Dr. Gary Russell has been teaching Economics and related subjects in Canada for many years. Since 2001, he has been teaching Economics and Business Administration at several universities in China. In the process, he has conducted considerable research in cultural differences as they apply to business and investment in China. In 2007 he participated in the International Anti-corruption Conference in Athens, Greece. Over the years he has been honing his expertise on how to negotiate with Chinese business and government. He is the founder of the Russell Research website.
Q: Dr. Russell, in a general sense, what is your opinion of the Chinese economy at the moment? The media has been reporting recently that there have been calls for the withdrawal of stimulus into the Chinese economy given that it has grown 10%+ since last year, what are your thoughts on this?
A: Well, certainly there has been impressive growth in the past year, especially in comparison to the rest of the world. But in a sense, it's only 2% growth. It is widely felt that China needs a good 8% growth just to maintain social stability, so that should really be considered the baseline. Where in the west, anything below 0% growth means trouble and decline, in China anything below 8% means trouble and decline. The Chinese leadership has an unwritten pact with the population. They will provide an environment where everyone can feel their prospects for the future are bright, and the people (or at least the mainstream) will forgive anything they do (within limits). It's a delicate balance. As long as they can keep job prospects growing, people will focus on forging ahead to a bright future -- and will have no patience for ne'er-do-well critics who would distract them from playing their part in re-establishing the glory of China. It's a dynamic with a lot of momentum, as long as the promise is kept -- but it will prove to be very fragile if the promise fails.
But that doesn't mean that any growth will do. Paltry levels of growth, like we often have in the West, would spell disaster in China. If there's enough growth, people from the countryside can flock to Shanghai or Shenzhen and work for dream wages. Families send their spouses and children to the Eastern centres to earn a good income, and send it back home. Then the whole family can thrive, and their children can even get a higher education and bring further glory to the family. When Chinese growth was flagging a little in recent years, though still robust by western standards, country folk were losing their jobs and dragging themselves back to poverty in the countryside, to the dismay of their families. That is a sure recipe for the discontent that Beijing dreads. If they hadn't been able to return to the eastern centres to find new jobs in short order, the entire countryside would have been seething by now.
But it's not only a problem in the countryside. I've worked with Chinese students since 2001, when they had stars in their eyes about becoming rich VIPs shortly upon graduation. Nowadays they're worried, and grumbling about the great difficulty in finding jobs -- even actually worried about not finding jobs. When growth was booming, the Chinese invested heavily (really heavily) in universities, in the hope of pulling the population above poverty and the economy out of low productivity by creating opportunities for everyone to get a higher education. The result was soon a massive increase in graduates looking for jobs, and perhaps Beijing is even more afraid of their grumblings than they fear the country folk. Students have been a catalyst of insurrection in the past, and if they feel that the promise has been broken, they will not be so easily put down next time. As long as 8% holds, Beijing holds -- if that 8% growth translates into jobs.
Why do they need 8% to keep things on an even keel? Because there's so much slippage -- in a word -- corruption. So much capital that should feed into productivity and jobs is siphoned off under the table, mainly in the provinces and municipalities. Beijing is relatively clean and, with aspirations of Chinese greatness, very much aware of how regional corruption is pulling them down. But they're still at a pretty heavy-handed stage of dealing with it, so their effectiveness is limited. In addition, with decades of communism behind them, they have a tradition of making investment decisions on the basis of political affinity, creating an absolutely enormous problem of non-performing loans. While the eastern centres are becoming more professional about it, there's a solidly entrenched cronyism mis-shaping investment patterns across the country. China needs that slack of 8% growth, along with the U.S. policy of financing their fiscal growth by borrowing from the Chinese, to keep her nose above water.
So what's an investor to do? Well, you can certainly count on stimulus keeping growth escalating for the near future. They'll rein it back from time to time, just to keep the economy on a steady course, but it's steady growth they have in mind. In such an environment, you need to be incredibly careful. There's no shortage of rogue companies piggy-backing onto the growth trend, and flying under the radar of inconsistent regulation. You need reliable information from trusted sources, and you need a good negotiator who knows how to interpret the maze of regulation and corruption. With impressive renewed growth and the 2008 Olympics under their belt, they're flying high, and they're not giving any quarter to anyone. You may have noticed the recent shift in tone.
Q: On a related note, officials in China have recently stated that some of the nation’s banks have been asked to limit lending after they failed to meet requirements including those for capital - does this portend something ominous for the capital markets going forward?
A: There's a reason why they have trouble meeting requirements. Chinese banks are having great difficulty getting up to standard in the modern economy.
For decades, economic decisions were political decisions, and investment patterns conformed to the political visions of the party bosses. A successful bank manager was skilled at conforming to the political wishes of his superiors, while at the same time building his own patronage network below him. There was little economics to be found -- it was all about personal networking, where an investment loan was a reward for loyalty. This is a prime recipe for political cronyism, and by the time China made a turn toward the market in the 1980s, the crony network in the banking system was firmly established and lucrative.
So what's going to happen when the political masters start to say that bankers should start paying attention to profitability when making loans -- but not too much because it was still a socialist economy with a public investment policy? First they're going to get ignored. Mixed signals. The norm for decades was to grant loans on the basis of political clout and patronage, and it would not easily be dislodged by confusing directives. When some manager's colleague's nephew who belongs to the party had a business deal in the works, he wasn't going to turn the guy down and be disloyal to the party.
