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Shifting China’s
Export towards the Domestic Market
By
Henry C. K. Liu
Part I: Breaking Free
from Dollar Hegemony
This article appeared in AToL
on July 29, 2008
The vast expansion of US-led globalized trade since the Cold
War ended in 1991 had been fueled by unsustainable serial debt bubbles
built on dollar
hegemony,
which came into existence on a global scale with the emergence of
deregulated
global financial markets that made cross-border flow of funds routine
since the
1990s. Dollar hegemony is a geopolitically-constructed peculiarity
through
which critical commodities, the most notable being oil, are denominated
in fiat
dollars, not backed by gold or other species since President Nixon took
the
dollar off gold in 1971. The recycling of petro-dollars into other
dollar
assets is the price the US
has extracted from oil-producing countries for US tolerance for the
oil-exporting cartel since 1973. After that, everyone accepts dollars
because
dollars can buy oil, and every economy needs oil. Dollar hegemony
separates the
trade value of every currency from direct connection to the
productivity of the
issuing economy to link it directly to the size of dollar reserves held
by the
issuing central bank. Dollar hegemony enables the US
to own indirectly but essentially the entire global economy by
requiring its
wealth to be denominated in fiat dollars that the US
can print at will with little monetary penalties.
World trade is now a game in which the US
produces fiat dollars of uncertain exchange value and zero intrinsic
value, and
the rest of the world produces goods and services that fiat dollars can
buy at
“market prices” quoted in dollars. Such
market prices are no longer based on mark-ups over production costs set
by
socio-economic conditions in the producing countries. They are kept
artificially low to compensate for the effect of overcapacity in the
global
economy created by a combination of overinvestment and weak demand due
to low
wages in every economy. Such low market prices in turn push further
down
already low wages to further cut cost in an unending race to the
bottom. The
higher the production volume above market demand, the lower the unit
market
price of a product must go in order to increase sales volume to keep
revenue
from falling. Lower market prices require lower production costs which
in turn
push wages lower. Lower wages in turn further reduces demand. To
prevent loss
of revenue from falling prices, producers must produce at still higher
volume,
thus lowering still market prices and wages in a downward spiral.
Export
economies are forced to compete for market share in the global market
by
lowering both domestic wages and the exchange rate of their currencies.
Lower
exchange rates push up the market price of commodities which must be
compensated by even lower wages. The adverse effects of dollar hegemony
on
wages apply not only to the emerging export economies, but also to the
importing US
economy. Workers all over the world are oppressed victims of dollar
hegemony
which turns the labor theory of value up-side-down..
In a global market operating under dollar hegemony, the
world’s interlinked economies no longer trade to capture Ricardian
comparative
advantage. The theory of comparative advantage as espoused by British
economist
David Ricardo (1772-1823) asserts that trade can benefit all
participating
nations, even those who command no absolute advantage, because such
nations can
still benefit from specializing in producing products with the lowest
opportunity cost, which is measured by how much production of another
good
needs to be reduced to increase production by one additional unit of
that good.
This theory reflected British national opinion at the 19th
century
when free trade benefited Britain
more than its trade partners. However, in today’s globalized trade when
factors
of production such as capital, credit, technology, management,
information,
branding, distribution and sales are mobile across national borders and
can
generate profit much greater than manufacturing, the theory of
comparative
advantage has a hard time holding up against measurable data.
Under dollar hegemony, exporting nations compete in global
market to capture needed dollars to service dollar-denominated foreign
capital
and debt, to pay for imported energy, raw material and capital goods,
to pay
intellectual property fees and information technology fees. Moreover,
their
central banks must accumulate dollar reserves to ward off speculative
attacks
on the value of their currencies in world currency markets. The higher
the
market pressure to devalue a particular currency, the more dollar
reserves its
central bank must hold. Only the Federal Reserve, the US
central bank, is exempt from this pressure to accumulate dollars,
because it
can issue theoretically unlimited additional dollars at will with
monetary
immunity. The dollar is merely a Federal Reserve note, no more, no
less.
