China Emerges as the New Powerhouse from Worldwide Financial Chaos

In times of chaos investors often become terribly shortsighted. Who could blame them? When the likes of Bear Stearns, Lehman Brothers and Washington Mutual disappear in a flash, when stock market indexes swing by hundreds of points during a single day, it can be very tough to keep an eye on the big picture.
The obvious change in the big picture is the enormous black eye that the United States’ financial system has suffered during the past year. Not only have we seen horrendous declines on Wall Street, the entire U.S. economy has fallen into a deep and possibly protracted recession. Housing foreclosures have never been higher since the Great Depression. Worldwide, the economies of developed countries have followed the U.S. into an economic sinkhole.
Few political leaders except for some Chinese politicians have been impolite enough to point out that the United States dragged the economies of most industrial nations into the tank. With a breathtaking display of recklessness American financial institutions seeded the system with millions of toxic mortgages. As we all know, this mountain of worthless debt was packaged as so-called Structured Investment Vehicles (SIVs), stamped as a Grade A financial product, and sold like gold-plated poison pills to credulous financial institutions around the world.
To make matters worse, the U.S. doubled down its bets and doubled down again with so-called Credit Default Swaps (CDSs) which were unregulated, unsecured, unregistered and unsound insurance bets on bad mortgage loans. It had to end badly. Over-leveraged investment banks like Lehman Brothers toppled, and insurance giant AIG swooned into the arms of the federal government as a stunning $61 trillion dollars in dubious CDS bets came home to roost.
It is small wonder that head of China’s sovereign wealth fund says he has lost the confidence to invest any part of that nation’s mountain of foreign reserves in U.S. banks. As he put it, he didn’t have the courage to invest in the U.S.
BANKING ON CHINA

Anyone in the financial industry over thirty-five years of age will remember when China’s banks and its fledgling stock market were an international laughing stock. How times have changed. China’s banks are now towers of strength compared to their western models.
Commenting on China’s exposure to the global financial implosion, Louis Kuijs of the World Bank office in Beijing remarked, “We feel China’s financial system and its banks are, in relation to the chaos in the U.S. and other parts of the world, relatively shielded from those problems.” Shielded is an understatement.
For example, Industrial and Commercial Bank (ICBC) has emerged as the world’s biggest bank by market value with a capitalization of almost $1.5 trillion. ICBC did hold a number of toxic U.S.-based assets including $151 million worth of Lehman Brothers bonds, half a billion dollars worth of collateralized debt obligations (CDOs), mortgage-backed securities and SIVs worth almost $1.9 billion.
ICBC shrugged the problem off, noting that these near-worthless investments represented only 0.55% of the bank’s total assets. Third quarter profits for ICBC increased by 25.5%, something of a disappointment after increasing profits by 65% during 2007. The bank has relatively few bad mortgages on its books because Chinese borrowers are required to make a down-payment of as much as 40% on real estate purchases.
Chinese financial institutions have actually grown stronger in profitability and risk management during the global financial crisis according to China’s Premier, Wen Jiabao. As Premier Wen calmly explains, “The financial system is sound and safe…we have full confidence in China’s economic development and financial stability.” It is not an idle claim.

AMERICA’S BANKER

The world has never seen a mountain of foreign reserves as large as the hoard of cash that China has amassed during its thirty-year economic expansion. With approximately two trillion dollars worth of foreign reserves, China has the cash it needs to stimulate its internal economy as western export growth weakens. Beijing committed some of that cash in November, announcing a $586 billion dollar economic stimulus program that will include widespread infrastructure development.
China’s robust cash position has given its leadership a sense of security that it can cope with the ongoing global crisis.
Even more important to the United States is the fact that China has now officially taken over the number one spot as America’s banker.

INSERT FIGURE ONE (Source U.S. Treasury)

As Figure One shows, China’s holdings of U.S. debt have soared over the past year. The U.S. Treasury recently acknowledged that China had finally surpassed Japan to become the world’s biggest buyer of U.S. Treasuries with holdings of $585 billion and rising.
With money comes power. The mandarins of Beijing are well aware that they now hold most of the cards in the financial relationship between the U.S. and China.
Beginning two years ago the U.S. Treasury Secretary Henry Paulson has been flying to Beijing periodically to lecture the Chinese about the right way to run their economy and their stock markets. Paulson once explained to Chinese monetary authorities that they were failing to expand the size and security of the nation’s stock markets because of their reluctance to embrace “sophisticated” investment tools like derivatives.
How times have changed. During Paulson’s most recent visit to China for Strategic Economic Dialogue (SED) talks, it was Beijing, not Washington, in the driver’s seat.
Speaking bluntly, Central Bank Governor Zhou Xiaochuan told Paulson that it was high time for the U.S. to rein in its huge trade and fiscal deficits. American consumers should be more like the Chinese and start saving more, relying less on their credit cards. Part of the cause of America’s financial crisis, according to China’s central bank governor, is over-consumption. The lecture didn’t end there.
During the Treasury Secretary’s visit, Paulson opened the door to “commercially based” investments by China’s central bank and by its sovereign wealth fund in various U.S. industries including finance. Until now, America has been blocking banks, insurance companies and brokerage houses from setting up shop on U.S. soil. Now America needs every cent it can get from Beijing.
The danger lies in Beijing’s power to stop investing its reserves in the U.S. That would weaken the dollar, but even worse, Chinese authorities could take their money back. Cashing in more than half a trillion dollars worth of U.S. Treasuries would obviously have shattering consequences for America’s weakened economy.
A blunt remark by China’s Vice Premier, Wu Yi was taken by many to be a threat. He told America to, “take all necessary measures to stabilize its economy and the financial market to ensure the security of China's assets and investments in the U.S.” It’s worth noting that China’s previous U.S. investments, including a $3 billion dollar stake in Blackstone Group, have performed terribly and sparked sharp criticism at home.
Strip away the diplomatic language and it is apparent that Vice Premier Wu is warning us that China might stop financing U.S. debt and stop investing in America. As the saying goes, “He who pays the piper calls the tune.” For the first time, Beijing is calling the tune for America and telling us to get our financial act together or else.

