What Will China Do?

There's been a lot of speculation, in the press & elsewhere, about what the governments of every major country will do to respond to the current global economic crisis. Not only are specifics eagerly sought and eagerly speculated upon, but there is also (it seems to me) a lot of noise under the surface regarding two other aspects of the current situation. The first is about whether governments really understand what's going on. The answer to this one is two-fold, and they are both pretty straight-forward. No one knows what will happen over the next year and a half and governments are no different. Is this a severe recession with Global Characteristics? Certainly, it is. Is that all it is, or will things take a turn for the worse and will we irretrievably move away from "the world as we have come to know it"? And here is where things get tremendously speculative because, unless you can find Merlin the Wizard, or some soothsayer in a cave in Tibet, everyone is just guessing. For some its an educated guess. For others, its a wild stab in the dark. But no one I know can tell the future. And I've been to some of those caves in Tibet; they aren't talking about the global economy there. While there's a lot of guessing going on (although we might be better off calling it "scenario building"), the uncertainty remains high and the predictions are unreliable at best.

The second subject of background noise regards whether or not governments know what to do and (if they do) whether they have the will do what needs to be done. Here is where it gets a bit dicier. Certainly, there's a lot of policy debates in process. And a number of major decisions have been made. But: it ain't over yet! Like a very long and slow-paced movie, the story takes a long time to develop. Even if governments aren't quite sure what will happen next, they are certainly trying to figure out what to do to right the ship. They really have no choice. But it also seems to me that policy makers are feeling their way and searching for the right solutions for the major challenges before them. As we've seen in Washington, London, Berlin, Paris, Ottawa, and elsewhere, politics intrudes. That's the nature of a democracy.

The second & closely related question has to do with political will. Presuming the effective steps are known, do the governments of the world's major nations have the political will necessary to do what needs to be done? In my opinion, this is the major question. There is no doubt at all that, given the scope of this crisis, some -- and in all likelihood, a great many -- of the things that will be required will be difficult and sometimes unpopular.

Of one thing there is no doubt in my mind: when it comes to China, the Chinese government has the political will to take the steps it will need to take to build momentum towards economic recovery. Whatever it takes. No doubt in my mind.

None at all.

Nero Returns!

You know the image: Nero, the Roman Emperor, who is famously remembered as focusing on his lyre as Rome burned to a crisp. Whether History (at least as we popularly remember it) does him justice, the myth is being re-enacted today in Washington. It all makes it it very difficult for all of us American expats who have so self-righteously preached to the Chinese for years that they should look to the U.S. model for China's future.

While I still hold on with one hand to the mantra of free and open markets, the banner has gotten a bit tattered of late. Open markets have their limits, and if you don't understand that, you've been asleep for the last few years. The Chinese have not missed that point, altho I'm not too convinced we always see the same limitations. Nevertheless, the main points have not been missed. The Chinese government is, of course, no stranger to the skills of managing economic growth. If anything, they're too good at it. Too much growth, after all, can be a bit hazardous, too. Maybe not as hazardous as too little, but the risks are unmistakable.

Many of my Chinese friends are looking on in bafflement today as the debate rages on in Washington about the details of the pending stimulus package. They aren't alone. Many expats are also a little baffled, but for different reasons. What they don't see the value of is the political give & take of a democracy. Here in China, the debates are usually behind closed doors and mostly pretty short-lived. And, once over, the debates are . . . well . . . over. Already, the effects of the Chinese government response to the economic chasm we're all teetering on the edge of is being felt. Whether China will avert the worst is unknown; no doubt, this will be a tough economic year. But no one here thinks the government is not concerned or that, if early efforts are inadequate, further action won't be taken. They will do whatever it takes. And they will learn their lessons well. Probably, they already have.

Meanwhile, back in Washington, the Democrats have watered down the fiscal package in order to attract Republican support. In the U.S. House of Representatives, it didn't work -- not one Republican supported the original House stimulus plan. In the Senate, support was minimal. In each case, the final bills became more skewed towards tax breaks. I like tax breaks! Everybody does; nobody likes to pay taxes. But anybody who thinks people worried about losing their jobs (and already having lost much of their retirement savings) will buy a new car because the taxes are now lower is an idiot. Likewise with real estate purchases. If you're worried about your family's economic viability, your first thought is NOT about buying a new house. Unless you're independently wealthy or just scammed the taxpayer out of billions in undeserved bonuses, in which case tax savings is, maybe, a pressing concern. And, if you think about it, in order to pay income taxes, you've got to have an income. The unemployed don't pay income taxes.

