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The United States and Europe are China’s biggest customers. Their combined imports in 2007 totaled US$675 billion. If Canada, Japan and some other developed economies are added to the importers list, then the combined imports rise to US$950 billion.
China’s total merchandise exports stand at US$1.2 trillion. In return, it imports US$900 billion of raw materials and other goods. That leaves a favorable trade surplus of US$300 billion a year. This surplus adds to China’s ever-increasing store of foreign exchange cash reserves.
As the United States and Europe fall into recession, followed by the rest of the world, it is very likely that demand for consumer goods in America and Europe will decline. Add to this the lack of available credit, and the situation worsens. If the recession lasts longer than two or three quarters, demand for consumer goods will take a much bigger hit. This unintended collapse in demand does not bode well for Chinese exports.
The jury is still out on whether the recession will be mild or persist for a long time. The credit crunch and its effect are leading economists to believe that this recession is much different from any recession in living memory. This is not only because it will last three to four years, but also because its repercussions may be much deeper than thought.
Economists believe that India and China, with their high-growth economies, will suffer between 3 and 5 percent reduction in their economic growth outlook. India probably will see its growth scaled back 5-6 percent from its previous forecast of 9 percent, and China, with 60 percent of its gross national product being export-oriented, is likely to suffer a greater decline of 5-6 percent growth from its previous high of 11 percent.
In the West, this recession will be an engine for a complete restructuring of how economies are managed. Some changes within the United States are unavoidable, like the complete restructuring of Wall Street, greater government control of banks, elimination of the trade deficit that is a drain on the economy and efforts to repay some of its US$10 trillion debt.
The implementation of these changes will be a starting point for the new administration, which will take office in January 2009.
Let us hypothetically assume that recession leads to a 1.5 to 3 percent decline in the European and U.S. economies during 2009-10. Its net result will be a decline in retail sales of 3 to 4 percent each year. Merchants will place an average of 10 to 15 percent fewer orders with Chinese factories. Besides, the West will ask for lower prices. So, there will be a double whammy on Chinese exports: first, there will be less demand; second, prices will need to be lowered, cutting heavily into an already thin margin on exports.
Fewer orders to Chinese factors leading to losses of US$120 billion will translate into thousands of small, marginal units closing down. Close to 10-12 million people will have to be laid off or sent to work elsewhere on other state projects.
The above is already happening in China. Although they do not officially admit it, there has been a decline in export orders for toys for the upcoming Christmas season. This has resulted in marginal manufacturing units closing down, throwing thousands out of work. The Baltic Dry Index of freight rates has already taken a nosedive. This indicates that shipments all across the world are down; Chinese ports are no exception to this decline.
Recession in China is very different from the West. Although the Shanghai Stock Exchange has already taken a 60 percent hit, it is still not the talk of the town. Factories, except for toy manufacturing units, are still turning out products.
If no export orders are received, the Chinese government will offer excess products for domestic consumption. However, if 10 to 12 million people are out of work and an additional 10 to 12 million new workers are not employed, as has been the case for the last four years, then the internal demand for manufactured products will also take a nosedive. Unsold merchandise will pile up in warehouses.
Unlike in the West, workers do not go on strike in China. They just accept the situation. Also, governments do not fall, as elsewhere. Leaders explain the causes and hope for better times in the future.
The impact of this slowdown in India will be similar to China. But the current government will not survive a major slowdown. It will most likely fall. Luckily, India is not a major export country; hence, the impact on it will be less severe. Also, information technology and business process outsourcing companies will pick up sooner rather than later, and that will help beat away the ugly aspects of recession.
China’s US$1.8 trillion in reserves, which is on paper, is unlikely to benefit it during this slowdown as the bulk of it is in the United States, which is unlikely to hand it back to China when facing an acute economic crisis of its own. Some 40 to 50 percent of these holdings are in U.S. Treasury bonds, which cannot be cashed easily. The rest of it is in euros and investments on both sides of the Atlantic. Although the real impact of the current slump on Chinese reserves is not yet known, a good guess is that they will be worthless.
The point is that future trade deficits will be cut in half as exports reduce. The growth of Chinese reserves will also be less spectacular than before. A future of balanced trade is about to begin.
All the prosperity in China is primarily based on two things: a favorable dollar-yuan relationship and the amount of foreign direct investment pouring into China. A favorable currency exchange rate has, in the last 10 years, promoted exports and discouraged imports.
The United States and Europe, China’s biggest trading partners, have allowed for a huge trade surplus in China’s favor by allowing the yuan to be undervalued. Even after a 7 percent increase in the yuan’s value to the dollar in 2007, the currency is still undervalued by as much as 12 to 15 percent. The next two years will see the yuan’s value increase by 15 percent. This will lower exports and increase imports.
Changes in trade policy toward China are forthcoming. In three months’ time, there will be a new administration in the United States; the current financial crisis topped with a longer recession will force a different type of economic management. It will surely result in revisions to the yuan-dollar and yuan-euro relationship. The revised rate will level the playing field.
The next five years will see a new economic structure in the West. China could be in for a rude shock during 2009-10, if its trade surplus is cut in half. What will happen to its dollar reserves is not yet known.
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(Hari Sud is a retired vice president of C-I-L Inc., a former investment strategies analyst and international relations manager. A graduate of Punjab University and the University of Missouri, he has lived in Canada for the past 34 years. ©Copyright Hari Sud.)
