News Analysis
Inclusive growth, green energy, more trade, and a move away from financial crisis management to long-term planning—those are the official goals of the 2016 G-20 meeting in Hangzhou, China.
And wouldn’t it be great if the leaders of the world’s biggest economies could just flip a switch when they meet Sept. 4–5, forget about the huge economic issues, and focus on a prosperous future?
“China’s leadership steered the debate to facilitate the G-20 to move from short-term financial crisis management to a long-term development perspective,” U.N. Secretary-General Ban Ki-moon told Chinese reporters in New York on Aug. 26, according to state-run news outlet Xinhua.
But reality doesn’t work like that and huge frictions already lie beneath the surface, especially concerning the host. Aside from a very messy geopolitical situation in the South China Sea, the Middle Kingdom faces an economic crisis at home.
Neither the West nor China knows how to deal with China’s overcapacity and debt problems without ruining world trade and globalization altogether, let alone promoting inclusive growth and green energy.
“China is angry with almost everyone at the moment,” a Beijing-based Western diplomat told The Fiscal Times. “It’s a minefield for China.”
Global Effect
Despite China’s relatively closed financial system, the economic growth of many countries, like Brazil and Australia, depends on China’s huge consumption of commodities. Other countries, like the United States, are not vitally dependent on Chinese inflows of capital but have gotten used to trading Treasury bonds and New York real estate for cheap Chinese goods.
Ideally, the West would encourage China in its official quest to reform and rebalance its economy from manufacturing exports and investment in infrastructure to a more service- and consumption-driven economy.
The United States’ and most of Europe’s trade deficit with China would be reduced. The Chinese consumer would have more income to consume at home, importing Western goods and services instead of commodities.
“The necessary structural reforms would make it the largest consumer market in the world. Every other economy would benefit,” independent economist Andy Xie wrote in the South China Morning Post.
Chinese leaders and state media have repeatedly stressed they are behind this goal. “What is called for is not temporary fixes: My government has resisted the temptations of quantitative easing and competitive currency devaluation. Instead, we choose structural reform,” Xinhua quoted Premier Li Keqiang, who said the country has no Plan B.
Regime leader Xi Jinping again stressed the importance of reform in a meeting of the Central Leading Group for Deepening Overall Reform. “The country should focus more on economic system reforms and improve fundamental mechanisms that support these overhauls,” Xinhua wrote about a statement released by the group.
However, China has not entirely followed through with the reforms, which will cause short-term turmoil, and local governments are not prepared to handle worker unrest. Up to 6 million people will lose their jobs because of the regime’s rebalancing program, and the official unemployment rate could reach 12.9 percent, according to a report by the research firm Fathom Consulting.
For example, Hebei Province was supposed to close down 18.4 million tons of steel-producing capacity in 2016. By the end of July, it had only closed down 1.9 million tons, according to Goldman Sachs.
The economies of Australia, Brazil, Russia, and South Africa—all major commodity exporters—are slowing because Chinese imports have collapsed, falling 14.2 percent in 2015 alone, according to the World Trade Organization. In 2015, world merchandise imports crashed 12.4 percent, while world merchandise exports crashed 13.5 percent.
This collapse in world trade happened before China even started to implement its goals of reducing overcapacity, liberalizing the capital account, and floating its currency.
Instead, it has been buying time by pushing credit in the economy and spending it on infrastructure investment through state-owned companies and local governments, while private companies have thrown in the towel.
Debt Problem
China has also told banks not to push delinquent companies into default but instead to make their loans evergreen or swap debt for equity.
The real question the West and China should be asking is how much pain they can endure in the short term to reach the Chinese reform goals and achieve a rebalancing toward a consumer economy.
“To avoid a financial crisis that would be bad for China and the world, the government needs to tighten budget constraints, allow some firms to go bankrupt, recognize the losses in the financial system, and recapitalize banks as needed. ... History shows it makes more sense to help the affected workers and communities rather than to try to keep alive firms that have no prospect of succeeding,” the Brookings Institution stated in a paper on the subject.
However, the proposed remedies, which in the long run would be good for China and the world, cannot happen without upsetting the global financial system in the short term.
Billionaire investor Jim Rogers pinpointed the main issue in an interview with Real Vision TV: “I would certainly like to see more market forces everywhere, including in China. If that happens, you'll probably see more fluctuations in the value of the currency.”
What sounds innocent, however, will be even more detrimental to world trade and the global financial system. If China wants to realize the losses it accumulated through 15 years of capital misallocation, it will have to recapitalize the banks to the tune of $3 trillion.
It’s impossible to do this without heavy intervention from the central bank of the kind Li Keqiang wanted to avoid. On the other side, Chinese savers will try to move even more money abroad to protect the purchasing power of their currency.
In 2015 alone, China lost $676 billion in capital outflows, mostly because residents and companies wanted to diversify their savings, the majority of which are tied up in the Chinese banking system.
If China were to restructure corporate debt and recapitalize banks on a massive scale, the currency would devalue by at least 20 percent, according to most experts.
Trade Collapse
Because China is such a large player, exporting and importing $4 trillion of goods and services in 2015, a 20 percent devaluation of the Chinese currency would destroy the current pricing mechanism for importers and exporters across the world—a mutually assured destruction scenario.
“The world is over. The euro breaks up; there’s just no euro in that scenario. Everything hits the wall. There is no world after the tomorrow where China devalues by 20 percent. Their share of world trade has never been higher. … You would destroy global manufacturing,” Hugh Hendry, principal portfolio manager at Eclectica Asset Management, told Real Vision TV.
For China itself, a net importer of food supplies, a devaluation would make necessities even more expensive for the vast majority of the population, adding a layer of social unrest on top of the unemployment pressures.
So China is damned if they do and damned if they don’t. Even the West won’t favor a quick and painful devaluation scenario and isn’t in the best shape to offer many alternatives.
The other option, possibly discussed behind closed doors at the G-20, is a Japan scenario. China won’t realize bad debts, will keep zombie companies alive, and will prevent money from moving abroad, defaulting on its ambitious reform agenda.
“In lieu of a quick adjustment, a ‘gradual adjustment approach’ would leave us with the outcome of an extended period of excess capacity, disinflationary pressures, and declining nominal growth and returns in the economy,” investment bank Morgan Stanley stated in a note.
China, the West, and Japan share the same problem of excess debt and no expedient way to get rid of it. By not naming the real issues at hand and choosing feel-good topics instead, the G-20 has already admitted defeat in finding a solution to the problem.
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