Britain's love affair with China comes at a price

David Cameron is right to treat Xi Jinping with respect but commercial pickings are likely to be thin as China's economic miracle fades

By Ambrose Evans-Pritchard
Robbery of the Summer Palace, by Sun Tao, one of the works produced in a  101.6 million yuan government drive for propaganda art to celebrate its 60th birthdayRobbery of the Summer Palace, by Sun Tao, produced as part of a state propaganda drive Photo: BLOOMBERG

It is a sobering experience to travel through eastern China with a British passport. Again and again you run into historic sites that were burned, shelled or sacked by British forces in the 19th century.

The incidents are described in unflattering detail on Mandarin placards for millions of Chinese national pilgrims, spiced with emotional accounts of the Opium Wars.

The crown jewel of this destructive march was the Summer Palace of the Chinese emperors outside Beijing, looted of its Qing Dynasty treasures by Lord Elgin in 1860, and burned to ground.
It was a reprisal for the murder of 18 envoys by the Chinese court, but the exact "casus belli" hardly matters anymore.

The defilement lives on in the collective Chinese mind as a high crime against the nation, the ultimate symbol of humiliation by the West. The Communist Party has carefully nurtured the grievance under its “patriotic education” drive.

David Marsh, from the Official Monetary and Financial Institutions Forum, says Britain’s leaders are implicitly atoning for a colonial past by rolling out the red carpet this week for Chinese President Xi Jinping, and biting their tongue on human rights. They are acknowledging that British officialdom is in no fit position to lecture anybody in Beijing.

The exact line between good manners and kowtowing is hard to define, but George Osborne came close to crossing it on his trade mission to China last month, earning plaudits from the state media for his “pragmatism” and deference.

But as the Chancellor retorted, you have to take risks in foreign policy. Moral infantilism is for the backbenches. “China is what it is,” he said.

The proper question for David Cameron and Mr Osborne is whether they have accurately judged the diplomatic and commercial trade-off in breaking ranks with other Western allies and throwing open the most sensitive areas of the British economy to Chinese expansion, and whether they will reap much in return.

The US Treasury was deeply irritated when the Chancellor defied Washington and signed up to the Asian Infrastructure Investment Bank (AIIB), China’s attempt to create an Asian rival to the Bretton Woods institutions controlled by the West.

Mr Osborne was correct on the substance. Congress acted foolishly in trying to smother the AIIB in its infancy and stem the rise of China as a financial superpower. It was tantamount to treating the country as an enemy, an approach that soon becomes self-fulfilling.

The AIIB is exactly what is needed to recycle China’s trade surpluses back into the world economy, just as the US Marshall Plan recycled American surpluses in the 1950s. The problem is that Britain carelessly undercut a close ally, putting immediate mercantilist interests ahead of a core strategic relationship.

Anglo-American ties are now at their lowest ebb for years, a risky state of affairs at a time when the UK faces a showdown with the European Union.

The effusive welcome for Xi Jinping aims to secure Chinese funding for nuclear reactors at Hinkley Point and Sizewell, with the quid pro quo that China’s nuclear power companies will later build their – as yet unproven – Hualong One reactor in Essex.

The trip may unlock funding for the Northern Powerhouse project, intended to revive Manchester and the great industrial cities of the North, along with finance for the HS2 high-speed rail link and a host of infrastructure schemes.

What is China's real growth rate?

  • Official: 7pc
  • IMF: 6.8pc
  • Capital Economics: 4.5pc
  • Lombard Street: 4-5pc
  • Citi: 4pc or less
  • Fathom: 3pc

China has agreed to sell renminbi bonds in London, anointing the City to be its offshore hub in the Atlantic region.

The British gamble is that an open-door policy – when the US and the EU reflexively treat Chinese state investors as a threat – will lead to a reciprocal welcome for British firms in China.

The Chinese market is a tough nut to crack but not a hopeless cause. The UK already has flourishing niches: its architectural houses – Lord Norman Foster, Zara Hadid, Sir Terry Farrell – have designed the country’s prize buildings; Rolls-Royce has dealerships across the country, though Xi Jinping’s crackdown on corruption has killed the fashion for conspicuous wealth.

British exports to China are just 4.8pc of total shipments, barely more than trade with Belgium, but that, of course, is a lagging indicator. There is much to play for as China ditches its 30-year model of smoke-stack industries and switches to a mid-income service economy higher up the value chain.

This phase is better suited to British strengths, though whether China is really willing to open its hinterland to foreign banks, insurance firms and software companies remains to be seen.

Mr Cameron’s courtship comes late in the day, just as China slows from double-digit growth to barely half the pace. Official figures claim that GDP rose 6.9pc in the third quarter but this is based on a faulty deflator.

Capital Economics said its proxy measure shows that growth slowed to barely more than 4pc earlier this year – a de facto recession, caused by a fiscal shock – but has since stabilized and has been ticking up over recent months.

The economy is not collapsing and is highly unlikely to do so since the banking system remains an arm of the state, but nor will China take over the world or match the fevered expectations of Sino-enthusiasts.

The hangover from the country’s $28 trillion investment and credit blitz will be slow and painful, a variant of the Japanese reckoning. The World Bank warns that China is heading straight into the middle-income trap unless the Communist Party relaxes its iron grip on the political system and opens the country to the free flow of ideas.

