Sometimes we are so absorbed with events that come across our radar screens that we miss the more fundamental developments that fly below them. So we all know about soaring crude oil prices, the sinking dollar, the political carryings-on in America, and the fluctuations in share prices. But we have paid less attention to last weeks important developments in China, a country that has accounted for a larger share of world economic growth in the past seven years than has the United States.
Start with the fact that Chinas economic reform program has had more than mere ripple effects on the worlds economy. Last year, the Chinese economy grew at a rate of somewhere around 10 percent. It sucked in steel and other products from Japan and its Asian neighbors, triggering renewed growth in that region. It attracted more foreign direct investment than the United States, with investors in Americaincluding the great sage, Warren Buffettand Taiwan and Hong Kong leading the parade.
Chinas thirst for oil became so great last year that its imports increased by 30 percent, making it the worlds second largest importer, behind the United States. The economic consequences are already being felt: Chinas demand is adding to pressure on cartel-restricted supplies to drive crude oil prices closer to $40 per barrel than they have been in a long time. The geopolitical consequences are even more worrying: China has become a major supplier of nuclear technology to Saudi Arabia, and cruise missiles to Iran. Arms-for-oil is not a trade that encourages regional stability.
China has until now helped to keep world inflation low by providing consumers with well-priced goods. But that may be changing. China is now the worlds largest importer of copper, tin and zinc; a major consumer of coal and rubber; and the worlds largest consumer of cement. All are rising rapidly in price as suppliers welcome the return of pricing power after a long period in which they were selling into a buyers market. Add to that Chinas massive demand for ships to move those goods, and you get a spurt in freight rates, driving them up by some 550 percent since 2001, according to economists at Barclays Capital.
Meanwhile, Chinas insistence on pegging its currency to the dollar has become a hot political issue in America, where Democrats are berating President Bush for losing jobs to China and other countries. This has pushed trade to the front of the political agenda, a spot that is traditionally a bad one for advocates of freer trade in a presidential election year.
Last week, a high-level U.S. delegation, visiting Beijing, tried to persuade the authorities to allow the renminbi to float upwards, making Chinese goods less competitive in America and American goods more competitive in China. No such meaningful revaluation is in the cards, especially since Federal Reserve Chairman Alan Greenspan gave the Chinese ammunition by warning that the Chinese banking system is too shaky to permit depositors to withdraw funds and convert them to other currencies, as they would be able to do if the renminbi is floated. Premier Wen Jiabao has promised to gradually perfect the exchange rate mechanism, which probably means that a small adjustment might be in the cards now, and that the Chinese understand that as a long run matter they will have to bring their currency more in line with market realities.
But not soon. China is currently running an overall trade deficit as a consequence of its massive imports of raw materials, and so can argue that there is no need for immediate action. It also faces the problem of providing employment for the 300 million people who have given up their farms to find jobs in the cities, and the 250 million more who will follow them by 2020. Thats more than the combined population of the EU and the U.S. The Chinese authorities prefer to continue financing exports, and creating jobs, rather than to face the massive social upheaval that would result if these hundreds of millions could not find work.
The good news is that the authorities seem to recognize that reform they must. Perhaps the most significant event at last weeks gathering of the National Peoples Congress was its unsurprising decision to rubberstamp the leaderships surprising proposal to add a clause to the nations constitution. It states, lawful private property is not to be violated. Of course, those who have watched the changing definitions applied to lawful in this context by another reforming communist, Vladimir Putin, are right to urge a wait-and-see attitude before giving three cheers.
Still, the recent loosening of media ownership rules to allow foreign investment, the spread of the Internet, the emergence of an entrepreneurial class that is now granted membership in the Communist Party, and a new, young middle class more interested in designer sun glasses and cell phones than Maos preachings, all suggest that economic reform may, indeed, bring at least some political reform in its wake. That process will accelerate in 2006 when China is obliged by the World Trade Organization to open its financial sector to foreign competition, with all the free and rapid contact with the world that will require.
All of that, of course, unless those who fear that Chinas double digit growth will result in overheating and a bust prove prescient. Wen Jiabao concedes that Money and credit have been growing too fast, creating perilous risk. And The Wall Street Journal warns, China in 2004 feels like Nasdaq in 1999. The question on which world economic growth hinges is whether Wens plans to hold growth this year to 7 percent, tighten credit, and reform the banking system will let the air out of this balloon ever so slowly. If not, China might export a disease more dangerous to our economic health than SARS or chicken flu.
This article appeared in Londons Sunday Times on March 14, 2004.