I read a note posted by an old acquaintance last week. He is convinced that this whole thing will be over by the end of 2009, no matter what the U.S. government does. In one sense, he's right: the U.S. will get thru 2009. And then it'll be 2010. Time marches on, no matter what. Its what happens in the meantime that's the issue. If the U.S. is to avoid running the American economic locomotive into a brick wall, Congress will have to be both decisive and effective. There is no guarantee that the U.S. and World economies will be better in a year. More likely, if nothing is done, they'll be considerably worse. The Chinese can see that very clearly, as they can also see the inevitable linkages between the two economies. What is much harder to explain to them is why some Americans, who they think should know better, seem to be working so assiduously for broad American failure and for their own narrow self-serving interests. Even Chinese friends here who dislike the "powers that be" here readily point out that, in this crisis, the Chinese government is doing the right things. Why don't all American politicians want to do what clearly needs to be done?

I have no answer.

Meeting the Challenge of Slower Growth

The Chinese Central Government has floated the story, reported widely, that unemployment among China's roving migrant population has reached some twenty million workers. Reuters points out that, with additional workers just coming into the workforce, that will push the total up to about 25 million unemployed out of a total of approximately 130 million migrant workers. I believe that this actually understates the problem. Here's why: first of all, these totals are only for migrant workers, rural workers who leave their homes in search of jobs in other areas (usually urban areas, both large and small, and also usually coastal). In fact, the story was made public thru Chen Xiwen, director of the Office of the Central Rural Work Leading Group. But, again, these numbers are only for rural workers. Urban workers will also be losing their jobs as the growth rate slows, and many already have. And none of the unemployment projections around the country account for underemployment, a factor little discussed in China by labor economists. Also reported widely in the west have been the difficulties of recent university graduates in finding employment. This isn't a new problem, nor is it confined to China, of course. But everything in China, when it comes to population and labor issues is just plain bigger.

The central government (and, consequently, local and provincial governments around the country) are concerned about a probable increase in public protests. This concern is not new. China's government is nothing if not vigilant when it comes to public order and the threat of social chaos.

Western observers of China, particularly casual ones, frequently misunderstand these public outpourings. The Chinese "Laobaixing" ("Old Hundred Names", the common Chinese term for the masses of Chinese, both urban & rural) retain a strong trust in both the Central Government as well as with the Chinese Communist Party. On the other hand, distrust of local officials, particularly on the county, village & municipal level is not uncommon. When public demonstrations break out, unlike in the West, it is generally not to impress the press. It may be a spontaneous outpouring of angry emotion, a group reaction to events, a plea for attention from higher authorities, or an effort to pressure others. Despite the well known exceptions reported outside China, such as the unrest in many areas of ethnic Tibet (the Tibetan A. R. itself along with parts of Sichuan, Qinghai, and Gansu provinces) and Xinjiang in the last year, the anger and frustration are not directed at the central government.

Look for China's central government to be quite proactive in meeting the social repercussions of a slowing economic growth rate. Unlike Washington, Beijing is not hampered in taking quick and forceful action thru fiscal stimulus. The powers that be are quite sensitive to conditions in the countryside not likely to be taken by surprise. And the word has gone out from Beijing: pay attention to what the masses are saying and use a softer hand. That's good news.

What's Next?

As the global economic order collapses, most of the attention has been, for obvious reasons, on economics. After all, this is, first and foremost, an economic problem. We've all, those paying attention, become steeped in the vocabulary of economics and the financial world: credit-default swaps, hedge funds, yield curves, Treasury bond pricing, currency valuation, trade imbalances, savings rates (or lack thereof). For me, it has always been useful to try to look at problems from a completely different perspective. Sometimes its an empty and fruitless exercise -- interesting, perhaps -- but ultimately, providing no new insight. At other times, a whole new light can be shone on something and we see it in a new way.