Dollar hegemony has created a built-in support for a strong
dollar that in turn forces the world’s other central banks to acquire
and hold
more dollar reserves, making the dollar stronger, fueling a massive
global debt
bubble denominated in dollars as the US becomes the world’s largest
debtor
nation. Yet a strong dollar, while viewed by US authorities as in the US
national interest, in reality drives the defacement of all fiat
currencies that
operate as derivative currencies of the dollar, in turn driving the
current
commodity-led inflation. When the dollar falls against the euro, it
does not
mean the euro is rising in purchasing power. It only means the dollar
is losing
purchasing power faster than the euro. A strong dollar does not always
mean
high dollar exchange rates. It means only that the dollars will stay
firmly
anchored as the prime reserve currency for international trade even as
it falls
in exchange value against other trading currencies.
In recent decades, central banks of all governments, led by
the US Federal Reserve during Alan Greenspan’s watch, had bought
economic
growth with loose money to feed debt bubbles and to contain inflation
with
“structural unemployment” which has been defined as up to 6% of the
work
force to
keep the labor market from being inflationary. Central banking has
mutated from
an institution to safe guard the value of money to ensure wages from
full
employment do not lose purchasing power into one with a perverted
mandate to
promote and preserve dollar hegemony by releasing debt bubbles
denominated in
fiat dollars. See my November
6, 2002
series in in AToL: Critique
of Central
Banking.
Despite all the talk about globalization as an irresistible
trend of progress, the priority for the United
States in the final analysis has been
to
advance its superpower economic objectives, not its obligations as the
center of
the global monetary system. This superpower economic objective includes
the
global expansion of US
economic dominance through dollar hegemony, reducing all domestic
economies,
including that of the US,
to be merely local units of a global empire. Thus when the US asserts
that a
healthy and strong economy in Europe, Japan and even Russia and China,
all
former enemies, is part of the Pax Americana, it is essentially
declaring a
neocolonial claim on these economies.
The concept of “stakeholder” in the global
geopolitical-economic order advanced by Robert
B. Zoellick, former US
Deputy Secretary of State and now president of the World Bank, is a
solicitation from the US
to emerging economic powerhouses to support this Pax Americana. The
device for
accomplishing this neo-imperialism is a coordinated monetary policy
managed by
a global system of central banking, first adopted in the US in 1913 to
allow a
financial elite to gain monetary control of the US national economy,
and after
the Cold War, to allow the US as the sole remaining superpower
controlled by a
financial oligarchy to gain monetary control of the entire global
economy.
With the help of supranational institutions such as the
International Monetary Fund (IMF) and the Bank of International
Settlements
(BIS), the US
aims to negate national economic sovereignty with globalization of
unregulated
trade conducted under dollar hegemony. Unregulated trade globalization
in the
21st century aims to neutralize national economic
sovereignty to
preempt national development financed by sovereign credit. Trade
through export
has become the sole operative path for national economic growth in a
political
world order of sovereign nation states that has existed since the
Treaty of
Westphalia of 1648. No national domestic economy can henceforth prosper
without
first adding to the prosperity of US-controlled global economy
denominated in
dollars.
Holy Dollar Empire
Echoing the Holy Roman Empire, the
global economy has been operating as a global Holy Dollar Empire with
the
Federal Reserve as the Holy Dollar Emperor. Similar to the Holy
Roman Empire which disintegrated from the rise of Lutheran
nationalism, this Holy Dollar Empire will eventually disintegrate from
progressive centrifugal forces of a new populist economic nationalism.
This new
populist economic nationalism is not to be confused with regressive
trade
protectionism. The formation of the new Group of Five (G5 - China,
Brazil,
India,
Mexico
and South Africa)
in the 2008 Group of Eight Summit in Tokyo
(G8
– US, UK,
Germany,
France,
Italy,
Japan,
Russia
and the
European Union) is a sign of this new trend of progressive new economic
nationalism. The 2008 US
presidential election may herald in a new populism in US
history to reform the structure of US
debt capitalism.
In his speech to the G5 leaders, President Hu Jintao said:
“It is necessary to take into full account the issue of food security
in
tackling the challenges in energy, climate change and other fields.”
