This summer, for the first time,
financial turmoil in China created turbulence around the world and even hit New York. This is a historic event and is a portent of things to come.
Yes, China fumbled. It could have avoided certain obvious mistakes which many saw coming, but the Chinese will learn from it. What the episode shows is how the relative weights are shifting in the world way beyond just trade.
China still accounts for less than 15% of global GDP, but its contribution to global growth last year was in the range of 40%. So when that growth slackens, pretty much everyone around the world feels it.
Not surprisingly, people all over the world are concerned about China’s prospects. Is this the beginning of a decline? Are the internal contradictions sharpening, portending further, more serious problems?
In my view, China’s prospects are good. The closer you are to China, the more you feel that.
The more you visit China, the more you realize that, despite all the problems, the country is organically still in the phase of growth.
In terms of aggregate demand, it will take many more years before the Chinese economy has a big enough domestic consumption sector to replace investment as the principal driver – and that consumption must increasingly shift to services.
Coastal China has become very expensive, more expensive than all of Southeast Asia, except Singapore, so the factories that were in China for quite some time have moved down to Southeast Asia.
The Chinese government wants to move some of them inland to develop inner China. These are long-term trends.
For the time being, the Chinese will still need investments to maintain sufficient growth. There are still many things to be done, many areas to be opened up, but the pace of future growth will no longer be as dramatic.
This is why President Xi Jinping’s initiative “One Belt, One Road” is of huge importance – not as an immediate plan, but as a long-term approach toward China’s development.
To begin with, China has all this excess capacity – in steel, cement, factories producing rolling stock and so on – which can be applied to great use linking China to its neighbors.
This growing connectivity of China to its neighbors deep into Eurasia is a story of epic proportions, which is why we should follow it closely.
Building Global-Asia Connectivity
Consider that earlier this year China established a rail link to the Persian Gulf via Kazakhstan, Turkmenistan and Iran. With the opening of Iran, the dynamics across a large part of Asia will change.
Remember that, throughout history, Imperial China and Imperial Persia always had good relations – two high civilizations maintaining peace in the region. You will see this relationship revivified, not least in view of pent-up demand in Iran.
But China, ever a comprehensive, long-term planner, is proposing or already executing enormous railroad expansion – to the Gulf of Thailand, to the Andaman Sea, to the Arabian Gulf (through the Khunjerab Pass to Gwadar), to the Black Sea, to the Baltic Sea and all the way to the North Sea.
Early this year, China and Russia agreed in principle to build a fast train connecting Moscow and Beijing probably through Kazakhstan.
The distance between these two cities is 7,000 km, and the journey is supposed to take less than two days!
How can one justify such an investment? Of course, one cannot – if one just looks at the proposition on the basis of earnings from freight rates and passenger fares. But all these calculations about the economic feasibility change profoundly if, along the way, one builds a belt of cities.
This is why the words “One Belt, One Road”, announced by President Xi first in Astana in October 2013, and then in Jakarta in November 2013, are far more than a slogan. They represent a strategic reorientation.
“One Belt, One Road” goes way beyond being a plan on paper. It is intended to create a huge flow, a 21st century revival of the old overland and maritime silk roads, at the end of which we are going to find all of Eurasia crisscrossed by connections.
Using a biological metaphor, the growth of these connections is like
angiogenesis in the human body.
First the vessels grow, then logistics companies provide the blood circulation — and development of organs follows.
Importance of AIIB
Eurasia is a large part of the world, and it will, in a few decades from now, be the principal driver of the global economy.
This is why the AIIB is so important. Many analysts saw its establishment as a power move against the United States, contesting the Bretton Woods institutions.
That may be a collateral effect but it is not the main purpose of the AIIB, which is an absolute economic and financial necessity.
Even so, this new institution can only supply a small part of what is required to finance all the infrastructure needed, which will be in the trillions of dollars.
Although it is not yet said, one day we may find the Chinese rail system and Indian rail system linking up through the Nathu La Pass.
It is a gap of a few hundred kilometers and shorter than the one between the Chinese and Pakistani rail systems that are being connected.
Politically, the time is not right to talk about it, but watching the developing relations between China and India, it is no longer something to be dismissed.
The development of China-India relations is of great historical importance because of their large populations. Together they comprise some 40% of the world’s population.
When Indian Finance Minister Arun Jaitley was asked recently in Singapore how India could benefit from the crash in the Shanghai stock market, he replied that India did not see relations in zero-sum terms. He added that China’s growth was good for India and vice versa.
Developments in China
China knows that to improve the productivity of its real economy, it must deepen and liberalize its capital markets.
Inefficiencies there have led to inefficient SOEs, causing all kinds of problems in the country.
Despite the recent financial turmoil, this strategic intent to deepen capital markets will not be deflected.
The Chinese will learn from their mistakes and they will have to experiment along the way, because they are doing things which no other country has done.
The internationalization of the Renminbi is a case in point. This is not an easy maneuver to execute.
The Chinese are now attempting to create two separate oceans of renminbi – one within China, which is the much larger one, and another outside China (of which London is determined to be a major financial center).
The two are connected through portals like Hong Kong and, to a lesser extent, Singapore. Between the two oceans are tidal barrages like the ones protecting Venice.
If there is financial turbulence outside, the barrages can come up to protect the inland ocean until the storm subsides. The engineering is obviously complex and may not be foolproof.
Why can’t China allow the internationalization of other currencies like other major countries? To understand this we have to go back to the
long history of China and the difficulty of governing a large part of the world’s population.
Whoever governs China must always be able to exercise some control over its own internal destiny.
In the second half of the 19th century, after the second opium war, western customs officers inspected any ship landing on the China coast. By the late Qing dynasty, China had lost control of its monetary system and therefore an important part of its sovereignty.
China will not allow this again. But managing the renminbi properly will not be easy because, if the two oceans are at different levels, there is a permanent arbitrage opportunity. Mistakes will be made, but the Chinese are learning. It is a deep imperative.
Recession not likely
What about fears that China will go into recession? This is not likely. Its growth will slow down, maybe to 6%, or even 5.5%, but is now on a very high base of a GDP of about $10 trillion.
That the slowdown in China is causing alarm around the world is because of the lack of aggregate demand powering the global economy. Despite easy money in the last seven years, the global economy has still not performed well.
Central bankers fear that if they withdraw the liquidity, asset markets will implode, bubbles will burst, and the real economy will spiral downwards.
Europe is still floundering. Earlier this year, freight rates per container from China to Europe went down to $200. This has never been seen before and it may take a bit of time before Europe recovers.
The United States is looking better but the Fed’s nervousness cannot be without reason. Better policy coordination with China will help but it is no guarantee that the global economy may not plunge into another crisis.
It will take many more years before the Chinese economy, together with other developing economies, become big enough to make up for insufficient demand in the mature economies.
China is probably the only major country in the world today which is able to exercise a national will on a range of subjects.
This is principally because the economy is still in a late adolescent phase and partly because the political culture over the centuries accepts centralized governance.
For example, when President Xi promulgates “One Belt, One Road,” the message percolates right down and funds are allocated. The countries involved know it is credible because it is backed by a strong national will.
There is much talk about the South China Sea becoming a flashpoint. Yes, the South China Sea is important, but it is not the most important issue.
It is a trial of strength between the United States and China but one which both sides will be careful not to mismanage. The most important issue is still the global economy, because if we get that wrong, everything else is in danger.
Editor’s note: Adpated from a speech given by George Yeo at the Singapore Summit.
