China s Role in the Global Economy

Transcription

1 China s Role in the Global Economy Lawrence J. Lau, Ph. D. President and Ralph and Claire Landau Professor of Economics The Chinese University of Hong Kong and Kwoh-Ting Li Professor in Economic Development, Emeritus, Stanford University W. I. Harper Group Fund VI Annual Conference Diaoyutai State Guest House Beijing, 3 June 2009 Phone: (852) ; Fax: (852) LAWRENCELAU@CUHK.EDU.HK; WebPages:

2 Outline Introduction China in the World Economy The Partial De-Coupling Hypothesis Chinese Vulnerability to External Disturbances China and Global Imbalances The Macroeconomy in the Near Term Towards a New Financial Infrastructure Concluding Remarks Lawrence J. Lau, The Chinese University of Hong Kong 2

3 Introduction

4 Introduction The global financial crisis has affected all of the developed economies, especially the United States. While North America and Europe have gone into economic recession, it is not an ordinary recession, because it is accompanied by a serious breakdown of the capital and credit markets and bankruptcy, insolvency and illiquidity of many major financial institutions. Fortunately, in East Asia, despite the steep decline in the stock markets, the financial institutions remain relatively sound and financial stability is not seriously threatened. However, East Asian exports to North America and Europe has slowed, and export orders have fallen precipitously since mid- September, following the failure of Lehman Brothers, to the order of 50%, on an year-over-year basis. This has caused derivative declines in the demands for shipping, transportation, logistics and storage services. More recently, the export orders have begun to stabilize and even increase in some sectors. Lawrence J. Lau, However, The Chinese University overall, of Hong it is Kong still between 20 and 4 30 percent below the peak level in 2007.

5 The Impact of the Economic Recession The overall economic slowdown and recession in the U.S. and in Europe, caused by the global financial crisis, will last at least another year or two (probably longer in the U.S.), until more positive expectations are restored for both firms and households and the U.S. mortgage loan default/negative equity problems are straightened out. U.S. home prices still have some way to fall, and the rate of growth of real GDP turned negative in 2008Q3 and remained so through 2009Q1 and is unlikely to turn positive before the end of 2009, and the unemployment rate has reached a new high of over 9%, the highest level since The U.S. demand for imports will likely decline with the reduced household consumption. Such decline will have a negative effect on the rate of growth of East Asian and Chinese exports to the U.S. and hence on Chinese GDP, but the effect is expected to be marginal. Despite the near-term strength of the U.S. Dollar (it actually appreciated relative to most East Asian currencies with the exception of the Japanese Yen and the Chinese Yuan and the Hong Kong Dollar in 2008Q4, caused in part by the repatriation of U.S. investment overseas to the U.S.), in the longer term horizon of 3-5 years, it is likely to weaken relative to other reserve currencies as the net inflow of capital to the U.S., especially that of direct and portfolio investment, is reduced. Uncertainty concerning future U.S. inflation is also a factor affecting expectations of future relative exchange rate Lawrence movements. J. Lau, The Chinese University of Hong Kong 5

6 Impact on East Asian Economies Since mid-september, 2008, when Lehman Brothers failed, there has been a precipitous decline in export orders received by East Asian firms across the board by as much as 50 percent. Concurrently, there has also been a sharp decline in the East Asian stock markets, driven mostly by selling by overseas investors in need of cash. Between mid-september and December, the East Asian currencies, with the exception of the Japanese Yen (which appreciated significantly), the Chinese Yuan and the Hong Kong Dollar (both of which held steady), have all declined in value relative to the US$. The strengthening of the US$ was mostly due to the repatriation of the capital of the U.S. investors. But the East Asian stock markets and exchange rates have begun to stabilize since December, The exchange rates have even begun to appreciate relative to the US$. The stabilization of the East Asian stock markets and exchange rates indicates that the Lawrence exodus J. Lau, of The overseas Chinese University capital of Hong from KongEast Asia has 6 largely come to an end money that can and wants to leave has left.

7 Impact on East Asian Economies The declines in the East Asian stock markets were due primarily to three reasons: repatriation of capital back home by foreign investors; de-leveraging; and loss of confidence by both domestic as well as foreign investors (irrational panic). Initial public offerings and other financial transactions such as mergers and acquisitions have dried up. The reduction in wealth (even unrealized) also has had a negative impact on domestic consumption and investment. There has also been a significant decline in the inflow of foreign direct investment (FDI) into China and East Asian economies and in visitor arrivals, especially from North America and Europe. But outbound visitors from China have continued to increase moderately. All this means a decline in the rates of growth of real GDP and a rise in the rates of unemployment in many East Asian economies. More recently, hot money has begun to flow back into the East Asian markets, driving up their stock markets and exchange rates vis-à-vis the U.S. Dollar but Lawrence the high J. Lau, The levels Chinese of University the stock of Hong prices Kong are expected to 7 be mostly temporary.

