Magazine of Socialist Action in Australia

China's economy: The sound of bubbles bursting

Reading Time: 13 minutes

Nothing is going right for the Chinese regime in this Olympic year. While China’s economy is still, based on current projections, expanding at double-digit rates, the global capitalist crisis arising from the bursting of the giant credit bubble in the United States gets closer to China every week.
By Vincent Kolo, CWI Hong Kong

In particular, the collapse of the dollar, now a ‘subprime’ currency, especially since the US central bank (Federal Reserve) has panic cut its main lending rate by 3 percentage points in six months, to 2.25 percent, is beginning to inflict real pain on China’s economy. Not for nothing did Premier Wen Jiabao recently say he was “deeply worried” by the falling dollar.

The renminbi’s accelerating rise against the US currency – by 4.1% in the last quarter alone – has led to some of the features of a recession in southern China’s export powerhouse, the Pearl River Delta (PRD), a region that accounts for one-eighth of China’s GDP. Based on some estimates, 1,000 shoe factories have closed down in this region in the last year, most of them moving to cheaper, less regulated inland provinces, or to Vietnam and other lower-wage economies. The local government in Dongguan, an industrial city in the PRD, recently announced a new fund to help foreign companies there upgrade technologically, to shift out of labour-intensive lines such as footwear and textiles, which have faced the brunt of the renminbi’s rise.

The dollar’s fall affects China in a number of ways, firstly in a marked slowdown in export growth (not yet a contraction). China’s legendary trade surplus plunged 64 percent in February. Based on the first two months of this year, exports to the US market are stuck at the same level, compared to a 14 percent growth overall for 2007. But the dollar’s slide has also led to a fresh flood of “hot money” into China, as speculators jostle to preserve the value of their capital by buying into rising currencies like the renminbi. On present trends, the Chinese currency is set to appreciate by a further 7 percent this year against the dollar, after climbing 15 percent in the past two years. The speculators are even gambling on a larger, one-off revaluation, possibly triggered by the Beijing regime’s desire to purge inflation, running at an annual rate of 8.7 percent. Such a move cannot be ruled out, although it depends on where the regime sees the greatest danger: from food riots and protests driven by inflation, or from a wave of factory closures and possible strikes in the export sector brought about by currency appreciation.

Fear of inflation

Few regimes in the world fear inflation more than China’s misnamed ‘communist party’. Inflation was an important ingredient in the revolutionary upheavals of 1949 and also 1989. Inflationary pressures, especially galloping food prices, which are 23 percent higher than a year ago, were undoubtedly also an important factor behind the riots in Tibetan areas last month, which combined with pent-up discontent over religious and national persecution to produce the worst unrest in Tibet for 20, perhaps 50 years. The Beijing regime has ordered universities across China to increase subsidies in their cafeterias, fearing possible unrest among students, another phenomenon conjuring up images of 1949 and 1989.

Like the governments of Indonesia, Egypt, Morocco, Argentina, Mexico and several other countries, the Chinese regime has reintroduced price controls on basic foodstuffs such as cooking oil and rice, but these are not particularly effective given that the state no longer controls the food distribution industry. “Administrative control over commodity prices has little effect in the current stage of market development. Businesses and the market have various means to negate State price controls,” commented Yi Xianrong of the Chinese Academy of Social Sciences in China Daily (4 March 2008). Soya cooking oil, the cheapest and most popular type of cooking oil among the poor, has disappeared from shops completely in the last two weeks. This type of oil is subject to price controls, but the main producer is a privately-owned Sinaporean company. As a top regime economist, Gao Huiqing, said last month, “China is in the wagon of the world economy in terms of globalisation. But it is not the helmsman. As 70 percent of mainland price rises can be attributed to international factors, the nation cannot tackle the problem on its own.” [South China Morning Post, 19 March 2008].

China is now a major importer of farm produce such as soya beans, corn and meat, and domestic farm prices increasingly reflect world market prices, which have hit historic highs and are set to stay there. “World agriculture is in crisis,” stated a new report from the International Food Policy Research Institute, quoted in China Daily (22-23 March 2008), pointing among other things to extreme weather phenomena, shrinking land availability, increased consumption (as in China) and bio-fuel production. This report went on to warn surging food prices are “a major political concern”. In the short-term, the price hikes have lifted incomes for some farmers, while a large section of society, both urban and rural, and especially the poorest strata, are substantially worse off now compared to a year ago. The severe winter in southern and central China, combined with a two-year drought in northern China, has damaged one-sixth of the country’s arable land, putting further upward pressure on farm prices this year. This is why the government has designated the fight againt inflation its ‘number one’ priority. But as Chinese workers and peasants know, there is a huge gap between the regime’s stated intentions and its actual results!

