Goldman Sachs allays fears of 'bubble' economy in China

[OhioChick]

Beijing, March. 7 (PTI): The US investment bank Goldman Sachs has allayed fears that China, now the fourth largest economy, could emulate Japan's 1980s 'bubble' economy and impact the world.

China's stock market saw a whopping rise of 130 per cent last year, land prices have surged in the past five years and the currency keeps going up.

These factors have raised widespread debate over whether China's economy is overheating and developing a bubble like Japan in the 1980s, especially in the stock market.

A noted financial expert and Vice-chairman of the Standing Committee of the National People's Congress, China's top legislature, Cheng Siwei warned that the bubble was developing in the stock market last month. Also a Chinese central bank survey last year showed 42 per cent of Chinese bankers believed the economy was overheating.

However, the Goldman Sachs report said, "China now and Japan then share a few macro similarities, but a more open economy and markets, stricter forex controls and better developed corporate governance could prevent China from repeating Japan's boom-bust experience." The Tokyo stock market, in 1990, fell 38 per cent, wiping out USD 2.07 trillion as Japan tightened its monetary policies.

http://www.hindu.com/thehindu/holnus/006200703071119.htm

[Kutjara]

1. No doubt a totally unbiased report.

The fact that GS is deeply invested in the rikety Chinese economy (along with just about every other financial institution in the West), and that an economic collapse there would take a large chunk of our economy with it, has in no way influenced the high minded search for pure truth that is this report. No indeed.

I seem to remember similarly rosy forecasts for the pre-collapse Japanese economy and the pre-collapse global stock market back in 1987. Investment bankers are not notorious friends of the truth, particularly when their wallets are better served by lies.

[fasttense]

2. Good point.

GS is in it for the money. It would not make them any money if they started telling people that the unstable Chinese economy, which impacts our economy so easily, is in bad shape. It might scare off investors.

But real people need to take this sudden drop in the stock market as a warning of worse things to come. They need to get out while the outing is good and the market is still (fairly) high. I think the worse of it will hit us in May 2007. Good luck to everyone here.

[Ghost Dog]

3. ROFL

:rofl:

[pampango]

4. Why do you think the Chinese economy is "rickety"?

Because it is overheated or flawed in some other fundamental way?

Isn't there a saying about how economists have predicted 6 of the last 3 recessions and have a similar record with recoveries from recessions? We would all be wise to take the analysis of investment firms with a large grain of salt. They may be right, but they are self serving in the short run, for sure. Longer term some of them may value their reputations (if only because that helps fatten their wallets in the future.)

Japan does seem to have finally steadied their economy, but 20 years after the predictions you referred to.

[Kutjara]

5. China needs to make some serious adjustments to its...

...business thinking if it's going to have a viable capitalist economy (assuming any capitalist economy can be considered viable). The root of the problem lies in the way corporations are financed. Under the purely communist economic system, enterprises were state-owned. They received a grant from the government every year and had to produce a given amount of output. Unfortunately, without a market mechanism to match supply and demand, some enterprises vastly overproduced products for which there was little demand, or underproduced products for which there was high demand. The managers of these enterprises didn't really care, however, because they were meeting quotas. As far as they were concerned, matters of supply and demand were the government's business, not theirs.

Fast forward to the new capitalistic economy. The old government-owned enterprises are now corporations (usually with mixed government/private ownership). These corporations are no longer funded by government grants. Instead, they are funded by loans from China's newly privatized banks (or the large number of international banks eager to do business in China). Once again, however, important components of the market mechanism are missing. First, the banks are obliged by the government to lend to the corporations, whether or not such loans make good business sense. Second, the corporations' senior management feel no pressure to repay these loans (in many cases, they still consider them to be grants in all but name). The banks aren't worried becasue the government will repay the loans if the corporations can't/won't. Finally, corporate management still measure success by output. Production quotas and targets are set, with little concern for the marketability of the products produced.

This economic model is very similar to the communist model, in so far as it is the government that ultimately funds the large enterprises. Such an economy is unsustainable, inefficient and very wasteful. You can walk through any city in China and see shops that sell only, for example, beads or ribbons or cups. What's most striking, though, is that there are thousands of varieties of beads or ribbons or cups, and they cost virtually nothing. The factories are churning the stuff out by the gigaton, whether or not anyone really needs or wants 50,000 indistinguishably variegated toothbrushes.

Western banks are so hot to get involved in the market that they've wilfully overlooked the structural weaknesses of the Chinese economy. Every couple of years, one banker or other gets up the courage to suggest that things need to change, but all that happens is a quick reposting for that particular banker. Meanwhile, the gold rush goes on. The irony that the most ruthless capitalists in the world (Wall Street investment bankers) are essentially financing a communist economic system appears to be lost on all the participants.

