China's Future: Western Optimism and Chinese Pragmatism

Back in March, we posted about a declining phase in Chinese growth and the need for a new economic model.  Hedge funds which have made bets on a "hard landing" for China are likely to be disappointed.  The reasons are rather simple.  In Western financial markets, shocks are transmitted quickly through financial speculation, markets turn volatile and overshoot before a new equilibrium is found.

This scenario shouldn't apply to China.  Investments are controlled by the government and directed into jumbo, state run enterprises.  The government is sitting on vast hordes of liquid currencies and securities, and the currency is managed.  Financial markets are not all transparent. Numbers cannot be trusted. Look at the long running fiasco at Sino Forest, which would have collapsed within weeks on any major international exchange.  Sophisticated investors are as powerless as retail investors in a pink sheets stock. 

The Chinese landing won't be a hard landing.  It will be more like a King Air that loses both its engines.  If the Chinese government is a good pilot, the plane will continue to fly and glide to a landing, perhaps with some bumps at the end.  This isn't to say that there won't be  prices to be paid among segments of the Chinese population.  The private sector folks who have made quick fortunes on light manufacturing will be chastened by recessions in their customer countries.  Since the Chinese model is a mercantilist, managed model with humongous external balances and muted internal demand, a steady hand on the stick can bring the plane in. 

The longer run question is what happens when China continues to pursue its own nationalistic, pragmatic interests.  Isolation from the international community could be an unintended  and undesirable consequence.  We've written before about sweeping Chinese claims in Pacific waters around contested islands.  In the absence of an operative Law of the Sea Treaty, the U.S. has no basis to dispute any of these claims, except to object and refer to customary international law. 

As an example of China's thumbing its nose at Western trade management mechanisms, we have the Chinese government slapping tariffs and anti-dumping charges on SUV's exported by General Motors.

    credit: David Gray/Reuters in New York Times, 12/15/2011
Even though the Government is said to have conducted a two year study into the issue of subsidies and dumping, their results weren't shared with the Office of the US Trade Representative, even as a courtesy. 
With the already high levels of taxes and fees, GM's commitment to this potentially lucrative market is likely to yield no results in a profitable vehicle line.  Meanwhile the sight of its Buick SUV's covered in dirt and clay on a Chinese pier does nothing for the brand equity either.  Don't think that this little poke in the eye wasn't carefully orchestrated. 

Besides indignation, the U.S. has no meaningful response, except pushing papers and filing claims.  There may not be as much gold in Shangdu as hoped for GM and other US exporters.