China's chance to lead the global economy

SCMP September 24 2008

There is no point in trying to predict where so-called financial markets will go in the next few days and probably weeks. As astonishing as the price gyrations has been the praise heaped on US Treasury Secretary Henry Paulson for adding massively to the US public debt to help save the un-transparent system of investment bank derivative scams and gambles that he, as head of Goldman Sachs, had helped create.

So he let Lehman Brothers go down. But Goldman Sachs, with its assets 23 times its capital base, would quite likely have gone the same way but for the billions in public funds injected to try to save a rotten system. Contracts, understandings and trust, hallmarks of well-run markets, have been torn up or sidestepped to help out the least worthy of all institutions.

If this were Indonesia or Malaysia, the commentators from Goldman Sachs would be crying about the evils of crony capitalism, the corruption of the system of government, the impoverishment of the public purse to save the well connected - all things that happened in Asia a decade ago when banks that had been robbed by their owners and should have been allowed to fail were bailed out.

This is described as a global crisis. It is actually far more a crisis of New York and London. Others have suffered serious peripheral damage, but there is no crisis in Germany or Japan, China or France. They have not been printing IOUs on an unprecedented scale to the save the face of a corrupted financial system.

But recent events have caused global damage to capitalism and market systems - and to Hong Kong. This city had itself become too dependent on being a branch office of an overwrought western financial structure with its plethora of activities that have supported property, lawyers, hotels and restaurateurs.

The panic of recent days has also had some salutary effects. It has brought the world face to face with what should have been obvious for a long time but was obscured by new financial instruments and monetary excess. The latter emanated from the US with its easy money policy magnified both by its reserve currency role and by a China willing to absorb limitless amounts of US dollars into its reserves for lending back to America, while inflating its own money supply.

For China, the question now is whether it has the courage to change economic course, admit that export-led growth is no longer viable and that it has better uses at home for the assets now parked in the US. These are sure to decline in value thanks to a US preference for printing money, ensuring future dollar devaluations, than squarely face the consequences of a decade or more of excesses.

For its population's sake, China needs to stimulate consumer demand - now less than 40 per cent of gross domestic product - as well as infrastructure investment. It must accept that there is a probability that domestic demand-driven expansion is likely to eliminate its trade surplus, perhaps even push it into deficit.

Unfortunately, it has come to see surpluses and forex reserve levels as symbols of strength rather than burdens on its own people, who are for the most part badly in need of better health services and education.

Wage rises, particularly for the lower paid, need to be encouraged by the state, which itself has ample fiscal room for increased outlays on the recurrent as well as the capital account.

A rapidly falling trade surplus will eventually benefit the US - the fewer Treasury bonds China buys, the sooner the US will see the return of positive real interest and the end of its money-printing delusions.

Aside from the benefits for its people, domestic stimulus at this time would be extremely well received by China's neighbours. It can take a lead in a way that Japan, with its high incomes but declining workforce, cannot. China and others will suffer from the sudden change in the global climate. But this can also be its chance to show a real maturity of vision and claim to be a leader, not a follower, of the global economy.

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