Over the last decade China has pursued, essentially, what we used to call Mercantilist policies and for which the new words are Export-led growth. Export growth has been the main creator of China’s amazing growth rates especially over the last decade. The Chinese currency has been kept cheap and a high Savings Rate generated, partly because of the lack of any welfare net. China has developed the economic profile of gross exports representing 40% of GDP and domestic consumption only 30% of GDP.
But with Savings Rates having been allowed to dwindle, virtually to zero, in the USA and UK, China has effectively provided the “vendor finance” to the West to buy more and more Chinese imports, via, largely, the investment of China’s burgeoning recovery in US Government Treasuries.
Clearly the era of “vendor finance” has come to an end and where citizens are under pressure to de-gear, Savings Rates in the West are likely to recover over time to around 10%.
The crucial question is as to whether or not China realises that the ball is in their court. Globally, if savings recover in the West and nothing changes in China, there will be an excess of global saving and a shortage of global demand and consumption – a glut – not good for China or the world. From China’s own perspective the policy of following high growth policies has been to head off social unrest. Now 40 million people have already been thrown out of work in China’s coastal export industries and for the next few years, clearly, the best that China can hope is that Chinese exports grow more slowly assisted by the measures being taken by Western Governments to prop up demand.
I suggest that China needs to move to implementing significant
welfare benefits – unemployment pay and pensions – to reduce the
Savings Rate and to stimulate domestic consumption. Politically, I
also suggest this will be necessary to head off major social unrest.
How China manages its monetary and exchange rate policies also
raises major issues for both the Chinese and world economies. In
response to China’s sharp economic downturn the prior monetary policies
of sterilizing the additional money supply impact of China’s burgeoning
trade and current account surpluses, has been suspended. The money
stock is already rising fast where, unlike the West, the ability of
Chinese banks to lend is not constrained by major losses.
With economic growth having already halved in 2008 and the money
stock increasing rapidly, there is the potential for current
deflationary concerns to change in the course of 2009/10, as velocity
of circulation recovers, to rising inflation. Either to head off; or
address, this, China may be obliged to end the RenMinBi’s Dollar peg
and allow it to appreciate. Current Chinese exchange rate policy has
swung to encourage, e.g. depreciation, to help exports, but thereby
increasing the risk of protectionist measures in the USA which would
not be in China’s best interest. RMB appreciation, which I anticipate
within 2 years, is likely to increase inflationary pressures in the
West at a time when the West, itself, may be struggling to contain
rising inflation resulting from its current policies to sustain the
money supply, to head off deflation.
But allowing the RMB to appreciate should help accommodate the
necessary rebalancing of the Chinese economy towards higher
consumption, lower savings and a reduced trade surplus. This is also
central to restoring global economic balance, but implies downward
pressure on Western living standards and upward pressure on Western