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Sol Sanders Archive
Friday, June 29, 2007

China's utterly distorted economy is a train wreck waiting to happen

For the nonafficionado, Peking opera is “full of sound and fury, signifying nothing” to quote a famous dramatist from another culture. [Cantonese opera even more so; for as snobbish Mandarin-speakers have sometimes quipped, not even Guandong natives ever really master the six, sometimes considered eight, tones of their language, so they just keep shouting louder and louder.]

There is certainly plenty of noise now with the media and interested parties promoting the Chinese economy. Straight line projections of future gross national product growth [and projections for imported raw materials sales] may be the way we get to Mars before the astronauts. Most of those writing and talking about the China scene at the moment seem never to have heard of “the problem of the unanticipated consequences of purposive action”.

Just as in the Chinese opera, the attention is directed to the personalities with the accompanying music simply emphasizing the stylistic movements – most always predictable – in a drama having little to do with reality.

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Yet, what may be unfolding now in China is less Chinese opera than Greek tragedy. That is, if we use one of the definitions for Classical Hellenic drama where an individual [or in this case individuals] cannot escape from the toils and tribulations of events in his present environment leading to disaster.

But is our metaphor out of control? Are we, indeed, comparing apples and oranges?

Dr. Hu of Shih, one of modern China’s most illustrious and original thinkers, claimed one long-neglected Chinese philosophical school, Later Mohist writings [c. 300 BCE], often dealt with themes familiar to Western philosophers. But for whatever reason, the glorious ancient Chinese civilization which gave the modern world so many things – including gunpowder and movable type and [alas!] the idea of a meritorious ruling bureaucracy – never developed formal logic.

“Metaphor seems to be emphasized over more rigorous argument forms in China; deductive geometry became a model for philosophical method in the West but not in China; no work with concerns similar to Aristotle's Metaphysics became a paradigm of Chinese philosophy; atomism [Ed. Note: “The theory that all statements, propositions, situations, etc., are composed of mutually independent, simple, primary, and irreducible elements”- OED] arose in the West but not in China.” [Jean-Paul Reding,]

Some have said the fundamental difference comes from the fact the Chinese language never developed a verb equivalent to the Indo-European languages’ “to be”.

This is not obscure philosophicbabble but probably crucial to understanding the present situation in which the Chinese – and now the world – find themselves. For it brings us back to where we are – or rather, where we will be.

The roaring Chinese economy – and its fragile political structure based on nonrepresentative one-party government founded on Marxist dogma which its leadership now in fact rejects except as propaganda – is headed for a fall.

Crises overtake governments on almost a daily basis somewhere in the world. But there are differences with such a happening – if and when it comes in China. The multitudinous effects of a breakdown in China, the world’s most populous country, could be categorized in all sorts of ways.

But whatever else is occurring, China’s fate is rapidly increasingly being linked to the economies, if not the political stability, of the rest of the world. And that is happening with an increasing escalation and intensity, even though in terms of statistics, China may not represent that much of the world’s riches, production and, well, wealth.

China’s subsidies for exports, barriers to imports, a phenomenal savings rate so high there is a totally distorted consumer economy, corruption so widespread it is an economic factor, politicized lending for bankrupt state-owned enterprise, giantism in premature infrastructure, a skyrocketing military expenditure, an overload of mammoth foreign exchange holdings, a collapsed tax system, regional boondoggling out of the center’s control, a falling rural standard of living, etc., etc., have despite its rapid GNP growth created a totally distorted economy hurtling toward crisis.

As Minxin Pei of the Carnegie Endowment has said, it is hard to predict where, how, and when the bubble will burst because like a human patient suffering from a number of life threatening diseases and malfunctions, it is hard to know which one will kill him.

But what some Western business circles have whispered behind their hand as “China magic” has intoxicated outside investors and traders to the point where they have thrown “the rule of the prudent investor” to the winds. When the first bust of the Shanghai stock market-cum-casino came a few weeks ago, the markets of the rest of the world reacted sharply because there was fear that “magic” had disappeared. But the bailout by the government soon restored the aura of the China boom, so that more recent radical Shanghai market fluctuations have been seen for what they are, just another turn of the roulette of largely manipulated government stocks. [Shanghai has climbed 50 percent in less than a year.]

Meanwhile, foreign financial houses are rushing to buy equity participation in Chinese banks which officially list vast amounts of their loan portfolio as in default. China has begun to spin off part of its currency reserves as overseas investments including in foreign private equity firms. Unable to profit at home, Chinese oil companies are pumping up inflated world prices with all sorts of under-the-table deals with rogue and pariah producers. With huge new buildings in Shanghai and Beijing nearly empty, “hot money” is pouring into China to be “parked” in new real estate in anticipation of an eventual reevaluation of the yuan. The old Marco Polo Syndrome of unlimited numbers of Chinese customers lives on with international service organizations from accounting to IT software firms willing to collaborate with Beijing’s notorious secret police in order to secure “market share”. The American consumer has become addicted to cheap Chinese imports – often exported at below cost – to the point where again well publicized traditional Chinese food adulteration has taken a quantitative leap.

An index to what is happening is an announcement by Beijing’s State Administration of Foreign Exchange that 29 banks – 19 of them domestic including the Big Five state-owned commercial institutions – had received unspecified punishment for "assisting speculative foreign capital to enter the country disguised as trade or investment".

"There has been a huge turn-round in the overall balance of payments coming from the capital account with 'hot money' inflows of around $5-$10 billion a month," Jonathan Anderson, UBS's chief Asia economist told the Financial Times.

Beijing’s action, more than anything else, is proof of what many Old China Hands had long believed: the draconian foreign exchange regulations which make China’s currency legally nonconvertible are leaking like a sieve. With U.S.-China trade, for example, now running at about $25 billion a month – including a surplus in Beijing’s favor of over $19 billion in April alone – it is child’s play for wily Chinese exporters and importers to bribe their way through customs for overinvoicing and underinvoicing. Or there is the anomaly that many Mainland entrepreneurs use Hong Kong’s status as a foreign destination for all kinds of shenanigans. Money secreted outside China is then exchanged with the banks for ren min bao delivered in China for speculation and to await the “inevitable” reevaluation.

That’s why it may be too late for Beijing to take the advice of even their most devoted admirers like Nobel Prize Economist Robert Mundell that they should begin to accommodate Washington and other critics by ending export subsidies, particularly by increasing their undervalued currency if only slowly. But any reevaluation of Chinese currency would have to be massive to compensate for its incredibly undervaluation which have given it enormous competitive advantage over even such low-wage producers such as Mexico and India. On the other hand, many exporters are marginal producers now and more resistance from foreign customers because of higher prices would be catastrophic.

A massive exchange readjustment now would probably set off all kinds of alarm bells, not only for foreign investors and traders, but for the Chinese. A run from the yuan into dollars by all that “hot money” could create a crisis of confidence by that incredible Chinese devoted saver. The memory of runaway inflation – more than events on the battlefield what defeated the Chiang Kai-shek government in its civil war with the Communists – hovers and any currency manipulation would set off panic.

So, just as in the Greek tragedy – not the Chinese opera where virtue is generally rewarded – the events will have to play themselves out with grim ferocity. Brace yourselves: it is going to be a rough ride.

Sol W. Sanders, (, is an Asian specialist with more than 25 years in the region, and a former correspondent for Business Week, U.S. News & World Report and United Press International. He writes weekly for World and

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