It’s probably one of the hoariest clichés in the book about China but in this case it keeps popping up because it has a core nugget of real insight. The word for crisis in Chinese is weiji, 危机, made up as the tale goes from two characters, one meaning ‘danger’ and the other ‘opportunity.’ Although it’s a bit of a stretch linguistically, it is a clever formulation and also an excellent description of what the unfolding financial crisis looks like when viewed from Beijing. As discussed in the preceding post, the opportunity part stems from the enormous mountain of cash that China’s amazing economic growth has generated. The country’s foreign reserves of some 1.7 trillion dollars obviously aren’t all about to be used to snap up ailing banks, much as the U.S. Federal Reserve would like that. But a good portion will certainly continue to be used to buy U.S. government bonds (i.e. lend money to the U.S.) and some of it will be used to buy up the good bits of bankrupt companies.
In fact, China’s main sovereign wealth vehicle, the China Investment Corporation, has been widely reported to be in talks with Morgan Stanley about increasing its current stake of just under 10 per cent by another 49 per cent. Considering that original stake is worth over 2.5 billion dollars less than CIC paid to acquire it last December, a fact that has not gone unnoticed or unremarked on in the Chinese media and internet, it will take considerable guts to fork out another huge chunk of China’s hard earned dollars (well north of ten billion dollars if my back-of-the-napkin calculation is correct), even for a controlling stake. Morgan Stanley “will be worth an awful lot of money one day” says Michael Pettis, who teaches finance at Tsinghua University in Beijing and spent a decade and a half on Wall Street. But “whoever takes the risk of buying it now will be subject to very, very strong criticism if the purchase also shows even fairly small losses in the meantime.” Even if the Morgan Stanley deal doesn’t go through though, Pettis says that “there are always great bargains” out there in times of crisis like these and there is little doubt that China will be actively looking for acquisitions in the coming weeks and months.
There is also another aspect to possible acquisitions by Beijing, argues Sun Fei, Managing Director and Chief Economist at Hong Kong based fund manager China International Capital. The current crisis is also an occasion on which China can step up and demonstrate that it is ready to take on more responsibility for helping to manage the global financial system. “China has impressive foreign exchange reserves, and I think it is well qualified to join the efforts to halt the escalating crisis,” Sun told my colleague Lin Yang. “It’s not only about preventing losses. It’s also about playing a more active role in the world economy.”
But what about the ‘crisis’ part of the equation? In some respects economists say China’s peculiar combination of unbridled capitalism and top down state control will seal it off from some of the potentially harmful effects of the crisis. Beijing still keeps a steely grip on its currency, for example, making the prospect of a sudden devastating plunge of the kind that proved so devastating during the Asian financial crisis in 1998 remote. And while “joining the WTO prompted China to open its financial services market in 2006,” Sun Fei says, “there is still only a narrow range of derivative instruments and innovation in financial products is still slow.” But Sun and others note that areas where markets are more developed, China is just as vulnerable if not more so than other countries. Its stock markets, for example, were already in turmoil before the current crisis hit, with the Shanghai composite index having plunged some 70 per cent in the last year. Well aware that further declines could have grave social and financial consequences, the authorities took a range of steps to restore confidence in the last couple of days, adjusting reserve requirements to free up capital, dropping some duties on stock purchases and promising to step in prop up banking counters. The measures worked, at least for today, with the index shooting up by 10 percent, one of its biggest ever daily gains.
Such wild volatility is however a reminder to some economists of the fundamentally contradictory nature of China’s economy and its consequent increasing vulnerability to external shocks. That’s’ particularly the case given the huge social imbalances that have been generated over two decades of breakneck growth such as the four-to-one wealth gap between urban and rural residents. Another Achilles heel is employment. “In China, each percent of the GDP growth is creating 10 million jobs,” says Sun. “I think China could not afford a GDP growth below 5 per cent.”
With annual GDP currently growing at 10 per cent or more that might seem a remote prospect. But that growth has been built on three pillars, all of which currently look potentially shaky. One is exports, which are already showing signs of weakening and would obviously be subject to large declines if (when?) the U.S. and European economies start to contract. Another pillar is the huge inflow of fixed asset investment. That is holding strong but would be bound to be sharply affected if the global economy starts to cool. Lastly, there’s China’s growing domestic consumption. There too, China has maintained some good numbers in the last couple of months. But as one Beijing economist who preferred to remain anonymous (“no one wants to shout ‘fire!’ in a crowded theater’) notes, domestic consumption is heavily influenced by consumer sentiment. The government is “acutely aware of how delicate sentiment is. Just look at the media’s coverage of the crisis. It has been very, very low key precisely because they don’t want people getting alarmed.” Taken together with a banking system that is still largely opaque and an inflation threat that is by no means tamed, it’s easy to see why Beijing will likely be concentrated much more on the ‘danger’ side of things than plotting how to make money from the ‘opportunity.’