Tuesday, April 26, 2011

Hedging against a (Chinese) rainy day

China’s banking sector, weighed down by billions of dollars in non-performing loans used to finance massive insfrastructure projects, is a time bomb whose impact on the economy as a whole can only be guessed at

It is clear that whoever hopes to win the presidential election next year will have to propose a sound strategy on how to deal with China: not just politically, but also economically.

The process of cross-strait economic liberalization launched in the 1980s and sustained even under the pro-independence Democratic Progressive Party from 2000 until 2008, accelerated dramatically after President Ma Ying-jeou (馬英九) of the Chinese Nationalist Party (KMT) stepped into office on May 20, 2008. With the signing of the Economic Cooperation Framework Agreement (ECFA) in June last year and various other economic pacts in recent years, the dependence of Taiwan’s economy on China has grown by leaps and bounds.

Putting the political implications of those agreements aside, we will leave it to the history books to judge whether the decision to open the gates to Chinese money was economically sound for Taiwan. A growing number of economists are claiming that China’s economic miracle is heading full speed for a brick wall. Although such predictions have been made for more than a decade, there is evidence that this time the alarmists could be right.

My editorial, published today in the Taipei Times, continues here.


mike said...

"The Chinese Ministry of Finance last week confirmed that its debt currently stands at US$276 billion..."

No,no,no... the real figure will be subtstantially higher than that, since the MOF figure doesn't include debts from SOEs and the provincial governments. Add to that debts from State-controlled banks and asset companies from the nominally private sector and you can forget billions. The real figure will most likely be in the trillions.

As to Taiwan's exposure to Chinese money: unavoidable - and if the government attempts to manage this too obviously, that might create a certain amount of market panic and make things worse. If they don't attempt to manage it, they will get blamed for some of the consequences anyway.

"...redoubling efforts to attract foreign investment from sources other than China; and diversifying export destinations..."

Or try to extricate the State from its presumption of duty to manage, stimulate and check international trade; let people make their own decisions - as they will surely try to anyway.

As for finding alternative export destinations and sources of foreign investment - sure, but that leaves us exposed to the U.S. which has a broadly similar problem to China (i.e. so much debt that it will most likely be monetized through inflation) only much larger (in the tens of trillions).

The priority for Taiwan is to start dealing with its own national debt - which stands at approximately NT$21 trillion (not the NT$15 trillion which somebody on the editorial desk mistakenly altered in my letter published yesterday). That can only mean two things: fiscal reform (cutting public spending) and monetary reform (return to inelastic commodity currencies).

My confidence that the next administration will do either of these things? Approximately zero.

mike said...

In addition I could mention that the chief China economist at Standard Chartered (Stephen Green) estimates PRC debt to be as high as 77% of GDP (so that'd be approximately U.S.$8 trillion), which is much higher than the conservative U.S.$2-3 trillion other commenters are guessing and positively dwarfs the MOF's own U.S.$276 billion. The renminbi will be subject to massive inflationary pressure once the PRC runs out of "stimulation" ideas and their only choice is to start monetizing debt - same goes for the U.S. as I warned in my first letter published three years ago. I was wrong about the time-scale, but I cannot see how currency collapse is avoidable now.

But that isn't even the chief danger (it just means anyone holding government debt or NT$ savings is going to get shafted); the chief danger is going to be political over-reaction by the government and the relaunch of another New Taiwan fiat dollar and the outright nationalization of the banking sector. That must not be allowed to happen as it could set us back for decades.

Whatever the new currency system is, it must be inelastic and that can only mean commodity-backed currencies. Fractional reserve banking will not need to be abolished per se, but there will have to be legal reforms to allow the market to more clearly differentiate banking services from loaning services.

J. Michael Cole 寇謐將 said...

I concede that my figures are on the low end of the estimated total debt. However, beyond this, what I think is equally important is the fact that a large share of that debt will never be repaid, something that is unlikely to happen in, say, the US. Writing off hundreds of billions of dollars in debt is going to create untold problems for China; those problems will only be more painful if the figures you provide are closer to the mark, as they very well might be.