The actions of the US Federal Reserve, in drastically cutting interest rates, has seriously limited the room to manoeuvre of the Chinese regime and central bank. Despite the loosening of its peg to the dollar in 2005, the renminbi is still closely tied to the greenback. But interest rates in the two economies are diverging sharply, as the “subprime” crisis deepens. After raising interest rates six times last year, to put a brake on an overheating economy, the People’s Bank of China’s (PBoC) base lending rate is currently 7.5 percent, compared to a rate of 2.25 percent in the US. This has sucked a fresh wave of speculative capital into China, presenting a number of problems for policy makers. In the first two months of this year, China saw foreign direct investment (FDI) surge 75% above the level for the same period last year, to $18 billion. Should this trend continue for the whole year it would mark a new FDI record.

This capital must be ‘sterilised’ by the central bank, by replacing dollars with yuan, leading to a further unwanted expansion of the money supply, which in turn fuels inflation. Much of this foreign ‘investment’ is purely speculative, ploughed into real estate deals which help drive up land prices thereby feeding a monstrous property bubble that could burst at any time, and in some cities including Shenzhen and Beijing, may already have burst. Shanghai banks report mortgage applications are down ten percent on the level of a year ago. The Wall Street Journal reports that property prices have declined by as much as 30 percent in some top-tier cities, adding that “China’s property developers are under siege. Property prices are showing signs of weakness in many of the country’s key markets, and capital markets have all but seized up for these – and other – offerings.” [Wall Street Journal, 26 March 2008].

Property bubble… still inflating?

The surge in home prices over recent years has compounded problems on other economic fronts. Many ordinary Chinese have been priced out of the housing market. In the 70 largest cities, overall house prices surged 11.3 percent in January from a year earlier, the biggest increase for three years. Super-rich property tycoons have amassed phantasmagorical personal fortunes – they regularly top the various ranking lists of China’s super rich – a fact that fuels political discontent. Over half the tycoons on last year’s Forbes list of China’s 40 wealthiest individuals were involved in the property sector.

“This year marks the tenth anniversary of China’s removal of its decades-old welfare housing system in 1998,” proclaimed an editorial in the ‘communist’ party-run China Daily (8-9 March 2008). As this paper noted, “While rapidly meeting the need of the few rich, the booming property market has largely ignored the demand of lower or many middle-income families for affordable houses, not to mention the urban poor’s need of shelter.”

The spiralling cost of housing is one important factor why consumer spending continues to languish at levels far below even those of other ‘developing’ countries. Last year, consumer spending accounted for around 40 percent of GDP in China, compared to more than 70 percent in the US, and 59 percent even in India. The idea, put forward by many capitalist economists, and by the Chinese regime above all, that the Chinese consumer is poised to ‘take up the slack’ in world markets caused by falling US consumption, is a fallacy. Chinese salaries are too low, and the cost of basic necessities like housing and schools is too high. Reliable statistics of salaries in China are virtually impossible to find. There is no end of claims that workers in the cities at least have seen ‘significant’ wage increases in recent years. But this is simply not true; at most it applies to a smaller layer of urban-based workers in the private and especially hi-tech sectors. Only 30 percent of Chinese workers will pay income tax this year, and the threshold for personal income tax is 1,600 yuan (160 euros) per month. So, 525 million of China’s 750 million strong labour force earn less than 1,600 yuan a month – a very credible figure. Without huge increases in wages, which the capitalists of course will resist tooth and claw, these workers are excluded from the grand designs of boosting consumption to compensate for the contraction of the US economy. Justin Lin Yifu, the Chinese chief economist of the World Bank, recently argued in an influential speech delivered at Beijing University that China must keep its low labour costs and emphasis on labour-intensive assembly industries, arguing this is where it enjoys ‘comparative advantage’. The message: Don’t expect big salary increases any time soon!

It is not uncommon for new homeowners to spend half their monthly income on mortgage repayments. A CCTV report (15 March 2008) featured a couple from Beijing who pay over 4,000 yuan a month to the bank for their two bedroom apartment, 60% of their monthly income. In addition to housing costs eating up a growing share of an urban family’s income, education and medical costs are also extreme, rising from 10 percent of an urban resident’s total expenditure in 1990, to 30 percent in 2006 [China Daily, 14 March 2008].

