Dr Andy Xie considers that neither devaluation nor another stock market bubble can promote China’s economic health.
China is in the midst of serious debt deflation. Massive debt-funded investment has engulfed the economy since 2008. It was justified on the grounds of shoring up the economy during the global financial crisis. When the global economy recovered, the built capacities could be utilised. Unfortunately, the expected demand boom hasn’t come. Instead, investment demand has been sustained to keep factories occupied – that is, building more capacity to keep the existing capacity occupied. The end to such a story is always deflation and bad loans.
A new bubble like that in the stock market can never be a proper tool to handle the consequences of an old one. The only path forward is to cut excess capacity, handle the resulting bad loans, and massively cut taxes to rebalance the economy.
Devaluation has been marketed as necessary for boosting the economy but the real motivation is to create room for printing money to bail out speculators. At best, this will buy time to delay the necessary reforms, but it will create a bigger problem for the future. At worst, it could trigger a confidence crisis and massive capital flight, repeating the mistake that Indonesia made in 1998.
Beijing’s devaluation is a trial to see how the world will react. If there are no strong responses from the market or the US government, a big devaluation may well be coming. One likely consequence is that the US Congress could pass a protectionist bill with a punitive tariff to match the devaluation. While China could go to the World Trade Organisation, it would be a long time before a judgment was rendered and, even if favourable, it would be too late to help.
Reform, not devaluation, or a new bubble, is the only viable path forward.
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Dr Andy Xie 謝國忠, Shanghai-based independent economist, has just been named “ 50 Most Influential Persons in Finance”by Bloomberg, and is currently director of Rosetta Stone Advisors.Dr Xie is one of the few economists who has accurately predicted economic bubbles including the 1997 Asian Financial Crisis and the more recent subprime meltdown in the United States. He joined Morgan Stanley in 1997 and was Managing Director and Head of the firm’s Asia/Pacific economics team until 2006. Prior to that he spent two years with Macquarie Bank in Singapore, where he was an associate director in corporate finance. He also spent five years as an economist with the World Bank.
Dr Xie earned a PhD in economics in 1990 and an MS in civil engineering in 1987 from the Massachusetts Institute of Technology.