Int'l Herald Tribune

What if things go wrong in China?

International Herald Tribune
Saturday, December 11, 2004
By William Pfaff

While the flutter of a butterfly's wing might not be quite enough to disrupt the international economy, it does not take more than a few flutters to spook traders, bankers and governments into interlinked financial crises. The vulnerability of advanced national economies to international disruption was demonstrated first in 1914, and again in 1929. It could find a new demonstration in the case of China today - or the near future.

Before 1914, people had been told that international economic interdependence made major war impossible. They discovered this was untrue. They found that "globalized" economies don't prevent war. Typically, when the time comes, they spread chaos, not peace.

Consider China.

Today the world economy is more integrated than ever before. The promotion of international financial deregulation started out in the 1990s as an American strategy for expanding investment and profits for Wall Street. Few thought through the consequences that globalization could have for unsophisticated economies and financial systems. These have included much social and political destruction, as well as the deployment of new energy for growth in many of these nations. The dangers of interdependence were ignored at the start. This proved a mistake.

We may have seen nothing yet. China is now a huge and inexperienced player in the globalized game. Sheer scale now gives it immense, intricate and largely unregulated - or at least uncontrolled - involvement in the world economy and leverage over it. This is because all has been connected up.

The elements of a possible multiple crisis are well known. The first is American dependence upon Asia's - particularly Japan's and China's - purchase of American state and private debt. A halt to this investment in U.S. debt could devastate the American economy.

The halt seems unlikely, since Asian investors are caught in a dilemma. Withdrawal from dollar investments will speed the fall of the dollar, devaluing their investments quickly rather than slowly.

A few days ago, a rumor that China might reduce its dollar holdings gave the market a bad few hours. Nonetheless, it is reported that while China's foreign currency holdings have been increasing, its dollar exposure is not increasing.

Next, China's economy depends on continuing Western, and especially American, outsourcing of production and import of manufacturing sourced in China, although in this respect it is probably the least vulnerable of the new Asian industrial countries. Its foreign investment is largely from overseas Chinese, who will not shift out of China.

The third source of potential international disruption is China's globalization of its raw-materials purchases and sources. Recent large Chinese trade missions to Latin America and Africa, and the virtual takeover by China of the industrial raw-materials exports of certain countries, like Australia, mean that disruption of the Chinese economy in the future could disrupt a large segment of the world economy.

Is a crisis likely? There are signs of a bubble mentality in the outside world's attitude toward China. Its economy and soaring trade importance inspire analysts to wonderment and superlatives, despite the well-known fact that much of China's statistical growth is a result of speculative real estate development.

However, the possibility of political ruin is what means the most. Counting from the Tiananmen demonstrations, China has been politically stable, and under close police surveillance, for 15 years. Counting from the death of Mao Zedong, the defeat of the Gang of Four and the rise of the reformers led by Deng Xiaoping, China has been stable for somewhat less than 30 years.

To those economic analysts, stock traders, investment bankers and think-tank experts who know no history, China is therefore stable.

However, counting from China's forced opening to foreign trade in 1834 to Mao's death, modern China knew virtually nothing but instability and disruption for a century and a half, as well as the decline and fall of two dynasties, the Manchu and the Maoist.

This regime awaits its political crisis. The Communist Party lacks ideological legitimacy and survives by bureaucratic presence and power - and fragile economic growth. Political and economic ferment is everywhere.

One of these days, something is going to happen. The world, and its economy, will take notice.