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INTEREST RATE HIKES LIKELY TO LEAD TO GLOBAL SLUMP

By Shi Weigan; The author is a PhD degree holder from the Institute of World Economics and Politics under Chinese Academy of Social Sciences, July 3, 2006.

At the regular meeting of the Federal Open Market Committee (FOMC) which ended on June 29, the US Federal Reserve raised the federal funds rate by 25 basis points to 5.25 per cent, the 17th interest rate rise in a row.

Unlike the statement issued after the May meeting, at which the federal funds rate was raised to 5 per cent, after its June meeting, the FOMC did not say that “some further policy firming may yet be needed to address inflation risks.” The omission was meant to be interpreted by the market as an indication that the possibility of further interest rate rises had been ruled out.

However, given repeated worries over inflation in the United States, openly expressed by Federal Reserve Chairman Ben Bernanke, a rate increase as mild as 25 basis points is unlikely to rein in inflation. It is a common expectation that the interest rate will soon reach 5.75 per cent to 6 per cent.

Echoing the Fed, the European Central Bank increased its key interest rate to 2.75 per cent on June 15. The Republic of Korea, Denmark and South Africa have also raised their interest rates by 25 basis points. And Japan’s central bank may introduce its first interest rate rise in six years in July.

As a result, a global wave of interest rate rises will probably follow. Most countries may resort to tight monetary policies to combat intensifying inflationary pressure caused by global commodity price hikes, especially that of crude oil.

A worldwide tightening of monetary policies, though targeted against inflation, would serve to speed up a global economic slump. Led by the price rises in copper, petroleum and gold, commodities have witnessed a global price surge since the beginning of this year.

By mid-June, the Reuters Commodity Index (CRB), one of the most widely used indicators of global commodity prices, stood around 370 points, its highest since 1980. Crude oil prices remain above US$70 per barrel and the gold price is more than 20 per cent higher than it was a year ago.

The long-time high prices of major commodities will certainly push up the prices of other products, making inflation almost inevitable. More importantly, such inflation would not be confined within the borders of one or several countries it would sweep the world.

The economic harm resulting from commodity price hikes is similar to what happened in the 1970s when the whole world was dragged into a depression by the soaring price of petroleum.

This time, the price hike involves metals used widely in industries, such as copper, lead, aluminium, zinc, precious metals like gold and silver as well as the agricultural produce. The inflationary pressures posed by all these hikes cannot be compared with those in the 1970s.

Therefore, even if a worldwide economic depression is not at hand, it is not far away.

Besides inflation, the world economy is also being burdened by several other factors: Economic engines that used to operate vibrantly have been fading away, the imbalance caused by the lopsided economic structure could not be corrected and several countries are in big trouble for trade deficits or fiscal deficits, or even both.

At the same time, one of the world’s biggest economic powerhouses, the United States, saw its real estate bubble burst earlier this year.

The most important question to be answered is whether it is possible for the world economy to have a soft landing after so many countries apply the economic brakes.

European countries are seeing a resurgence of its industry and a strengthening consumer confidence, but the higher-than-normal level of its capital market will soon have a negative impact on its economy.

Admittedly, not every stock market slump is followed by a major depression. Yet in previous experiences, a new round of economic depression is always preceded by a stock market slump.

A dip in the stock market has been looming in many parts of the world since mid-May, including the United States, Europe, Japan and India.

In effect, the Fed’s latest interest rate hike has underlined market expectations of further rate rises.

The drop in the stock market is probably a signal indicating the beginning of a new economic cycle in one or two years and a depression will certainly emerge soon.

The only good news is that the global economy has accumulated much stronger capability against the inflationary risks, which makes it able to resist the threats looming close.

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INTERNAL REASONS FOR IMBALANCE OF INTERNATIONAL PAYMENTS

By People’s Daily Online; July 04, 2006. The author was identifiedas “a researcher at the Institute of Finance of the People’s University of China.”

In recent years, China’s total current account surplus and capital account surplus has continuously exceeded $100 billion. Without a doubt, the international payments imbalance has highlighted some problems that have occurred in China’s domestic economic development.

In terms of the relationship between the internal and external economy, external trade balance is equal to a country’s net savings: savings-investment = export-import. In an open economy, a country can accumulate capital reserve by itself, or can increase savings through acquiring foreign wealth. Therefore, the current account surplus is also frequently called foreign net investment in international economics. In an open economy, there are two sources of: domestic investment and foreign investment. The successive foreign trade surplus of China has highlighted the problem of the relative superabundance in savings.