Apart from
calling for the setting up of an UN-led international co-operation
mechanism
and a global food-security safeguard system, Hu said all countries
should
strengthen co-operation in grain reserves, a process of proven success
in China
but not recommended by the UN Food and Agriculture Organization which
views
such scheme as a distortion of trade.
Liberation from this Holy Dollar Empire of dollar hegemony
can only come from sovereign nations withdrawing from the global
central
banking regime to return to a national banking regime within a world
order of
sovereign nation states to put monetary policy back in its proper role
of
supporting national development goals, rather than sacrificing national
development to support global dollar hegemony through wage-suppressing
export-led growth. In a world order of sovereign nation states, the
supranational nature of central banking will render it inoperative, as
it can
be and has been used as an all-controlling device for the world’s rich
nation
to neutralize the sovereign rights of financially weak nations. In a
democratic
world order, central banking is also inoperative within national
borders, as it
can be used by a nation’s rich as a device to deny the working poor of
their
economic rights. Central banking, in its support of dollar hegemony,
operates
internationally in opposition to the economic interests of sovereign
nation
states and domestically in opposition to the economic rights of the
working
poor by discrediting enlightened economic nationalism as undesirable
protectionism.
To preserve dollar hegemony, exporting economies that
accumulate large dollar reserves through trade surplus are forced by
the US to
revalue their currencies upward, not to redress trade imbalance, which
is the
result of dysfunctional terms of trade rather than inoperative exchange
rates,
but to reduce the value, in foreign local currency terms, of US debt
assumed at
previously stronger dollar exchange rates. When commodities prices
rise, it
reflects a defacement of all fiat currencies led by the dollar as a
benchmark.
When the currency of another nation rises against the dollar, it does
not mean
that currency can buy more; it only means the dollar can buy less than
what the
appreciating currency can buy. This is why commodities prices have been
rising
in all currencies, albeit at different rates.
The bursting of the latest dollar-denominated debt bubble
created a global credit crisis in August 2007 that is beginning to
cause
globalized trade to contract. Exporting economies around the world are
now
forced to reconsider their dysfunctional strategy of seeking growth
through
export for fiat dollars that are pushing the world economy towards
hyperinflation, leading all other fiat currencies in a depreciation
race to the
bottom.
China’s High Trade
Dependency
At the top of the list of exporting economies is China’s
which in 2006 registered an unwholesome trade-to-GDP ratio of 69%, with
a per
capita trade value of $1,645. In 2007, China’s
nominal GDP was 24.66 trillion yuan, or $3.38 trillion at then exchange
rate of
7.3 yuan to a dollar. The 2007 per capita GDP for the population of
1.32
billion was 18,655 yuan, or $2,556, translating to $9,711 on purchasing
power
parity (PPP) ratio of 3.8. If China’s
export were to be redirect towards the domestic market, China’s
2007 per capita GDP on a PPP
basis would have increased by $5,384 to $15,095, even not counting any
stimulant multiplying effect. Chinese household consumption remains at
a record
low of 37% of GDP, the smallest ratio in all of Asia,
due to low Chinese wages.
China’s
trade surplus fell 20% year-on-year in June 2008 to $21.3 billion
because of a
drop in export growth. In Chinese currency (RMB) terms the drop is more
due to
a rise in its exchange rate against the dollar. Still, it was the
biggest
surplus since December, 2007 which totaled US$22.7 billion. Exports
value in
June was $121.5 billion, 18.2% more than a year earlier but the growth
rate was
nearly 10 percentage points down from the May figure. Imports totaled
$100.1
billion, up 23.7% from a year earlier. China’s
trade surplus with the US
in June totaled $14.7 billion, 5% higher than 2007. The surplus with
the EU,
its biggest export market, was worth $13.2 billion, up 21.2% from 2007.
Chinese
exports are slowing because of reduced global growth caused by a
developing US
recession, while imports are rising on the back of rising commodity
prices.
These figures are not inflation adjusted. However, they reflect the
rising
exchange value of the RMB. In other words, export has been falling more
in RMB
terms. The fall in export is expected to accelerate as no market
analyst of
worth is projecting any quick or sharp recovery in the US
economy.
