Platt Perspective on Business and Technology

China and its transition imperatives 26: rethinking China’s economy and the Party and government policy that shapes it 2

Posted in macroeconomics by Timothy Platt on December 6, 2015

I have been writing about China in this blog for a significant length of time now, at least as measured in terms of this online endeavor itself and its lifespan up to here. And for most of that, I have written and uploaded my China installments in what for me is the usual manner: writing them well in advance of their scheduled publication dates to this site and adding them into an ongoing queue of postings waiting to go live here. This of necessity imposes an at least somewhat longer-term perspective on what I offer here; I am not just addressing the more ephemeral “here today, gone tomorrow” of short-term, fleeting interest news. And that constraint, I add, is not all that much of an imposition as I am not at all interested in addressing the short-term only in this blog. My goal for all of it is longer-term and both for what I write about and for its overall ongoing significance and context.

I have recently posted a number of quick notes on China for essentially immediate live publication to this blog, in what might be seen as violation of that policy and practice, and certainly since I came to what I saw as an unavoidable conclusion that China’s economy was about to tip over the edge of a cliff, and imminently. I wanted to capture and present my thoughts on this in much closer to real-time than is usual for my writings here. But I have decided to shift back to my more long-term, considered approach and to writing in advance, and with all of the stripping off of “flash news updates” and the like that that imposes.

I offered Part 25 of this series (with it going live on October 23), over a month before it was set to do so. I suggested at the end of Part 25 that I might add addendum note updates to it, but chose not to, waiting for this posting before continuing its narrative, and with this one written and uploaded with my usual delay before it goes live too. And with that orienting note in place, I begin this posting with some thoughts on China’s third quarter 2015 economic performance as measured and openly published (see China’s Growth Slows to 6.9%.)

• China’s economy has taken a tremendous hit, but it still showed overall growth of 6.9%, which is down from the 7% growth of the first two quarters of this year but not by much. This growth is largely and even primarily driven by overseas sales, and particularly importantly for this just recently reported third quarter.
• This, on the face of it, is good news and even if Beijing has been able to report higher growth rates in recent years. Right now, in late 2015 and after the eruption of China’s economic challenges of the second half of this year, that is good. But what has caused it and what does this mean?

That is the subject of this posting. And I begin with some timing considerations. China’s economic slide began, at least undeniably and with drops in their stock market at the very end of June, 2015 and beginning of July when this reporting quarter began. And immediately after that, China’s government entered into a quick succession of currency devaluations for their Renminbi. And that was intended to help stabilize their economy by among other things driving down the cost of Chinese exports in foreign markets and to foreign buyers, by making their goods cheaper against other currencies. There are a number of reasons why a government would take this step; a crucial one for China’s leadership was to support their manufacturing system by driving up export sales and increasing demand for their products, as a means of showing the strength and the validity of their system and of their leadership in it.

But this cannot work all that effectively for their production systems where they require purchase of imports in order to be able to manufacture and sell themselves. And in this regard, I cite the drop in imports of iron ore and related concentrates from Australia (as discussed in Part 25), where these essential import raw materials have suddenly become more costly for Chinese manufacturers – and the resulting drop in sales and export from China of finished steel because of that.

When a currency valuation drop makes export sales easier and more profitable, it also makes import purchases more costly and risky. This type of currency valuation decision can drive an overall increase in exports and it can improve the overall import/export balance of a country, and it can improve a country’s overall economic performance, at least short-term. But it leads to skewed support of their overall industrial and productive base, favoring businesses that can readily manufacture entirely from raw materials that come from within their own country, and from preassembled components where necessary, that are also manufactured locally within their own national borders. Over a significant period of time, this at least holds potential for skewing the balance of what a country can produce at significant levels and cost-effectively, and it can create barriers and challenges to businesses that do in fact require foreign input to their production systems, in order to remain open and working.

China is already expending significant funds to support and in cases even prop up at least certain of its industries that it sees as essential to maintain for national security reasons. If the international exchange rate valuation of the Renminbi were to go down even further and stay down for any significant period of time, would their government have to dip deeper into their foreign reserves to protect still more essential but endangered businesses and industries, and particularly state owned and controlled ones that cannot simply gain from this shift in import/export trade flow? Or will they have to speed up the printing presses for their currency and risk further devaluation from that, as driven by failure to acknowledge the dynamics of Gresham’s law?

It is going to take a long time and a great deal of effort, much of which would be very painful to take politically, for China to pull itself out of the hole that their economy has fallen into. Currency devaluation can help and there are definitely circumstances where that would be an essential first step in organizing any recovery – particularly where a country’s fundamentals were sound and it was in a position to be able to rebound back into recovery. But China was already keeping its currency at least undervalued in the international currency exchange market and their fundamentals were a disaster and worse going into this, which is a significant reason why their economy has been collapsing now. Currency devaluation per se can be a two edged sword, and a very dangerous one when it cuts the wrong way and that is a risk that China may be facing. And with this point made, I return at least briefly to the line of discussion that I offered in Part 25 where I discussed their People’s Liberation Army (PLA), as the largest single owner of businesses and even entire industries in China and a major participant in any economic decisions.

What would happen if the leadership of their PLA were to see some of their core interest businesses and industries challenged by adverse shifts in their costs to import raw materials and other industrial input that they need, in order to stay open and effectively productive? Right now, China’s government faces that challenge as only one of many sources of concern of this type. Their emerging private sector industries which have become centerpieces of their government policy, and certainly in fields such as electronics and computer production, are heavily dependent on essential raw materials imports, that they run the risk of seeing increase still further in price and in ways that would have to impact on the minimum price points they could sell their finished products at and still remain profitable. So a devaluation in the Renminbi might give to them with one hand but end up taking even more from them with the other.

I offer this posting as a though piece on the consequences of remediative decisions made and actions taken, and will follow it with a next installment where I will look at wider-ranging areas of impact and both from China’s downturn, and from how their government seeks to address that. Increased challenges to their environment comprise only one part of that story.

Meanwhile, you can find this entire series and all of its postings at Macroeconomics and Business as postings 154 and loosely following for Parts 1-12 and for a supplemental posting: Part 12.5. And see Page 2 to that directory for subsequent main sequence and supplemental installments to this. You can also find other, China-related postings and series at those directory pages, and at Ubiquitous Computing and Communications – everywhere all the time too. (Note: I wrote this posting for uploading to the server on October 21, 2015.)

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