Can China Lead the World Out of Crisis?

China may have hit a brick wall, but they have the cold hard cash and significant policy flexibility to lead the world out of its crisis.

First, let me lay the ground work for the reader. Chinese consumption on a per capita basis is only 1/11 of an America's. America consumes roughly $10 trillion every year compared to China's $900 billion. I will argue that the U.S. rate of consumption has entered a long-term secular decline.. (The first credit card was issued in the U.S. in the 1960s, credit proliferated throughout the 1980s-1990s as interest rates fell, the S&P500 grew 10 fold from 1982-2000, wages grew for all Americans during this boom, and real estate prices increased 75% on a national basis from 2002-2007...all of these consumption drivers are now in reverse and will take years to stabilize before growing again). This decline will hurt the global economy and it will hurt China.

It is therefore imperative that China not depreciate their currency and attempt to lure Americans with even cheaper goods. If China wants to get to the next level of economic growth and lead the global economy, China must increase its consumption in order to offset America’s decline. Many young Chinese are consuming like proud Americans, but China is an aging country and most still save 30%-70% of their income. In order to change, China must take a bold step and employ each of the following policy initiatives: Land Reform Healthcare Reform Pension Reform Currency Appreciation First, land reform.

By giving citizens ownership rights or enhanced lease holder rights to their land, it will immediately increase consumption. Landowners invest in their property to enhance its value and/or return. Chinese landowners would increase consumption of equipment and fertilizer, which in turn, would enhance their return and their own consumption. A landowner could also sell their property and migrate to an urban area versus migrating with nothing in hand as is the norm today.

Second, healthcare reform. The healthcare market in China is a disaster. If care is available, it is only for those with money, which is why Chinese are forced to save for healthcare. If the government were to enact comprehensive healthcare reform the savings rate would be reduced and consumption over the long-term would increase. Third, pension reform. The second thing Chinese save for is retirement. Like healthcare, if China were to enact a comprehensive pension system, the savings rate would fall over the long-term and consumption would rise.

Finally, currency appreciation. China is off to a good start, but it must continue. Case in point: Retail sales in China are growing over 20% this year. Did anyone think part of the reason for the significant increase this year may be due to the strength of China's currency? The CNY is up nearly 20% against the $USD in the last 18 months and nearly 30% against the Euro (China's largest trading partner) since July!

Whatever the case, a strong currency will increase imports and domestic consumption. The data coming out of China is worsening and a lot could go wrong over the coming months, but there is no other country with more cash on hand and policy flexibility than China. If China gets this right, China will emerge from this crisis ahead of its peers as the dominant force in global economics.

Final thought: What if China does hit a brick wall? Well then, who will buy America’s Treasuries and will China be forced to sell Treasuries in a rapid response to flood their own economy with domestic stimulus?

Disclosure: Long CNY

Comments

[Uln:]

Yes fiscal policy with a social profile, that is what we want China to do, and lately everyone seems to believe it's going to happen. Look at the latest World Bank report, for example, where it is taken as a fact that China's stimulus package in 2009 will be spent sensibly to "rebalance its economy"

I find it hard to believe, for a few reasons.

1- Will the development hawks in the CCP allow Hu to implement this kind of policies? Especially considering that some of them, like Health care system, are costly and someone needs to finance them. How much power do Hu and Wen really have to oppose the interests of business?

2- Chinese like to save money, that is just the way they are, it is a trait of character. No amount of health care or Land reform is going to make them spend more in 2009. How would it make sense that the same people who were saving during an economic boom decide to spend now more now that there is fear of crisis? It will take one new generation to change consumer behaviour.

3- All the advice you give makes sense in the long term, but it will not help China weather a difficult 2009. How well will the system resist the social and political tensions that will arise? And how well will Hu Jintao resist them in the Party?

It is all very good to dream, but I am afraid the largest part of China's money in 09 will go to help the companies, not the peasants. And as for currency, exporters pressure will be strong to keep RMB down, we can only hope that Hu won't let them get away with this one at least.

China will have enough trouble helping itself next year, so I wouldn't count on it saving the world.

2008 Dec 07 07:14 AM