Going forward, the ratio of nominal-GDP
to PPP-GDP
can be expected to fall as Chinese domestic inflation rate continue to
exceed US
inflation rate. This trend will gain momentum as China
attempts to use its trade surplus denominated in dollars for domestic
development, which requires it to issue more RMB into the Chinese money
supply.
And market pressure can be expected to push the RMB down against the
dollar
until Chinese inflation rate is at parity with US
inflation rate. But a falling exchange rate causes more domestic
inflation from
imports denominated in dollars; and rising domestic inflation adds
pressure to
a falling exchange rate in a downward spiral, preventing the RMB to
rise
against the dollar from market forces. That is the dysfunctionality of
the
RMB-dollar exchange rate regime in relation to the inflation rate
differentials
between the two economies, when the exchange rate is set by trade
imbalance
denominated in dollar. This dysfunctionality is cause by the flawed
attempt to
use exchange rates to compensate for dysfunctional terms of trade,
which has
been mostly caused by wage disparity.
The Stagflation
Danger
Li Yining, a leading Chinese economist, former president of
Guanghua School of Management at Beijing University and member of
the
Standing Committee of the 11th National Committee of the
Chinese
People’s Political Conference (CPPCC), the country’s political advisory
body,
opined in the Second Meeting on July 4, 2008, that China is facing a
pressing
challenge in preventing inflation from turning into stagflation, the
dual evils
of high unemployment along with high inflation, if market expectation
concludes
that Chinese policymakers will fail to insulate the economy from the
developing
global slowdown that is expected to deepen next year with no prospect
of a
quick recovery. Overwrought anti-inflation macroeconomic measures by
Chinese
policymakers may cause investors to dump shares of companies in the
export
sector, putting these companies in financial distress and causing
foreign
capital to exit the Chinese economy to cause unemployment to rise in China.
As China
is
unhealthily trade dependent, this will hurt domestic development and
curb
consumer spending.
Li argues that China
should decelerate the pace of capital and foreign exchange decontrol
within the
context of an on-coming, protracted global economic slowdown to
preserve the
value of its huge foreign exchange reserves in RMB terms. He wants the
government to avoid being misguided by the static concept of a fixed
low
inflation rate target of 3%. Rather, an inflation rate up to 60% of the
economic growth rate should be permissible, meaning to allow an
inflation rate
at around 6% for a 10% growth rate.
China’s
inflation rate hit an 11-year high of 8.7% in February 2008 and eased
to 7.7% in
May, still high above the government-set goal of 3% annualized. Li
points out
that incoming economic data show that the Chinese economy is on sound
footing despite
new challenges from abroad and at home, including the May 12 massive
earthquake
and serious floods in the south. However, Li warns the government to
avoid
risks of stagflation in formulating macro policies going forward.
Li’s advice is sensible. It serves no useful purpose to
cause a collapse of the economy to fight inflation, as Paul Volcker did
in the US
in the1980s, making the cure worse than the disease. Still, Volcker was
facing
20% inflation rate in 1980 which might have justified drastic action.
Yet Li
should realize that under dollar hegemony, Chinese central bankers must
try to
keep Chinese inflation rate target below 3% to stay on par with the
dollar
inflation rate target set by the US Federal Reserve, the head of the
world’s
central bank snake. A 6% inflation rate in China would more than triple
current
inflation rate target set by the US central bank, the defender of
dollar
hegemony even as it allows the dollar’s exchange rate to fall.
A Chinese inflation rate of 6%, as proposed by Li, would
cause market forces to push the RMB down against the dollar, further
exacerbating US-China trade tension and reviving protectionist pressure
in the US.
As China
is
being pressured relentlessly by the US
to further revalue the RMB upward against the dollar, RMB interest
rates must
rise above Chinese inflation rates. At 6% interest rate for the RMB,
the
disparity with dollar interest rate will cause hot money denominated in
dollars
to rush into China
through “carry trade” to profit from interest rate arbitrage, betting
on
continuing Chinese government intervention to keep the RMB from falling
against
the dollar despite higher Chinese inflation.
