CHINA´S BEST WAY FORWARD / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( A MUST READ )

China’s best way forward

By Yu Yongding

Published: January 18 2011 20:33

After 30 years of breakneck growth, China overtook Japan to become the world’s second largest economy in 2010. The reaction in the west to this stunning success boils down to one question: what role will China play in the world? China will have a bigger part to play in global areas such as climate change, poverty alleviation, infrastructure, and reform of the international monetary system. But my country has long remained inward-looking, a tendency most clearly expressed in our Great Wall. Despite occasional bellicose reactions to what it regards as provocations, China still harbours no ambition to be a hegemonic power.


Even so, as former US national security advisor Zbigniew Brzezinski noted recently, the risk of a “drift into escalating reciprocal demonisation” with America is the worst possible outcome for Asian stability, and US-China relations. Avoiding this fate requires careful management – especially as 2011 sees no shortage of economic challenges. An unstable global recovery, the threat of protectionism, and fiscal pressures all require strong and coordinated action. Here China must play a critical role – just as it did during the global financial crisis when it did more than any other economy to pull the world out of the recession.


China will remain an important engine of global growth, even as its economy is changing. Over the next four years it will shift from export and investment-driven growth to a more balanced pattern. Growth may soon be significantly lower, if more sustainable. Inflation, currently at 5.1 per cent, is an important near-term risk. Global liquidity overhangs have led to rising input costs, but a recent credit binge is the main culprit.

As investment growth and strong exports constrain capacity, abundant liquidity, strong demand and supply-side shocks (such as bad weather) make inflation inevitable. The tug of war between real estate developers and central government is also ongoing. To avoid a Japan-style bust China must stabilise property prices, while meeting the public’s demand for affordable housing.


Crucially, China must be willing to make short-term sacrifices, such as asset price adjustments or temporary employment losses in certain sectors, to guarantee long-term stability. Its strong fiscal position and low debt can ease any pain, ensuring domestic demand does not suffer dramatically. There will be tough choices, but failure to cool the economy will have serious consequences for China’s long-term growth – while a hard landing would shake confidence in emerging markets, and set back the global recovery.


America, meanwhile, continues to attempt to blame an undervalued renminbi for its economic woes – a view that is largely without merit. Even so a stronger currency would benefit the US, while also helping China promote structural adjustment and contain inflation. Here China must choose between large current account surpluses and lower reserve accumulation. The latter path means less central bank intervention in foreign exchange markets, and thus tolerating greater appreciation.


Within the Group of 20 leading nations China should, as a show of goodwill, support Tim Geithner, US Treasury Secretary, and his indicative current-account targeting ideas. Capital flows will also remain a problem as China tries to rein in inflation and asset bubbles. Like other emerging economies, it must strengthen its management of cross-border capital inflows, even though some of these flows are not actually speculative in nature.


China has stated that it will do nothing to destabilise sovereign bond markets. But the US and eurozone must also act responsibly towards creditors here. China has supported eurozone policy throughout the current crisis, but must urgently seek clarification as to whether its holdings of euro periphery debt will be part of any restructuring. Until such clarification is provided, or the eurozone comes up with a permanent resolution mechanism, China should give no commitment to support the eurozone through direct government bond purchases – this risks simply throwing good money after bad.


America may need to change course too. At present the US is debasing its currency through more quantitative easing, while President Barack Obama’s recent tax deal failed to address the deficit in a way that would allay the fears of its creditors. As a result 2011 could be the year where China sends a clear message to the US: do not expect any more munificence.


The lack of alternatives to the dollar as a reserve currency has bred a false sense of security in the US. Yet when China reduces its current account surplus (and diversifies from dollar assets) the effect will be felt in US Treasury markets. Some in Washington dismiss this possibility, but surely a healthier US fiscal balance is in everyone’s interests? Here the US must make sacrifices too. China must also face up to its responsibilities, but we will demand that rest of the world reciprocates.


The writer is a former member of the monetary policy committee of the Chinese central bank www.mediatank.com


Copyright The Financial Times Limited 2011.