China’s Economic Problems Have Been Hidden for Years

In light of my numerous columns regarding China’s economic problems dating back a couple of years (http://progresshg.com/2015/08/12/trump-shows-abject-ignorance-on-china-world-economy/ , http://progresshg.com/2015/08/12/trump-shows-abject-ignorance-on-china-world-economy/ just to hyperlink a couple) the recent Chinese stocks sell-off is not surprising to me. Moeover, it’s magnifying concerns about the health of the world’s second-biggest economy…and rightfully so. But beyond the markets, I still maintain that there are huge doubts in my mind that the Chinese government is adequately tooled to handle the second largest economy in the world.108545_600

The Shanghai Composite Index on Thursday tumbled 7 percent in 30 minutes before trading was suspended. The damage quickly rolled around the world: Stocks plunged in Tokyo, Hong Kong, London and New York. The Dow Jones industrial average finished Thursday down a steep 2 percent. On Friday, the Shanghai Index closed up 2 percent.

As in the U.S., China’s stock markets actually have very little connection to the rest of its economy. And in China right now, one of the big reasons Chinese shares are sinking is that Beijing is trying to undo some of the measures it took to prop up stock prices after the Shanghai market collapsed in June. Yet China watchers say there are several very good reasons to worry about the Chinese economy and the effects they will have on the U.S.

Among them:

  • A WEAKENING CURRENCY

The Chinese government spooked world markets in August by suddenly pushing down its currency, the yuan, by about 2 percent. The biggest fear was that perhaps Beijing had grown so worried about the country’s economic prospects that it had decided to give its exporters more help by lowering the yuan’s value, which makes Chinese products more affordable in foreign markets; especially it’s $1 trillion steel inventory that nobody wants.

The government said it was merely responding to signals from the market: The yuan, closely linked to a surging U.S. dollar, had risen too high. After the August devaluation, the yuan stabilized for three months. Then it started sinking again. It’s dropped (or more accurately, was forced downward) more than 4 percent against the dollar since the end of October.

The Chinese economy has been “weakening for years,” says Derek Scissors, resident scholar at the conservative American Enterprise Institute. “That hasn’t changed. What has changed is they pushed the yuan down.

“There’s a heightened risk that the Chinese are going to be more aggressively predatory on trade,” he said. “Everybody who competes with China — their profits are now in jeopardy.”

“If you left it alone, it would probably fall another 5, 6, 7, 8 percent,” says Yukon Huang, senior associate at the Carnegie Asia Program.

But Chinese authorities want to keep the yuan from going into free-fall and investors who fear that the currency has further to fall are likely to sell investments that are denominated in yuan, thereby putting further downward pressure on China’s currency and stocks.

  • IT’S SIMPLY HARD TO TRANSITION

Although China’s economic slowdown is, to some degree, calculated, the country’s super-charged growth of the past quarter-century was built largely on massive investment in real estate and factories, much of it increasingly wasteful and inefficient, and used to build huge, cheap, badly made steel and still vacant ghost towns…some the size of New Orleans.

The government is attempting to guide the economy toward slower but more sustainable growth built on spending by Chinese consumers and prodding the country away from its historical overdependence on manufacturing toward more reliance on services industries.

But overhauling a sprawling and enormously complex economy was always going to be a formidable task, and a report Wednesday, pounced on by global investors, suggested that the transition might not be going so well. Of particular concern was that the report noted that services firms weren’t hiring fast enough to offset factory layoffs.

  • ECONOMIC MISMANAGEMENT

Chinese policymakers, long admired for their stewardship of a fast-growing economy, have worsened things by communicating poorly, meddling clumsily in the markets and backsliding on reforms.

“The ongoing rout in China’s stock and currency markets reflects a sharp erosion of confidence in the economic management skills of Chinese policymakers, coupled with rising concerns about the state of the economy,” says Eswar Prasad, professor of trade policy at Cornell University.

The government’s ham-fisted attempts to stop a freefall in the Shanghai stock market disheartened those who had hoped China was moving toward a more open financial system. Chinese authorities banned investors from betting against stocks, forced middle-income citizens with homes to take second mortgages on their homes and invest the proceeds in the markets or risk losing their homes and jobs, suspended trading in hundreds of companies and poured money into the market. Yet stocks plunged again once the government began to back away.

The authorities have shaken investors as well by repeatedly confusing investors about their policy toward the yuan.

You have to explain what you’re doing to the investment community and the Chinese economic managers are not good communicators.

The uncertainty corresponds with persistent doubts about China’s economic statistics. Even Premier Li Keqiang has conceded that Chinese figures for economic growth are “man-made.”

Officially, the Chinese economy grew about 7 percent last year. Most economists suspect the actual growth rate might be 5-6 percent or lower.

Government intervention after a boom and bust last year has kept stock prices at artificially high levels. Ultimately, they must come down, particularly as the government attempts to withdraw its support measures. An unwise “circuit breaker” trading halt system, which kicked in twice this week, also added to volatility.

WHAT DOES IT MEAN FOR THE U.S. AND THE REST OF THE WORLD?

Foreign investors have limited ownership of Chinese stocks because the country’s financial system is still largely fenced off from the world. However, the country’s rising economic clout mean fluctuations on the Shanghai stock exchange have the power to rattle investor sentiment and hit the portfolio values of everyone from mom and pop investors to big pension funds. A bigger impact, both positive and negative, could come from the weakening the Chinese currency, since it would affect commerce and consumers around the world.

So, are the Chinese up to the job? I guess time will tell. But in a little more than two decades, Chinese leaders have overseen a transformation that has lifted hundreds of millions out of poverty and made China into the world’s second-largest economy. In hindsight, that may have been the easy part. Now that growth is slowing, the challenges multiply and Beijing’s ham-fisted handling of its stock market turmoil this week is eroding the image of China’s Communist Party leaders as a skilled managers. “Unfortunately, this sends signals that at least in area of the stock market, policymakers are making big mistakes and are going back and forth and have kind of lost the game on policy,” said Kuij.

The fragility of the U.S. economy is not helping. With the GOP-led loosening of banking regulations, the worsening concentration of bank assets and control only serves to make U.S. exposure to bank crashes like the one at the end of George W. Bush’s two terms in office. The next one could be twice as bad and the GOP will surely blame weak leadership or some other lame reason like taxes that are too high for the next collapse, when the opposite is the real reason.

Given the propensity for Democrats to lack the organization, communication skills, and sheer will power to make their own case stronger, I’m sure the usual scapegoats (Social Security, high taxes, Obamacare, public education, unions, immigration, and too much money spent on the poor) will be in their crosshairs.

We’re coming to a very sad time in America and it doesn’t seem to be getting the press it needs because the broadcast media has succumbed to news-for-profit rather than news-for-truth. If the Republicans win the White House you can be sure that Obamacare will be repealed, Social Security will take huge hits and the U.S. recovery will be D.O.A. by the end of the new President’s first term.

If you don’t believe me, look at any of the states with Republicans in control. They are all suffering enormous financial hardships; none as much as Wisconsin, Kansas and Louisiana…so much so that deep red Louisiana elected a Democrat as Governor. It marked the first time in more than a decade that ANY state in the South has elected a Democrat as governor.

Harvey A. Gold