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Don’t Get Giddy About China February 14, 2010

Posted by tkcollier in Geopolitics.
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There is a Russian proverb that says our fate plays out on the exact path we take to avoid it. This is the story of China in a nutshell. Policy makers have accumulated forex reserves in large part to avoid a balance of payments crisis, and yet the massive reserve accumulation has meant a parallel accumulation of high-powered money and an epic credit expansion over not just the past year, but over the past four or five leading to dangerous asset and credit bubbles manifesting throughout China’s real economy and financial markets.

Chinese policymakers appear to be trying to spur private consumption by building out social safety nets. While better social safety nets are an important and positive development, the fundamental answer for policy makers to improve the allocation of capital (and in so doing to shift China Inc. away from its export/production orientation to a more sustainable consumption driven model) is only going to come from a combination of four key policy initiatives, in order of importance:
·         Interest rate liberalization
·         Exchange rate regime liberalization
·         Major reform liberalization in the service sector, especially in financial / banking sector, which is currently dominated by state players.
·         Liberalization of rural land ownership rules.
None of these is likely to happen soon, unfortunately, given the political reality – even in a one-party country like China – that it is difficult to implement tough-medicine reforms during a period of global economic stress, and this is especially true for President Hu Jintao and Premier Wen Jiabao as the country gets closer to its next leadership transition cycle in 2012.

If I am wrong about the bearish scenario for China above, I think it will be because I am too optimistic. A possible worst-case scenario is that the bursting of China’s credit bubble leads to a second-wave global credit crisis and a freeze in global financial markets no matter what the People’s Bank of China or the US Federal Reserve does to reflate markets – and we get a classic global liquidity trap scenario and a major debt-deflation Great Depression redux.

via Asia Sentinel – Don’t Get Giddy About China.

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