IS CHINA IMMUNE TO THE GLOBAL CRISIS?

As a major exporter, China is already feeling the effects of the worldwide financial crisis. Some factories have closed and there have been angry demonstrations by laid-off workers in southern provinces. China’s GDP growth is slowing and financial newspapers often remind readers that China’s export engine in slowing down. But how serious will the effects be?
It is vitally important to examine real statistics in order to get some perspective on China’s economic performance. Mainstream financial newspapers are littered with headlines shouting that China’s exports are slumping. Are they really? Not at all. As you’ll see in Figure One below, China’s exports and imports have been increasing steadily except for the month of February when a freak blizzard shut down much of China’s economic heartland.


(Insert Figure 2) (Source: General Administration of Customs)

It is the rate of growth of exports that is easing off as western economies contract. China’s actual export growth rate was up 19.2 percent in October.
The astonishing fact is that China is showing astonishing resilience in the face of worldwide recession. China’s trade surplus set a new record in September of 2008, up a remarkable 20 percent to $35.2 billion for the month.
As you’ll see in Figures Two and Three, part of the reason for China’s increasing trade surplus is a relative decline in imports to the Chinese mainland. Any further weakness in China’s economy will be reflected in a drop in demand for imports, a trend that once again puts China in the driver’s seat.
Exports aren’t as vital to China as many observers believe. Chinese economists maintain that exports account for only a quarter of the nation’s economic activity.
Zhou Shijian, a senior researcher at Tsinghua University, recently told China Business News that Chinese enterprises were able to overcome weak overseas demand because China's exported products are mostly “daily necessities with low elasticity of demand.” Demand from emerging markets remains strong, and Beijing is increasing tax rebates to keep China’s products competitive in the less developed countries.
Insert Figure Three (Source: General Administration of Customs)




China’s powerful economic rise is not about to fall into the western abyss. There is no credible source in the world projecting a decline in China’s GDP in the foreseeable future.
Not surprisingly, the most optimistic forecasts come from Beijing. The official voice for the Chinese government, the People’s Bank of China predicts economic growth between eight and nine percent next year. In Beijing, China Galaxy Securities projects a growth rate next year of 8.6 percent. The International Monetary Fund says the Chinese economy will expand at an 8.5% rate in 2009.
The most pessimistic prediction comes from the World Bank which forecasts a 7.5% growth rate for China next year, a decline of more than two percent from 2008. Recovery should be relatively fast according to the Institute of Strategic and International Studies of Malaysia, which is forecasting that China will return to double-digit growth in two years at the most.

CHINA’S STOCK MARKET CRASH

Gloomy predictions about China’s viability in a global financial crisis invariably mention the Shanghai Stock Market, which has tumbled nearly 70 percent from a record high of more than 6000 during a buying frenzy which peaked last year. Currently the Shanghai Composite Index is hovering at roughly 2000.
It is true that the Shanghai market began to plunge from its highs before western stock markets started to drop precipitously. That’s because stocks listed in Shanghai were grotesquely overvalued by any standard measure such as P/E ratios as China was caught up in a retail investor bubble.
Chinese stocks listed in Shanghai and abroad are no longer overvalued. Many Chinese companies are reporting steady double-digit growth, a fact that has not yet been reflected in share prices. Galaxy Securities says of Beijing says the average P/E multiple for stocks traded on the Shanghai Exchange is now 16.02. Valuations of Chinese ADRs are much lower due to intense volatility on U.S. stock exchanges.
Chinese companies are expected to see earnings grow by seven percent in 2009 and fifteen percent in 2010 according to Galaxy. Some of China’s largest companies are cash-rich and looking to buy up foreign assets.
· China Life, the world’s biggest insurer by market value says it wants to buy parts of AIG.
· PetroChina, Asia’s biggest oil and gas producer says it may buy some overseas companies badly hurt by the global financial crisis.
· Industrial & Commercial Bank, China’s largest commercial bank says it aims to double its assets outside China within three years.
And, as Chinese companies reach into the global economy, multi-national firms are looking to China’s internal market to drive their future growth. Dell Computer realized sales increases of 33% in China during the second quarter of 2008 and the company now says it looks to the expanding Chinese market for future growth.
As Michael Dell said at a briefing in Shanghai, China is one of the most critical emerging countries in the world with vast parts of the country still in need of IT tools and huge numbers of people coming on line. In fact, an estimated 240,000 new Internet users come on line daily. The total population of netizens is expected to hit 500 million within three years.
As the global crisis grows, many other multinationals, some as large as General Electric and others as small as Cold Stone Creamery are looking for their future growth by aggressively expanding into the Chinese economy.

