The China Dilemma
By Staff News & Analysis - January 13, 2011

Chinese bank lets U.S. customers buy, hold yuan … A state-owned Chinese bank says its New York City branch has begun offering accounts denominated in China's tightly controlled yuan in a move to expand the currency's global reach … "They are trying to expand the scope of people who can hold renminbi (yuan) and that increases demand," said Daniel Hui, a foreign exchange strategist for HSBC in Hong Kong. Economists say the process of making the yuan an international currency on the level of the U.S. dollar, euro or yen will take years and depend on factors such as how many foreign companies want to use it. China's central bank governor, Zhou Xiaochuan, called in 2009 for a new global currency managed by the International Monetary Fund to replace the dollar for trade and storing reserves. Economists say such a change is unlikely, but the comments reflected Beijing's unease about the dollar, which it uses for the bulk of its trade and to store an estimated one-half of its $2.5 trillion in reserves. – USA Today

Dominant Social Theme: Watch out West – China's a-coming. The Biggest Tiger is on the loose.

Free-Market Analysis: In a problematic global economy, China is being cast as the ultimate Asian Tiger. It is seen as challenging America from a military standpoint and even, eventually, of challenging the dollar's tottering role as the world's reserve currency.

We have, of course, pointed out that the Chinese economy is not nearly so healthy as it is made out to be in the mainstream press; today we wish to revisit this position based on China's increasingly willingness to be a banker to the world. On the surface, for instance, the willingness of China's leaders to ameliorate Europe's indebtedness is the act of a powerful and confident country. But perhaps this apparent strength may mask considerable weakness.

There is no doubt that China is attempting to take on an economic-leadership role, and its leaders are trying to make the yuan more liquid as a matter of policy. (See article excerpt above.) They are signing trade deals that facilitate yuan liquidity, most notably with Russia and Brazil. With the recent announcement that China is going to use some of its massive reserves to purchase euros, China has actually been cast as the protector and savior of Europe.

The mainstream media has acted as a vast echo chamber for this new view of China – call it "China resurgent." Just yesterday, a Reuters article carried the upbeat message once more. China, with its great dollar (and euro) reserves and mighty 1.3 billion population was surely capable of strapping a tottering Europe on its big back and carrying both civilizations to greater heights. Here's an excerpt from the Reuters' piece:

Europe can "definitely" solve its debt problems and China will continue to support the euro's role as an alternative to the dollar in global financial markets, a Chinese central bank adviser said on Wednesday. Xia Bin, an academic adviser to the People's Bank of China, told Reuters on the sidelines of a forum that no one wishes to see the euro disappear … "In the long run, it is not a problem. Europe will definitely solve the problem," Xia said. "We don't want to see the euro disappear." He also said that global financial markets are better off with a balance between the dollar and euro, as opposed to having only dollar dominance. "Walking on two legs is certainly better than walking on one leg," Xia explained.

There is wisdom here of a certain variety. Xin Ban comes across at once as a comforting fellow, reassuring Western audiences that with China's help, "Europe will solve the problem." With a deft rhetorical twist, he fashions a Chinese proverb – "walking on two legs is better than one" – and in doing so presents a Chinese persona that is technocratic, paternal and folksy all at the same time. Some rhetoric – and great PR for the ChiComs and their system (such as it is) as well.

Yet, there are dissenting voices. Much as the European Union itself has begun to be seen as a failing program, so increasingly the Chinese are being perceived as promising more than they can deliver. This perception admittedly is more prevalent on the blogosphere than in the mainstream press, but the level of skepticism is increasing. Here's a different take on China and Europe from the International Business Times:

Can China save euro? Answer is ‘no' … On Thursday Spanish daily El Pais reported that China has offered to purchase Spanish sovereign debt worth about $7.89 billion. There is euphoric expectation that China, armed with its $2.6 trillion reserves, will emerge as the ultimate white knight for Europe. Is that belief founded on facts and substantiated by strategic thinking? Analysts at Capital Economics have said "China is unlikely to be able or willing to do much to solve the debt crisis in the euro-zone," even though the popular perception is that it will. "China's leaders naturally want to be polite to foreign hosts and visitors, but their actions frequently fall short of the expectations raised by their words," writes Julian Jessop, chief international economist and Mark Williams, senior China economist, in a note.

