Futures Magazine Website
June 15, 2007
China is without a doubt one of the giants in the global economy. While they are welcome at the ever growing “adults table” at the Thanksgiving feast, the strains of their rapid ascendance is raising some eyebrows.
Intervention: A means to an end?
China ’s rapid rise has revived an old debate in trade and development economics: whether governments should intervene to nurture emerging industries. Some would argue that governments m ight try to gain a dominant position by subsidizing and protecting their producers. This is evident in the strained economic relations between the U.S. and China as of late. The current U.S. Congress is pushing the presidential administration towards what could turn out to be a trade dispute with Beijing . U.S. Senators have introduced legislation that would send disputes over exchange rates to the World Trade Organization, essentially treating them as unfair export subsidies.
As expected, the most immediate target of this legislation is China ’s weak currency. But a change of this magnitude could spark volatility in global financial markets. The bipartisan bill would require the U.S. Treasury to co-ordinate with the U.S. Federal Reserve and other central banks to intervene in currency markets where the exchange rates have become “fundamentally misaligned .” The argument is that China ’s fixed exchange rate subsidizes the country’s exports contributes to a record annual bilateral U.S. trade deficit of $233 billion (yup, billion with a capital B).
In July 2005, China abandoned an 11-year-old practice of holding the Yuan fixed against the dollar and revalued it by 2.1 % . Since then it has risen only a further 6 % , frustrating U.S. legislators and sparking these debates. Beijing did announce in mid- May that it was slightly widening the range its currency could move against the dollar in a single day from 0.3 % to 0.5 % . Most critics, however, were unimpressed by such a small widening of the currency band.
Rapid Consumption
The rising economic boom of China does have its downside – the increasing demand for raw materials. This translates to increased costs in manufacturing, and increased prices for many of our daily necessities.
The U.S. is not the only country that has been impacted by China . While American manufacturers and American consumers complain loudly, they are not the ones that stand to be impacted the most by China ’s boom. Other countries that are being impacted are the middle-income Asian countries that are geographically and economically close to China . Economies such as Indonesia , Philippines , Brazil and Egypt are at risk being stuck in what the World Bank has called a “middle-income trap.” This means they have achieved basic industrialization but are now struggling to find new areas of high growth where they can compete with the Chinese. These countries are acutely aware of the need to find niches in the global economy and closely monitor the various competitiveness indices published by the World Economic Forum and other international benchmarks of cost and productivity.
Impacts for the USD
The U.S. trade deficit with China that hit a record $232.5 billion last year has become a heated political target for U.S . lawmakers. Some believe the trade deficit illustrates that the Chinese have unfair, predatory trade practices . Lawmakers blame the United State ’s soaring trade deficits and the loss of one in six manufacturing jobs since 2000 , in part on China ’s trade practices in such areas as currency manipulation and copyright piracy.
Pressure in China
Prices in China have risen 3.4 % this year leading up to May, the fastest pace in two years. This has substantially increased already volatile food prices. The price of cooking oil in China will see a 10 % increase in this new round of consumer goods price hikes due to soaring prices of raw materials, according to the Beijing Times. The price hike is mostly because of a supply shortage of raw materials and an increase in soybean oil prices in the international market. The cost of other food items has been on the rise of late as well. According to the Ministry of Agriculture, the price for live pigs in April stood 71.3 % higher than a month earlier, with pork costing 29.3 % more. The price of eggs also rose 30.9 % on average.
Food comprises , one-third of Chinese spending and prices , do not look set to stabilize . Issues such as falling land supply, regular natural disasters and a limited water supply look to further drive up the price of food in China .
“China faces a serious problem of water shortages. This has become one of the important factors restraining economic development this year,” said Wang Jirong, a senior official at the State Environmental Protection Administration. China is short of 30 b illion to 40 b illion cubic meters of water a year, equivalent to the capacity of the Three Gorges reservoir.
China is also vulnerable to rising grain prices, accounting for about 20 % of global consumption. Beijing has until recently tried to protect its farmers by dipping into strategic grain reserves, but this tactic can only continue so long. The rise in food prices is also putting pressure on wages, by an average of 15 % a year. Wage increase has so far been absorbed by productivity gains and margin erosion.
China ‘s import of raw materials has soared dramatically. Between 1995 and 2005, China ‘s oil imports went up five-fold, while its wood imports rose four-fold, the report notes. In the same period, imports of iron ore surged by 570 % , copper by 738 % , cobalt by 4,145 % and aluminum by 2,247 % . It has also become the world’s largest importer of cotton and rubber.
“China ‘s appetite for raw commodities will undoubtedly grow stronger,” the researchers predict. They refer to the country’s boom in railway construction, shipbuilding and car manufacturing. In 2006 alone, more than 6.5 million new cars hit the Chinese roads. “By 2010, China is expected to produce 10 million automobiles a year for the domestic market, a target that not only heralds a huge rise in fuel demand but also an increasing need for aluminum.”
The demand for wood, too, will continue to rise because of growing urbanization. A recent study proclaims, “All scenarios indicate that China ‘s dependence on imports of raw materials will increase. The national government estimates that China will have to draw 55 % of its oil from overseas markets by 2010. For iron ore this is 57 % , for copper 70 % and for aluminum 80 % .”
Beijing has reacted in two ways to this acute shortage of raw materials. On the one hand, it opened its market to foreign suppliers and imposed tariffs on the export of raw materials such as copper, iron and forest products. On the other hand, it has stimulated and assisted Chinese state-owned companies to gain direct control over foreign resources.
China ’s CPI rose by 3.3 % in March and 3 % in April, reaching the 3 % inflation “alarm level” set by the central bank, prompting concern from many parties . “Shortages of grain, water, electricity, coal, transport capacity and other things are becoming clearer and clearer,” said one official in a key economic ministry. “We have to cool things off or prices may start to rise even more sharply.”
Summing it up
China needs greater control over its economy and soon, before the United States and other countries continue to suffer. How to do this is the million-dollar question . The government has already raised interest rates three times in just over a year to restrain a liquidity-fuelled investment boom, which has promoted fears that economic boom could turn to bust. Many people believe China needs to start letting its y uan currency rise in value to try to shrink a record U.S. trade deficit.
John Engler, president of the National Association of Manufacturers , says “The Chinese must realize that the risk now lies in acting too slowly rather than acting too rapidly, not just in trade, but in addressing their own overheating economy.”
If China does not act quickly, many members of the U.S. Congress are pushing legislation that would impose economic sanctions on Chinese products unless China moves faster to allow its currency to rise in value.
Recently the president of the New York Fed, Timothy Geithner, stated, “The enormous growth in Asian foreign exchange reserves is a sign of distortions in resource allocation caused by inappropriate exchange rate policies.”
Beijing has indicated that it is committed to making its exchange rate more flexible over time and weaning their economy off over-dependence on exports, though it insists on making the shifts incrementally.
Harvard economist and influential critic of free-trade fundamentalism, Dani Rodrik, says, “The need for industrial policy is bigger than ever, but this cannot be the heavy-handed industrial policy of old – trade protection through tariffs, subsidized credit to priority sectors or tax holidays.”
During the next couple of months, I will be watching the charts, checking the news and keeping abreast of the economists’ views of the global markets. We will just need to wait and see and be prepared for the movement of the markets.