Strangely enough I think I am among the least disappointed people about Premier Wen’s speech this morning during the opening of the National People’s Congress. Like most people I think there was very little of substance in the speech except the usual statements about boosting consumption, maintaining growth, and promoting social welfare – all easier said than done – and I have already argued many times, in a recent blog entry, for example, and in today’s WSJ Op-Ed piece, that China’s development model and financial system make it very difficult for China to boost consumption in the short term except by boosting investment, which is both slow and contrary to China’s role in the global crisis.

The main thing I got from his speech is that while Premier Wem claims that China is ready significantly to expand its stimulus, for now policymakers plan to wait and see what are the effects of the current stimulus spending. This makes sense, I think, because there is a real risk that continued deterioration in the global environment and rising domestic unemployment may panic the government into throwing everything they can into the stimulus mix.

And if they do, what will that accomplish? Global demand is contracting so there is no way to get around the fact that Chinese overcapacity will have to decline, and since it cannot decline sufficiently via a sharp increase in net domestic consumption, it will inevitably decline in the form of reduced production, especially as the threat of protection, which Wen explicitly addressed, rises.

I think to a certain extent this was recognized by the premier. According to Xinhua’s coverage of the speech:

When delivering a government report to the annual session of the Chinese legislature, he said that the global financial crisis continues to spread and get worse. Demand continues to shrink on international markets; the trend toward global deflation is obvious; and trade protectionism is resurging.

“The external economic environment has become more serious, and uncertainties have increased significantly,” he said. “Continuous drop in economic growth rate due to the impact of the global financial crisis has become a major problem affecting the overall situation. This has resulted in excess production capacity in some industries, caused some enterprises to experience operating difficulties and exerted severe pressure on employment,” according to the Premier.

But what if policymakers try to force the problem away? The risk is that they cause a massive increase in investment in the hopes of boosting employment, but if this boost comes as a consequence of building even more capacity, there are, in my opinion, likely to be two very dangerous outcomes. First, they will enter next year with even more excess capacity, and second they will have weakened the banking system further and increased government direct and contingent indebtedness.

If the world recovers quickly, then none of this will matter. But if it doesn’t, China will face 2010 with even more excess capacity and in a much weaker fiscal position to combat the contraction.

There were a few worrying aspects to the speech. Recently there has been an increasing chorus among exporters demanding RMB depreciation, and three days ago Commerce Minister Chen Deming said that February’s trade figures would be much weaker than January’s. According to an article in the South China Morning Post:

Mr Chen did not rule out the possibility that the country would adopt some trade protection measures but said it would resist out-and-out protectionism. “Trade protection does not equal protectionism. Some measures are allowed under the [World Trade Organisation] framework,” he said.

I am not sure I understand how trade protection is different than protectionism, except perhaps in a strictly legalist sense that will hold little water in the global debate. I would propose, if anyone wanted my opinion, that the world’s leading exporter by far of overcapacity – and the only major country that has seen its trade surplus surge during the crisis – does not need to push exports, especially not via any form of protection, legal under WTO rules or not.

More worrying, at least superficially, it seems that it was not just Chen who is making these kinds of noises. The People’s Daily, in reporting today’s speech by Premier Wen, had an article with the kind of headline almost designed to catch my eye: “Wen’s report urges unslackened efforts to promote export.” According to the article:

China “must not slacken efforts” to promote export amid a sharp decline in external demand and growing international trade protectionism, Chinese Premier Wen Jiabao said Thursday, pledging reinforced government support.

…”We will continue to diversify our export markets and compete on quality, enhance traditional export markets, and energetically open up new markets,” said Wen. The government is to take a series of measures to relieve the difficulties of exporters and to ensure steady growth in foreign trade, according to Wen.

The rest of the article was a little less worrying, suggesting mostly anodyne feel-good measures

A central government fund for trade development will be increased, eyeing to cultivate brand-name export products and support small and medium-sized enterprises in expanding their international markets, Wen said. To improve the country’s financial services for importing and exporting, the government will expand the coverage of export credit insurance, and encourage financial institutions to develop export credit, he said.

The government will adjust the prohibited or restricted commodity categories of processing trade, and encourage the relocation of export processing industries from the eastern to the central and western regions, Wen said.

Perhaps all of this is more designed to ward off continued attacks by a frantic export sector than to represent a real attempt to force export growth. Let’s watch the trade figures over the next few months. China has only just begun to feel the impact of sharply declining exports, and is suffering a lot less than most other Asian countries.  This should change soon.