This was the base from which they tried to reform banking. Over the past few decades, the reformers have been chipping away at the old system, and establishing commercial banking standards bit by bit, bank by bank. It's only in recent decades that the lead banks (China has a lot of banks) started to come on board and adopt the kind of professionalism that makes for successful banking. But a large enough chunk of the banking system is still stuck in the era of cronyism, and there's still a huge problem of non-performing loans, especially in the western provinces. The government and the leading banks are pushing for high commercial standards with increasing resolve, but there's still a long way to go (though I must admit they've made rapid progress).
So there are two reasons for the government to limit lending. Part of it is for macroeconomic stabilization, to keep the growth steady without inflationary bubbles. But a major part of it is because too many loans are still being made for the wrong reasons, and the resulting high default rate is dragging the real growth rate down, with inflationary results (not to mention productivity results).
For investors it's a good sign, because it’s meant to rein in the businesses you don't want to invest in anyway. But you still need good information before you venture in, because some of the big players are still riding on political clout and don't really have the fundamentals to hold up in the long run.
Q: Given the rigidity expressed by the Chinese Government with respect to re-valuing the remnimbi - what is your outlook for the U.S. Dollar and the Yuan going forward?
A: The Chinese have never felt bound by the priorities of western economics. In theory, if we remove all trade restrictions and let all prices (including exchange rates) float freely, the market will find the most efficient trade patterns and everyone will be better off. The Chinese don't buy into that. Exchange rates are a development policy tool, used to jockey for advantage. When pressure from the west reached a fever pitch, they opted to control the renminbi the same way other countries control it -- through asset management rather than decree -- and allowed a little token easing up, but remained just as much in control as they've ever been. They have the slack (thanks to the American policy of borrowing from the Chinese so they can go to war) to underwrite any economic policy they choose.
You can be sure that China's exchange rate policy will be governed by two goals. First, to keep up world demand for their exports and keep their growth rates in the safe zone, which will keep any changes moderate and conservative for some time to come. Second, as a weapon in their campaign to gain the upper hand in the world economy. Whether they make any moves to adjust currency rates depends on whether (or when) they decide to turn their enormous claims on the American treasury into a power play. If they ever decide that dumping American treasury bills will trigger a shift in power to their advantage, we can expect they will tolerate a little monetary instability as the world economies reel, if they expect a long run power shift in their favour. We can watch the news bureaus that are constantly taking their temperature, but it probably won't help. They're good at keeping the watchers in the dark, and coming up with surprise shifts once in a while. But still, they're not going to unleash any degree of instability that will seriously threaten their own 8% bottom-line growth requirement. The most we have to fear is miscalculation. They'll hold the line, but they'll walk the edge from time to time.
Q: Dr. Russell, a number of people suspect that the Chinese are hoarding copper, thus keeping the price of copper artificially high. Over the last few months, copper inventories have been steadily rising and so has the price, do you have any insight into this situation?
A: Well, we have to keep that in the context of China's overall long-term development strategy and her aspirations to become a dominant world power. They're smart enough to know that the trick to gaining economic power on a world scale is to capture a strategic set of key resources, the ones that will create major bottlenecks for their competitors if they hold them back. Few countries have their act together in that arena. Western countries are tied up in political knots, while the Chinese have more clear resolve and power to act than ever before. They know it. They have the strategy in place to capture the key resources. They have little concern for their impact on other economies -- they'll all prosper under the new Chinese order in the long run anyway. And they're on the move, negotiating deals with corporations and dictators alike to put all the pieces in place before we wake up and smell the coffee.
So copper is only one piece in the jigsaw puzzle. Yes, hoarding keeps the price of copper artificially high for the rest of the world, which works to China's advantage in the grand overall strategy. If western countries pay more for this absolutely crucial metal, but the Chinese can use it cheaply, they can boost their exports without having to rely so much on exchange rate strategy -- giving them more leverage in the international financial arena. But the same applies to a range of key minerals and other resources, for which they are cornering markets and making deals all over the world. As far as investment goes, it all depends on whether you want to fight them or join them. Do you try to develop and consolidate counter-acting world bases for mineral development, or do you make deals with the Chinese?
Q: So, Dr. Russell to summarize, what is your economic outlook for Canada?
A: First of all Canada has a large resource base, and Canadians are not inclined to let the Chinese get their hands on them. So there are those in my country who see an opportunity for Canada to take a leading role in building up a countervailing power to the Chinese juggernaut, at the same time as we take advantage of trading with them. We're strong (resources) but we're weak (massive dependence on cheap Chinese imports, like everyone else). It's quite a balancing act, but it looks possible. The Canadian government is in a good position to take a leading role in building up an alternative power base, though they're hamstrung by their naive and distracting obsession with market benevolence. Nonetheless with a well-designed strategic policy thrust, and a careful eye to ensuring that other countries don't capture too great an access to our resources (i.e., a willingness to buck the historical trend), Canada is well positioned to be a strong anchor in the turbulent seas of international trade.
Thank You, Dr. Russell!