China and the world economy.
To start with i would like to ask to take a look on the world economy macro picture. As the next pie shows, the total world GDP is about 74.5 trillion US$, out of it about half is produced by Europe, China and USA. China as a major factor in the world economy stage is relatively new phenomena. Its position wouldn’t be as significant if not measured by Purchase price parity, which annualized the undervalued Chinese currency effect. At official exchange rate the Chinese GDP would drop to almost half and it would be of similar size of Japan. (Ch.1)
The Chinese amazing economic grow started about 30 years ago with new openness, and export oriented economic growth. This economic policy was probably adopted to try to copy the Japanese economic miracle. And so it did.
On the other side of the pacific ocean USA it brought growing trade deficit, which accumulated debt with accelerating speed. (Ch2.3.).
The question is why USA did not bother to prevent this trend, that obviously is very damaging it economic interests on the long run. The answer is, because it was politically convenient to maintain the US standard of living, without the need to pay for it. As we can see, the US personal savings run into minus figures during these years. (ch.4), and the public deficit as well. (ch.5).
This means that US population could live standard of living above its means, and it was financed by saving of other nations, mainly China.
Of course there where same political nuisances during this process, like the drop of manufacturing employment (ch.6), but who really cared, when the blue colored jobs were replaced by white colored ones?
On the long term some clouds appeared on the sky, like increasing debts of the government and private sector to the foreign bonds holders. (ch.7). As we can see the main foreign bond holders are China and Japan, who hold almost 50% of the US government bonds.
At 2011 the value of US government bonds hold by foreign entities reached 4.4 trillion US$. The major holders were;
Foreign US government Bonds holders in milliard US$
The US debt originate mostly from the public sector and partly from the private sector (Ch.8).
On the other hand China created continuous surplus on its foreign trade. (Ch.9)
This dept caused continuous decline of the US$ against the Chinese Yuan.(Ch.10)
Compared to USA Europe did not create huge trade deficits, even if in the last 5 years it had negative balance with China. (Ch.11, 12). Yet even in the last five years when Europe had trade deficit with China it total current account was rather balanced.
But as it is nicely seen in the next two graphs, this balance of foreign trade did not prevent unbalances within the European states, namely between Greece, Ireland, Portugal and Spain from the one side and Germany from the other side.
Current account at 6.2011 as % of GDP
On the chart 15 and 16, another perspective of these debt creating countries, you can see clearly the difference between Countries like Greece, Portugal and Spain, that are heavy in debt with other countries, and need continuous funding from them against Italy and France, that are internally heavily in debt, but do not generate net debt to foreign countries.
In the last 10 years following the crash of “DOT.com” economy, in some economic forums few economists warned against these trend, but they were hushed immediately and sometime even rudely
Such unbalance in the world major economies could not be sustained for ever. Since the beginning of 2000 following the ” dot com ” financial market crisis, economists spoke about this unsustainable trend in the US and EURO zone economy, but were hushed by others, by monetary argumentation, which always leans on some sophisticated mathematical model that in its substance is leaned on believe that green paper (US$) or the blue one (EURO) is actually a product of same substance as a car, TV set etc. But mainly everybody was rightly afraid of the butterfly wing effect that can create a world economic crisis as it at the end in reality happened.
It is just oddity that the crisis started with sub-prime loans, that happened to be one of the instruments, the financial system used to recycle the accumulated US$ reserves from net exporting countries back to the US economy.
But now that we are in the middle of the crisis since autumn 2008, what is to be done to restart the European and the US economy? First we have to understand, that the crisis is crisis of declining demand in the most developed countries (USA, Europe, Japan), with heavily indebted governments, that can’t effectively increase their demand, in contrary they have to take austerity measures. Curiosity is that within this mostly developed countries, there are countries with surplus, like Germany, they continue their conservative policy of balanced economy.
At 2009 G-20 Summit of IMF had been concluded two major points of strategy to be taken in the world economy;
one- internal, involving a hand-off from public to private demand led growth;
Two- global, involving rebalancing demand in countries with large current account deficits toward external demand and in countries with large current account surpluses toward internal demand.
Under this circumstances, when in USA, and Europe, that represent almost half of the world economy the demand will stagnate for the near future, the only countries with capacity to create new demand are the large emerging economies like China, India, Russia, namely the BRIC countries. Since China as described has a leading position among the BRICS, it is important to understand what was their economic policy in the last 3 years and to try to predict to where are they heading too.
One of the main aspects of Chinese policy is it exchange rate policy toward the US$. Interestingly this policy is more important to Europe than to USA, since its freely fluctuated currency becomes over valued against the Chinese RMB if the last one stagnates against the US$. But as we can see in the chart 19 and 20. there are good news on the way, while China gradually evaluated its currency until the beginning of economic crisis, it freeze this process until the mid year 2010. But since then it started again gradually to evaluate it.
The other important Chinese policy applied was creating demand. Since its export oriented economy lost the demand for its products with the outbreak of the economic crisis and its economy grows has almost stopped at the end of 2008, Chinese government started immediately policy of huge encouragement of investment. In the chart 20 we can see that the investment grew from 40% out of GNP at 2008 into 46% in 2009, this huge shift wasn’t caused by reduction of public or private consumption but rather by huge additional investments, that prevented economic slowdown in Chine.
The huge increase in investment was followed by growth in imports that reduced significantly the trade surplus (ch.21) and this process is probably still continuing.
I strongly believe that the investment jump of 2009-2010 is going to slow down, and probably the next step should be to encourage increase in the private household spending. This development is expected to happen anyway due to the slow revaluation of the RMB and the significant wage grow that started to happened since 2010 with the encouragement of the government policy.