Tags: NPC

With the tense start of China’s parliamentary season this afternoon – and with the National People’s Congress meeting Thursday – there isn’t much incentive to try to figure anything new out in China since we are likely to be given a lot more information and proposals over the next few days. What are the major topics likely to be covered in the meetings? I suspect that this article from yesterday’s South China Morning Post, on the topic of unemployment, gives a pretty strong hint:

If this is not addressed, it will be even more difficult for the government to maintain social stability down the road if unemployment remains high. China’s official urban unemployment rate is expected to be 4.6 per cent this year, which would make it the highest since 1980 when figures first began to be collected.

But, economists, including Zhou Tianyong from the Communist Party’s Central Party School, forecast that the real unemployment rate could reach 14 per cent, counting migrant labourers.

Senior officials estimate that up to 20 million migrant labourers have already lost their jobs because of the global economic crisis. They were mostly laid off by private firms and foreign-funded enterprises, the hardest-hit sectors.

I was told privately by a friend of mine two days ago that the number of migrant laborers who have already lost their jobs is actually closer to 30 million, but nonetheless Mr. Zhou’s comments reinforce some other claims to which I refer in a piece by me in the current Newsweek:

Although official estimates put urban unemployment in China at just over 4 percent of the workforce, most unofficial estimates are much higher—closer to 8 percent—and nearly everyone agrees that the figure is set to rise significantly in the next few months. Some credible estimates suggest that even if China were able to achieve the 7.5 percent growth projected in 2009 by the World Bank, unemployment would nonetheless double before the end of the year.

Clearly unemployment is going to weigh heavily on the minds of policymakers in China, like in the rest of the world, and we will have to wait and see what specific new measures are proposed over the next few days. Meanwhile I did nonetheless want to make a few comments about interesting stuff I’ve seen recently.

The first is a reference to an article in yesterday’s Financial Times, “Asean split on protectionism,” which highlighted the difficulties of getting leaders to agree on free trade even during a conference whose primary goal was to defend free trade:

As south-east Asian leaders gathered on Friday for their annual summit, the region’s united front against protectionism was starting to crack under the pressure of the global economic crisis. The fight against protectionism is top of the agenda at this weekend’s meeting of the 10-country Association of South East Asian Nations, which on Friday signed an agreement cutting tariffs and other barriers with Australia and New Zealand.

However, the leaders appeared far apart in pre-conference comments on the balance to be struck between sustaining open markets and promoting economic activity at home. In the most forthright remarks, Abdullah Badawi, Malaysia’s prime minister, said every country had the right to encourage its citizens to buy local products.

“I think it is a normal reaction under this kind of situation. First of all we have to protect our people; we are doing the same thing. If we do not create projects by Malaysia, for Malaysians, then who will buy our products?” Mr Badawi told the Bangkok Post newspaper.

For some of my readers I may be beating a dead horse, but as usual I will put up my warning that we need to be very aware of the deterioration in global trade relations that is likely to be a consequence of the rising unemployment everywhere in the world. The fact that even in a region heavily dependent on exports it is so easy (and so natural) to make the case for protectionism doesn’t bode well for trade discussions in North and South America, Europe and Australia. The article goes on to say:

Lee Hsien Loong, Singapore’s prime minister, said Asean might miss its target of establishing a regional economic community along the lines of the European Union by 2015 if member states failed to maintain open markets. “In this global environment, if we give the impression that Asean is not fully open for business I think we will be the losers when the new landscape emerges,” Mr Lee told CNBC.

Most of the regional economies have built their prosperity on the back of export growth, and the slowdown in the US, Europe and Japan has hit them hard. “I think we all worry about protectionism, and not just from traditional channels,” said Mari Pangestu, trade minister for Indonesia. In spite of Mrs Pangestu’s reservations, Indonesia is encouraging civil servants to buy Indonesian products, an echo of Barack Obama’s Buy American campaign that angered so many both within and outside Asia.

It may seem like a non sequiter to follow up with a second Financial Times article from yesterday, this one called “Emerging market finance: a gap to fill,” but bear with me:

Two years ago, nearly a trillion dollars flowed into emerging markets as investors in rich countries toured the globe in the hunt for yield. Now there is a melancholy long, withdrawing roar as private capital flees to safer havens.

