Fair Trade

It’s US election season again (when isn’t it?), so it must be time to beat up China on everything to do with economic and trade matters.

Now I would be the first to agree that the Beijing government has made a couple of mistakes recently, and I’ll come back to these in a moment together with my suggestions on how to fix them. But some of the claims being made especially by Republican presidential candidates during their debates are simply so far away from the truth that they must be corrected.

For example more than one candidate has stated as fact that China has kept its currency artificially low so as to gain an advantage in international trade. Front runner Donald Trump has even pledged to impose tariffs on Chinese products to "level the playing field", notwithstanding that this would be contrary to all the rules of the World Trade Organisation. It is correct that the RMB has slipped by about 6% against the US dollar in the past few months, but that follows a rise of over 20% in recent years so the net position is still a gain of around 15%. In fact a true reading of the position is that the RMB has been pulled up by the strong dollar and most economists would say it is probably now over-valued compared with most other currencies.

Some observers have blamed China’s reduced purchases of commodities for the fall in world prices, most spectacularly that of oil from well over US$100 per barrel to around $30. Yet our imports in 2015 were equivalent to 6.7 million barrels per day – a record high. The real reason for the sharp decline in price is the substantial increases in supply. OPEC has continued to pump oil from the ground to try to force high cost producers like the American shale companies out of business. This policy has begun to work, but the newly improved relations with Iran promise to bring fresh supplies to world markets to take their place. As China rebalances the economy to put more emphasis on the service sector, and less on domestic infrastructure spending, it inevitably needs less steel (and hence iron ore) and concrete than previously. However as the Belt and Road initiative starts to take off, some of the slack will no doubt be taken up by projects in countries along the routes.

Some have talked up the prospects of India taking over from China as an engine of global economic growth. Nobody wishes India ill, and it would be good for everyone if the country’s economy could enter an era of prolonged substantial growth such as China has enjoyed over the past 35 years. Yet the figures are not encouraging, at least in the short term. In 2014, the last year for which the International Monetary Fund has figures for all major economies, the USA was the world’s largest with GDP of just over $17 trillion. China was second with just over $10 trillion, ahead of Japan stagnating on $4.6. India? Well down the list at number nine with GDP of $2 trillion. In other words, even if Prime Minister Narendra Modi is able to galvanize the Indian economy to achieve growth close to 10% -- and most observers believe this target is unlikely to be reached – the result will be an increase in global economic growth equivalent to $200 billion. That is equivalent to Chinese growth of just 2 per cent, whereas even the doomsayers are talking of 5% against the target of 6.5%. The truth is the upper end of US growth forecasts (2%) would produce less of a lift to the world economy than 5% growth for China.

Now to the errors and how to correct them. Probably the biggest mistake of the last decade was the effort starting in the autumn of 2014 to talk up the stock market, supported by editorials in official newspapers and a softly softly approach to market regulation especially with respect to margin trading. By the middle of 2015 the Shanghai index had doubled, a rise that was totally divorced from economic fundamentals. Although the mainland stock market has a much smaller impact on the overall economy than in more advanced countries, nonetheless when the inevitable crash came the PR effect was devastating. China is in the east, so when media reports of the day’s trading begin, they start with Tokyo, Sydney and Shanghai. The repeated sharp drops in stock prices and the clumsy attempts to prop up the market therefore attract world attention every day. China needs to follow more closely President Xi Jingping’s directive and let the market take a decisive role. That means accepting modest price/earnings ratios which create a healthy market. There is nothing to be gained by delay, so authorities should withdraw the special support measures and take the hit. Thereafter let the market find its true level and become a serious arena for solid companies to raise capital.

The next question concerns the exchange rate. By the middle of last year, the authorities had (correctly) concluded that the RMB was overvalued. They then engineered a sudden devaluation for which the rest of the world was psychologically unprepared. The urgent need here is for more transparency. China should seek IMF assistance in assessing a reasonable value for the RMB, then move towards that figure using a "crawling peg" methodology. From that point on, let the market determine a fair price. China has joined the majors in the world economy club. It’s time to play by the big boys’ rules.