24 March 2014
For a while China was a beacon for those who thought centrally planned or partially controlled economies had an edge over the unpredictable nature of unrestrained entrepreneurialism. Until now, writes Ian Verrender.
Capitalism has had a bad rap in recent years.
The trigger may have been the near meltdown of the global banking system that rocked the foundations of western democratic society. But it was the ignominy of having to go cap in hand to a communist state for financial assistance that really set conventional economic thinking on its ear.
China. In the space of three decades it has evolved from political pariah and economic nobody to rock star status. The world’s fastest growing economy had gathered momentum to the point that pundits in recent years began taking bets on exactly when it would overtake the US as the world’s economic superpower.
It all added credibility to the idea that market based economics was not all it was cracked up to be; that centrally planned or at least partially controlled economies had an edge over the haphazard and unpredictable nature of unrestrained entrepreneurialism.
Until now. While the wheels haven’t exactly fallen off the great China growth saga, what once was deemed the miracle economy has begun to fray around the edges, to endure the kind of pain regularly experienced in the west.
The true test of the resilience of quasi central planning is nearly upon us. Just how China responds to the myriad economic crises now besieging the country will have huge ramifications for the rest of the globe. And nowhere will that be greater felt than here.
It is, perhaps, the ultimate irony. As an economy almost at the polar extreme to China, Australia has allowed itself to be almost purely driven by market forces.
We’ve embraced the concept that a free market is the best and most efficient way to determine the allocation of resources, that the smart way to operate is to play to your strengths. We’ve accepted that state support for industry and ad hoc protection comes at a cost.
As a philosophy, it has at times been harsh but it has paid dividends. For over the past three decades it has led to efficiencies and productivity growth that has elevated our living standards.
But the resources boom that has fuelled our growth in the past decade and a half has hollowed out the economy, rendering vast segments of Australian manufacturing and service industry uncompetitive. More dangerously, it has left us largely exposed to one industry, one market and one country.
How serious are China’s economic problems? No one really knows because deep down, no one seriously believes any of the official numbers broadcast by Chinese authorities. While it has been possible to deduce longer-term trends from official data, the actual numbers have been close to useless.
Where Australian Treasury officials have been castigated for miscalculating forecasts, Chinese authorities have an enduring record of pinpoint accuracy. If the central committee forecasts 7.5 per cent growth, lo and behold, in it comes 12 months later to a tee.
Never was this ludicrous situation more apparent than earlier this month when Premier Li Keqiang forecast growth this year to remain at 7.5 per cent. In the same address he signaled the closure of significant amounts of the country’s steel industry purportedly as an attempt to combat pollution.
Meanwhile, a few hours drive to the southeast, the port of Tianjin was being clogged with record piles of red dirt from Western Australia’s Pilbara district. A week later, iron ore prices suddenly slumped, briefly falling below $US105 a tonne after months of steady retreat.
For months, China has been awash with talk of iron ore traders using these vast piles of iron ore as collateral to raise finance to then on-lend to desperate borrowers, some of whom were cash-strapped steel mills. Even more worryingly, the same collateral reportedly has been used on multiple occasions in what appears to be a crude re-run of America’s sub-prime property crisis.
Its heavily regulated and controlled banking system has spawned the growth of a shadow banking system where massive but largely unreported debt levels reside. Local governments and state controlled corporations have borrowed to the hilt, investing in largely unproductive assets that have spurred on further investment in steel production.
China’s steel industry now is in a funk. Last week, domestic steel prices slumped to their lowest level in more than eight years and many smaller mills are uneconomic. That’s the real reason Premier Li has announced a scale back in steel output. Even more worrying, rumours swept through Beijing this week that the country’s biggest privately owned steelmaker, Highsee Iron and Steel Group, based in Shanxi was facing default on its 3 billion yuan debt.
Adding to concerns, an overheated property market has had monetary authorities spooked for more than a year resulting in occasionally harsh and clumsy crackdowns on credit growth. Meanwhile, the past week has witnessed the yuan – recently partially unshackled from its US dollar peg – drop sharply on currency markets.
No matter how you read it, the outlook for raw materials demand, and hence Australia’s future, appears far less optimistic than this time last year.
China is attempting to rebalance its economy. But that will be no easy task. Throughout its growth spurt, it has encouraged savings but put a cap on interest rates, a policy that favours borrowers over savers. Its currency was artificially depressed, delivering it global competitiveness that resulted in massive trade surpluses.
That has shifted wealth into sectors such as property and exports and created a powerful class of business leaders who have derived not just wealth but enormous power which will be employed to resist any such change.
Last year, fears of a China hard landing rocked global markets. Those concerns waned after authorities injected yet another round of stimulus. But once again, debate about the health of China’s economy is beginning to weigh on the west.
Rather than a doomsday scenario – a sharp downturn in the economy as it grapples with the legacy of years of uneconomic investment – the more likely probability is that authorities will refuse to allow any kind of harsh adjustment that could provoke political instability.
The alternative could be a rerun of exactly what has happened in Japan; a slow economic decline stretching over decades.
China’s leaders are at a cross road. Either accept greater free market participation but risk political upheaval. Or ignore the pressures building in the system and squander the tremendous gains it has made during the past three decades.
Capitalism may well be in the ascendancy.
Courtesy of The Drum
24 March 2014