This explains why solidly neo-liberal agencies like the OECD and journals like The Economist have become welfare-state-zealots in relation to China, urging its rulers to rebuild basic public services as a means to coax the population to save less, and spend more of their still very low wages on consumer goods. For the rural majority especially, health care infrastructure is a shambles. Three quarters of China’s total medical resources are concentrated in the urban areas, home to just 35% of its population. According to China Daily (14 March 2008), with 22 percent of the world’s population, China disposes of only 2 percent of the world’s medical resources. On this basis, the 750-strong rural population, roughly one-eighth of the world’s population, have access to just 0.5% of the world’s medical resources.

Stock market bubble… burst!

The Chinese stock market has been one of the worst performers in the world in 2008, only Vietnam has suffered bigger losses. The first quarter of 2008 was the worst in the Shanghai exchange’s 16-year history, with the main SCI index losing 34% of its value. In financial market jargon a fall of ten percent is a ‘correction’, while a drop of 20 percent is a ‘bear market’. Of course, stock markets in today’s world are really over-sized casinos that only indirectly reflect processes in the underlying economy. Nevertheless, the panic on the Chinese stock market is both a symptom of impending crisis, but also a source of serious problems for the wider economy.

Since last October’s peak, more than 12 trillion yuan of share values has been wiped out, a sum equivalent to half China’s GDP. While the stock market was not an important factor in China’s economy even four years ago, this changed with the financial sector reforms of 2005, the most important of which meant that all the shares, not just a minority, of the country’s major companies became tradeable. This led to a succession of top, mostly state-owned companies, banks and utilities, launching what were very lucrative initial public offerings (IPOs) and tapping into the huge pool of savings of the population. China dominated the global IPO rankings in the last two years, accounting for 35% of IPOs worldwide in 2007. This “IPO bubble” has come to an abrupt halt in the first months of this year as the market has plummeted. Many top companies are now trading at below the price they realised on their first day of trading, leaving gullible ‘investors’ in a rage. This process is symbolised by PetroChina, briefly the world’s most valuable corporation when it was floated on the Shanghai exchange last October. Since then the company’s market capitalisation has plummeted 62 percent – and that for an oil company, with the oil price at $100-a-barrel!

China’s stock market bubble of 2005-07, which has now burst, caused further serious problems for the economy. Based on the booming price or equities, major companies were less dependent on the banks for funds and were able to circumvent central government lending constraints designed to curb over-investment and its inevitable results: overcapacity, falling profits and possible bankruptcy. Fixed-asset investment grew by a staggering 24.8% in 2007, 0.9 percentage points higher than in 2006, despite government efforts to rein in this growth.

The IPO mania of the last two years almost certainly helped to lift the investment bubble to a new level of absurdity. It also pulled millions of small savers into the stock market ‘casino’. Ironically, gambling is illegal in China, since the revolution of 1949. And for a very good reason! Many of China’s new breed of small ‘investors’ are now nursing catastrophic losses and, once again, the result can be political instability. “My husband condemns me as so stupid that we lost our family’s savings,” said Zhang Liying, a retired waitress, to the International Herald Tribune (2 April 2008). Internet chat sites are full of angry comments turning on the government, and blaming them for the market’s devastating slide.

And there is likely to be more economic fall-out if the ‘bear market’ continues, as is most likely, as China’s financial sector is shaken by the turbulence in global markets. Some commentators downplay the stock market’s significance because even with 150 million individual trading accounts, the Chinese market has not accounted for the same kind of “wealth effect” as in older industrialised countries, where 40, 50 or even 60 percent of the population hold savings linked to the stock market. But in China’s case, many of the individual accounts are actually “fake accounts” used by companies and even banks to speculate in the market. This highly illegal trade generated a sizeable portion – 15 to 20 percent by some estimates – of the profits of major Chinese companies last year. “Companies had a lot of excess cash, explained Jing Ulrich of JP Morgan in Hong Kong. “And a lot of that cash did leak into the stock market”. [International Herald Tribune, 2 April 2008].

The big speculators mostly got out before the market tanked, leaving the small traders to take the heavy losses. But a prolonged bear market, by closing off this source of additional “quick fix” profits, will have a detrimental impact on the balance sheets of China’s big companies, at a time when profits are anyway facing a squeeze from rising raw material and energy costs, a tougher export outlook, and the effects of serious overcapacity. These processes are self-reinforcing. The National Bureau of Statistics survey of industrial companies shows total profits for the first two months of 2008 grew by 16.5 percent from a year earlier, less than half last year’s frothy rate of 36.7 percent – for full-year 2007. A string of profit warnings in recent days at major corporations like PetroChina and China Telecom has fed the stock market gloom. Another cause of the market plunge are rumours of an interest rate hike, the first this year, as part of the regime’s anti-inflation policies.