8 Exchange Rates of Selected East Asian Economies (1/2/2007=100) 170 Exchange Rate Index (1/2/2007=100) of Selected Countries/Regions Japanese Yen Chinese Yuan Hong Kong Dollar Indian Rupee Indonesia Rupiah Malaysia Ringgit Philippine Peso Singapore Dollar Korean Won New Taiwan Dollar Thai Baht /02/07 01/16/07 01/30/07 02/13/07 02/27/07 03/13/07 03/27/07 04/10/07 04/24/07 05/08/07 05/22/07 06/05/07 06/19/07 07/03/07 07/17/07 07/31/07 08/14/07 08/28/07 09/11/07 09/25/07 10/09/07 10/23/07 11/06/07 11/20/07 12/04/07 12/18/07 01/01/08 01/15/08 01/29/08 02/12/08 02/26/08 03/11/08 03/25/08 04/08/08 04/22/08 05/06/08 05/20/08 06/03/08 06/17/08 07/01/08 07/15/08 07/29/08 08/12/08 08/26/08 09/09/08 09/23/08 10/07/08 10/21/08 11/04/08 11/18/08 12/02/08 12/16/08 12/30/08 01/13/09 01/27/09 02/10/09 02/24/09 03/10/09 03/24/09 04/07/09 04/21/09 Lawrence J. Lau, The Chinese University of Hong Kong 8 Day

9 Exchange Rates of Selected East Asian Economies (7/2/2008=100) Japanese Yen Chinese Yuan Hong Kong Dollar Indian Rupee Indonesia Rupiah Malaysia Ringgit Philippine Peso Singapore Dollar Korean Won New Taiwan Dollar Thai Baht Exchange Rate Index (7/2/2008=100) of Selected Countries/Regions /15/09 04/22/09 Lawrence J. Lau, The Chinese University of Hong Kong 9 07/02/08 07/09/08 07/16/08 07/23/08 07/30/08 08/06/08 08/13/08 08/20/08 08/27/08 09/03/08 09/10/08 09/17/08 09/24/08 10/01/08 10/08/08 10/15/08 10/22/08 10/29/08 11/05/08 11/12/08 11/19/08 11/26/08 12/03/08 12/10/08 12/17/08 12/24/08 12/31/08 01/07/09 01/14/09 01/21/09 01/28/09 02/04/09 02/11/09 02/18/09 02/25/09 03/04/09 03/11/09 03/18/09 03/25/09 04/01/09 04/08/09 Day

10 Stock Market Indexes of Selected East Asian Economies (1/2/2007=100) 300 Stock Market Index (1/2/2007=100) of Selected Countries/Economies China Hong Kong 250 Indonesia Korea Malaysia Philippines Singapore Taiwan 200 Thailand Japan India Lawrence J. Lau, The Chinese University of Hong Kong 10 01/02/07 01/16/07 01/30/07 02/13/07 02/27/07 03/13/07 03/27/07 04/10/07 04/24/07 05/08/07 05/22/07 06/05/07 06/19/07 07/03/07 07/17/07 07/31/07 08/14/07 08/28/07 09/11/07 09/25/07 10/09/07 10/23/07 11/06/07 11/20/07 12/04/07 12/18/07 01/01/08 01/15/08 01/29/08 02/12/08 02/26/08 03/11/08 03/25/08 04/08/08 04/22/08 05/06/08 05/20/08 06/03/08 06/17/08 07/01/08 07/15/08 07/29/08 08/12/08 08/26/08 09/09/08 09/23/08 10/07/08 10/21/08 11/04/08 11/18/08 12/02/08 12/16/08 12/30/08 01/13/09 01/27/09 02/10/09 02/24/09 03/10/09 03/24/09 04/07/09 04/21/09 Day

11 Stock Market Indexes of Selected East Asian Economies (7/2/2008=100) 130 Stock Market Index (7/2/2008=100) of Selected Countries/Economies China Hong Kong Indonesia Korea Malaysia Philippines Singapore Taiwan Thailand Japan India Lawrence J. Lau, The Chinese University of Hong Kong 11 07/02/08 07/09/08 07/16/08 07/23/08 07/30/08 08/06/08 08/13/08 08/20/08 08/27/08 09/03/08 09/10/08 09/17/08 09/24/08 10/01/08 10/08/08 10/15/08 10/22/08 10/29/08 11/05/08 11/12/08 11/19/08 11/26/08 12/03/08 12/10/08 12/17/08 12/24/08 12/31/08 01/07/09 01/14/09 01/21/09 01/28/09 02/04/09 02/11/09 02/18/09 02/25/09 03/04/09 03/11/09 03/18/09 03/25/09 04/01/09 04/08/09 04/15/09 04/22/09 Day

12 China in the World Economy

13 Thirty years of Chinese Economic Reform China has made tremendous progress in its economic development since it began its economic reform and opened to the world in China is currently the fastest growing economy in the World averaging approximately 10% per annum over the past 30 years. Between 1978 and 2008, Chinese real GDP grew 16.5 times, from US$267 billion to US$4.41 trillion (2008 prices) (3rd largest economy in the world) and real GDP per capita grew more than 12 times, from US$267 to US$3,320. By comparison, the U.S. GDP (approx. US$14 trillion) and GDP per capita (approx. US$45,500) were respectively 3.2 and 14 times the comparable Chinese figures in Lawrence J. Lau, The Chinese University of Hong Kong 13

