Asia's train is not yet decoupled from West

Despite recovery, China's economy does not seem ready to wean itself off the dollar - and its consumers are loath to loosen their purse strings.

Crane ballet: China, faced by falling demand for its exports, bolstered its economy with a 4 trillion yuan stimulus package.
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Despite recovery, China's economy does not seem ready to wean itself off the dollar - and its consumers are loath to loosen their purse strings, writes Wayne Arnold The annual hungry ghost festival is under way in East Asia, when ethnic Chinese across the region appease the spirits by staging noisy performances of traditional opera and setting fire to copious amounts of fake money in the streets.

This year, as the region emerges tentatively from the global recession, the question is whether the surge in growth from China that has sparked Asia's recovery is sustainable or whether, like so much "joss money" burned in the street, the enormous combination of spending and lending by China's government and state-controlled banks has rekindled growth without dispelling the demons of global recession.

If Beijing starts to back off, can China's domestic consumer take up the slack? Or will China, and with it the rest of Asia, succumb again to the slump in global trade? "The recovery in China is real," said Manu Bhaskaran, an economist at Centennial Group Holdings in Singapore, "but it depends hugely on the monetary stimulus." Battered by a collapse in demand for its exports from the West, China pumped up growth by wheeling out one of the biggest government stimulus packages to date: a 4 trillion yuan (Dh2.15tn) economic stimulus package coupled with an increase of 30 per cent in lending, which managed to stimulate growth up to 7.9 per cent in the second quarter and stoke higher industrial output, household incomes and consumer spending in spite of slumping exports.

It was a remarkable achievement, a victory for the kind of fiscal stimulus advocated by the economist John Maynard Keynes. China's recovery has important implications not just for the rest of Asia, which has recovered largely by supplying China's newfound demand, but also for commodity exporters such as Australia, Russia, Brazil and the Gulf. The Middle East still relies largely on the price of oil, which stands to be driven increasingly by how fast China's demand for energy grows. In the past decade, China's demand for oil has almost doubled and now accounts for almost a 10th of all the oil consumed globally in a year.

The recovery in China and the rest of Asia has revived a long debate over whether emerging markets in Asia and elsewhere might be "decoupling" from economic cycles in the US. Many economists have said the crisis demonstrated the fallacy of this argument, but others have projected that the sudden loss of US demand might actually accelerate Asia's decoupling. This more rapid recovery could also herald a sea change in East Asia's role in global capital markets. In the past, suppressing domestic import demand and managing currencies meant lending export earnings to the US government. Financing for economic development was dominated by western investment banks.

Now Asia may generate fewer reserves, some economists say, but invest a greater portion of those reserves either at home or in faster-growing markets in Asia itself, the Middle East and Africa. China has already made dramatic moves in this direction, investing heavily to buy access to resources in Africa and Australia, while pledging to help finance the IMF with cash it would previously have used to finance the US deficit.

David Fernandez, the head of emerging Asia research at JPMorgan in Singapore, said: "The way the world fell apart in the crisis exposed the vulnerabilities of a system dominated by the dollar." China has therefore convinced a growing number of countries, including Argentina and Malaysia, to accept its currency, the yuan, instead of US dollars when selling China goods and services. So is the region decoupling from the US to congregate instead around China? Some economists say that Asia's very recovery is proof in the affirmative. Previously the region never would have regained its footing until the US, and Europe, had done so first. Now it appears to be leading the world out of recession, led by a boom in domestic investment in China.

One of the biggest sceptics, however, is China's own government. Authorities in Beijing fear their stimulus may be creating an asset price bubble that may be disguising deeper problems, including over-investment, overcapacity and a looming surge in loan defaults. Likewise, other authorities around Asia, such as Singapore's government, are wary that industrial overcapacity means the region has a lot further to go before it can proclaim an end to the crisis.

Decoupling's resurgent advocates are undeterred. Despite booming growth in loans, they say, China's banks are supported by vast deposits, a symptom of the country's high savings rate. Lending can continue to grow, they say, with out stoking inflation or putting the banks themselves in danger. Paul Schulte, a strategist at Nomura International in Hong Kong, is one of several analysts and economists who believe China's explosion in conspicuous consumption is only beginning. China's GDP per capita recently passed the US$6,000 (Dh22,038) mark, according to Nomura, a level that in studies of 23 other nations has coincided with rapid growth in consumer demand.

Having breached this key level of purchasing power, Mr Schulte and his colleagues at Nomura say, Chinese workers are likely to spark a boom in demand for such consumer staples as meat, water, grain, health care and, of course, more credit. "Men buy new Levi's at the same time as they buy a motorcycle," Mr Schulte wrote in a recent report. "Women buy new furniture at the same time they buy new and more expensive dresses, make-up or shoes. At this time, people get fillings filled and can visit a doctor regularly for the first time."

But other economists say China and its neighbours are not ready to wean themselves off exports or from the dollar. The problem is that even if China convinces its neighbours and trading partners to start accepting the yuan instead of US dollars, they cannot invest them back in China the way they can invest dollars in the US. China's markets remain heavily restricted to foreign investment. "China needs to liberalise its capital account if wants to internationalise its currency," Mr Fernandez says. At the same time, whatever global aspirations Beijing may have, the Chinese consumer is no superpower. The average Chinese worker still saves roughly half of what he or she earns. Domestic consumption still amounts to just 35 per cent of Chinese GDP, according to Merrill Lynch.

Most Chinese do not dare to spend like there is no tomorrow; they know there is one and fear it will be tough. China's reforms over the past 30 years have sped economic growth but did away with the "iron rice bowl" of lifetime employment, education, housing and health care that was once provided by state-owned enterprises. The economic crisis has not emboldened China's workers. Beijing has moved to improve the social safety net, cutting taxes and promising to boost health care and improve access to education. "Over time, these should help boost domestic demand," Mr Bhaskaran said.

This boost will not come with enough speed or heft to pull the rest of the world out of recession, however. According to Bank of America Merrill Lynch, Chinese households spend only 15 per cent of what American households do. To offset a single percentage point decline in US consumption, therefore, China's consumers would need to boost their own by 6.5 per cent. Despite the efforts by China's authorities to promote a world free of the dollar's dominance, therefore, even they seem to recognise that for the time being they have to hope for help from the US consumer.

Data from the US Treasury indicate that China and other governments in Asia are buying more, not less, US government debt, an indication that they are trying to prevent their currencies from rising and reducing the competitiveness of their exports. Sean Darby, another strategist at Nomura in Hong Kong, said: "A glance at the total foreign acquisitions of US treasuries suggests that Asian central banks have returned to their old habits of recycling US dollar export revenues and returning them once again into the US treasury market.

"Asia cannot seem to kick the habit of mercantilism that has been the bedrock of its growth for the past three decades." Decoupling may therefore come once the global economy recovers, but not before.