The economic collapse we're witnessing is so complex and so multi-faceted & nuanced, that it gives us all kinds of different angles to watch from. One very popular Scenic Viewing Spot, a great Photo Op, you might say, is to look at the current situation and compare it to the Great Depression of 1929-1939 (or so). Certainly, there's a lot we can learn from the mistakes of the past that will help policy makers deal with the dilemmas of today. Its not the same, of course; it never is. But there are enough similarities, and the mistakes of the 1930's were so glaringly obvious, that the same mistakes won't be repeated. In China, in the U.S., in Europe, the media (and policy makers meeting rooms, you can bet) are filled with analysis and studies of lessons to be learned. There's been at least one thing that's been largely missing from the discussion, altho I'd bet that, at least in Zhongnanhai, the Powers That Be have been paying close attention. The media, to be sure (at least from my reading) hasn't woken up to the problem yet. What is it? Its the issue of what's next. What happens in the aftermath of an economic collapse of this magnitude? Again, a look back to the Great Depression is useful. It doesn't mean that the same things will happen; they never do. But similar things could happen, even if in different ways and in different places. Here's what I mean: the biggest & most consequential result of the 1929-1933 economic collapse was not economic, altho that was bad enough. It was political. Europe saw a turn from liberal democracy towards fascism, resulting in the rise to power of the National Socialists (who weren't really socialist at all) in Germany and the National Fascists in Italy. In Asia, Japan turned to the militarism that was latent in Japanese culture and politics. And, of course, the consequence of this broad political shift was World War Two. I'm not suggesting that the current problems will lead to another big war. Not at all. What I'm suggesting is that a broad shift downward in the economic prospects of hundreds of millions of people, if not billions, is likely to have political repercussions.

Already we have seen the Icelandic government collapse. Russians are restive, as are people in other pockets, both in Europe and in China. The U.S. has seen a peaceful, albeit dramatic, political change. With apologies to Elizabeth Kubler-Ross, I'd like to suggest that her Five Stages of Grief (Denial, Anger, Bargaining, Psychological Depression, and Acceptance) have a sociological and political application. First off, though, some caveats. These stages are not predictive, meaning they aren't inevitable. They may come in a rather random order. While, for individuals, there is a sequence, the edges are rather fuzzy (one can be alternate, for instance, between denial and anger). lastly, people don't necessarily go thru all the stages. Kubler-Ross maintained that people always experienced at least two stages, altho which two could vary. This is, in my opinion, even more true with large groups of people. Certainly, some of these stages of grief are already apparent. Who would today suggest that as recently as last summer, denial was not common? Americans were characterized as a "nation of whiners" by former Senator Phil Gramm. John McCain famously said the American economy was "fundamentally sound". If that isn't denial, the meaning is lost on me.

While some are still in denial, you can see evidence of bargaining, particularly in the halls of government. Then again, that's their job. In the U.S., at least, anger has been apparent, but it hasn't been a broad motivating factor. In other regions, it has been more visible. In China, it has sprouted up but has not been a broadly motivating factor for most of the population. For most of the world, the situation is in its early stages. There is economic pain, to be sure, but it is still characterized by early stage shock and denial. What is to be feared is the anger that may come as people realize their prospects & wealth may have been forever altered. If the world's government leaders, with their central bankers & finance ministers, are successful in limiting the disintegration that is potentially right around the corner, the dragon of political and social disruption will go back in its lair to hibernate for another eon. That's a big "if".

Creeping Socialism?

Its a real dilemma. Some of the biggest & best known names in American banking are, well . . . ready for foreclosure. They've failed. You can still call up your broker (assuming he or she is still employed) and buy stock in either Bank of America (where I started my career) or Citigroup, but the obvious question would be, "Why bother?" In the last year, B of A has lost 84.36% of its value and Citigroup has lost even more: its down by 87.30%. In the last 30 days alone, they're down by 53.29% and 48.44% respectively. Bank of America's market capitalization is a measly $39.9 billion dollars. Citigroup's an even more pitiful $16.9 billion. These were, once upon a time, the largest and most powerful banks in the world. To put that in further perspective, Citigroups' losses for 2008's fourth quarter totaled $8.29 billion. Another two quarters of equally stellar results and there's no equity left at all. Bank of America isn't much farther behind.

If there are any two banks in the U.S. that are really "too big to fail", its these two. But what are you gonna do? No investor, outside the Alzheimer's Investment Club would willingly put their money into these banks' common shares. Enter the U.S. Treasury and its "tag team" partner, the U.S. Federal Reserve System. Investors of Last Resort. When no one else will pony up, there are always these two. I can't see that there is any real choice on this one. The problem is, though, government bureaucrats make really bad bankers. Not that the bankers themselves have done so well. Those of us in China can attest to the fact (yes, a fact) that government owned and controlled banks are subject to political pressure and can all too easily make lending & investment decisions supported by political reasons alone. If you remember "Crony Capitalism" in Southeast Asia (remember the Asian Financial Crisis?) and the mess that Chinese banks have only slowly & recently emerged from, you know what to expect. Of course it won't be exactly the same, but its not a strategic plan that will warm the hearts of anyone who wants a healthy banking sector in the U.S.