14 Thirty years of Chinese Economic Reform Despite its rapid growth, China is still a developing economy in terms of its real GDP per capita. An economy is generally considered to be developed if its GDP per capita exceeds US$10,000 (if we take into account inflation, this threshold probably should be higher). It will probably take another years before China joins the ranks of developed economies, achieving a per capita real GDP of US$10,000, and a further years before China reaches the same level of real GDP per capita as the United States, some time past the middle of the 21 st Century (bear in mind that in the meantime, the U.S. economy will also continue to grow, albeit at rates significantly lower than those of China). Lawrence J. Lau, The Chinese University of Hong Kong 14

15 The Chinese Real GDP and Real GDP per Capita: Past, Present and Projected Future US$ (2008 prices) Real GDP (trill.) Real GDP/capita 277 3,320 6,250 Lawrence J. Lau, The Chinese University of Hong Kong 15

16 Real Chinese GDP in US$ Since 1952 (2008 Prices) Chinese Real GDP, in 2008 prices 5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1, Billions US$ Lawrence J. Lau, The Chinese University of Hong Kong 16 Year

17 Real Chinese GDP per Capita in US$ Since 1952 (2008 Prices) 3,500 Chinese Real GDP per Capita, in 2008 prices 3,000 2,500 2,000 1,500 1, Lawrence J. Lau, The Chinese University of Hong Kong US$ Year

18 Thirty years of Chinese Economic Reform Growth Rates percent per annum Pre-Reform Reform Real GDP Real GDP per Capita Real Consumption Real Consumption per Capita Exports Imports Inflation Rates (GDP deflator) Lawrence J. Lau, The Chinese University of Hong Kong 18

19 Thirty years of Chinese Economic Reform Despite the many problems that have arisen within the past decade income disparity, environmental degradation, inadequate infrastructure it is fair to say that everyone has benefited from the economic reform since 1978, albeit to varying degrees, and few want to return to the central planning days. China is one of the very few socialist countries that have made a smooth transition from a centrally planned to a market economy. It is a model for other transition economies (e.g., Vietnam) and potential transition economies (e.g., North Korea). The rate of interest (the price of money) and the exchange rate are the only prices that are still administratively managed on the margin, in addition to the prices of different forms of energy, which are also regulated. The private (non-state) sector accounts for more than 75% of GDP and an even greater percentage of employment compared to essentially 0% in Increasingly, even public utilities, such as electric power and water, are managed by private enterprises. Lawrence J. Lau, The Chinese University of Hong Kong 19

20 Thirty years of Chinese Economic Reform The distribution of Chinese GDP by originating sector has become approximately: Primary, 11.3%; Secondary, 48.6%; and Tertiary, 40.1%. But the bulk of the labor force, more than 40%, is still in the primary sector, ensuring that there is no upward pressure on the real wage rate for unskilled entry-level labor for decades to come. Lawrence J. Lau, The Chinese University of Hong Kong 20

21 The Distribution of GDP by Sector The Distribution of GDP by Sector 100% 80% 60% 40% 20% 0% Year Lawrence J. Lau, The Chinese University of Hong Kong 21 Primary Sector Secondary Sector Tertiary Sector

22 The Distribution of Employment by Sector The Distribution of Employment by Sector 100% 80% 60% 40% 20% 0% Lawrence J. Lau, The Chinese Year University of Hong Kong 22 Primary Sector Secondary Sector Tertiary Sector

23 Total Foreign Exchange Reserves minus Gold, Selected Countries and Regions 2,000 Total Foreign Exchange Reserves minus Gold 1,800 1,600 1,400 China, Mainland Japan Russia Africa Taiwan Prov. Of China 1,200 1, M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M M Lawrence J. Lau, The Chinese University of Hong Kong 23 Year USD billions

24 Major Foreign Central Banks Holdings of U.S. Treasury Securities 800 Major Foreign Holders of U.S. Treasury Securities China, Mainland Japan Russia United Kingdom Brazil Mar-09 Lawrence J. Lau, The Chinese University of Hong Kong 24 Mar-00 Jun-00 Sep-00 Dec-00 Mar-01 Jun-01 Sep-01 Dec-01 Mar-02 Jun-02 Sep-02 Dec-02 Mar-03 Jun-03 Sep-03 Dec-03 Mar-04 Jun-04 Sep-04 Dec-04 Mar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Month USD billions

25 The Partial De-Coupling Hypothesis

26 The Partial De-Coupling Hypothesis: The Shifting Economic Center of Gravity The economic center of gravity of the world has been gradually shifting to East Asia from the United States and Western Europe and within East Asia from Japan to China. In 1960, East Asian GDP, comprising of the GDPs of ASEAN (Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand and Vietnam) + 3 (China (Mainland only), Japan, and South Korea) was less than 12 percent of World GDP. Today, East Asian GDP accounts for approximately a quarter of World GDP, comparable to the size of the U.S. economy and that of the Euro Zone. Lawrence J. Lau, The Chinese University of Hong Kong 26

27 East Asian Share of World GDP, 1960-present 26 East Asian Share of World GDP, 1960-present Lawrence J. Lau, The Chinese University of Hong Kong 27 Year Percent

28 China s Share of World GDP, 1960-present China's GDP as a Percentage of World GDP Lawrence J. Lau, The Chinese University of Hong Kong Percent Year