…Net capital flows to emerging markets will drop to just $165bn (£115bn, €130bn) this year, down from $929bn as recently as 2007, according to estimates by the Institute of International Finance, which represents the world’s leading financial companies. Net lending from commercial banks, the IIF says, is likely to go into reverse. The reasons for this are not altogether straightforward. Some accuse rich governments, particularly the US, of “crowding out” emerging markets, sucking up all the available capital to finance their stimulus packages. But Brad Setser, a former International Monetary Fund and US Treasury official, notes that as the private sector retrenches, the US current account deficit – and hence its need for outside financing – has actually been declining.

More likely, he says, is that emerging markets are being hit by a general decline in demand for riskier assets, as banks and investors haul money back home to shore up balance sheets and reduce borrowings. Similarly, the global shortage of the trade credit that finances cross-border commerce reflects a general desire of banks to reduce leverage, not the rich countries hogging all the available loans.

Why is this relevant to a blog on Chinese financial markets? Because if annual net capital flows to emerging markets drop by the projected $700-800 billion, an inevitable consequence is that foreign currency reserves plus net imports for those emerging market countries will also have to decline by exactly the same amount. In other words while some of this decline will be accommodated by a running down of central bank reserves, we should expect a very large decline in net imports among those developing countries, to add to the decline in net imports from North America, non-German-Europe and other trade-deficit-countries. Needless to say this decline in net imports must have as a necessary corollary an equal decline in net exports in the trade surplus countries.

My final comment – hinted at in the title – is on Paul Krugman’s Op-Ed piece in today’s New York Times. he starts off by discussing the viciousness of the global crisis and then goes on to ask (and answer):

How did this global debt crisis happen? Why is it so widespread? The answer, I’d suggest, can be found in a speech Ben Bernanke, the Federal Reserve chairman, gave four years ago. At the time, Mr. Bernanke was trying to be reassuring. But what he said then nonetheless foreshadowed the bust to come. The speech, titled “The Global Saving Glut and the U.S. Current Account Deficit,” offered a novel explanation for the rapid rise of the U.S. trade deficit in the early 21st century. The causes, argued Mr. Bernanke, lay not in America but in Asia.

In the mid-1990s, he pointed out, the emerging economies of Asia had been major importers of capital, borrowing abroad to finance their development. But after the Asian financial crisis of 1997-98 (which seemed like a big deal at the time but looks trivial compared with what’s happening now), these countries began protecting themselves by amassing huge war chests of foreign assets, in effect exporting capital to the rest of the world. The result was a world awash in cheap money, looking for somewhere to go.

Most of that money went to the United States — hence our giant trade deficit, because a trade deficit is the flip side of capital inflows. But as Mr. Bernanke correctly pointed out, money surged into other nations as well. In particular, a number of smaller European economies experienced capital inflows that, while much smaller in dollar terms than the flows into the United States, were much larger compared with the size of their economies.

I have written often about the savings glut hypothesis and my very strong belief that it lies at the heart of the fundamental global imbalance of the past decade, and I think it has extremely important consequences both for our understanding how the crisis will evolve and what are the likely consequences to the major players involved in the imbalance. I am a big admirer of Krugman’s and have been for fifteen years – in the 1990s I used to read everything he wrote, and often within days of his publishing it – so I am delighted that he seems to agree with Bernanke’s thesis, but I should add that I believe the evidence in support is so overwhelming that even if Krugman decided to deride the whole notion, I would remain convinced that the sudden and massive rise in Asian net savings following the 1997 Asian crisis was a prime cause of the corresponding and necessary decline in US savings.

I know I know, this is going to be considered a very controversial statement – and inevitably someone will very stupidly demand to know why I am blaming China when obviously the full blame for the crisis should fall on the US – but there it is. I just don’t see how recent events can be explained without the Asian Crisis of 1997 having played a major role. At least Krugman seems to agree. At any rate he finishes worryingly with:

And the saving glut is still out there. In fact, it’s bigger than ever, now that suddenly impoverished consumers have rediscovered the virtues of thrift and the worldwide property boom, which provided an outlet for all those excess savings, has turned into a worldwide bust. One way to look at the international situation right now is that we’re suffering from a global paradox of thrift: around the world, desired saving exceeds the amount businesses are willing to invest. And the result is a global slump that leaves everyone worse off.

Tags: Krugman, NPC