With 6% inflation rate, China
will be forced to pay currency traders massive sums to defend an
overvalued RMB
dictated by US
trade policy in contradiction with US Treasury policy of a strong
dollar. That
was how the Bank of England allowed itself to be broken by George Soros
on
Black Wednesday, September
16, 1992,
when the British central bank attempted in vain to defend an overvalued
pound
sterling out of sync with its interest rate regime. It was also how the
Hong Kong government was
forced to execute its “incursion” in the
equity market in August 1998 to defend the Hong Kong
dollars peg to the US dollar against market fundamentals.
China
has been forced to take steps to offset the impact of the US Fed’s easy
money
policy on the Chinese economy. The US Fed has cut the Fed funds rate
target
eight times since September
18, 2007
from 5.75% to 2% on April 30, and the discount rate nine times since
August 17,
20007 from 6.25% to 2.25% on April 30. Although China’s
central bank has issued notes to absorb excess liquidity, market
pressure still
exists for the central bank to put more currency into circulation to
add to
already excessive liquidity. China’s
central bank has increased interest rates six times and the bank
reserve ratio fifteen
times since 2007, but Shanghai
interbank rates have increased only slightly, signaling major
resistance to
monetary policy.
LIBOR and SHIBOR
Assistant Governor Yi Gang of the People’s Bank of China,
the central bank, in a speech in the 2008Y SHIBOR (Shanghai
inter-bank borrowing rate) Work Conference on January 11, 2008, outlined the role of
SHIBOR,
introduced a year ago as a benchmark rate for money market
participants. At the
initial stage of the index’s launching, central bank promotion is
deemed
necessary. But the SHIBOR, as a market benchmark, will be set by the
market and
all market participants. Central banker Yi asserts that all parties
concerned
including financial institutions, National
Inter-bank Funding
Center,
National Association of
Financial Market Institutional Investors should have a full
understanding of
this, and actively play a role in the operations of SHIBOR as
“stakeholders”,
the new buzzword in Chinese policy circle, thanks to Robert B.
Zoellick.
Governor Yi said that “under the command economy, the
central bank is the leader while commercial banks are followers. But
from the
current [market economy] perspective of the central bank’s functions,
the
bipartite relationship varies on different occasions. In terms of
monetary
policies, the central bank, as the monetary authority, is the policy
maker and
regulator, while commercial banks are market participants and players.
But in
terms of market building, the relationship is not simply that of leader
and
followers, but of central bank and commercial banks in a market
environment.
This broad positioning and premise will have a direct bearing on how we
behave.
On the one hand, it requires the central bank to work as a service
provider, a
general designer and supervisor of the market. On the other hand, it
requires
market participants and various associations to cultivate SHIBOR as
stakeholders and players on a leveling playground.”
The fact of the matter is that in the US,
the central bank, in addition to being a lender of last resort, has
become a
key market participant in the repo
market to keep short-term interest
rates
aligned with the Fed funds rate target set by the Fed Open Market
Committee.
Until proposed reforms are adopted by Congress, the Fed is not the
regulator of
non-bank financial institutions, be they investment banks and brokerage
houses,
hedge funds, private equity firms, or the recently active foreign
sovereign funds.
The role of regulating the issuing of securities belongs to
the Security Exchange Commission (SEC), created by the Securities Act
of 1933
to protect investors by maintaining fair, orderly and efficient markets
while
facilitating capital formation. Securities offered to the general
public must
be registered with the SEC, requiring extensive public disclosure,
including
issuing a prospectus on the offering. It is a time-consuming and
expensive process. Most commercial paper, the market that precipitated
the
credit crisis in August 2007, is issued under Section 3(a)(3) of the
1933 Act
which exempts from registration requirements short-term securities with
certain
characteristics. The exemption requirements have been a factor shaping
the
characteristics of the commercial paper market. Private equity
firms with
less than 15 investors and hedge funds, even though they may control
billions
of equity and multi billions of credit, are not regulated by the SEC.
When the Federal Reserve and other central banks take crisis-induced
actions since August 2007 to calm markets to get market participants to
believe
that the financial system will continue to operating normally, market
indicators, such as London InterBank Offered Rate (LIBOR), on which
SHIBOR is
modeled, suggest that the Fed’s message has not be accepted by market
participants. The LIBOR, a global benchmark, normally trades
predictably at
only a few basis points (hundreds of a percentage point) above the
federal funds
rate. It is a “traded version of the fed funds rate”. As
such, it’s an important benchmark for
determining lending rates on big corporate deals, mortgages and other
lending
markets.