29 The Shifting Economic Center of Gravity East Asian shares of world exports, imports, and international trade have also grown from approximately 10 percent in 1960 to a quarter in 2007, paralleling the growth of East Asian share of world GDP. Because of the rapid economic growth of China and the rest of East Asia outside of Japan, and the demand and supply that such economic growth has generated, the East Asian economies now trade more with one another than with economies outside of East Asia, including the United States. Approximately half of East Asian trade is among East Asian economies. This is a sea change compared to say thirty years ago when most of the East Asian trade was between East Asia and the United States and Western Europe. Lawrence J. Lau, The Chinese University of Hong Kong 29

30 The Rising Ratio of East Asian Trade in Total World Trade, 1960-present 30 East Asian Share of Total World Trade, 1960-present Share of World Exports Share of World Imports 5 Share of Total World Trade Lawrence J. Lau, The Chinese University of Hong Kong 30 Year Percent

31 The Ratio of Chinese Trade in Total World Trade, 1960-present The Ratio of Chinese Trade to World Trade The ratio of Chinese Exports to World Exports The ratio of Chinese Imports to World Imports The ratio of Chinese Total Trade to World Total Trade Lawrence J. Lau, The Chinese University of Hong Kong Month Percent

32 The Ratio of Chinese Trade in Total East Asian Trade, 1960-present 35 The Ratio of Chinese Trade to East Asian Trade The Ratio of Chinese Exports to East Asian Exports 30 The Ratio of Chinese Imports to East Asian Imports The Ratio of Chinese Total Trade to East Asian Total Trade Lawrence J. Lau, The Chinese University of Hong Kong Month Percent

33 The Changing Pattern of World Trade Interdependence of the East Asian economies has been rising sharply over the years and East Asian dependence on the United States and Western Europe has declined. Interdependence of the East Asian economies will rise even further within the next five to ten years as East Asia becomes the only region with significant economic growth. The ASEAN Free Trade Area as well as its variations (+1 (China); + 3 (China, Japan and South Korea)) are rapidly becoming a reality. This is what gives credence to the idea of partial de-coupling of the world economies that the Chinese and East Asian economies can continue to do reasonably well despite the current economic problems in the U.S. and elsewhere. However, China and East Asia are not large enough to turn around the whole world. Lawrence J. Lau, The Chinese University of Hong Kong 33

34 The Share of East Asian Exports Destined for East Asia 53 The Share of East Asian Exports Destined for East Asia Jan-98 Apr-98 Jul-98 Oct-98 Jan-99 Apr-99 Jul-99 Oct-99 Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Lawrence J. Lau, The Chinese University of Hong Kong 34 Month %

35 The Share of East Asian Imports Originated from East Asia The Share of East Asian Imports Originated from East Asia Lawrence J. Lau, The Chinese University of Hong Kong 35 Jan-98 Apr-98 Jul-98 Oct-98 Jan-99 Apr-99 Jul-99 Oct-99 Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Month %

36 Chinese Vulnerability to External Disturbances

37 Export Dependence The export dependence of the Chinese economy is much less than it appears. A common misconception is that Chinese economic growth has been supported by large trade surpluses. This is not true. Chinese trade surplus vis-a-vis the World did not become significant until 2005 (long after the sub-prime loans have begun to pile up in the United States). Lawrence J. Lau, The Chinese University of Hong Kong 37

38 Chinese Monthly Real Exports, Imports and Trade Surplus (2008M12 prices) 1,000 The Real Level of Exports and Imports of Goods at the End of the Month, in RMB (in 2008M12 prices) Real Exports, fob Real Imports, cif Real Trade Balance Jan-94 Apr-94 Jul-94 Oct-94 Jan-95 Apr-95 Jul-95 Oct-95 Jan-96 Apr-96 Jul-96 Oct-96 Jan-97 Apr-97 Jul-97 Oct-97 Jan-98 Apr-98 Jul-98 Oct-98 Jan-99 Apr-99 Jul-99 Oct-99 Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan Lawrence J. Lau, The Chinese University of Hong Kong 38 Month RMB billions

39 Export Dependence Chinese exports as a percentage of Chinese GDP is somewhat less than 40 percent. However, the domestic value-added content of Chinese exports is only approximately 20 percent, that is, for every US$ of Chinese exports to the world, only 20 cents are value-added in China itself the rest consists of imported raw materials, intermediate goods, components, parts, semi-finished goods, etc. The domestic value-added percentage is even less for the so-called Processing and Assembly exports. If we multiply 40 percent by 20 percent, we obtain 8 percent, which is approximately the contribution of Chinese exports to Chinese GDP. 8 percent of GDP is a large number no one wants to lose 8 percent of GDP--but if 8 percent of the GDP does not grow, and the remaining 92 percent manages to grow, the economy will do all right. Lawrence J. Lau, The Chinese University of Hong Kong 39

40 Export Dependence Even if exports decline by 25 percent, the rate of growth of real GDP will be reduced by approximately 25 percent of 8 percent, or 2 percentage points. So, for example, since the whole-year rate of growth of 2008 is 9 percent, a 25 percent decline in exports should result in a reduction of the rate of growth to 7 percent, other things being equal. An important implication of the relatively low export dependence of Chinese GDP is that the rate of growth of Chinese real GDP is relatively stable even as Chinese exports and imports fluctuate as widely as the exports and imports of other East Asian economies. Lawrence J. Lau, The Chinese University of Hong Kong 40

