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AFTER THE CRASH, CHINA SMILES

The tables have turned and emerging economies are on top

Today’s lucky ‘eight-eight’ celebrations were marked by happy, smiling crowds in the world’s fastest growing major economy. Chinese President Hu Jintao, presiding over the official celebrations, acknowledged the cheers from his people with a modest wave.

Following the credit crunch turned global financial meltdown, a new economic order has emerged, with developing countries like China and South Africa stronger and surging, while the old world countries are humbled and weak.

More than a decade before any OECD economists would have predicted it, China has risen to center stage of the trade and finance league. “There is no question that the US will remain the dominant global power,” said Nicholas Burns, a former US State Department spokesperson and ambassador who now teaches politics and diplomacy at Harvard. “Our military might and broad political reach will remain unrivalled. And, the US will remain the largest global economy with many strengths, in innovation, biotechnology and nanotechnology.”

But perversely, even as the US economy crumbled, China’s dollar-based holdings remained strong, as risk-averse capital fled to the US currency.

As growth slowed after the Beijing Olympics, China had plenty of fiscal and monetary ammunition to stimulate a revival. Falling resource commodity prices played into China’s hands, reducing its input costs.

The final master-stroke was the liberalizing of land ownership, creating hundreds of millions of entrepreneur farmers and small business owners, with their own collateral.


ANALYSIS >> SYNTHESIS: How this scenario came to be

Enter the financial dragon
In the face of the global financial crisis, where whole countries go bankrupt and stock markets experience ‘the worst week in our lifetimes’, the largest hoarder of currency reserves is China, and therefore the only country with sufficient financial muscle to shrug off the situation and benefit from a total collapse of the previous ‘rampant capitalist’ economic order.
The global crisis has so far had little impact on China. Far from depending on capital inflows, it is a huge exporter of savings; the financial system is awash with cash; capital controls shield it from volatile outflows; and its banks are underdeveloped and inward-looking.

China’s financial position is not perfect, as non-performing loans are rising and some city banks are suspected of having problems, but there appears to be substantial room to relax fiscal and monetary policies. Inflation is declining. The big national banks appear to be in good condition, with abundant liquidity because of lending caps that have become increasingly stringent over the past two years. China’s government is in a strong financial position. Savings rates for the Chinese are high.

As bourses around the world slipped ever downwards, the Chinese leadership announced a plan for land reform, which appeared to show 21st-century China values economic pragmatism more than Communist Party ideology. It is another matter that no further detail has been released, but experts say whenever it happens, China’s land reform will be a giant leap forward for a country poised to become the world’s largest economy by 2040.

The most likely outcome to the current crisis is a fundamental change in the economic order. Will China emerge as the ‘winner’ in this scenario?

August 2007: Sub-prime is a dirty word>
The sub-prime crisis begins to shake global financial institutions. Citibank is one of the first multinationals to take a write-down of billions of dollars.

August 2008: Beijing Olympics dazzle>
The opening ceremony of the Beijing Olympics is a visual feast of choreography, music, technology and spectacular fireworks. China rides high on the hog, the center of media attention, and astounds the watching world with its efficiency and attention to detail. The budget is gigantic, and financial issues are far from the authorities’ minds. It’s all about face, and making the best impression. And in this department at least, China confounds all its critics, and puts on a magnificent show.

September 2008: Global financial crisis
The credit crunch becomes the global financial crisis, as banks in the US, UK and EU face an unprecedented liquidity squeeze. Governments are forced to put rescue packages together, and nationalization of failing banks becomes the only option.
As American and British authorities scramble to avert the crisis, the influential Hong Kong daily Ming Pao quotes Beijing sources as saying the Chinese central government is ready to buy at least US$ 200 billion more US bonds to help China’s ‘economic partner’ tide over difficulties.
The story is officially denied by the People’s Bank of China a day later. However, it is likely that the Hu leadership will continue to bail out the humbled financial super-power.