LIBOR has been out of normal alignment with the Fed funds
rate since the credit crisis began in August 2007. The Fed and the
European
Central Bank (ECB) have already been greasing the markets by adding
liquidity
through reserve operations. When the credit crisis broke, one-month
LIBOR was
traded at an abnormally high of 5.82% when the Fed funds rate target
was 5.25%,
a 57 basis points spread, and the Fed discount rate was cut 50 basis
point to
5.75%. The Fed has since cut the fed funds rate target from 5.25% to
its
current 2% and the discount rate from 6.25% to 2.25%, but the spread
between the
Fed funds rate and LIBOR has not narrowed. Three-month dollar LIBOR is
trading
at 2.75% as of July 11, 2008,
75 basis points above Fed funds rate. It means banks are not willing to
lend
short-term money to each other for fear of counterparty default. Also,
as part
of general tightening in the current credit crisis, banks have been
hoarding
cash to respond to the frozen asset-backed commercial paper market.
Many
European banks have committed to credit lines to big issuers of this
paper, and
because nobody wants to take on more of that paper, those paper issuing
companies
are forced to borrow from banks using their bank credit lines — making
banks needing
more cash to build up required reserves. With more than $1 trillion of
commercial
paper set to come due every six weeks since August 2007 and more than
$700
billion as of June 2008, banks are reluctant to tie up
their reserves lending to other banks even at
rates that would normally seem
extremely attractive.
At present, lending and deposit
interest
rates are regulated
in China
with a
floor lending rate and a ceiling deposit rate. Central banker Yi said
that
“When clients complain about high interest rate, commercial banks can
pass the
buck to the central bank because the central bank sets the interest
floor. When
SHIBOR matures, SHIBOR will become the culprit. Such a change bears
important
legitimacy, authoritativeness, and persuasiveness, and can make SHIBOR
a
recognized and authoritative benchmark.” Yi
sees market-based interest rate coming from
deregulation. But if the
central bank deregulates deposit rate ceiling and lending rate floor
when there
is no other reliable benchmark to substitute them, the result could be
worse.
When is the right timing for deregulation? The answer is when a new
benchmark
matures. SHIBOR is an important benchmark in the process of making
interest
rate more market-based. Interest rate floor and ceiling are likely to
exist for
some period. Can the market-based interest rate transformation process
start with
discount rate linking with SHIBOR? In fact, discount facilities are
loans. A
breakthrough with discount rate will have far-reaching impact on
market-based
interest rate transformation, and provide experience for future
interest rate
reform, according to Yi.
Central banker Yi touched on the relationship between SHIBOR
and the RMB internationalization. In the past, the central bank only
looked at
the domestic market, but now it must adopt a global perspective. Many
currencies in the world have their benchmark interest rates, including
LIBOR,
EURIBOR, TIBOR, etc. The launch of SHIBOR shored up transaction volume
in the
Chinese money market. Comparatively speaking, Shanghai’s
money market capacity now is much smaller than that of London
and New York. But the
RMB will
soon become an important currency in the world, so China
will steadily push ahead with RMB convertibility under the capital
account. At
present, great pressure of appreciation on the RMB driven by large
amount of
capital influx is to a large extent due to a positive speculative
outlook of China’s
economy and purchase of RMB-denominated assets by foreign companies and
individuals. The money market is part of the financial infrastructure
that will
establish the role of RMB in world markets, according to central banker
Yi.
Many existing financial products are linked to interest
rates set by the People’s Bank of China (PBC). So when the PBC adjusts
interest
rate, multiple factors have to be taken into account so as to balance
the
interests of various parties. Any move to balance interests involves
different
interest groups involving complex situations. So a widely accepted and
objective benchmark is needed, and SHIBOR can serve that need. More
products,
from company provident funds, public welfare funds, company trust funds
to
wealth management products, housing provident funds and broker
depository funds
can be linked to SHIBOR.