41 Quarterly Rates of Growth of Exports of Goods: Selected East Asian Economies 50 Figure 3.2: Year-over-Year Quarterly Rates of Growth of Exports of Goods in US$ (Percent) Annualized Percent per annum Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Lawrence J. Lau, The Chinese University of Hong Kong 41 Quarter China,P.R.:Hong Kong India Indonesia China,P.R.: Mainland Japan Taiwan Prov.of China Korea Malaysia Philippines Singapore Thailand

42 Quarterly Rates of Growth of Imports of Goods: Selected East Asian Economies 80 Figure 3.3: Year-over-Year Quarterly Rates of Growth of Imports of Goods in US$ (Percent) Annualized Percent per annum Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Lawrence J. Lau, The Chinese University of Hong Kong 42 Quarter China,P.R.:Hong Kong India Indonesia Korea Malaysia Philippines Singapore Thailand China,P.R.: Mainland Japan Taiwan Prov.of China

43 Quarterly Rates of Growth of Real GDP: Selected East Asian Economies 20 Figure 3.1: Quarterly Rates of Growth of Real GDP, Year-over-Year, Selected East Asian Economies Annualized Rates in Percent Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Q Lawrence J. Lau, The Chinese University of Hong Kong 43 Quarter China,P.R.:Hong Kong India Indonesia Korea Malaysia Philippines Singapore Thailand China,P.R.: Mainland Japan Taiwan Prov.of China

44 Chinese Vulnerability to External Disturbances An important implication of the relatively low export dependence of Chinese GDP is that the rate of growth of Chinese real GDP is relatively stable even as Chinese exports and imports fluctuate as widely as the exports and imports of other East Asian economies. In addition, China has a very high domestic savings rate that is on average above 30% and on occasion exceeds 45% (of its GDP). It has sufficient resources to finance all of its domestic investment needs. Foreign direct investment (FDI) accounts for less than 10% of aggregate domestic investment in Mainland China. Foreign loans are unimportant as a source of investment finance. Thus, fluctuations in FDI have only very marginal impact on the rate of growth of the Chinese economy. Lawrence J. Lau, The Chinese University of Hong Kong 44

45 China and Global Imbalances

46 The Global Reliance on the U.S. Dollar for International Transactions The central banks and monetary authorities of many countries hold U.S. Dollars and U.S.$-denominated assets as part of their foreign exchange reserves because the U.S. Dollar is widely accepted and hence widely used in the settlement of international trade and capital transactions. Two countries trading with each other may not trust each other s currency, so that unless the bilateral trade is completely balanced and a straight barter is possible, they will need to use the currency of a third country which both of them trust. This currency often turns out to be the US$. The majority of world trade today is denominated in US$, including the trade in oil. Thus, US$ reserves held by these central banks and monetary authorities serve as the transaction balances for international trade and investment between countries which do not wish to accept and/or to hold each other s own currencies. Lawrence J. Lau, The Chinese University of Hong Kong 46

47 The Global Reliance on the U.S. Dollar for International Transactions A normal way for a country to be able to acquire net US$ balances is for it to run a trade surplus vis-a-vis the United States. Thus, it will receive more U.S. dollars for its exports to the U.S. than it will need to pay for its imports from the U.S. The net excess U.S. dollars will then be sold by the exporter to its central bank for local currency. The central bank will then retain the U.S. dollars in its foreign exchange reserves. It can, if it so wishes, purchase U.S. Treasury securities or other U.S.$-denominated assets or other assets. To the extent that it purchases U.S. Treasury securities it will become a creditor of the U.S. The United States, on its part, will have been able to import more than it exports, paying for the difference with U.S. Dollars and eventually with U.S. Treasury securities, which the U. S. can print at a very low cost in the short and medium run. As international trade increases, the need for U.S. Dollar balances for transactions purposes rises. It has been estimated that the amount of transactions balances Lawrence needed J. Lau, The by Chinese a country University of can Hong be Kong six months or more 47 of the value of its imports.

48 The Global Reliance on the U.S. Dollar for International Transactions The U.S.$ balances held by the foreign countries, whether in central banks or in public and private firms, thus serve a useful function in making international trade and capital transactions possible. These balances have the same relationship to international economic transactions as the domestic money supply to domestic economic transactions. For its contribution, the U.S. has what is called seigneurage, that is, it can enjoy the benefit of being the issuer of the international money, the banker to the world s trading nations. It can purchase goods and services internationally using only paper money or paper bonds which it can print more or less at will; in other words, it can purchase with credit. Lawrence J. Lau, The Chinese University of Hong Kong 48

49 The Global Reliance on the U.S. Dollar for International Transactions An obvious question is what happens if the United States stops running a trade deficit and even begins to run a trade surplus. The aggregate US$ balances in the world will no longer grow but may start shrinking. But this may constrain the growth of world trade, unless there is an alternative currency to enable international transactions or an alternative method of settlement of net trade balances is found. This is a question that needs to be addressed within the next couple of years. Lawrence J. Lau, The Chinese University of Hong Kong 49