October 2008: Financial meltdown
As the credit crisis spills over to the stock markets, panic sets in and markets tumble. Then recover, then fall again. Volatility is the name of the game, as western leaders scramble to put together multi-billion-dollar bail-out packages.
The shock waves echo round the world, as hedge funds collapse, oil prices drop, and investors flee from anything remotely resembling risk. Resource commodity prices collapse, and emerging markets see a double-edged effect, crashing stocks and lower demand for their exports.

Wolfgang Grulke, FutureWorld Guru, comments: “China is going through exactly what the rest of the world is going through…the Shanghai stock market is down 66%, the value of their vast investments in the US are being shredded, their primary market (the United States) is being destroyed. Hu says their internal market will take up the slack. It will take some of it but not make up for the loss of international consumer markets.

“China is not immune from this crisis. Their growth will decline ‘massively’ – from more than 10% historically to 6-8% per year. This will be a disaster for China (they need to grow at 7% just to feed new jobs coming into the economy) and the third world (the moment China’s growth dips – and it’s already started – the demand for resources will drop and resource stocks will crash) – this will be bad for resource-rich economies. Just take a look at the current SA Rand exchange rate – that will give you a clue – even with the high gold price.”

“I am not arguing that emerging economies are immune, just that they might weather the storm better, because of their less ‘free and open’ economies,” counters Doug Vining, MindBullets Editor. “Obviously the markets are crashing, and the currencies taking a hit, but these are some of the ‘shock-absorbers’ that may protect them in the long run. None of their banks are going to fail, precisely because they are not free to take the risks taken by the US and EU banks.”

“Remember the Chinese banks are in a far worse state than the Western banks – corruption, lack of transparency and so on. Much has been written about this – and any financial difficulties could result in a major shakeout,” says Wolfgang Grulke in reply.

But are they? The Economist tells us that while many emerging economies have larger foreign banking liabilities than assets, this is not the case with China and South Africa. The foreign assets of Chinese banks exceed their foreign liabilities by 350%, and dollar-denominated instruments remain strong. In fact, like South Africa, much of the shake-out has occurred before the global crisis, and Chinese banks are the more resilient for it.

On 1 November, the People’s Bank of China announces that it will “lift limits on commercial bank loans to support stable and fast economic growth amid the global financial crisis.”

February 2009: China land reform
In a bold and unexpected move, China accelerates the pace and intent of land reform, effectively giving tenant farmers title to their land, and freedom to borrow against their land, or even amalgamate or sell their farms.
The effect of this unlikely move is extraordinary, catapulting the Chinese economy back into double-digit growth, as entrepreneurs and would-be business owners take advantage of their newly found collateral to move to the cities or begin commercial farming in earnest.
A new ‘cultural revolution’ grips China, this time converting peasants into landowners, and changing the face of the internal economy forever. Food production rockets, and China begins to export staple crops in addition to manufactured goods, for which there is a ready market in Asia and beyond, as cost of production is still much lower in China than elsewhere.

August 2010: China Smiles
The crash of October 2008 is over. Business and investment cycles have turned. Many banks are still owned by their governments, and major corporations have down-sized, regrouped, merged and split. Stock markets and investors are licking their wounds, and gathering their resources for a fresh cycle of unpredictable growth.
The balance of power has changed. China has emerged with a glowing credit rating, astounding growth, and ever more fortified financial reserves. The eyes of the world are now on the new big gorilla – China.
But China’s success comes at a price. Having assumed center stage in the global economy, China can never extricate itself and return to its isolationist ways. Like it or not, China has a Faustian pact with Western economics and values.

Warning: Hazardous thinking at work

Despite appearances to the contrary, Futureworld cannot and does not predict the future. Our Mindbullets scenarios are fictitious and designed purely to explore possible futures, challenge and stimulate strategic thinking. Use these at your own risk. Any reference to actual people, entities or events is entirely allegorical. Copyright Futureworld International Limited. Reproduction or distribution permitted only with recognition of Copyright and the inclusion of this disclaimer.