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Dow Jones Newswires interviews analysts who expect gold above $500
By Hamish McDonald
Sydney Morning Herald, Australia
Sunday, May 8, 2005
http://www.smh.com.au/news/Business/Full-speed-ahead-to-another-
Asian-meltdown/2005/05/08/1115491044455.html?oneclick=true
HONG KONG -- For Jim Walker, the chief economist at CLSA Asia-
Pacific Markets in Hong Kong, the signs are coming thick and fast.
At the Crown Casino in Melbourne, the front money for gambling
junketeers this Chinese New Year was double the amount that Asian
high-rollers plonked down last year.
In Shaanxi, a province in China's inland normally regarded as
heavily in surplus with labour, minimum wages have just been
increased 30 percent.
At Disneylands around the Pacific rim, signs are going up in
Chinese. "They went up in Portuguese a year before the Brazilian
rial crashed," the Scots economist notes wryly.
All these, Walker says, point to China coming to the late stage of
its frenetic economic cycle, one characterised by massive oversupply
of a currency so long pegged to the US dollar its holders treat it
as the same.
Across town at investment bank Morgan Stanley, its China-watching
economist Andy Xie also sees an economic machine going at high speed
towards a crash, similar to the meltdown that hit Asian economies in
1997.
"China is an export and investment-driven model and the connection
between exports and investment is basically that the state banking
system takes the money earned by exports and puts it into investment
regardless of returns," Xie says. "That model is likely to last
until the crisis."
Neither of these two economists see China's leaders as likely to
respond in more than a token way to the invitation by many Western
financial chiefs, most recently at last week's Asian Development
Bank meeting, to start taking the medicine early in the form of a
currency revaluation.
Walker says the signals he's been getting are that Chinese officials
agree they have to do something to placate the baying trade
protectionists in the US and Europe, set off by the 35 percent surge
in China's first-quarter exports.
But he says it will probably be "disappointing," perhaps only a 1-
percentage-point widening of the band around the peg of 8.28 yuan to
the US dollar maintained for the past 10 years. Maybe over a couple
of years, the band could be widened further.
Xie says he expects Beijing will keep stalling, keeping the
expectations of a yuan float or revaluation alive so that
speculative inflows from overseas Chinese keep flowing in but trying
to put off the evil day as long as possible. Xie thinks they can
spin it out another two years.
"If China appreciates the currency like other people are urging,
China will eventually have a financial crisis just like in South-
East Asia in 1997," Xie says.
These views are in distinct contrast to some others. On Friday, for
example, the ING Bank's team in Hong Kong said China could reform
its exchange rate within three months. "We have changed our view on
the initial revaluation and now expect it will be big, around 10
percent," the bank said. "Our change of view that the initial yuan
revaluation will be big stems from the heightened threat of loss of
market access."
While the outside world views China as an emerging super-economy,
Xie and Walker portray it in different ways as a more fragile
developing country with classic weaknesses.
Xie says the case for currency revaluation is a "bubble" itself;
like the other bubbles, a revaluation is supposed to deflate. "With
an emerging market economy, the pressure for currency to appreciate
-- usually it's a bubble," he says.
"Look at what happened in South-East Asia 10 years ago or in Latin
America before that. Currency value depends on competitiveness and
also financial health. In emerging economies, you cannot maintain
financial health, so periodically you have a financial problem. You
have an overexpansion of money supply and you eventually have
currency depreciation. China is no different."
Walker sees China hitting a wall, chiefly in the form of a labour
shortage; not the much-publicised reluctance of inland Chinese
recently to serve as factory fodder in the sweatshops of Guangdong,
the industrial province bordering Hong Kong, but supply gaps in
skilled workers and managers.
With about 1 million Taiwanese already employed on the mainland --
about 10 percent of the island's workforce and therefore probably
close to the limit -- newspapers in Hong Kong and South-East Asia
are packed with ads for supervisory or technical jobs in China.
Looming ahead, perhaps in 2007 when a year or two of vanishing
profits finally cause a contraction in business activity, is China's
first serious slowdown in years, one that could bring new kinds of
pain, the CLSA economist says.
"This is the first truly capitalist cycle that China has had,"
Walker says. "They've had upswings and downswings before but they've
all been state sector-led. It's all been manufactured by the
government. This time round there will be bad debts accruing to
private sector companies and the banks will react much more
differently to that."
The fuel for the overheated economy is coming from the central
bank's conversion of rapidly accumulating foreign reserves -- which
hit $US610 billion (AU$783 billion) at the end of last year and are
on track to grow another $US250 billion this year -- into yuan and
then trying to "sterilise" the monetary effect by forcing Chinese
banks to buy low-yield bonds.
As two New York University economists, Nouriel Roubini and Brad
Setser, pointed out in a widely remarked paper last week, the
central bankers' efforts had been only partially successful and the
sterilisation effort limited their ability to apply conventional
interest-rate remedies to excessive demand.
Nor was the diet of low-yield government paper doing much for
profitability in the scandal-prone Chinese banks, whose non-
performing loans Roubini and Setser put at somewhere between 46 and
56 percent of China's GDP.
Also last week, the ratings agency Standard & Poor's said
recapitalisation of two of the big four state banks -- the
Industrial and Commercial Bank of China, and the Agricultural Bank
of China -- would require injections of between $US110 billion and
$US190 billion.
Indeed, the weak position of the Chinese banks and their huge
requirements for capital are cited by Xie as one more reason against
early revaluation. As well as adding to bad debts by raising
domestic real estate and other prices in relative terms, a higher
yuan would require more US dollar investment to achieve sound
capital adequacy.
Although disposal of bad debts via asset management corporations is
lagging badly, Chinese financial authorities are still hoping to
bring two large banks -- the China Construction Bank, whose assets
are mainly infrastructure loans to governments, and the Bank of
Communications, which already has a 19.9 percent "strategic" holding
by HSBC -- to international share offerings in coming months.
Like others, Roubini and Setser found a Chinese economy driven by
cheap factor inputs -- including credit, energy, and land -- rather
than productivity growth. "In this dimension, China looks like
the 'Asian Miracle' that went bust in the 1990s," they said.
There was a growing perception, at least among Chinese economists,
of the "bad bargain" in the China economic model, whereby foreign
investors were guaranteed an effective 15 percent return and China
put the earnings into US dollar reserves earning 4 percent.
They, like CLSA's Walker, see a need for China to switch to an
economic model more driven by domestic demand. "China's existing
growth model looks to be running up against real limits, both
internally and globally," Roubini and Setser wrote. "Sustaining
growth will require re-orienting China's economy and relying at
least for a while on rapid expansion of domestic consumption to
sustain growth."
Revaluation would help do that but at the price of an unknown amount
of short- to medium-term pain. Xie says that's the hidden purpose of
many advocates of currency reform. "What those people are trying to
do is to make China crash now," he says. "They don't believe the
political system will tolerate real financial reforms unless it is
forced to. But the economic consequences are serious. What you are
talking about is stagnation."
Xie says Beijing hopes to insulate China from the approaching
crisis. "Senior leaders know what's going on," he says. "They hope
to accumulate as much capital as possible, as many people getting
rich as possible, so when you need to make a dramatic overhaul of
the economy the country is still stable because enough people have
jobs."
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