Change from China?


There was little fuss when China overtook the US as the world’s largest economy, as measured using figures corrected for relative purchasing power.  

There was more concern in the US as China asserted itself by claiming the nine dash line from Taiwan round to the Paracel islands, seeking control over a series of islands and pushing oil rigs into disputed territory. President Obama announced a tilt of his policy from Europe to Asia, and set about constructing a Trans Pacific Trade Partnership that excluded China. The US keeps several carrier groups in the Pacific area, and seeks to exercise its rights to sail seas near China that international law regards as international waters.

No-one should deny the great economic success of China in recent years.

The arrival of President Trump ratcheted up the anti-China rhetoric of the US, but dropped Mr Obama’s response of signing a trade agreement with other Asian powers. The new President has strengthened ties with Japan which has very stressed relations with Beijing. He has been more aggressive in condemning North Korea, whilst willingly co-operating militarily with South Korea as his predecessor did. China states both that it wishes to be an ally of North Korea and to persuade it to more orderly conduct, which is proving an impossible task. The Chinese were strong in forcing Mr Trump to continue the One China policy, by not offering special treatment for Taiwan, but have been more muted in response to Mr Trump’s annoyance at their large trade surplus and currency level.

No-one should deny the great economic success of China in recent years. For all the armies of critics who challenge the figures, worry about the debts and point out the problems, any visitor must see the huge advances made in building large modern cities on the east coast, dominating many industrial product markets world wide, and now moving on to higher real incomes and more services and consumption for Chinese citizens. The national statistics may not always be accurate, but there is real achievement visible in the buildings and the physical exports and domestic sales.

It is true China now faces more difficult choices and decisions. A command society recognises it needs to liberate its economy more to grow faster, but finds it difficult to let go. In an age of growth through social media and digital technology, full freedom may have political and social consequences the single party state does not want. Ironically, with Mr Trump complaining that the Chinese currency has been manipulated and is too low, China feels it has to manipulate the yuan higher or at least keep it stable. Over the last two and a half years there has been a large outflow of capital from China, with a large drop in their high foreign currency reserves to below $3 trillion. As a result China has recently raised its short term rates a little, asked the banks to rein in loans and credit, and has tightened controls on Chinese sending money out of the country. The rises in interest rates in the US still keep the dollar strong, increasing the problem. The state daily grapples with the poor balance sheets of state industries that have borrowed too much and generate too little cash, and with the banks that have made the loans. Fortunately the Chinese state owns or controls both sides of these transactions, so they would need to be very incompetent to lose control of the bad debts. The government wants to cut back excess capacity in coal, steel and other manufactures, but needs to take into account the impact this has on employment and on communities dependent on these industries.

For the world economy to continue to grow at around 3%, and for US reflation to work, it will require China to achieve something close to its growth targets of a little over 6%. It is requiring more and more money and debt to be injected to bring about that growth, but it seems likely the Chinese government will need to do so. The Chinese economy already has far more money around relative to GDP than advanced countries. In the US M2 money – both ‘narrow money’ and ‘near money’ combined – is around 70% of GDP, whereas in China M2 is more than twice GDP. It leaves China prone to bubbles in asset markets, with share and property bubbles resulting from sudden enthusiasms by money holders seeking to find a more productive way of holding their surplus.

China is a large economy with far more to do to raise living standards and meet the aspirations of its people. The more the Chinese see of the west, the more they are going to want its living standards. Some will even want more of its freedoms. The Chinese state will equip its forces better and extend its reach with more ships and planes. China wishes to be taken seriously in world affairs, but is usually cautious about expressing views on matters beyond the China seas. We do not expect either the Chinese economy or Chinese politics to derail the recovery this year worldwide. This giant will be cautious as they size up President Trump, and should be able to keep their growth continuing, with ever increasing amounts of money and debt behind it.


The above article by John Redwood, Charles Stanley’s global chief economist, was first published by Charles Stanley on 24th March 2017.