The experience of the big four Chinese banks may, ironically, provide a model. Industrial & Commercial Bank of China (ICBC), Bank of China, China Construction Bank, and the Agricultural Bank of China were, for much of their history, part of the Peoples' Bank of China, China's central bank. As such, they were firmly under the control of the central government of China. And, as such, they made most of their loans based on government policy and had little (if any) independence. Predictably, operating results were nothing to brag about. Non-performing loans (NPL's) were difficult to isolate from the rest of the loan portfolio, but ranged anywhere from 20% to close to 50%, depending on who you asked and how you defined "non-performing". That's not sustainable. Today, after years of hard work cleaning up bad loans, selling them off to state-mandated "bad banks' (using one of Washington's latest buzz words) and revamping the management standards of each of the four, the portfolios are much more manageable. Indeed, all four have gone public and, in the process, have become much more disciplined.

My point is not that B of A & Citi should model themselves after the big four Chinese banks. But the Chinese banks do provide a lesson: there is an afterlife for state-owned banks. And while government ownership is not a formula for banking success, the Chinese banks recent history shows clearly that poorly managed banks can be cleaned up and learn to be disciplined financial firms. They can also go public and, in doing so, "go private" -- private in the sense of not being owned by the government. Current Citi & B of A shareholders & bondholders placed their bets long ago on bank management that was doing little more than rolling dice. They lost. If taxpayers are going to have to foot the bill, taxpayers deserve to reap the rewards. Calling it Socialism or Nationalization is not a useful excersize. Let's call it what it is: financial & economic necessity. The sooner the U.S. gets on with it, the sooner the problems can be solved and the sooner the banks can be returned to where they belong: in the private sector.

Riptide

A story we've been returning to with some regularity, the U.S. Treasury bond market & U.S.-China economic relations, and especially currency valuation, returned to the headlines this week. And, for the first time, it was one of the top headlines both in the U.S. and in China. The proximate cause was Tim Geithner's statement to the Senate Finance Committee that President Obama thinks China has been “manipulating” its currency. Personally, I'm not sure what this means. Certainly, China has been managing the value of the RMB. Is that manipulating its value? At any rate, what's really at issue is the desire of many in the developed world for the RMB to be freely tradeable and for its relative value to be set by the market. The assumption in the West (and great swatches of the East as well, no doubt) is that the RMB will rise against the US Dollar, the Japanese Yen, the Euro, the Pound (if, indeed, the Pound could go much lower). This is desirable, from a US policy perspective, because it would make exports to China cheaper. Cheaper goods from the US means more sales to China, or so the reasoning goes. But it also means less Foreign Direct Investment (FDI) coming into China, as well as (in relative terms) cheaper investments in the US by China. In other words, The RMB, having hypothetically gone up in value against the Dollar, will buy more New York real estate, more government bonds, etc. It also means a few other things, of great concern to the Chinese: US Dollar holdings by the China Investment Corporation (China's Sovereign Wealth Fund) will go down. They've already gone down a bunch and further declines will bring more criticism from within China and, paradoxically, make further Chinese investment in the U.S. less politically attractive. In addition, current Chinese holdings of U.S. Treasuries will be cheaper in RMB terms or, stated differently but with the same essential financial meaning, interest rates will need to go up, as we've predicted, only more so. Already, since 2008 Year End, Treasury yields have risen. They bumped up a bit more this Friday after Geithner's remarks were made public. And Chinese newspapers led with the story meaning, at the very least, that China took notice.

There's nothing really new in this issue. China's friends as well as her critics in the U.S. have been warning for years -- and by that I mean at least since 1998 -- that the issue of currency values and the U.S. trade deficit with China would be an issue someday. Every year, it has seemed, those who have been doing the warning have looked like a combination of Chicken Little (of "The Sky is falling! The Sky is falling!" fame) and the Boy Who Cried Wolf. You can only warn so many times without the danger arriving before you're ignored and even perceived as a bit of a naive idiot. As the Chinese would say, if the weren't being polite, "Er Bai Wu" -- the Village Idiot! If, as the Chinese may fear, the era of the gentlemanly "Go Along to Get Along" policies of the Bush Administration are over, things will get interesting pretty quickly.