We would tend to agree with this. The crisis in Europe is systemic and has to do with congenital overspending, especially among the Southern PIGS. While "austerity" cutbacks may have had made a difference, the societies themselves are intertwined with state welfare and pensions in such a way that the market itself will likely have to impose the necessary discipline. Will the Chinese have the stomach – or resources – to mediate between the various unionized factions of, say, Spain and Italy, to help provide the appropriate solvency? No matter what China does, it may lose and be cast in a bad light besides (perhaps even an anti-worker one). At some point, we would imagine, Chinese patience will lapse.

China has growing problems of its own. We've long-charted the real-estate distortion in China and while officials regularly downplay the idea that there is any fundamental problem in the Chinese economy, we find more and more evidence to disagree. Most notable was the startling series of Google earth photographs that purported to show a variety of empty cities and vast, uninhabited developments throughout China.

China may (or may not) be the savior of Europe but there is something amiss on the home front. More and more of the Chinese middle class is invested in "real estate" – empty Chinese apartments owned by the government and offered to buyers via long-term leases. These empty apartments – often in empty cities – should be a red flag to anyone looking at China realistically. Real estate distortion is a fundamental signal of something amiss. Even Bloomberg is beginning to cover it:

Is There A Property Bubble In China? … "Bloomberg's Paul Allen reports from Dongguan, [touring] the South China Mall, originally conceived as the world's largest mall, and finds retail space that has been largely vacant since 2005 … "The reality at South China Mall is … shuttered shops, unfinished, never occupied by a single tenant. The few retailers that are here have favorable leases, but little profit." Allen also states that despite obvious problems, the mall's owners plan to expand to more than one million square meters of retail and residential space will be available.

The video report is available on the Internet and shows both the vastness of the mall and its relative failure to attract shoppers even five years later. The population surrounding the mall is working-class, with little disposable income for the kinds of goods a mall is supposed to provide. The workers come to give their children rides at the mini-amusement park but don't venture inside where some 1,500 empty shops drearily await leaseholders that have never arrived.

The emptiness of the mall some five years later provides further evidence that the current Chinese perspective regarding construction – build it and they will come – is not a viable one. They have NOT come to this Chinese mall and one would question whether they will "come" to the increasing inventory of empty Chinese cities. The faith that both Chinese technocrats and Western investors have in the vitality of the Chinese economy and its teeming population may eventually prove misplaced.

What surely WILL come is a downturn. It is strange to us that people cannot see this authoritarian system for what it is. In free-markets, cities are built gradually as people gather together to trade. There are no "empty" cities in a free-market environment. It makes no sense economically. These empty cities – and malls – are obvious evidence of the authoritarian nature of Chinese society.

Behind the mask of the market is the Communist party itself, dictating where people should live, work and shop. The great banks and other financial institutions doubtless report directly to Communist party functionaries. It is a kind of Potemkin village writ large – and the inflation pouring out the Chinese central bank will eventually displace the facade. The market always pushes back – as authoritarian leaders eventually discover to their dismay.

Currently, the ChiComs continue to fight the market. They build great, empty cities to keep workers occupied. They offer to buy euros to keep bankrupt countries viable, and buying Chinese goods. But ultimately it will make little difference. The more that Chinese – and Western – technocrats do to organize and manage their societies the more the market itself performs in unexpected and eventually ruinous ways. For every action, there is a reaction.

Is the Western leadership aware of China's liabilities? We would have to think so. However, the Anglo-American power elite always seeks to create adversaries (or at least powerful challengers) and China is obviously the next candidate in this regard. The contest is not perhaps to be as overtly military as the one with the USSR, but certainly China is being cast as a rival to Western (American) hegemony.

It has been the intention, no doubt, of the Anglosphere to manage the current downturn in such a way as to encourage further internationalization; but this economic episode in our view has been far more severe than anticipated and has taken place under Internet's merciless gaze. Summoning China (as world-power and rival) to help may only compound the problem, especially if China's relationships with Europe grow more complex as its own economy begins to tumble.

Edited on date of publication.

After Thoughts

Can a handful of aging men in Beijing run a country of 1.3 billion? To open up the Chinese economy to real competition would probably entail a severe contraction; thus, the Chinese leadership may believe it has no choice but to continue to support an increasingly distorted domestic economy and to help the European Union as well. Time may show this larger union is no stronger than the individual players involved.

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