Chinese equity markets have been taking a beating in recent
months. The Shanghai
composite
index fell from a peak of 6,124 in mid-October 2007 to 2,566 in early
July
2008, a fall of 58%, largely due to the rising exchange value of the
RMB and
market pressure on RMB interest rates to rise to keep lenders from
cutting off
loans at negative interest rates. If the RMB becomes freely convertible
and
tradable, China
would be receiving 3% interest on its sizable dollar reserves currently
at $1.8
trillion while paying 6% interest on much larger RMB deposits.
By seeking growth through export for dollars, China
has trapped itself in an incurable mismatch between necessary domestic
macroeconomic policies to assure sustainable growth and its central
bank’s
monetary policy dictated by dollar hegemony. This mismatch is
counterproductive, crisis-prone and unsustainable. And as China
liberalizes its interest rate regime and currency convertibility as
advised by
neo-liberal economists whose credibility has been bankrupt by unfolding
events,
the Chinese economy will face another financial crisis that will wipe
out a
good part of the export-led financial and economic gains in the last
decade.
All exporting economies that had abandoned capital control since the
emergence
of deregulated globalization of financial markets had been regularly
devastated
by recurring financial crises that imploded every decade, the last
three being
the 1987 market crash, 1997 Asian Financial Crisis and the 2007 Credit
Crisis. This latest crisis has yet to
fully play out its destructiveness and there are no signs so far that
US policymakers
trapped in dysfunctional supply-side ideology have the economic wisdom
and the
political dexterity to prevent it from turning into a global
depression.
China
had been relatively spared in 1997 Asian Financial Crisis largely due
to its
then cautious pace of opening up its financial sector to global market
forces
reacting to dollar hegemony. This time around, China
can only insulate itself from this pattern of global financial crises
by making
a concerted effort to shift its export to the domestic market and to
reduce
substantially its trade dependency from the current near 70% to below
30% in a
planned manner and on an orderly schedule. Export should be returned by
policy
to an augmentation role in the economy, supporting domestic development
which
should be the main focus of economic growth. The domestic sector should
no
longer be made to sacrifice to support the export sector. Export should
support
domestic development, not act as a parasite on domestic development.
Breaking Free from
Dollar Hegemony
A first step in this redirection of policy focus on domestic
development is for China
to free itself from dollar hegemony. This
can be done by legally requiring payment
of all Chinese exports to
be denominated in RMB to stop the unproductive role of exporting for
dollars
that cannot be spent domestically without incurring heavy monetary
penalty.
Such a policy affects only Chinese exporters and can be implemented
unilaterally by Chinese law as a sovereign nation, without any need for
international coordination or foreign or supranational approval.
Importers of
Chinese goods around the world will then have to acquire RMB from the
Chinese
State Administration for Foreign Exchange (SAFE) to pay for imports
from China.
RMB exchange rate and Chinese export prices can the be coordinated
according to
Chinese domestic conditions. Import prices denominated in RMB can then
be more
rationally linked to Chinese export prices. Foreign trade for China
then will benefit the RMB economy rather than the dollar economy. There
will be
no need for the People’s Bank of China, the central bank, to hold
dollar
reserves.
China’s
economic growth since 1980 has been driven by export of low-price
manufactured goods
with a dysfunctionally low wage scale. To correct the imbalance of
trade that
has been giving China
trade surpluses of dubious financial or economic benefit, China
needs to raise wages, not to revalue its currency. Raising Chinese
wages to the
level of other advanced economies will redress the current inoperative
terms of
international trade that now benefits only the dollar economy to
benefit the
Chinese RMB economy. This low-wage-driven growth has distorted the
progressive
purpose of Chinese socialist society by reintroducing many of the
pre-revolution socio-economic defects common found under market
capitalism,
such as income and wealth disparity, market-induced chronic
unemployment,
inequality of opportunities, collapsed social safety nets resulting
from
privatization of the part of the economy best handled by the public
sector,
rampant corruption from a collapse of societal morals and excessive
influence
of money in the political process, uneven regional development and
environmental deterioration of crisis proportions.
