The problem with China
Christine St Anne  |  07/10/2015Text size  Decrease  Increase  |  

Christine St Anne: In part two of our interview, author Satyajit Das joins us to talk to us about the real issue behind China and what the country slowdown means for one particular country.

Satyajit Das: The real issue about China is why there was a stock market boom and that was engineered to divert attention from two things, which is the slowing property market and also the other economic problems which is a slower growth, the massive over capacity, all of those types of things. And fundamentally, what has happened is the stock market crash has actually drawn attention to the overall problem of China.

But also don't underestimate that $4 trillion to $5 trillion of value being wiped off, despite the fact that the market remains above where it used to be, is of significant. And I would expect there is going to be problems in the Chinese banking system because the amount of leverage used to purchase these shares were significant. So I think those problems are there, but at its heart there are two issues which this has raised. And the first issue that it's raised is the reform agenda that we all know China needs.

My view is that the stock market crash will lead to an internal debate in China about more market-based reforms versus on the other side going back to more command economies. But the other thing is it's also undermined that position of the existing administration of President Xi Jinping. And what is clear, is in China there is what I call the 'mandate of heaven', every leader rules by the 'mandate of heaven', which in modern times has translated into a compact between on the one-side the Chinese Communist Party and the People of China.

And the compact is pretty simple. We will improve your living standards and some of you will get quite rich, most of you will improve at least and in return for that we are left to run the economy by ourselves. The problem is that if the stock market crash and the slowing economy signals the inability to meet those two objectives of growing wealth and prosperity and living standards, where does that leave that particular compact. But also it exposes weaknesses in the existing administration.

President Xi Jinping's much touted anti-corruption campaign is really a Stalinist purge. What we are seeing is him removing people who are very powerful from previous regimes, who may not actually share the same objectives and same policies as the existing administration. The problem is the stock market crash, the weakness in the economy, the poverty bubble ending has brought into doubt President Xi Jinping's personal credibility and also his policies. And what we are going to see is some behind-the-scenes battle between previous leaders and their acolytes and this. And I don't know that anybody knows exactly how that's going to be resolved, but political instability layered on top of the economic problems becomes hugely problematic.

Most people are assuming this is very much an internal Chinese problem. I don't think it is. It will flow into the rest of the world along several lines, one of which is obvious, which is commodities, which has already affected the commodity economies. But people like Germany export a heck of a lot of BMWs, VWs, Mercedes-Benzs, and have large domestic operations in China, so does General Motors. So these will be affected by anything that goes on in China.

The third thing, which I think is really important is what this does to how China starts to manage its economy. It is very clear, China is going to use a policy of devaluation of the yuan and also reverting to using the state banks to pump more money into the economy. Now the problem with that is as follows.

With the pumping of more money into the economy, Chinese debt is now over 250 per cent of GDP, and because most of its state-owned enterprises and the Chinese state-owned banks and the state itself, either directly or through local government, if you actually look at that, a lot of it's just state debt directly or indirectly, which means they are extremely vulnerable if they continue to expand the debt. And the devaluation is very interesting because that's setting off a huge problem for the rest of the world when everybody wants to devalue their currency to gain competitiveness.

So all of those factors are going to be highly destabilizing, but it will be, in my view, a slow process to understand that because everything in China is opaque. So none of us get a really good view of that, but I think to be very, very much in one camp, which is a soft landing or the hard landing is very difficult because none of us have the full facts. But I think China is in the process of a major transition and when the second largest economy on the planet is going through that, it is very, very significant.


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