A high savings rate is not bad in itself. The underlying reason of savings surplus is the inefficient investment and financing system and the poor profitability of micro-economic entities. At present, major problems in the investment and financing system are: underdevelopment of capital markets (including stock and bond markets, venture capital markets, private markets, etc.); high proportion of indirect financing, inefficient operation of banks as entities of indirect financing, high rate of non-performing assets, weak monitoring capacity to enterprises; inadequate protection on the interests of investors, cultural deficiency in equity right and creditor’s right, etc. As a result, the transformed cost of savings to investment is very high but the efficiency is poor. Deficient investment distribution between sectors and companies leads to poor allocation of resources.

At the same time, microeconomic profitability is low. Particularly, long-term loss of a considerable proportion of state-owned enterprises makes it difficult to turn investment into high-quality output, therefore leading to fruitless investment and lower average rate of return on the investment. Profitability and survival ability of enterprises not only affect investment desires and transformation of savings to investment, but also determine the quality and sustainability of economic growth. A blocked and inefficient domestic investment and financial system as well as an incompetent micro-economy, has blocked part of the savings and made it impossible for this to be transformed into investments. Some savings, according to willingness of the owners, are “not expected” to be transformed to credit and investment. The result is the emergence of a relative surplus of domestic savings, such surplus has been demonstrated in the balance-of-payments surplus in China’s current account for many years.

In order to cope with the issue of continued balance-of-payments surplus, relevant Chinese departments have made a lot of positive response that has produced marked effects. However, due to the special structural features of the reasons that led to the “double-surplus” of international payment, a package of measurements including structural reform are to be taken so as to effectively ease the “double-surplus”. These mainly include:

Firstly, full use of domestic savings should be made and investment and financing systems reform should be sped up. International experience shows that the improvement of international competitiveness is not on foreign capital. In the final analysis, it relies on domestic savings and capital. To speed up the investment and financing systems reform, efforts should be made to strengthen the support of financial systems to economic entities, and explore how to set up effective channels to transform savings to investments, how to implement effective allocation of resources between regions, industries and corporations, and, how to promote economic growth of the entities. At the same time, attentions should be paid to continuously improve the profitability of state-owned enterprises, to vigorously promote the innovation in institution, technology and management based on the reform of state-owned asset management and the requirements of the modern enterprise system, and to improve the corporate governance structure.

Secondly, the concept of foreign capital application should be renovated and the quality of foreign capital utilization should be improved. Given the high saving rate of the country, China does not need foreign capital if only presenting financial analysis. Judging from the overall amount, the proportion of foreign investment in fixed assets is only less than 5%. Its direct stimulating effect on economic growth is limited. The use of foreign capital should be motivated to make up for the inadequate investment and domestic technological gap. However, in practice, there is some disorder in certain areas of foreign investment application: in impractical attraction of foreign investment and disregard to cost, blind introduction to preferential policies, or even treating the issue of foreign capital application as a political task. As a result, the majority of the foreign capital introduced by this means has become a sheer substitute for domestic savings, and eventually intensified the excess of domestic resources. This is a waste of national resources.

Thirdly, consumption and improve consumption concepts should be promoted. Currently, the key point is to support and encourage service consumption such as housing, cars, education, tourism, culture and sports, telecommunications, etc. Efforts should be made to improve the convenience and scale of consumption loans and encourage advanced consumption.

Moreover, in institutional arrangements, efforts should be made to further reduce import tariffs and non-tariff barriers, and in a systematic and planned manner to reduce the constraints on capital outflow. China is the beneficiary of trade liberalization. She needs to further curtail tariff and non-tariff barriers to facilitate imports. Import growth is conducive to competition introduction and long-term economic growth. At the same time, financial subsidies on exports should be further cut down, for instance by abolishing financial interest and further lowering export tax rebates rate, so as to ease external pressures, reduce financial burden for enterprises, mark down production costs, and improve operating mechanism. Additionally, efforts should be made to steadily advance convertible capital account and promote rational two-way fund flows. Measures should be taken to support overseas portfolio investment by insurance institutions and social security funds, and to enhance the momentum of support to follow-up financing of overseas investment enterprises.

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CHINA’S MACRO ECONOMY EXPERIENCING “DIFFICULT TIME”

Source: Xinhua, June 27, 2006

China’s fixed asset investment, which cooled down a bit last year, has been growing rapidly so far this year, indicating that the country’s macro economy is entering a “difficult time”.

Official figures showed that China’s fixed asset investment growth rate in May this year was 2.1 percentage points higher than that of the first quarter, and the trade surplus continues increasing.

China’s economy will probably grow around 10 percent in the first half of the year, economists here predicted.

The National Bureau of Statistics said that in the first five months of this year, the investment of local governments, which made up about 90 percent of China’s urban fixed asset investment, increased by 31.3 percent, up 2.5 percentage points from the same period a year ago.

A State Council meeting in mid-June has urged local governments to focus efforts on adjusting economic structure, changing growth patterns and deepening reforms.

The blind thirst for expanded investment and faster economic growth should be curbed, the meeting said.

