9 August 2003

Twenty years ago the quietest of all possible revolutions occurred in China which, this year, has just come to fruition. This was a method of selecting members of its most senior committee, the Politburo, started by Deng Xiaoping. Every year a few individuals in their late 30s or early 40s who have already reached positions of administrative authority, such as being mayors of large cities or governors of provinces are secretly chosen and, from that moment onwards, every aspect of their lives is investigated for any suspicion of corruption by a committee which has independent authority. Those selected are also expected to be of at least graduate standard with degrees in science or engineering. Ideally, they will already have had to grapple with considerable problems within their administrative responsibilities.

In stages, this group, which altogether consists of about 200 mandarins are promoted into successively more difficult jobs, their adminstrative ability assessed and whittled down in stages every few years to a candidate Politburo committee of about 30 members by the time they are in their late 50s. From these, candidates in their early 60s are selected in ones and twos every few years are selected for the highest office and rubber-stamped by the Communist Party Congress. Early this year (2003), the Politburo was completely selected for the first time by the new process started by Deng.

In short, the Chinese Politburo consists of the most intellectually gifted and administratively experienced politicians of any government in the world. Despite the enormous problems that they inherited from Mao Zedong and his even more dangerous wife -- particularly concerning the huge debts of the state banks and the chaos of the universities resulting from the Cultural Revolution respectively -- there can be little doubt that today's Chinese government is unlikely to make the sort of mistakes that quasi-autocratic, presidential-type governments, such as those of Bush and Blair, are prone to make.

As mentioned in one or two previous postings, it is almost certainly the case that a single world currency will emerge in the coming decades. The best candidate will be the US dollar or the Chinese renminbi (yuan) or, probably, a conjunction of both -- the world dollar (W$) perhaps? The renminbi is already tied to the dollar and, from all the accounts we read in the press, the Chinese Politburo is unlikely to decouple it anytime soon despite complaints from Japan, other south-east Asian countries and vested business interests in the western world. Stephen Roach is among the world's best economists and, as he writes below, there are sound economic reasons why the Chinese Politburo should not yield to the pressures that are now buuilding up.

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THE HYPOCRISY OF BASHING CHINA

Stephen Roach

China is fast becoming the scapegoat of a weak global economy. World opinion is increasingly united in urging China to alter its currency policy in order to relieve mounting global tensions. John Snow, US treasury secretary, and Alan Greenspan, chairman of the Federal Reserve, have suggested that China needs to boost the value of the renminbi. Japanese authorities have long blamed China for many of their problems, and Europeans believe that China's so-called currency peg -- a fixed Rmb8.3 to the dollar -- means that the euro will have to bear a disproportionate share of the world's adjustment to a weaker dollar.

The pressure is building for Beijing to change its currency regime. That would be a huge mistake for China, Asia and the global economy.

While China's export growth is truly extraordinary -- up 33 per cent in the year ending June 2003 -- this should not be construed as a threat to an otherwise weak global economy. For more than a decade, the vigour of Chinese export growth has come far more from the deliberate outsourcing strategies of western multinational companies than from the rapid growth of indigenous Chinese companies.

From 1994 to mid-2003, China's exports tripled from $121bn (£75bn) to $365bn. It turns out that "foreign-invested enterprises" -- Chinese subsidiaries of global multinationals and joint ventures with businesses from the industrialised world -- account for fully 65 per cent of the total increase in Chinese exports over that period. The power of the Chinese export machine is more attributable to "us" than it is to "them".

The Chinese phenomenon hardly amounts to grabbing market share from the rest of the world. It is more a by-product of the struggle for competitive survival by high-cost producers in the industrial world. Last year, a record $53bn of foreign direct investment flowed into China, making the country the largest recipient of such funds in the world.

These investments did not occur under coercion. A high-cost industrial world has made a decision that it needs China-based outsourcing to ensure competitive survival. Dismantling China's currency peg would destabilise the very supply chain that has become so integral to new globalised production models in Japan, the US and Europe.

There are several other reasons why China should leave its currency unchanged. Contrary to widespread perception, China does not compete on the basis of an undervalued currency. It competes mainly in terms of labour costs, technology, quality control, infrastructure and an unwavering commitment to reform.

Moreover, if China were to increase the value of its currency, as the world wants, that could lead to the emergence of bubbles in other asset markets, especially property. It could also send a signal to market speculators that the renminbi would be "in play".

The Chinese government has consistently reiterated its long-term commitment to a flexible currency and an open capital account. Yet it knows full well that a good deal of reform is required before these objectives can be accomplished, not least capital market reforms and a clean-up of its banking problems. This is a critical lesson of the Asian financial crisis of 1997-98 that an impatient world should not ignore.

Ironically, it is Japan that has led the way in recent China-bashing. Senior Japanese officials have blamed China for exporting deflation and for the "hollowing out" of the Japanese labour market. Nothing could be further from the truth. Low-cost, high-quality Chinese imports provide a windfall to the purchasing power of beleaguered Japanese consumers -- precisely the benefits that Japan's export machine provided the world in the 1970s and 1980s.

If you want an example of an undervalued currency, remember the yen averaged close to 300 to the dollar in the 1970s and about 220 in the 1980s -- dramatically cheaper than its current range of Y115-120. It is hypocritical for Japan to criticise China for emulating a strategy that was central to its own development model. Browbeating China to revalue its currency is a poor excuse for Japan's inability or unwillingness to reform.

US officials, politicians and businessmen are also busy bashing China. Many have noted that America's largest trade deficit is now with China -- a $103bn shortfall in 2002 that is set to widen further this year. Yet trade deficits should not come as a surprise for a US economy that is short of savings.

They are part and parcel of America's increasing need to import surplus foreign saving in order to finance growth. The only way to get that capital is for the US to run massive trade deficits. If the US was not trading with China, those deficits would have to occur with other nations: Canada, Mexico, Japan, or possibly even Europe.

As with Japan, China is providing US consumers with the cheapest high quality goods that world producers can offer today. If the US wants to reduce its trade deficit, it must come to grips with more fundamental problems of its own, namely a rapidly vanishing national saving rate. Until it does so, US trade deficits are likely to be the rule, not the exception, and the low-cost, high-quality option of Chinese trade is in America's best interest.

Periods of economic distress often produce scapegoats. China is the wrong target in today's weak global economy. It is high time for an increasingly self-absorbed world to put an end to this dangerous blame game.

The writer is chief economist of Morgan Stanley

Financial Times 7 August 2003

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