THE TIPPING POINT

Like multinational corporations, China knows that it must expand its internal economy and domestic consumption in order to continue growing while the world copes with recession. Much of the world is also looking to China to drive regional and global growth.
As world leaders flew franticly from continent to continent looking for ways to slow the global financial crisis, some European leaders asked China to pitch in some of its reserves to stem the downturn. Chinese leaders responded that the best thing they could do for the world was to continue the rapid growth of China’s economy.
Accordingly, China rolled out a stimulus package bigger than the plan it used to survive the Asian currency crisis a decade ago. Having effectively tamed internal inflation, the government took steps to stimulate the economy with a series of interest rate cuts and reductions in bank reserve ratio requirements, moves hailed by the World Bank and the U.S. Treasury because they could help other nations indirectly.
China’s contributions to world economic growth are now comparable to those of the United States according to UN Under-Secretary-General Sha Zukang. Sha isn’t the only one calling China an engine driving world economic growth. World Bank President Robert Zoellick agrees that China offers an “important” alternative to U.S. leadership in world economic growth.
The most resounding declaration of China’s growing importance comes from the International Monetary Fund’s chief economist, Olivier Blanchard. Blanchard says one hundred percent of global economic growth will come from emerging economies and China, which is deeply engaged in those economies, will certainly find itself in a stronger position as a result.
China is not yet the world’s biggest economy but it eventually will be. That is inevitable. It is only a matter of time. As IMF economist Blanchard told an Italian newspaper, “There will be a shift in power. China will emerge from these events in a stronger position.”
The shift in power is already happening. We are at a tipping point. As America declines into debtor status and its economy shrinks, China is rising.
China is already the preeminent economic power in Asia. Its rise as a global power is happening before our eyes whether we see it or not.

China Changes The World

Long after the Olympic flame has been extinguished at the “Bird’s Nest” Stadium in Beijing, the impact of Friday night’s Olympic ceremonies will be felt worldwide.

Yes, the opening ceremonies were spectacular, mounted on a scale never seen before in any Olympic celebration. But this was much more than a display of China’s growing economic power and its immense population. The 2,008 drummers who opened the show were carefully coached to smile in order to project a friendly face to the world. China has changed.

Much more than a bombastic national spectacle, the ceremonies were an artistic triumph. Ancient traditions were seamlessly married with dazzling technology in a cascade of unforgettable presentations. Amazingly, a survey of columnists worldwide shows that some westerners have already criticized the program as a display of excess. Not so.

What we Americans (and more than a billion Chinese) saw on 08/08/08 was pure history in the making. How quickly the cynics forget that China was a closed and secretive Communist dictatorship with a 19^th century economy only three decades ago.

For a hundred years, China had been thrown into unending chaos by war, invasion, civil insurrection, foreign exploitation and mass starvation. Suddenly, China is on a path to become the largest economy in the world. The Olympic ceremonies were much more than a coming-out party; they mark the rebirth of a great nation.

As well as announcing China’s historic reemergence onto the world stage, the Beijing Olympic Games and the opening ceremony marked an opening of China’s doors to the world. In a society that venerates symbols, few could be more powerful than the artwork laid out at centerfield.

Thousands of athletes walked through trays of colored dye and, with their feet, left a permanent and beautiful record of their presence on China’s huge “welcome mat.” Instead of rejecting foreigners, the Chinese have actually turned the record of their visit into a work of art that will be treasured for centuries to come. This alone marks a sea change in China’s attitude towards the rest of the world.

Some cynics have dismissed the Olympic spectacular as an act of propaganda to impress the Chinese masses. Nothing could miss the point more completely.

More than a billion Chinese, who had only the dimmest view of any nation other than their own, suddenly saw a vast global reality. They saw the world march into their home to join China in a glorious ancient Greek spectacle…a venerated global Olympic tradition that has never before found a home in China. What a breathtaking risk the leadership took!

Ruthless dictators guard their power and hide their populace from outside influence. But, as of 08/08/08, China actually embraced the wider world. Just as Yao Ming embraced the nine-year-old hero of the Sichuan earthquake, China effectively opened its heart to the rest of the planet. This will eventually be recognized as a watershed moment in the history of a once-closed kingdom.

Fourteen thousand performers, ninety-one thousand cheering spectators, countless fireworks and the proud athletes of an increasingly globalized world have joined to demonstrate that China is reborn as a partner in our planet.

Put past controversies aside for now. Four billion people have witnessed a turning point in the world’s economic, cultural and political history. We will never see anything like it again.