The current export-led growth of China
can be expected to be seriously hampered by a protracted slowdown in
the
importing economies. Despite China’s
image as an export juggernaut, Chinese per capita merchandise export in
2006
was $1,655, some $135 lower than global per capita merchandise export
of
$1,780. This is because Chinese wages are substantially lower than the
average
of all export economies, while the prices of raw material are the same
for all
buyers in the global market. A fall in world demand for exports would
hit China
harder than other export economies by pushing already too low Chinese
wages
further down just to keep Chinese export factories running. Also, since
China’s
trade dependency has increased steadily over time, importing inflation
through
the export sector to the domestic sector, China’s
economy would be hit proportionally harder by a downturn in export than
it was
during the previous global recessions, unless current policy to reduce
trade
dependency is accelerated.
Exports are measured by gross revenue while GDP
is measured in value-added terms. The rules of input-output
macroeconomics
requires import inputs to be subtracted from exports in value-added
terms, and
then convert the remaining domestic content into value-added terms by
subtracting inputs from other domestic sectors to avoid making the
denominator
for the export ratio much bigger than GDP.
Normally,
this would reduce the export to GDP ratio. But China’s
domestic input is excessively low due to low wages and rents, tax
subsidies and
weak environmental regulations. Thus such input adjustments have little
impact
on the trade to GDP ratio.
In recent years, China
has been shifting from exports with a high domestic content, such as
toys, to
new export sectors that use more imported components, such as steel and
electronics, which accounted for 42% of total manufactured exports in
2006, up
from 18% in 1995. Domestic content of electronics is only a third to a
half
that of traditional light-manufacturing sectors. So in value-added
terms,
exports have increased less than gross export revenues. This is not a
comforting
development because it turns the export sector into a re-export sector,
benefiting the domestic economy even less.
China’s
current-account surplus amounted to 11% of GDP
in 2007. This means its entire GDP growth was from the export sector,
and its economy
produced far more than it consumed domestically. This surplus
production was
shipped overseas for fiat dollars that cannot be spent in the RMB
economy while
Chinese workers could not afford the very products they produced at low
wages.
Thus under dollar hegemony, while China
has become the world’s biggest creditor nation, it suffers from
shortage of
capital needed by its still undeveloped economy, particularly in the
vast
interior, and had to depend on foreign capital even in the coastal
regions when
the export sector is located. In recent years, Chinese policy has
encouraged
higher domestic consumption, yet since 2005, net exports have
contributed more
than 20% of GDP growth.
Some analysts have suggested that China’s
GDP growth would
stay at 9% from strong
domestic demand. Yet this demand comes mostly from severe income
disparity. China’s
exports to other emerging economies are now bigger than those to the US
or the EU. Asia and the Middle East
accounted for more than 40% of China’s
export growth in 2007, North America for less
than 10%. But
Chinese trade with other emerging economies was at a deficit, with China
importing more, such as oil and other commodities, than the
oil-exporting small
economies could absorb more low-price Chinese goods for their small
population,
and poor emerging economies cannot buy more from China
because they do not have sufficient amount of dollars to buy more. If
Chinese
exports are denominated in RMB, trade with these poor economies would
explode
with balance because their exports to China
can also be denominated in RMB to pay for imports from China
denominated in RMB.
Export for dollars presents a diminishing return problem for
all exporting economies because of dollar hegemony. For China,
it is a problem of crisis proportions. Since global trade is
denominated in
dollars, China’s
economy faces capital shortage despite its new role as the world’s
biggest
creditor nation. China
is forced to accept foreign direct investment which accounts for over
40% of GDP,
despite China’s
chronic trade surplus and huge foreign exchange reserves of upwards of
$1.8
trillion and growing. Weaker export growth could lead to a sharp drop
in foreign
direct investment because exporters would need to add less capacity.
While over
half of all foreign direct investment in China is in infrastructure and
property, such investment is still mostly related to export,
facilitating
expatriate managers housing, foreign company offices in commercial
buildings,
power plants to supply export factories and highways linking production
areas
with shipping terminals. Only sovereign credit can redress China’s
problem of uneven regional development caused by excessive dependence
on
foreign investment.
July 28, 2008
Next: Developing
China’s
Economy with Sovereign Credit
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