Wednesday, November 9, 2011

China looks at life after Euro as its Economy falters....

China looks at life after Euro as its Economy falters....

By Antoaneta Becker

BEIJING - If Chinese detractors of liberal democracy and unbridled market development ever needed more fodder for their attacks on the West, then last week's Greek farce provided plenty. But behind the headlines announcing "the collapse of Europe" there is little sense of ideological triumph. Instead Beijing is busy drawing up contingency pans for the break up of the eurozone and absorbing the lessons of welfare state excesses.

Beijing - often at the receiving end of criticism that in its attempts to preserve social stability above all it often tramples on civil rights, did not miss a chance to deride Brussels for its "mantra of stability".

"The collapse of Europe is irreversible," declared an editorial in

Monday's 21st Century Business Herald. Rather than admitting that Greece was bankrupt and would never be able to repay its debts, it said Europe had instead "thrown its principles out of the window."

"Stability prevails over principle" was just another sign of the "degradation of the European spirit," the editorial said.

Not long ago it was Brussels that lectured Beijing on its economic management, but now Chinese leaders see it as their duty to admonish the European Union. Even before last week's Cannes fiasco and its public display of the EU's inability to follow through on the rescue plan of the eurozone it had painstakingly designed, Chinese premier Wen Jiabao had issued some stern warnings.

"The most urgent task is to take decisive measures to prevent the debt crisis from spreading further and avoid financial market turbulence, a recession and fluctuation in the euro," Wen told European Council President Herman Van Rompuy in a phone call two weeks ago. In marked contrast with Beijing's repeatedly voiced confidence that Europe can overcome its problems, Wen's comments sounded sobering.

"Apart from urgent measures to address these problems, the key is to undertake systematic and fundamental fiscal and financial reform," Wen said, according to a report on the Chinese Foreign Ministry website.

But after the Cannes meeting Beijing seems to have lost its confidence that Brussels has what it takes to undertake the fundamental reforms needed. The Cannes G-20 summit originally designed to put the final touches to Brussels eurozone rescue plan and entice emerging economies like China to dip into their foreign currency reserves and provide capital for Europe's bailout fund unraveled with the Greek prime minister's announcement then that he needed a national referendum to approve the bailout program.

The summit concluded last Friday without any concrete results. Even though Greek Prime Minister Papandreou withdrew his referendum idea later, and after he won a parliamentary vote of confidence, the damage had been done. The political uncertainties meant that neither China nor any other country could agree to join the European bailout.

To say that Chinese analysts have been perplexed at what transpired at the Group of 20 Cannes summit is an understatement.

"If a small country like Greece with an economy that accounts only for 3 percent of the EU's economy can derail the whole union and kidnap a summit of the world powers, this says something about the deficiency of the EU's political and economic integration," says current affairs commentator Xia Wenhui.

Comparisons were being made with the unification of the Chinese empire under the first Chinese emperor Qin Shihuang (259 BC-210 BC), pointing out that he first unified the different warring states politically before imposing a common currency. The comparisons were not flattering to Europe.

While before the Cannes summit the focus here was on the pros and cons of China buying more euro debt, now attention has shifted to crisis prevention. TV commentators are warning that if a new "financial tsunami" is coming, China should be busy strengthening its dykes and bracing for the onslaught of a new recession.

Beijing's export-led model of economic growth depends on European markets, and the euro bloc's crisis has already taken a toll on Chinese factories churning out goods for export. The impending recession in Europe would mean more pain for Chinese manufacturers.

China holds about a quarter of its US$3.2 trillion of foreign exchange reserves in euro assets. If the eurozone collapses, Beijing's stake in its biggest trade partner would be at peril.

But the Greek crisis has also provided Beijing with some valuable lessons on how to proceed with its own social welfare reform.

"We have to be mindful that with our population size and the huge number of retired people in the future, the pensions have to be adequate," said one government official who spoke on condition of anonymity. "If China's economy falters and we are not able to pay those social benefits, then the crisis here will be of much bigger scope than what we see in Greece."
A crack in the China wall....
By Benjamin A Shobert

WENZHOU, China - At first, he answers my question with a shrug. Having asked this factory owner how many businesses like his in this eastern Chinese coastal city are struggling to find capital, he goes on to say "a thousand, maybe more, I really don't know". They are all feeling the impact of a local loan crisis estimated to threaten 40% of businesses in the city with insolvency.

This part of China has long been home to China's most aggressive entrepreneurs, running small and medium-sized enterprises (SMEs) that serve as the world's factory for cigarette lighters, inexpensive leather goods (shoes and purses especially) and sunglasses, to name just a few of the locally produced products. These companies, once essential for China's economic growth, are today struggling to obtain bank credit that would allow them to pay their laborers, raw material providers and extend credit to their export customers.

Each of the factory owners I met with was quick to point out the speed with which the Chinese government has stepped in to address their problems. Several were obviously proud that the government had acted to move before the situation got any worse. In addition, the factory owners were obviously eager to present their businesses as stable and capable of handling new orders from the United States.

Most were eager to highlight the government's willingness to step up where private lenders had not been willing to extend credit. As part of this, a local government official, Zhou Dewen, chairman of the Wenzhou SME Development Association, recently announced that an additional US$141 million of capital was being made available to local distressed banks and the SMEs they serve.

