Is China the Answer?

The current economic climate is cloudy at best. The European debt crisis coupled with the lack of substantial growth in the United States has led many to believe that China is the answer to the world’s economic issues. Indeed, for the past decade China has been experiencing tremendous growth, averaging a 10% GDP growth over the last 30 years[i]. China’s influence was exemplified by its growing influence on the world stage. After Europe asked China for a bailout, it was a sign to many that China was the one calling the shots. Analysts claim that China will soon overtake the US as the world’s leading economic power[ii].

Despite the optimism, China’s situation is less than rosy. It is focused in two areas: its currency, and its growth.

China’s economy has always relied on exports. I cannot remember one instance where I bought a product that was made in Canada. China has covertly dominated the retail market with its cheap goods. China’s export industry is huge, and despite recent strides to diversify, it’s still heavily reliant on its export market.

 

However, this phenomenon is a wolf in sheep’s clothing. The essential component to an export economy is a cheap dollar. China’s success has hinged on the fact that many countries find its goods affordable. The reason why Asian supermarkets are so appealing to many is because of its cheap goods, which comes from a cheap dollar – other currencies have a greater buying power in China. What many people don’t realize are the measures taken by China to ensure its dollar stays low.

The only way for the Yuan (Chinese dollar) to remain devaluated is through China’s spending its Yuan on foreign investments. The value of the Yuan relative to the dollar must be low. Therefore buying US debt drives up the value of the dollar which makes the Yuan cheaper in comparison. In the United States, over 1 trillion dollars of US debt is held by China[iii]. Many would see this as a sign of China’s dominance of the US, but in reality it’s the other way around. The only way for China to devaluate its currency to the levels it needs requires it to buy huge amounts of US debt. Other currencies are not viable alternatives because they are either risky (Euro, yen) or unable to satisfy the vast quantities it needs (pound)[iv].

This is China’s predicament. China cannot sell its US bonds because the value of the Yuan would sharply increase (demand for US dollar decreases, which decreases value of dollar and increases the value of Yuan). At the same time China needs to spend its currency to keep it low. Although the Yuan, technically, is on a fixed exchange rate (which means its value is controlled by the government), the currency is still affected by the market, and China’s government has become increasingly open about the value of their currency[v].

China can’t even use its foreign reserves to help itself. By converting its reserves into Yuan it will again drive up its value, which is suicide to the Chinese government. It would be stuck with trillions of dollars of which it would not be able to use for itself[vi].

The second, and most disheartening, reality on China is its growth. China’s 10% GDP growth is astounding in itself, but when you take into account the circumstances, the results are less impressive. In order to outpace population growth and ensure positive per capita growth, China must have at least an 8 percent growth rate per year[vii].

Yeah, you read that right: 8 percent. The last time the annual GDP growth for the United States was that high was in 1984, when it was 7.2%[viii]. And that was only one year. The only period of year-to-year high GDP growth in the United States was during World War II, over half a century ago.

So you may now be wondering, is it possible for China to achieve such a high growth? It is actually quite simple, and China has been doing it for years.

For years, China has spent its money on infrastructure projects. This is the quickest way to create jobs and spur GDP growth, and has been the primary tool for in China for decades. This trend shows no sign of stopping. Currently, China plans to build 20 cities a year over the next 20 years[ix]. If you do the math, the scope is incomprehensible.

These new cities are the equivalent of a ghost town. Despite the massive population of China, nobody is interested in moving to these cities. It is said that there are around 64 million empty apartments in China. With skyrocketing housing prices, most see these apartments as investments, which explains why the condos were sold despite being uninhabited. This housing bubble in China has made even the US bubble jealous. Once people start realizing the houses are worthless, the resulting crash will ensue, and millions will lose their fortunes on bad investments[x].

There is an underlying social problem as well. People who need these houses cannot afford it. An average Chinese worker makes around $6000 a year, while an average condominium averages at $150,000 a year^ix. The rules of renting the condos are also stringent. The tenant is required to pay half of the cost up front, while the rest is paid over the course of 3 years. While this has slowed a US-style credit crunch, it has also left millions of Chinese with inadequate housing while there are millions of empty condos being built.

China needs to change. Growth is China’s opium. China’s insatiable desire for that 8% growth, fuelled by the desire to keep its citizens out of poverty, has led to a cycle of spending that cannot continue. Its export economy leaves it vulnerable to any changes in the value of their Yuan, and a growing gap between the rich and poor has caused social unrest within China’s lower class.

It’s not “if” China will feel the repercussions of its actions, but “when”. Although I cannot predict when this fallout will occur, I can assure you it will not be pretty.