By William Pesek
September 19, 2006
SourceSept. 20 (Bloomberg) -- What weighs 25 million tons?
Well, 1,000 replicas of the USS Enterprise. Or 68 Empire State Buildings. Or China's expected apple harvest this year.
Wow, 25 million tons! It's these kinds of shocking factoids that remind us how big a story China is. At $2.2 trillion, China's economy is less than half the size of Japan's. And yet China boxes well above its weight in the global financial system.
The issue gets at an important question: Is China, a developing economy, being given too much weight?
Many economists who have gathered in Singapore for the International Monetary Fund's annual meeting this week agree China would alleviate global imbalances by allowing the yuan to strengthen. While estimates for how undervalued the currency is range from 10 percent to 40 percent, just about everyone says it would shoot higher and stay there if traders had their way.
What if the opposite was true and the currency of Asia's No. 2 economy was overvalued?
``The argument that the RMB is undervalued is questionable,'' says Friedrich Wu, an economist at the National University of Singapore's East Asian Institute. RMB is the abbreviation for renminbi, China's legal tender of which the yuan is the base unit.
It is economic blasphemy even to suggest such a thing. There is cause for concern when virtually every economist in the world agrees on something. China faces an ever-growing number of risks that must be headed off to keep an economy growing at 11 percent from spiraling out of control.
Balancing Act
The argument for a stronger yuan seems straightforward. China is running a large trade surplus, has almost $1 trillion of currency reserves and lots of capital is flowing its way.
Yet think of the balancing act facing Chinese officials. They need to create millions of jobs to maintain social stability, slow the economy to avoid overheating, and pull off these daunting tasks without traditional tools.
Monetary policy has little effect in China because it lacks what central bankers call transmission mechanisms. Without a vibrant secondary bond market, monetary changes don't have the potency they do in more developed economies. Neither does China have an effective fiscal policy that can be tightened in Beijing.
That's why the focus has been on administrative steps to halt speculation -- and why China is still barreling ahead. Walking the streets of China and chatting to executives there, it's hard not to think the economy is growing much faster than the official rate.
Hype Factor
China also seems simultaneously on the verge of inflation and deflation. It's well-known that the furious pace of China's inward investment could boost consumer prices. Far less attention is paid to China's overcapacity problem.
And let's not forget the hype factor. Perhaps the best analogy is the dot-com boom and bust of the late 1990s and early this decade. China could be described as the economic equivalent of that phenomenon.
Just like the so-called New Economy of the period, China's potential is thought to be boundless. It's all good, and it's run by geniuses who can do no wrong. China is Asia's New Economy and anyone who disagrees just doesn't get it.
Let's hope this view is right. China spiraling into financial chaos could make Asia's 1997 meltdown look negligible. It is an economy that even Japan is relying on for growth.
China has some similarities with the region's economies that fell into crisis nine years ago. Its expansion is powered by public spending and investment from abroad. Asia was in that same situation back then.
`So Subjective'
It's funny, too, how observers apply classic economic theory to China's currency while suspending it elsewhere. For example, one wonders how China can thrive without a well-functioning bond market, a solid banking system, more entrepreneurship, greater domestic demand and freedom of speech.
``Whether a currency is too strong or too weak is a function of your perspective,'' says Stephen Jen, London-based head of global currency research at Morgan Stanley. ``You can look at it from the perspective of China's trade surplus (the RMB is too weak), or China's financial sector (the RMB is too strong), from the perspective of Shanghai (the RMB is too weak), or from Guaizhou (the RMB is too strong). That is why currency valuation is so subjective.''
So is economic forecasting. Many predict China will surpass Japan and the U.S. well before the middle of this century. Whatever happens, China still needs to avoid what no other industrializing economy has been able to: a hard landing.
Wu's Laundry List
``These optimistic, straight-line projections are based on extrapolations of past trends without paying sufficient consideration to the many challenges that China must face going forward,'' says the University of Singapore's Wu.
Wu offers a laundry list of potential ``growth decelerators'' marring China's outlook. It includes overheating, the widening gap between rich and poor, a fragile banking sector, rampant corruption, an aging population, worsening pollution and the risk of military conflict with Taiwan.
Amid so many risks, is it really a given that China's currency should be 20 percent or even 40 percent stronger?
Such views may owe more to a well-ingrained herd mentality about China's promise than the true state of its economy. Once traders look under the nation's hood, the yuan may very well sink under the weight of China's challenges.
(William Pesek is a Bloomberg News columnist. The opinions expressed are his own.)
To contact the writer of this column: William Pesek in Singapore, or through the Tokyo newsroom at
wpesek@bloomberg.net .
Last Updated: September 19, 2006 15:56 EDT