50 The Case of China China did not begin to have a significant trade surplus vis-a-vis the world until The Case-Shiller U.S. Home Price Index began rising in 2000 and reached a peak in There was a surge in total U.S. mortgage originations beginning in 2001, and in sub-prime (and Alt-A, also sub-standard) mortgage loans in particular beginning in 2003, reaching a peak in Thus, the Chinese trade surplus vis-a-vis the world could not possibly have been the source of the excess global liquidity back in 2003 or earlier, and hence the growth of the sub-prime and other sub-standard mortgage loans in the U.S. and the subsequent bubble in the U.S. residential housing market. The recent global imbalances are probably attributable to economies with chronic large trade surpluses such as Japan and the oilexporting countries of the Middle East. Lawrence J. Lau, The Chinese University of Hong Kong 50

51 Chinese Monthly Exports, Imports and Trade Balance, US$ 150 The Level of Exports, Imports and Trade Balance of Goods at the End of the Month, in U.S. Dollars Exports, fob Imports, cif Trade Balance Lawrence J. Lau, The Chinese University of Hong Kong 51 Jan-92 Apr-92 Jul-92 Oct-92 Jan-93 Apr-93 Jul-93 Oct-93 Jan-94 Apr-94 Jul-94 Oct-94 Jan-95 Apr-95 Jul-95 Oct-95 Jan-96 Apr-96 Jul-96 Oct-96 Jan-97 Apr-97 Jul-97 Oct-97 Jan-98 Apr-98 Jul-98 Oct-98 Jan-99 Apr-99 Jul-99 Oct-99 Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 USD billions Month

52 Chinese Monthly Real Exports, Imports and Trade Surplus (2008M12 prices) 1,000 The Real Level of Exports and Imports of Goods at the End of the Month, in RMB (in 2008M12 prices) Real Exports, fob Real Imports, cif Real Trade Balance Jan-94 Apr-94 Jul-94 Oct-94 Jan-95 Apr-95 Jul-95 Oct-95 Jan-96 Apr-96 Jul-96 Oct-96 Jan-97 Apr-97 Jul-97 Oct-97 Jan-98 Apr-98 Jul-98 Oct-98 Jan-99 Apr-99 Jul-99 Oct-99 Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan Lawrence J. Lau, The Chinese University of Hong Kong 52 Month RMB billions

53 Case-Shiller U.S. Home Price Index and the Chinese Trade Surplus Case-Shiller Home Price Index (2000Q1=100) and Chinese Trade Surplus Case-Shiller Home Price Index Chinese Trade Surplus Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 USD billions -50 Lawrence J. Lau, The Chinese University of Hong Kong 53 Month 2000Q1=

54 Growth in U.S. Mortgage Originations: from John Kiff and Paul Mills (2007) Lawrence J. Lau, The Chinese University of Hong Kong 54

55 Sub-Prime and Alt-A Mortgage Loans as a Percent of Total Mortgage Loans Sub-Prime and Alt-A Mortgage Loans as a Percent of Total Mortgage Loans Sub-Prime Alt-A Percent Lawrence J. Lau, The Chinese University of Hong Kong Year

56 Chinese Trade Surplus and Change in Its Foreign Exchange Reserves, US$ billions 80 Chinese Trade Surplus and Change in Its Foreign Exchange Reserves 70 Trade Surplus 60 Changes in Foreign Exchange Reserves Jan-92 Jul-92 Jan-93 Jul-93 Jan-94 Jul-94 Jan-95 Jul-95 Jan-96 Jul-96 Jan-97 Jul-97 Jan-98 Jul-98 Jan-99 Jul-99 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan Lawrence J. Lau, The Chinese University of Hong Kong 56 Month USD billions

57 Chinese Trade Surplus and Change in Its Foreign Exchange Reserves, US$ billions 80 Chinese Trade Surplus and Change in Its Foreign Exchange Reserves, US$ billions Trade Surplus Changes in Foreign Exchange Reserves Jan-09 Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct Lawrence J. Lau, The Chinese University of Hong Kong 57 Month USD billions

58 China and Global Imbalances It is therefore not the Chinese trade surplus per se that caused the global imbalances, leading ultimately to the global financial crisis, but multiple regulatory failure in the United States and elsewhere. Lawrence J. Lau, The Chinese University of Hong Kong 58

59 The Macroeconomy in the Near Term

60 Can Mainland China Grow at 8%? Is 8% economic growth achievable? Yes, despite the difficulties in the export sector, there should be sufficient aggregate demand to sustain a rate of growth of 7-8%. Contrary to widespread perception both in and out of China, Chinese economic growth has not been dependent on its trade surplus China did not have any significant trade surplus vis-à-vis the World until 2005, when the Yuan began to be expected to and actually did appreciate significantly relative to the US$ to the tune of 20%. Lawrence J. Lau, The Chinese University of Hong Kong 60

61 Near-Term Outlook The rate of growth of real GDP has slowed from over 11% (revised to 13% in January 2009) in 2007 to 9% in The Chinese economy has essentially reached bottom in 2009Q1, with a rate of growth of real GDP year-over-year of 6.1 percent, following a rate of growth year-over-year of 6.8 percent in 2008Q4. (It should be noted that year-overyear statistics are lagging indicators: for example, it is possible the year-over-year statistics show a decline whereas properly seasonally adjusted data may show a rise.) Lawrence J. Lau, The Chinese University of Hong Kong 61