Wang Tongsan, director of the Quantitive Economy Institute of the Chinese Academy of Social Sciences, told Xinhua that he believed China’s current investment growth rate was “rather moderate” compared to that of 2003.

The macro economic situation is “not bad,” he said, there were no “bottlenecks” in the sectors of coal, electricity, oil and transportation and the commodity price is “relatively low.”

He warned, however, the central government should be on alert in regards of the rebounced overheated investment and adopt appropriate measures to curb the trend. Otherwise, this will affect the nation’s economy to develop “fast and sustainably,” he said.

China is determined to adjust the investment and consumption structure and aims to realize a balanced international trade and balance of payments during the 11th Five-Year (2006-2010) plan period.

The country also plans to upgrade the proportion of tertiary industry in the country’s GDP and the reduce the per unit of GDP energy consumption by 20 percent in the next five years.

In January-May, China’s fixed asset investment grew 30 percent, while consumption grew less than 15 percent. China’s trade surplus amounted to 46.8 billion U.S, dollars.

If this trend continues, China’s trade surplus this year is expected to surpass last year’s record 101.2 billion dollars, economists said.

Wang said China’s macro economic regulation and control should combine the resolve of short-term problems with the realization of long-term targets so as to stimulate the transformation of the growth pattern and realize the goal of sustained and fast development of the nation’s economy.

As for the central bank’s raise of the benchmark lending rates by 27 basis points in late April and the recent hike of reserve ratio for commercial banks by 0.5 percentage points, Wang believed these measures were not enough to curb the overheated lending.

He suggested a more relaxed and flexible interest rate and exchange rate policy in a bid to control credit and achieve a balanced foreign trade.

Meanwhile, he noted, the policy of tax rebate, which has been in place since 1998, should be adjusted.

He pointed out the root for China’s economy to experience sharp ups and downs over the past years lies in the country’s administrative managing system, which spurs local officials to seek after higher economic growth to get promoted.

Reforming China’s administrative managing system and establishing scientific system to select officials is the fundamental way to solve China’s deep-rooted economic problems, he said.

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CHINA’S INCOME DISTRIBUTION GAP

By People’s Daily Online, June 29, 2006.

China is a country where the cities remain separate from villages and development is uneven amongst regions. Since 1990s, the income distribution gap has begun to widen. At present, the gap is measured in four areas: within urban areas, within rural areas, between urban and rural areas and amongst regions.

Gap within urban areas: 2005 Social Blue Book released by Chinese Academy of Social Sciences shows that the gap of disposable personal income (DPI) between the city’s richest 10 percent of residents and poorest ones will increase by 8 times. The DPI of some 60 percent of urban residents is lower than national average.

Gap within rural areas: The gap among farmers is also enlarging. By the year 2003, the ratio between the highest group and the lowest group was 7.3:1 (altogether five groups) and the Gini Index reached 0.37 in that year.

Gap among regions: The gap within urban and rural areas is closely related with that of regions. The seriously uneven development between east and west regions has caused the income gap to rapidly expand on certain levels.

Gap between urban and rural areas: Since China carried out the opening up and reform policy, the income gap between urban and rural areas has experienced the following: from a rapid narrowing to gradual enlargement, to gradual narrowing, then to speedy enlargement. The officially statistics showed that by the end of the first three quarters, the ratio between urban and rural residents reached 3.35:1.

Besides this, the gap among various industries also attracted great attention.

It is reported that the Gini Index of China calculated on the basis of purchasing power is much lower than that of the basis of nominal income, meaning that the gap is actually overestimated.

Yi Gang, assistant of president of People’s Bank of China, said on a form that the Gini Index is calculated on the basis of nominal income but does not take account of price differences among regions and could not only not indicate the actual income gap but also the side effects of the process of reform.

On the form, Director of Institute on National Economics Fan Gang pointed out that the reality and system of developing country would influence income distributions for a long time in China, and possibly many decades of years to come.

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CHINA’S OUTSTANDING FOREIGN LOANS STAND AT US$287.905 BILLION

Source: Xinhua, June 27, 2006

By the end of March, China’s outstanding foreign loans had reached 287.905 billion U.S. dollars, up 2.44 percent or 6.86 billion U.S. dollars over the end of last year, according to a press release of the State Administration of Foreign Exchange.

Outstanding short-term loans that should be serviced within a year were valued at 161.043 billion U.S. dollars, representing an increase of 4.9 billion dollars, or 3.14 percent, over the end of last year.

Outstanding loans for long and medium terms in contrast stood at 126.862 billion U.S. dollars, up 1.57 percent for an increase of 1.96 billion dollars over the end of 2005.

Between January and March, China borrowed 4.096 billion U.S. dollars in registered loans of long and medium terms, down 3.17 percent, declining by 134 million U.S. dollars over the same period last year.