The irony for both parties is that they need each other in innumerable ways. Both China & the U.S. have serious economic problems and need to work together as allies to effectively deal with those problems. This requires both candor & practicality. The problems are real. To be genuinely and effectively dealt with, both sides will have to put sensitivities aside and grapple with the real-world issues. The Bush Administration made the "Global War on Terror" the measure of all things. This was not to the benefit of either China or the U.S. A more nuanced & honest relationship would be better for both.

The Tide Turns

As the world watched the Obama inauguration with a great sigh of relief, one group of observers, hidden away behind the vermilion walls of Beijing's "Zhongnanhai" seemed a bit nervous. We expect a bit of anxiety from the shrunken and increasingly disdained Republican minority in Congress as well as from those Investment Bankers that are still employed. With the Republicans, the worry is understandable; the voters have spoken and the verdict was a harsh one. Now that Henry P. is out of Washington, along with his lap dog Neel Kashkari, the American public can hope that there will be at least a little bit of accountability in the Big Bank Bailout. In all likelihood, the days of "no questions asked" cash gifts to both troubled & untroubled banks will end. To many knowledgeable observers, its not the bailout that is at issue anymore, but the lack of accountability for what amounts to windfall gifts.

But back to the official Chinese reaction: much has been made of the Chinese censorship of the translation of Obama's inaugural address. From my perspective, this is not very surprising and nothing new. Censorship is alive & well in the Peoples' Republic. But underlying the surface facts, as usual, is another reality that is more telling. Official China, indeed, does seem to be a bit nervous. The question is, "Why?" To some extent, its perfectly understandable. As the Chinese themselves have pointed out, U.S.-China relationships have been remarkably unruffled over the last eight years since the Hainan Plane Incident in 2001. The only real threat coming from Washington wasn't from the Bush Administration at all, but from Congress and was centered around trade relations and, in particular, the relative value of the Chinese Renminbi against the U.S. Dollar. Since that time, the Peoples Bank of China has allowed the RMB to appreciate by almost 22% (from July 2005 through October 2008, its apex). That is not an inconsiderable movement, in the world of currency values. This doesn't mean that the pressure for change won't return, but at least defenders of PBOC currency policy will have a more defensible position.

So what is it that makes some people here nervous? The answer lies, at least partially, in who Obama is & how he thinks. As the first African-American President, Obama has achieved something that is almost inconceivable to Chinese leaders. China, of course, is approx. 92% ethnically Han. The likelihood of a Chinese head of state being Mongolian or Zhuang or Manchu (as they were during the Qing Dynasty) is extremely remote. And even the Manchu Qing largely pretended to be Han while they reigned. Even less likely are those minorities better known to the outside world: Tibetans & Uighurs. The even remote possibility that this could happen in China causes anxiety for some Chinese. The second reason has to do with who Obama is, not what he is. And who he isn't. Obama is not a party hack. He has had only three years as a member of the U.S. Senate. He is best known as having been a community organizer as a young man; community organizers are not your basic insiders. Obama also symbolizes to many the hopes & aspirations of the common man, not often these days something the rich and powerful in China are sympathetic to. In his initial appointments, he chose people of proven ability, but also of independent mind who speak their minds without fear. Obama also, I believe, looks to the Chinese -- with their often simplistic understanding of the U.S. -- as a sort of American Cory Aquino, a manifestation of "People Power". And in Obama's case, sporting a success fueled by outsiders (women, African-Americans, Hispanics, Jews, etc.), by small financial contributions (not big corporate ones), and popularly elected, no less. Obama's campaign famously used state-of-the-art eTools -- Instant Messaging, Facebook, even the more prosaic email & Internet web sites that have become ubiquitous political resources in the worlds' democracies for years. For some of China's Han leaders, Obama's rise to leadership is as worrisome as an imaginary charismatic Tibetan or Uighur leader who might rise to power in China on a wave of public popularity among the Laobaixing, the Chinese masses.

It is Common Wisdom among close (and even casual) observers of U.S.-China relations that, whatever may be said during Presidential campaigns about China, after a switch in power things continue pretty much as they have been since Jimmie Carter normalized relations 30 years ago. I don't expect that to change and China's leaders shouldn't either -- even if the rhetoric heats up by a few degrees. But the tide of history has surely turned in U.S. politics. The whole world has, rightly, taken notice. If this moment is an indicator of the flow of world history, as I believe it is, then China's leaders are right to be a bit anxious.