Lessons from 1990s – sudden crisis

The economic landscape in China is changing at breakneck speed. Last year the economic debate was dominated by the danger of ‘overheating’. Then in January, the scourge of inflation loomed large, with the government announcing a shift to “tight” budget policies, away from the “prudent” fiscal policy of the last four years. Now, in the shadow of the global crisis, the situation is changing again. If food and raw material (including energy) prices are excluded, China’s economy still displays significant deflationary features (deflation is the opposite of inflation: falling prices) particularly in the manufacturing and export sectors. The inflation rate, minus food and energy, is only 1.6% instead of 8.7% a year. Textile prices in China have fallen 0.6% in the last year for example. There are similar price declines in electronic products, steel and autos.

These pressures can intensify as a result of massive – as yet unrecorded – surplus capacity throughout industry, the result of the biggest investment boom in history. Overcapacity, aggravated by a global downturn, means more goods chasing fewer markets and inevitable downward pressure on prices. At a certain point, profits are annihilated and companies go bust. From there, the chain leads to the banks, mostly state-owned, which lent to the companies to fund their investment binge.

An explosion of non-performing loans could be just around the corner, threatening a banking crisis every bit as serious as America’s, albeit with different features. In such a scenario a “tight” or restrictive fiscal policy aimed at limiting credit and squeezing inflation would be catastrophic. Not only would the Chinese regime be forced to rapidly change direction towards an expansive or ‘Keynesian’ policy, some commentators believe this is already its unstated goal. “I expect the mainland will be half-hearted in applying its tight monetary policies and loosen to some extent when the situation demands.” argued Qu Hongbin, the cheif China economist at HSBC. Outlook, the influential weekly journal of Xinhua, also recently had an article urging the Chinese regime to “prepare for a US recession”.

But it’s not just a US recession! China’s economy could soon be facing a similar crunch to that experienced by South East Asian capitalism ten year ago, although on a much larger scale. In the mid 1990s, South East Asian currencies were appreciating rapidly as their economies experienced rapid investment-driven growth. By 1997, however, their export engines began to slow as cheaper producers – China among them – ate into their market share. The speculative “hot money” that had flooded into these countries to take advantage of the boom, pulled back abruptly, causing first a credit and banking crisis (not wholly dissimilar from the US crisis of today) and then a wave of corporate bankruptcies and a severe recession. This with the help of US capitalism and the IMF, who imposed policies completely opposite to what the Bush Administration and Federal Reserve are doing today i.e. massive interest rate rises and ‘austerity’ budgets.

This – nightmare – scenario is not a figment of our, Marxist, imagination. The World Bank has so far this year revised its growth forecasts for China down twice, from 10.8% to 9.6% in February, and last week again, to 9.4%. This is a substantial reduction, of 1.4 percent, in growth expectations. But a more alarmist prognosis has just been released by the financial company, China International Capital Corp (CICC) which warned GDP growth could slip to 7.5 percent next year. “China’s economy is now at a crossroads,” CICC economists wrote in their research note. “If policy adjustments are not appropriate, the economy may face high inflation this year but could turn sluggish next year.” In that case, warned CICC, “China’s unemployment rate and banks’ bad debt will markedly rise and companies’ profits will shrink substantially.”

In Chinese terms, growth of around seven percent would be a borderline recession, especially in terms of the effect this would have on the labour market, with an explosion of urban unemployment as the likely result. Every year, 10 million new urban job seekers come onto the market, not including the increase in the migrant labour force. As it is, with double-digit growth, employment has only grown by 1 percent a year over the last 4-5 years. Several factors, including the tens of thousands of temporary jobs in construction and services created by the Beijing Olympics, and a short-term investment boom in some of the worst-hit areas of winter strife, that will not apply next year, increase the likelihood of a slowdown and even recession. Perhaps the most startling evidence of this are the latest statistics for so-called fixed-asset investment, reported in the Wall Street Journal (1 April 2008): “After accounting for rising costs, investment grew by 18% or less early this year, compared with 23% to 25% for most of last year – a much sharper slowdown. Analysts blame weaker real-estate markets, as well as reduced factory expansion from exporters seeing less demand.”

Therefore clearly, the Chinese economy is headed into uncharted territory. After two decades of largely continuous rapid growth a slowdown, or slump, will create unprecedented tensions in Chinese society including open splits in the ruling party, and an explosion of popular protest. The need for fighting and democratic workers’ organisations – especially independent trade unions and factory committees – to struggle for workers’ interests in the face of increased capitalist attacks, is therefore greater than ever.

Footnote: The Chinese currency is called ‘renminbi’ (people’s money) in the context of foreign exchange dealings, but ‘yuan’ when used for domestic transactions, i.e. renminbi is the currency, but the notes and coins are yuan.


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