The Echoes of Beijing

Over the years, I have made probably ten visits to the Temple of Heaven in Beijing. But this time it literally took my breath away. Built in the 15th century, it is one of Ming China's greatest monuments an extraordinary complex of sacrificial buildings that is three times the size of the Forbidden City. The centerpiece the magnificent three-level white marble Altar of Prayer for Good Harvest was the scene for the major social extravaganza of the just-completed Fortune Global Forum. Staged by the Beijing municipal government, the Temple of Heaven was magically transformed by lights, music, opera, and traditional costumes and dancing into what had to be a preview of the opening ceremony of the 2008 Olympics. It was a truly spectacular event. On the surface, the China boom never looked more glorious.

Beneath the surface, however, there is a growing sense of unease in China. Don't get me wrong the backward looking data flow still looks terrific. GDP growth continues to soar gains in 2003 were just revised upward to 9.5% (from 9.3%) and the Chinese economy was estimated to be holding at that pace in the first period of 2005. The latest update of the more reliable industrial output figures paints an equally impressive figure a reacceleration to 16% y-o-y growth in April versus somewhat more subdued year-end 2004 comparisons of 14.4%. Growth is not the issue in China. There has been plenty of it in recent years and there is an ample reservoir of considerably more growth to come in the pipeline. The issue is the consequences of that growth.

Two considerations are especially critical in that regard China's own efforts to maintain the internal stability of its economy and the world's response to the China growth juggernaut. Recently, Chinese officials have taken dead aim on the nation's over-heated property sector with a new series of tough administrative measures. This is the third such action this year, but this one seems to have real teeth in going after excesses on both the demand and supply sides of the property. There is a new tax on any "property flipping" that will be imposed on transactions taking place within two years of a purchase and there are new penalties for excess developer's profits and the restriction of land supply. These actions were jointly issued by seven agencies within the central government underscoring a deep sense of determination on the part of China's senior leadership to come to grips with the major internal excess of the Chinese economy. This is clearly a much tougher message than I picked up in late March, when I met with senior officials at the annual China Development Forum (see my 22 March dispatch, "China Goes for Growth"). That could finally mean "game over" for the Shanghai property bubble.

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Meanwhile, back home, the US government has unleashed a multi-pronged assault on Chinese trade. The Commerce Department has imposed "surge protection" quotas on the imports of several categories of textile products made in China. The Treasury Department has issued the functional equivalent of an official ultimatum on the currency issue making it crystal-clear that China is on the brink of being found guilty of manipulating the renminbi. And the US Congress is moving full speed ahead in the consideration of a more broadly based scheme of stiff tariffs on all Chinese-made products shipped to the United States. Reflecting the confluence of lingering angst in a tough US labour market and a China-centric trade deficit, the scapegoating of China has now become the favourite political sport in Washington (see my 9 May dispatch, "Politicization of the Trade Cycle"). Never mind, the flawed macro logic behind this potentially tragic outbreak of protectionism. US politicians seem increasingly united in their efforts to blame China for America's massive foreign trade and current-account deficits.

The real test for China comes from the potential interplay between these two sets of forces internal measures aimed at containing the property bubble and external measures aimed at constricting Chinese trade. This could be an exceedingly difficult set of circumstances for an unbalanced Chinese economy, whose growth dynamic is powered by two major drivers exports and export-led investment. Collectively, exports and fixed investment now make up about 80% of total Chinese GDP. By going after the property bubble, Beijing is attempting to squeeze the biggest piece of that domestic investment whereas Washington is taking aim on the export component. This potential double whammy is especially disturbing in that China lacks the backstop of internal private consumption; in 2004, household consumption fell to a record low of 42% of Chinese GDP the smallest consumption share of any major economy in the world. (Note: While investment, exports, and private consumption collectively account for more than 100% of Chinese GDP, a negative offset of some 34% of GDP comes from imports, while another 12% shows up in the form of government consumption).

This could well be modern-day China's toughest macro challenge. Time and again but especially over the past eight years the Chinese economy has had to cope with very tough external and internal circumstances. The Asian financial crisis of 1997-98, the synchronous global recession of 2001, and the SARS outbreak of early 2003 were all formidable threats that most in the West thought would derail the Chinese economy. Yet China barely skipped a beat on all of those occasions. This time the challenge is very different and potentially much more significant ironically, coming just when the world has become convinced that the Chinese growth miracle is here to stay. If Beijing gives on the currency front after having just taken actions to pop the property bubble, the risk of a major shortfall of Chinese economic must be taken seriously.

But the real problem is political: China and the United States are on very different pages when it comes to assessing the reactions to these tough macro circumstances. The Chinese leadership is filled with indignation over Washington's protectionist leanings. But it seems unwilling or unable to recognize the political aspect of this threat. Instead, senior Chinese officials are very focused on the macro origins of America's external imbalances as being deeply rooted in an unprecedented shortfall of domestic US saving a case that I have made repeatedly in my own presentations in Beijing and around the world over the past several years. What Beijing seems to be missing is that Washington politicians could care less about macro they are focused are pinning the blame on someone else. Today, that someone else, unfortunately, is China.

What worries me most is that both nations China and the US are painting themselves into political corners from which there are no easy exits. Chinese officials speak repeatedly of the currency issue as a matter of "national sovereignty" stressing that any external pressure to change will be counter-productive for a nation that places great emphasis on its newfound pride. At the same time, Washington seems increasingly convinced that the US body politic is finally prepared to say, "enough is enough" on the trade deficit. At the late March China Development forum, I warned Chinese officials that 2005 was shaping up to be the worst year for US-China trade relations in a decade (see "China's Rebalancing Imperatives" published as Special Economic Study on 21 March). I was wrong. This year has turned out to be the worst outbreak of Washington-sponsored China-bashing on record. Political stalemates are resolved when one or both parties blink. China and the US are unflinching in their political resolve.

Recent actions in Washington offer little hope of compromise from the US side. At the same time, my conversations this week in Beijing left me increasingly concerned about China's willingness to compromise. Don't get me wrong the air is buzzing with speculation of an imminent shift in RMB currency policy. But a new wrinkle has just entered the political equation an escalation of efforts to contain an increasingly worrisome property bubble. Given its long-standing focus on stability, I get the strong sense that the Chinese leadership believes that there is a tradeoff between actions on the property and the currency fronts. Faced with worrisome downside risks to economic growth if it acts on both fronts, from Beijing's perspective, it may boil down to a choice between these two options. Having played its hand on property, the odds of China moving on the currency may well have declined. And that could mean that the political quagmire with the US may only deepen, as a result.

Like most things in China, there is more to the Temple of Heaven than meets the eye. The Imperial Vault of Heaven is surrounded by the so-called Echo Wall. If you stand at one part of this circular wall and whisper, your voice can be heard with perfect clarity by someone situated at the opposite portion of the wall. That's pretty much sums it up today. The echoes of Beijing are growing louder by the moment. The cacophony of US and Chinese politicians speaks of a debate that is working at cross-purposes charges and counter-charges that offer little possibility to resolve the mounting build-up of macro tensions between the two nations. For an unbalanced global economy and ever-complacent world financial markets, the echoes of Beijing left me with a deep sense of trepidation.

By Stephen RoacMorgan Stanley Economis