Mon, Oct 27, 2008 page8

• Will the US’ pain be China’s gain?

  • By John Delury
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  In their efforts to pass a bailout plan for the US’ financial system, Bush administration officials invoked the specter of the Great Depression of the 1930s. But, for most Asians, economic Armageddon is far more recent.

  The Asian financial crisis of a decade ago brought banks, corporations and governments to their knees. The bonfire was sparked by the collapse of the Thai baht in the summer of 1997. Contagion soon spread across East Asia, with the ripple effects of serial currency devaluations reaching as far as Russia and Brazil. The long-running “economic miracles” of South Korea and Hong Kong ended, as did surging growth in Indonesia and Thailand.

  The central lesson taken from that crisis was to maintain large foreign-exchange reserves. This became a virtual article of faith among East Asian governments. Asia’s fast-growing economies maintained small reserves in the 1990s, despite booming exports and foreign investment. Once the tailspin began in 1997, governments’ lack of reserves hampered their ability to rescue failed banks, forcing them to appeal to international institutions for relief.

  But the IMF’s bailout came with strings attached, including demands for more of the rapid capital market liberalization that induced the crisis in the first place. Indeed, what the West calls the “Asian financial crisis” is known in Asia as the “IMF crisis.”

  The political humiliation and economic frustration of dealing with IMF imperatives confirmed the central importance of maintaining large reserves, as an issue not just of currency stability, but also economic sovereignty.

  One Asian economy emerged from the 1997 to 1998 crisis relatively unscathed: China. There were many reasons for this, but foremost among them was that China had already amassed more than US$100 billion in reserves, and refused to revalue its currency, when the crisis hit.

  Since then, China has aggressively pursued a fast-growth, export and investment heavy model of economic development. By capping the exchange rate and producing far more than it consumes, China’s reserves grew into a leviathan, hitting the US$1 trillion mark in 2005.

  Even after China (under pressure from US Treasury officials) let the yuan partially float in 2005, the leviathan kept growing by about US$200 billion annually. Over the past year and a half, China’s reserves skyrocketed to US$1.8 trillion, far and away the world’s largest.

  The Chinese state probably hasn’t sat on so much lucre since the halcyon days of the Qing empire, when insatiable European demand for porcelain, tea and silk flooded the central coffers in Beijing with silver bullion. But the paradox is that today’s reserves are not real wealth that can be pumped back into the domestic economy. Instead, China’s reserves mostly underwrite the US’ debt.

  Even before Wall Street hit the skids, there was growing consensus in China that its reserves had grown far beyond what was necessary to avert another 1997-style crisis. Calls for a more diversified investment strategy intensified. Investing in US Treasuries, after all, was a sure loss-maker, given the gap between their modest yield and the steady appreciation of the yuan.

  With the creation one year ago of a US$200 billion sovereign wealth fund, the China Investment Corp, Beijing positioned itself for more equity investment (although its early investments in the Blackstone Group and Morgan Stanley were widely criticized).

  Economist Andy Xie (謝國忠), formerly with Morgan Stanley, proposed last week that China trade its dollar assets for shares in US companies on a grand scale, challenging the US to overcome its financial xenophobia to avert a disaster of undercapitalization.

  But many in China, from nationalist bloggers to social justice activists, advance a deeper critique of the leviathan reserve. Why bind up Chinese capital to finance the US’ debt-consumption economy, they ask, when so many needs go unmet at home?

  China was one of the world’s most egalitarian societies as late as 1985. Today, it suffers one of the world’s biggest gaps between haves and have-nots. Chinese-style capitalism is flaunting its defiance of one of Confucius’ basic teachings — don’t worry about poverty, he warned, worry about inequality.

  China’s physical infrastructure in booming central cities is undergoing radical modernization, but the social and environmental infrastructure is falling apart, especially in the interior and for the huge rural population. For years, the central government has talked about creating “social harmony”— with a “new-type rural cooperative medical services system,” by increasing spending on education to 4 percent of GDP and eliminating school fees, and implementing “sustainable development” models.

  The promises are grand, but the actions have not measured up. And the economic costs of restricted access to healthcare and education, on top of the scarcity of clear air and potable water, will be crippling in the mid and long-term.

  The challenge for China in the years to come is to divest itself of US debt, and begin investing in the health, education and environmental well-being of its own people. Growing the economy at an average annual rate of 10 percent, it turns out, may have been the easy part.

  John Delury is director of the China Boom Project at the Asia Society in New York.

  OPYRIGHT: PROJECT SYNDICATE
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