Whither China? Would you believe, in relative terms at least, downward?
From a contrarian perspective, China looks vulnerable these days - which perhaps explains why U.S. economist Stephen Roach, chairman of Morgan Stanley's operations in Asia, says India's economy will soon begin to grow at a faster rate than China's.
Long bullish on China, Mr. Roach said in Mumbai this month that he is now bullish on India, which is much less dependant on exports.
India's GDP will rise 6 per cent a year for the next two years, he says, and then rise to 8 per cent. As for China, he says, the odds are increasing that it will hit a wall.
Mr. Roach is famous for his contrarian calls, especially for his early call on the macro-meltdown that precipitated a global recession in 2008-09 (or, as he would label it, 2008-11). Although early, he was right.
Now, he says, the problem for the world is the deeply indebted American consumer - who experienced a $12-trillion (U.S.) "wealth shock" in the past year. A real recovery won't happen, he says, until U.S. consumers have stabilized their own economies, a process that could take years.
China's microeconomic risks lurk in what Mr. Roach describes as "the Manchurian Paradox" - a strategic contradiction that suggests "China just doesn't get it." He warns that China's leaders need to deepen their appreciation of the global shock to come. "Only then," he says, "can Beijing begin to comprehend the threat that this recession poses to its long successful, outward-looking economic growth model."
Mr. Roach notes that the world economy is headed this year for its first outright contraction since the end of the Second World War - by a "stunning" shortfall of 1.5 per cent ($3.2-trillion) in world GDP (which peaked last year at $64-trillion). For the past 40 years, world GDP has grown by an average of 3.7 per cent.
"Never before," Mr. Roach says, "has the modern global economy had to come to grips with such a severe and abrupt widening of the so-called global output gap." More than any other country, perhaps, the shrinking global economy threatens China. "China [is]ill prepared," he says, "for what could be the defining feature of the post-crisis world - a U.S.-led shortfall in world consumption."
Mr. Roach advances a comprehensive analysis of China's risks in the current issue of the National Interest, a bipartisan public policy magazine published by The Nixon Center in Washington.
First, China's spectacular growth in the past 30 years has been almost exclusively based on the export of physical goods, a strategy, he says, that China's leaders now seek to continue in the post-meltdown global economy.
In part, Mr. Roach says, China is betting that American stimulus spending will restore American consumer consumption. But this strategy will not work. The U.S. consumer will be down and out for a number of years. And China itself hasn't necessarily hit bottom. From a growth rate of 13 per cent in 2007, China's economy finished 2008, by Mr. Roach's calculations, "at a virtual standstill ... very close to zero." In the first two months of this year, export growth plunged 21 per cent on a year-over-year basis.
Second, China simultaneously pursues "an especially paradoxical" strategy in its critique of the U.S. dollar. On the one hand, it expresses a lack of confidence in U.S. Treasury securities (in which it has a $700-billion investment). On the other hand, it purports to want an alternative reserve currency. Yet, Mr. Roach says, only a strong dollar can safeguard China's investment in Treasury securities - and talk of an alternative reserve currency weakens the dollar.
As long as China relies on exports to sustain its growth, Mr. Roach says, it has no option but to recycle its foreign exchange earnings into U.S. bonds. As soon as it stopped, the value of the dollar would fall, the value of the Chinese yuan would skyrocket - and Chinese exports would hit yet another barrier. China's currency concerns, he says, "ring hollow."
Mr. Roach argues that China must replace its decline in exports by an increase in private, domestic consumption within its own borders. Only one-third of Chinese GDP now gets consumed in China - a record low set in 2007. Unless it commits much more of its GDP to domestic purposes, he argues, the country risks "social instability," the euphemism that normally translates as mass demonstrations but which could turn into insurrections in the countryside.
Mr. Roach describes a "wild card" scenario in which China would sell off its U.S. bonds - regardless of the financial losses that would ensue. First, the U.S. Congress passes some form of trade restrictions, this year or next, specifically directed at China. Second, President Barack Obama refuses to veto it.
Quite properly, he says. China would regard this legislation as an attack on its honour. "I have little doubt," he says, "that Beijing would retaliate."
This sequence of events could deliver the same cataclysmic hit on the world economy that the infamous Smoot-Hawley Tariff Act did in the 1930s.
What are the odds? Mr. Roach: "I would place a 25-33 per cent probability on the passage of anti-China trade legislation [by]early 2010."