62 Near-Term Outlook The rate of growth is expected to increase in 2009Q2, by at least a couple of percentage points, due to the expected partial recovery in Chinese exports and the effect of the 4 trillion Yuan economic stimulus package (equivalent to almost US$600 billion or 16% of Chinese GDP) spread over two years adopted in November, The effects are expected to kick in some time in the second quarter of As the economic stimulus package is gradually implemented, the rates of growth for the remaining quarters will either continue to increase or remain steady. Thus a whole-year rate of growth of between 7 and 8 percent is entirely feasible. Many forecasters have independently raised their projections for the rate of growth of Chinese GDP in Lawrence J. Lau, The Chinese University of Hong Kong 62

63 Macroeconomic Outlook for the Chinese Economy There is indeed some concern that the economic stimulus package may result in wasteful investment and even greater excess capacity. While this possibility exists, at this point the primary objective is to maintain the confidence of the enterprises and households in the prospects of the economy as expectations, especially negative ones, can be self-fulfilling. Once expectations turn negative, it is much more difficult to turn them around. Unemployment has become very serious in the export-oriented regions of Guangdong, Shanghai and Zhejiang. However, most of the unemployed are rural migrant workers, most of whom have returned to their home villages, where they have support. It is inevitable that social disturbances are likely to rise in localities where the unemployment is concentrated but it is believed to be manageable with the provision of subsistence welfare of those who migrant workers that do not choose to return home. Lawrence J. Lau, The Chinese University of Hong Kong 63

64 Macroeconomic Outlook for the Chinese Economy The rate of inflation of goods, as measured by the consumer price index has remained tame, making it possible to undertake fiscal expansion without fear of rekindling inflation. The core rate of inflation, that is, the rate of inflation net of the changes in the prices of agricultural and energy goods, has remained in the -1% to 1% range during the past few years. The inflation in 2007 and the first half of 2008 was mostly due to the increases in the prices of agricultural goods and energy, both of which have declined significantly. Given the excess production capacity in many key industries, it is unlikely that there will be much inflation in the prices of goods in the next couple of years, but inflation in asset prices, such as real estate, cannot be ruled out entirely as the economic stimulus package is implemented, money supply is significantly increased and commercial Lawrence J. Lau, bank The Chinese lending University is of loosened. Hong Kong 64

65 Macroeconomic Outlook for the Chinese Economy The stock markets have stabilized at the end of December, 2008, providing some support for business and consumer confidence, and have lately shown some signs of life. Retail sales have also remained relatively stable as a proportion of GDP. The decumulation of inventory has apparently reversed course in some sectors because of the anticipation of the effects of the economic stimulus package. Lawrence J. Lau, The Chinese University of Hong Kong 65

66 Quarterly Rates of Growth of Chinese Real GDP, Y-o-Y 25% Quarterly Rates of Growth of Real GDP (YoY) 20% GDPQ1 GDPQ2 GDPQ3 GDPQ4 15% 10% 5% 0% 1983q1 1983q3 1984q1 1984q3 1985q1 1985q3 1986q1 1986q3 1987q1 1987q3 1988q1 1988q3 1989q1 1989q3 1990q1 1990q3 1991q1 1991q3 1992q1 1992q3 1993q1 1993q3 1994q1 1994q3 1995q1 1995q3 1996q1 1996q3 1997q1 1997q3 1998q1 1998q3 1999q1 1999q3 2000q1 2000q3 2001q1 2001q3 2002q1 2002q3 2003q1 2003q3 2004q1 2004q3 2005q1 2005q3 2006q1 2006q3 2007q1 2007q3 2008q1 2008q3 2009q1-5% Lawrence J. Lau, The Chinese University of Hong Kong 66 Quarter Percent per annum

67 Monthly Rates of Growth of Real Value- added of the Industrial Sector, Y-o-Y 25 Rate of Growth of Real Value-Added of the Industrial Sector, Year-over-Year Lawrence J. Lau, The Chinese University of Hong Kong 67 Jan-95 Apr-95 Jul-95 Oct-95 Jan-96 Apr-96 Jul-96 Oct-96 Jan-97 Apr-97 Jul-97 Oct-97 Jan-98 Apr-98 Jul-98 Oct-98 Jan-99 Apr-99 Jul-99 Oct-99 Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Month %

68 Monthly Rates of Growth of Chinese Fixed Assets Investment, Y-o-Y 60 Rates of Growth of Fixed Investment since 2000, Year-over-Year Lawrence J. Lau, The Chinese University of Hong Kong 68 Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Month Percent

69 Monthly Rates of Growth of Chinese Real Retail Sales, Y-o-Y 25 Rates of Growth of Real Retail Sales since 2000, Year-over-Year Lawrence J. Lau, The Chinese University of Hong Kong 69 Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Month Percent

70 Provincial Economic Performance It is interesting to take note of the rates of growth of the individual provinces/regions/municipalities of China. The GDP-weighted averages of the provincial rates of growth for 2008Q4 and 2009Q1 are respectively and 7.93 percent (higher than the National Bureau of Statistics figure of 6.8 and 6.1 percent, which is normal). Among the provinces, the three slowest growing ones in 2009Q1 are Shanxi (-8.1%), Shanghai (3.1%), and Zhejiang (3.4%). Shanxi, the principal coal-producing region of China, has been affected by the decline in both the price and the demand for coal. Shanghai and Zhejiang (the Yangzi River Delta region) are among the most externally oriented regions in China in terms of exports, arrivals of foreign direct investment, and arrivals of foreign tourists. So it is no surprise that they have been the hardest hit. However, even Guangdong (the Pearl River Delta), equally externally oriented, has been able to grow at 5.8 percent, slightly below the national average. The three fastest growing provinces/regions/municipalities in 2009Q1 are Tianjin Lawrence (16%), J. Lau, Guizhou The Chinese University (15.9%), of Hong and Kong Inner Mongolia 70 (15.8%), all at double-digit rates.