There are quite a few businesses in China that follow a more "Western" model, but these are generally small companies or joint ventures between Chinese entrepreneurs and US coprotations. The vast majority of the economy is still comprised of old state enterprises dressed up in 21st century capitalist clothes. There will inevitably be a shakeout of this dead wood before China can build a stable economy. The big question is whether the shakeout can be done piecemeal, or whether it will happen all at once, in a big crash.

There is one final storey in this house of cards. China holds an enormous proportion of American's national debt. Noone is saying it publicly (except in the depths of a few specialist political economy journals), but this gives China enormous leverage in "persuading" American banks to continue lending to Chinese enterprises. The Chinese know they can pitch us into a financial crisis by simply refusing to rollover our debt (essentially bankrupting the US Government). Overnight, the bond market would vanish, as would all the Federally-backed securities markets. Even the FDIC guarantee on your bank savings would be worthless, at precisely the time banks would start to fail. Not a picture to promote sound sleep in the boardrooms of Wall Street. Nobody wants that to happen, so the Chinese pretty much have an unlimited credit line at Citigroup, Goldman Sachs, Morgan Stanley and the rest, no questions asked.

The whole thing is a variation on the shell game, except there isn't a pea under any of the shells and everyone's hoping like hell that the shells never stop moving.

[pampango]

6. Thanks for all of the information about their transition from a

communist to a capitalist economy.

I had not known that much about how the government funds and supports large enterprises. It will be interesting, to say the least, how the economic shakeout transpires. Also, I would think that how this economic shakeout occurs will greatly affect (either to speed up or slow down) whatever political transformation China will undergo.

I have heard that China holds so much of our treasury securities that, while they could destroy our bond market by refusing to roll over our debt, they would also be destroying the value of the US bonds that they hold and crippling the economy to which they sell the bulk of their exports. (That reminds me of the old saying to the effect that if you owe the bank a thousand dollars, and can't repay it, that is your problem. If you owe the bank a million dollars, and can't repay it, that is the banks problem.) To some extent isn't there a symbiotic relationship between China and the US in this regard?

Thanks again for all of the information.

[Kutjara]

7. At the moment, the relationship is indeed symbiotic...

...to an extent (perhaps mutually parasitic is a better word). As long as we keep pumping funds into the Chinese economy, they'll keep making stuff to export to us. The problem, as I see it, is that this simply can't go on forever. Here are a couple of scenarios, of the top of my head.

If we reduce our consumption of their goods (because of a recession, say), they could "retaliate" by reducing the amount of debt they will buy (if only because they had less hard currency with which to buy it). This would have the effect of magnifying the recessionary pressures on the US, further depressing consumption, in a negative feedback loop that could magnify the depth and duration of any economic downturn.

If time runs out on China before it can restructure its industries, it may have no choice but to adopt austerity measures, including slashing the foreign debt it holds. The result could be a fire sale of US debt in an effort to raise all possible cash. The result of this would be crashing markets for US debt, which would seriously harm America's ability to raise new debt.

The debt is a political tool. If the Chinese government believe it is in their interest to apply economic pressure to the US, they wouldn't need to send ships to block our ports or planes to police "no fly" zones. They could sit comfortably at home and simply refuse to buy more debt. Sure it would hurt them too, but the Chinese have demonstrated, countless times throughout their history, a willingness to endure enormous hardship if the situation demands it. Also, there are indications that the Chinese are seeking to reduce their dependency on US markets by aggressive expansion around the world.

Of course, this is just speculation. What does concern me, however, is that two countries which have such widely differing political ideologies have become so economically interdependent. History has tended not to smile on such relationships.

[AnneD]

8. You forgot to mention unrest....

If the government cannot continue the pace of growth, folks from the rural area are out a job and there is enough unrest now without adding to it.

[David__77]

9. These things are being worked on.

SOE reform is addressing them. I hold that maintaining a socialist sector is helpful to China and not harmful. It provides the strategic tools to keep them on their development track. The holding of US debt is like an insurance policy designed to prevent the all-too-typical economic subversion coming from the developed countries.

[Kutjara]

10. I agree to some extent.

Having a well-run socialist sector would be very beneficial for China. Unfortuantely, the country's current socialist sector is anything but well-run. It needs to shift from an output-driven model to one based on some measures of social good. While it's true that China is beginning to take steps to restructure formerly state operated businesses, the fact remains that these steps may be too slow or too timid to sustain the economic growth the Chinese people have come to expect.

I also agree that holding American debt is a great insurance policy for China, but it is a double-edged sword. While definitely providing some protection against US economic imperialism, it is a strategy that only works for as long as China can run a large trade surplus. To praphrase Alice in Wonderland, they have to keep running as fast as they can to stand still. If they want to get anywhere, they have to run twice as fast.