When people respect–excuse me, when people speak of what they call the rule of law, to me that’s a bit of a, what you might call a storytelling device. It’s not really about courts and judges and so forth as much as they want to see consistency in how the system is working. And right now we’re in a state of transition where the international financial markets are wanting to integrate with the Chinese market. The Chinese are talking about making their currency, the RMB, convertible, and the Chinese are also modernizing their internal markets. So all the structures are in a state of transition, and in a state of transition nobody quite knows how the game is played.
PERIES: Now, Rob, China’s debt-to-GDP ratio is now about 240, I think. Is this an indicator that there is a major disconnect between the market and the real economy? And also I’m curious that, you know, when the Greek economy’s GDP-to-debt ratio was increasing to 170, 180, 190, people were starting to panic. Why aren’t we having the same thoughts about the Chinese economy?
JOHNSON: Well, I think, first of all, there’s recent information suggesting that the growth of bank debt is much higher than what’s being reported publicly. And the data from the last part, the fourth quarter of last year, show almost no growth. If anything, slightly negative industrial growth. A very rapid rise in bank debt. And corporations having very what you might call thin profit margins or no profit margins, and decelerating revenue.
So to put it simply, people are taking on debt to cover the cash flow losses that they’re making, and they’re not servicing that debt, what in America we call a Ponzi scheme, or interest capitalization, where instead of paying interest you just let the bank debt grow in principle to keep a bookkeeping entry of the interest that was owed. But it’s not really a performing credit allocation, meaning something that inspires new investment, new activity. It’s something that’s covering losses that are accruing. And that appears to be accelerating quite markedly right now in China.
PERIES: Now, this circuit breaker rule that Stiglitz essentially said it was a technical problem, in terms of how it was implemented. That it was improperly, too quickly followed each other. So the objective of this was to calm the markets, but it had the opposite effect. And now the government had scrapped that plan last Thursday. Has the situation improved, and has the market calmed down since they pulled it?
JOHNSON: I don’t think, I believe the markets were down several percent last night, I don’t think anything can improve psychologically in that short a time frame. In other words, a faulty circuit breaker removed from what you might call the line of action is probably a good decision. But things are not in a state of repair.
And there’s a very unstable dynamic right now. As the economy is slowing down, the stock market is very fragile. And there is a great temptation to let the currency weaken. The currency weakening will then improve the profitability and competitiveness of the export sectors, some of the sectors that are really slowing down, decelerating very rapidly.
But the problem with that is there is a great deal of wealth within China that is not diversified internationally. And when wealth in China can smell that the currency’s going to weaken, what does it want to do? It wants to get out of the country. It wants to get out before the currency goes down. The government has a very, very high level of foreign exchange reserves, so they can stem that tide for a bit. But this dynamic between stock market weakness and currency weakness is a slippery slope. If the currency starts to weaken, people will sell more stocks in order to get their money offshore. So I think, to put it simply, the Chinese authorities have their hands full right now. They’re in a very difficult place.
PERIES: And in the past, Rob, the Chinese government had always used the Hong Kong market to help regulate fluctuations in the mainland. Is that still taking place?
JOHNSON: Well, the Hong Kong market is a test platform vis-a-vis what they’ll call innovative or offshore products related to the Chinese economy. But Hong Kong itself is a very mature market for things that relate to the Hong Kong Stock Exchange, Hong Kong dollar and what have you. So it’s a place also going back to the CSRC, the former chairman, it’s a place where there is a lot of talent in the financial services industry, both in the private sector and in the regulatory realm, that know how to handle things. So it’s a very good learning or observation platform for the officials in Shanghai and Beijing.
PERIES: Now, getting back to the mainland, one of the things that the Chinese government had done, especially when the 2007-2008 crash occurred here, is to try to switch their international demand for their goods to a domestic market. But the domestic market demand for goods and services produced by the Chinese economy requires–to stimulate that it requires a stronger wage for their workers. Is that scenario being discussed when you–you told me offline that you actually are headed to China in the next few days. Are these discussions taking place in China?
JOHNSON: Yes. The Chinese, what I call technocracy, policy officials at the international institutions, at domestic institutions, are very, very brilliant and well-educated people. They’re very sophisticated.
The problem for a middle-income country like China is it’s an enormous country, and it’s in transition from that export-led economy that you refer to, to a domestic demand-led economy. This doesn’t happen overnight. But with the stresses that occurred in 2007 and ’08 with the great financial crisis, the Chinese did something that’s akin to what I’ll call old-fashioned Keynesian fiscal stimulus of the first order, where they started building infrastructure, roads, hotels, construction, and real estate development, and that became the new what you might call impetus or thrust for demand and for growth as the export sector started to decelerate.
The secular stagnation, as Larry Summers and others have called it in the West, is contributing to the deceleration, decline, and depression of the export-led industries in China and other parts of Asia. And so they do have their hands full. They’re in this almost no-man’s-land before the wages go up, before there’s new growth in China, before private sector production can be directed to the domestic economy, you need that fiscal stimulus in the middle to build the infrastructure and take the pain out of what you might call the lessening reliance on the West, which has been slowing down, and performance has been quite tepid since the crisis.
PERIES: Now, this real estate and infrastructure development stimulus that you were just speaking about, is this–the current fluctuations in the market, is this an indication that that strategy may be slowing down and not working, as well? And will it be faced with the decision of having to improve domestic wages in order to create national demand?
JOHNSON: Yes. I think so. I’ve heard stories, and I can’t verify the data, but people say there has been more cement produced in the last decade in China than in the entire history of the United States of America. Meaning there was a robust boom in real estate development and infrastructure, highways and roads and bridges and the like. And I don’t think you can continue with that pace, with that vehemence, for a long, long time.
The wages going up is a double-edged sword. I think when you look at the balance in the Chinese economy, where investment and export and other things are very high and consumption is very low, there’s no question what direction it has to go. When you look at the distribution of income and wealth, it will become a more stable and healthy society if wages and prosperity and health conditions improve for the large majority of the population. But you have to remember that China’s previous period, this last 25 years, was largely built on foreign direct investment. They brought knowledge to their shores through joint ventures with basically American and European companies, and Japanese companies. And part of the condition that inspired that foreign direct investment was low wages and low environmental conditions. Now, as they have to improve the environmental conditions, as they have to let the wages go up, the attractiveness to the next round of foreign direct investment will diminish.
But I believe the Chinese have managed this reasonably well in the sense that they have gone up the learning curve. They don’t really need as much foreign direct investment, because the quality of their people, education, learning by doing through this experience in manufacturing, will contribute to their ability to build that domestic-based production system for the Chinese consumer.
But politics is always rugged. These things are not like fluid mechanics. And it’s a bumpy road getting certain groups to accept declines in their living standard. Or–their living standard can be enormous. But if their profit margin goes down, in our political economy, people will resist that. So they’ll resist those wage increases, because that means their profits go down.
PERIES: All right, Rob. This issue isn’t going to go away. We hope to have you back very soon.
JOHNSON: Thank you. I look forward to seeing you next time.
PERIES: And thank you for joining us on the Real News Network.
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