Xi Jinping has no intention of relaxing anything. The most powerful Chinese leader since Mao Zedong is described by one party survivor as a "needle wrapped in silk".

Whether Britain should prostrate itself entirely to earn a sliver of this slowing growth is open to doubt. But in diplomacy – as in life – there is nothing wrong with good manners.

The Fed Board is now seriously split

Gavyn Davies           

This week has seen speculation about a mutiny from two members of the Federal Reserve’s Board of Governors against the leadership of Janet Yellen and Stanley Fischer, both of whom continue to say that they “expect” US rates to rise before the end of the year. Although “mutiny” is a strong term to describe differences of opinion in the contemplative corridors of the Federal Reserve, there is little doubt that the institution is now seriously split on the direction of monetary policy.

Furthermore, these splits could extend well beyond the date of the first rate hike to the entire path for rates in the next few years. Janet Yellen faces an unenviable task in finding a compromise path that both sides of the FOMC can support.

This week’s “rebellion” within the Board was led by Lael Brainard, a rookie Governor who was previously an Undersecretary at the US Treasury, working on international economics.

During the euro crisis, her frequent trips across the Atlantic won her respect, and marked her out as a clear thinking Keynesian who wanted emergency action from the ECB long before Mario Draghi came to that view.

It is therefore no surprise to see her emerging as the “uber dove” on the Board of Governors. In a speech notable for its clarity, she directly opposed several of the main planks in the Yellen/Fischer orthodoxy (see Tim Duy and Paul Krugman.) For example, she said that the Phillips Curve is an unreliable guide to future inflation rates; that the predicted rise in the equilibrium real interest rate might never happen; and that the appropriate management of inflation and recession risks clearly pointed towards long term dovishness.

Ben Bernanke’s recent memoirs commented that divisions among the Board of Governors in Washington are more significant than divisions on the much larger and less disciplined body that sets monetary policy, the Federal Open Market Committee.

In 2013, Ben Bernanke faced a rebellion from three of his Board members, who wanted to taper the Fed’s asset purchases earlier than he did. His memoirs state that a rebellion from 3 of the 7 Board members would have made his position as Chair “untenable”, so he had to address this risk by accepting earlier tapering. The fact that he then became the spokesman for a messy compromise probably contributed to the miscommunications about the Fed’s intentions that were such a problem during the “taper tantrum” that summer.

It is possible that Ms Yellen is facing a similar problem today, though this time her opposition on the Board is coming from a dovish, not hawkish, direction. There are now only 5 seats on the Board actually filled, and two members (Brainard and Daniel Tarullo) indicated last week that they are opposed to a rate rise this year.

That is a tough obstacle, especially since the Brainard arguments about the downside risks to the US economy, and the tightening in monetary conditions that has already happened, are clearly also shared by Bill Dudley. Although Mr Dudley is not a Board member, he has a special position as Deputy Chairman of the FOMC and a permanent voter.

On the other side of the debate, however, the Vice-chair of the Board of Governors, Stanley Fischer, has consistently staked out a position in favour of early “normalisation” of interest rates, now that the labour market seems to have returned almost to normal. This view is supported by James Bullard and some other regional Presidents, probably including John Williams who replaced Ms Yellen at the San Francisco Fed. Up to now, it was thought that Ms Yellen herself might be leaning towards a rate rise in order to avoid dissents from this group of hawks, but now she faces the risk of dissents from either end of the spectrum.

One theory is that Ms Yellen is, in reality, a closet dove who has been irritated by the more hawkish public statements of her Vice-chair Mr Fischer. But, if so, why did she go so far out of her way to identify herself as one of the members of the FOMC expecting a rate rise this year in her recent comprehensive speech about inflation? That speech, delivered only three weeks ago, was intended to lay out the case for a pre-emptive rate rise, ahead of any concrete sign of rising inflation.

Another theory is that Ms Yellen has some predisposition towards “normalisation”, but is very influenced on the timing of the first hike by the flow of data. On this view, she keeps saying that policy is “data determined” because that is precisely the case. It would therefore be no big deal if she decided that the recent softness in US activity was a sufficient reason to delay the first rate rise by a month or two.

Again, Mr Benanke’s memoirs are relevant here. Going into the September 2013 meeting that unexpectedly decided against tapering, he was apparently much less certain about the appropriate policy than the market’s assumed him to be, entering the meeting. He wanted to do “the right thing”, rather than worrying too much about surprising the markets on the day.

Ms Yellen has always included so many caveats about her “expectation, not commitment” on raising rates that she will have a ready made alibi if she now changes her mind. Nevertheless, she will lose some credibility, and markets will pay less attention to her “expectations” from now on.

Perhaps more important, the Brainard speech will encourage people to believe that her fundamental objections to tighter policy are gaining ground at the FOMC, in which case the markets may conclude that there is little chance of a rate rise anytime in 2016. Ms Yellen will certainly not want that to happen.

So what will happen in December? The outcome looks increasingly uncertain. Ms Yellen herself still seems to believe that a rate rise is her central case but, this time, the ultimate decision really will be “data determined”. The growth rate in US economic activity has now dropped to only about 1-1.5 per cent. That means that the onus of proof has now completely changed: there needs to be an improvement in the data to keep a rate rise on the table.