But access to capital with favorable terms is not the only issue Wenzhou SMEs are facing. One factory manager admitted "this year, the orders have not been so good." His comments echo what the Chinese government itself has acknowledged in the past week. Orders placed during the critical Canton Fair in late October, which celebrated its 110th anniversary during this year's Guangzhou exhibition, were disappointing: down double digits over last year from the developed economies in Europe and the United States these SMEs all rely on.

As much as the liquidity crisis facing Wenzhou SMEs remains a concern, these businesses appear much more troubled by the downturn in orders from their American and European clients and the overall increase in costs they are facing on seemingly every front. Most, if not all, of these factories rely on thin margins to survive; margins so thin that the smallest disruption in order pattern, change in government policy, or increase in the relative cost of inputs could put any one of them out of business.

This trifecta is precisely what has been happening, which makes the true cause of the SMEs' failure - whether it is lack of liquidity or downturn in demand - not yet clear to outsiders.

Since late 2010, SMEs in Wenzhou have been facing each of these three problems; consequently, it should come as no surprise that many have chosen simply to close up shop or switch to producing other goods for export. A local Chinese businessman recently estimated that Wenzhou used to host over 4,000 cigarette lighter companies but now has only 100 factories still open of which, "only 50 are operating normally".

With little in the way of value-added manufacturing to offer their export markets, Wenzhou's many SMEs face an uncertain future. Interest rates for those companies lucky enough to qualify for a loan have risen over 40% since 2010. Wages have increased 20% over the same period and appreciation of the yuan relative to the dollar, while certainly not at levels significant enough to make politicians in Washington DC happy, has decimated these SMEs' profit.

Estimates vary, but it is widely agreed that SMEs in Wenzhou currently operate at between 3% and 8% profit margins. Couple these margin pressures to a downturn in demand, and you have a recipe for disaster. Even if banks were operating normally in these times, they would only serve to extend the runway a bit longer for businesses whose fundamentals are in disarray.

Earlier this year, the closure of several established businesses in Wenzhou (Zhejiang Jiangnan Leather, Portman Coffee, and Yueqing Three Citigroup) first brought attention to this question. Then, the Chinese government was quick to suggest that these three businesses had closed because of problems of their own making and disavowed that any underlying liquidity issues had driven any of them out of business. But now, given the thousands of SMEs in Wenzhou threatening to close their doors for good, it appears these three businesses might very well have been a signal that something else was going wrong.

Part of what may explain the central government's uneven response to the growing crisis has to do with how Beijing perceives itself. The country's leadership recognizes the inherent limits of China's export-led model, limits that SMEs whose only competitive advantage is low cost labor have been the first to encounter.

In many ways, the companies closing their doors in Wenzhou are similar to those low on the value chain that were forced out of Guangzhou and Shenzhen in the run-up to the 2008 Olympics and the higher minimum wages which the government mandated. But while the government may want to see its domestic producers move up the manufacturing value chain, the unpleasant reality Beijing is coming facing with the Wenzhou crisis is that the country is not yet ready to divorce itself from acting as the world's factory.

Wenzhou's thousands of SMEs may not be the future Beijing hopes for, but neither are they a remnant on which the country can simply turn its back. For the foreseeable future, Beijing needs a vibrant and stable SME sector as the entry-point for the millions of low-skilled rural workers who make their way into China's cities every year. The government's response to this crisis suggests that for all the posturing about building an economy around high-speed rail and aerospace, China will need plenty of cigarette lighter and shoe factories for quite some time if it is to continue growing.

Pundits have suggested that the problems in Wenzhou's SME sector represent the first major cracks in the wall of China's opaque banking system, signs the country's banks no longer have the risk tolerance or liquidity themselves to continue funding a portion of the economy most believe is extremely vulnerable to down-turn, inflationary pressures, and low-skilled labor from other countries in the region like Cambodia, Indonesia and Vietnam. While this may be true, the more general feeling in Wenzhou is that this crisis is a necessary growing pain for everyone involved.

For banks which have been willing to extend credit to SMEs whose financial condition has been and will likely continue to be fragile, the decision to push away from their historical support for the SME sector may well be a signal that China's economy is maturing. Seen from this perspective, Beijing's response to incentivize additional lending where banks choose not to should be understood primarily in a political context; namely, that the government wants to ease the way out for both existing businesses and workers who will use this crisis as motivation to move into other businesses and transition into jobs elsewhere.

Many SMEs caught in the midst of this crisis are likely to be among the first contemporary casualties of China's success. Once the industries, factories and workers that China's economic miracle began with, these groups are now outdated. Ultimately, even those SMEs able to make it through this rough patch will have to face the implications of the Darwinian process that capitalism and free markets have already set in motion. They may live to fight another day, but their long-term prognosis is not good, something the many banks and private lenders who chose to cut off lending and precipitate this crisis understood well before Beijing did.

Whether Beijing acts to prop this sector up at high cost to other national priorities remains to be seen. Given how the American and European governments responded to threats that certain key industries within their own countries might fail post the 2008 financial crisis, it should come as no surprise that Beijing has acted forcefully and quickly to protect this part of its own national economy.

After all, if capitalism with American characteristics has had to intervene to support vulnerable domestic industries, why shouldn't capitalism with Chinese characteristics inevitably walk down the same path?

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