71 Quarterly Rates of Growth of Selected Chinese Provincial GDPs, Year-over-Year Quarterly Rates of Growth of Provincial GDP, Year-over-Year Percent The Weighted Average Rates of Growth The National Real Rates of Growth Tianjin Inner Mongolia Shanghai Zhejiang Guangdong Guizhou Lawrence J. Lau, The Chinese University of Hong Kong Q1 2008Q2 2008Q3 2008Q4 2009Q1 Quarter

72 The Intra-East Asian Capital Flows Almost all of the East Asian economies, with the possible exception of the Philippines, have high national savings rates on the order of 25% or above. What this means is that East Asian economies and East Asia as a region have an adequate supply of savings to finance their own investments and do not need to rely on foreign direct or portfolio investment or loans to meet their domestic investment demands. There are sufficient savings to support an East-Asia-wide capital market. East Asia has also been an attractive destination for foreign direct investment, originating from both inside and outside East Asia. Japan has been a major investor in other East Asian economies for at least three decades. China has been the destination of investment, both portfolio and direct, from Hong Kong, Taiwan, Japan, South Korea, Singapore, Thailand, and many other economies outside of East Asia. It has also emerged, in recent years, as a major source of Lawrence J. Lau, The Chinese University of Hong Kong 72 direct and portfolio investment in other East Asian economies itself.

73 The Precipitous Decline of Export Orders The failure of Lehman Brothers in mid-september of 2008 caused bank credit to be completely frozen in the United States and in many parts of Europe, including the United Kingdom. It has meant that importers in these countries and regions can on longer have their banks issue letters of credit to exporters in the rest of the world, including East Asia and China. And even if their banks issue letters of credit, they may not be accepted by banks in East Asian economies. Moreover, it has also meant that importers will not have access to credit to finance their inventories. The result has been an immediate, precipitous reduction in the export orders, on the order of 50 percent compared to a year ago, received in East Asia and in China. Lawrence J. Lau, The Chinese University of Hong Kong 73

74 The Precipitous Decline of Export Orders However, it is important to realize that this reduction in export orders is primarily the result of a freeze in bank credit, as opposed to a reduction in the demand for imports, or the price of imports being too high (during this period, the US$ has actually been appreciating or holding constant relative to East Asian currencies with the sole exception of the Japanese Yen). Even with the United States in recession, domestic personal consumption in 2009 is projected to decline by no more than 10 percent, and that should translate into a decline in import demand of at most 2 or 3 times the decline in consumption. Moreover, imports from East Asia and China consist of predominantly low-end products, which should be relatively recession-proof as consumers shift from the high end to the low end (in fact, Wal-Mart sales have actually risen during this period). Thus, it is not possible for Chinese and East Asian exports to be reduced by 50 percent permanently. Lawrence J. Lau, The Chinese University of Hong Kong 74

75 The Partial Recovery of Exports What has actually occurred is a postponement of the orders by the importers in the U.S. and elsewhere until they have the opportunity to work down their inventories and thereby raise cash (since they no longer have access to commercial bank credit). The East Asian and Chinese Governments have also been pro-actively promoting or providing seller (exporter)- financing of their exports. Now, two quarters later, East Asian and Chinese export orders are beginning to recover. Lawrence J. Lau, The Chinese University of Hong Kong 75

76 The Partial Recovery of Exports But it is unlikely that the East Asian and Chinese exports will recover to their previous peak levels. This is because demand for goods such as furniture, large-ticket items (consumer durable) such as refrigerators, washing machines, large-screen flat-panel television sets will have to await the recovery of the housing market. Hightechnology exports will also not recover quickly because in a recession both firms and households in the U.S. and other developed economies will postpone the replacement of personal computers, notebook computers and other information technology equipment until better times return. Thus, these industries will continue to face low export demands and must reorient themselves to serve the large and growing domestic consumption market. However, everyday consumption goods such as apparel and shoes will gradually recover and this recovery has been borne out by anecdotal evidence and by preliminary statistics on logistics, Lawrence J. Lau, The Chinese University of Hong Kong 76 shipping and transportation.

77 The Chinese Economic Stimulus Package The Chinese Government has acted promptly and decisively in response to the global financial crisis and adopted a 4-trillion Yuan (over two years, equivalent to approximately 8 percent of GDP per year) economic stimulus package in November of last year. This has helped to maintain the confidence of both firms and households in China. As the effect of the economic stimulus package begins to be felt in 2009, the rate of growth should accelerate from its low of 6.1 percent in 2009Q1. Moreover, Premier WEN Jiabao of the People s Republic of China has committed to additional economic stimulus measures beyond the 4-trillion Yuan. Thus, an 8 percent rate of growth for the Chinese economy in 2009 and 2010 is entirely likely. Lawrence J. Lau, The Chinese University of Hong Kong 77