Meanwhile, China paid back 3.357 billion U.S dollars in principal, up 27.64 percent year-on-year, and 526 million U.S. dollars in accrual interest, up 10.04 percent year-on-year for an increase of 48 million dollars.

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CHINA’S REVITALIZATION DOESN’T MEAN A RETURN TO THE PAST

By Zhang Feng, Global Times Editor and translated by People’s Daily Online, June 26, 2006

China’s revitalization shouldn’t be understood as returning to the time centuries back when China was the dominant power in East Asia. Chinese people can be proud of their revitalization process, but shouldn’t have sentiments of ‘historical nationalism’.

“China’s rise’ is in fact a western concept to describe a country’s development. Most of western powers were either established on the bases of the ancient imperialist or the unlimited exploration of the new continent. However China’s progress is based on the five thousand years of history as well as absorbing fine culture from the west. Therefore it is better to describe China’s current development as ‘China’s revitalization’ than ‘China’s rise’.

China’s revitalization means China will prospect a new development road as a national state according to the United Nations Charter without a return to the past.

Misunderstanding On China’s Revitalization

Currently some western or bordering countries scholars are wondering if China’s revival means to go back to the time when China was the center of East Asian politics. According to their conclusion, China was the center of Asia in pre-modern history.

With the fast development in China, more and more western scholars became interested in China. Taking the famous American Sinologist David Shambaugh as an example, he pointed out in an article ‘Power Shift – China and Asia’s New Dynamics’ that, the power in Asia has shifted from Tokyo to Beijing and away from Washington, so America should not make enemies with Beijing.

The article tries to illustrate what China’s development means to Asian order.

In fact, today’s China has fundamental differences from the ancient dynasties. Modern China is a nation that is participating in the development wave in a global world. It is a new trial of development, but not a repetition of the past. On regional order, Chinese government has always expressed that China will not become a hegemony even if it becomes stronger. However, many western scholars like to use words such as ‘Chinese empire’, which in fact gives the wrong impression about modern China, as it there is reference to the ancient one.

China Shouldn’t Be A Historic Nationalist

To get rid of people’s misunderstanding about modern China, we Chinese must be sober-minded about China’s current revitalization. One should not think that China’s development will revert back to the time where China lead as the center. One should not take on such a historic nationalism.

Chinese people have a strong sense of history, which can be either a treasure or a burden. To say it is a treasure is because Chinese people can always have an historic example to identify themselves and have a historic view of the national mission and the state’s rise and fall. Therefore, even when Chinese people are in a very difficult situation, they will have a resolute will to revive the country. To say it is a burden is because Chinese people are used to being strong. And this kind of historic perspective imbues every Chinese with a strong sense of historic mission that China should be and is destined to be strong and powerful, any weakness or humility is temporary and every Chinese person should make his or her own efforts to carry on the splendor of the past.

In essence, both treasures and burdens are good because they can become a source of confidence for the Chinese people and inspire them to continue to struggle. But some individuals have overemphasized historic humility and still base their thoughts on the past. Such feelings or thoughts tend to be narrow-minded. It is the craze of the past prosperity and modern western nationalism that form the ¡®historic nationalism’.

Currently China is trying its best to merge with the world, thus we shouldn’t have such historic nationalism and should be careful about western scholars’ “China center” theory.

“Chinese Empire Revival” Will Scare The Bordering Countries

Historic nationalism can make bordering countries view China’s revitalization as “Chinese empire revival”, and thus feel scared. While some people suddenly think of ancient Chinese honor as people from many other ancient countries having come to worship Chinese emperors. The problem with this is that if people think like this and even tell our neighboring friends about it, it will probably hurt their feelings and cause some psychological shock and concern.

China’s current development is surely not a repetition of the past, but a chance to the bordering countries in economic development. However, due to misunderstandings, many of them are suspicious and worried that China will try to resume its ancient empire status. Therefore, to talk about Chinese civilization circle or Greater China Economic Rim are all easy to be misunderstood and can became the source of so-called “China threat”.

Under the current condition that Chinese cultural revival is being hot, it is better to know that to put Japanese, Korean or other Southeast Asian countries culture into Chinese civilization circle is not necessarily a consensus from them. Those countries have a strong pride and sense of belonging to their own culture. They might not think that their culture is also part of Chinese culture or Chinese culture is more advanced. A South Korean scholar said recently that in fact, they feel they have done better in protecting Confucius culture than China itself, but they don’t understand what the current so-called culture revival in China means.

I think China should send a message to the world that a revitalized China is not a China that returns back to the Han or Tang Dynasties over 1000 years ago, but a China that will participate in the global development as a national state, as equal as any other country. We should bare in mind that although the East Asian system has been destroyed completely by the rise of western power, many western countries still use such idea to separate good relations between China and other Asian countries. Therefore, Chinese people should remember no matter how strong China is, it is still equal to any other country.

Source: Travel Impact Newsletter