China to pull the plug?

March 30th, 2007

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In our previous musing in Chinese economic overhaul?, we briefly mentioned about this significant piece of news: Stephen Roach on China?s ?Unstable? and ?Unsustainable? Economic Model. According to that article, the Chinese leadership is highly concerned about the social and environmental impact of breakneck economic growth over the past few decades. There is worry that the status quo is ?unstable, unbalanced, uncoordinated and unsustainable.?

What is the implication? Here, we offer some of our speculative thoughts, which are by no means predictions on the future. If you have other ideas on this, please feel free to leave us comments.

Assuming that this news is true, we can expect significant policy changes in China that will shift focus from the economy to the environment and social stability. This means the Chinese government will take steps to slow economic growth significantly in order for the non-economic aspects of the nation to catch up and for the economy to catch a breather. Indeed, China, for all her impressive economic growth, has a host of other serious problems as side effects. The environment is one of them. Social stability is another. Other negative economic side effects include price inflation (see Cause of inflation: Shanghai bubble case study), rampant speculations (see China paradise for stock speculators) and overcapacity. We see that it is possible for the Chinese government to take steps that will result in short-term pain but better for the nation in the long run.

As investors, how will that affect us?

Much depend on what the Chinese government do specifically to achieve these objectives. We cannot predict what they are, but we can offer our conjectures. For example, one area the Chinese government may take action against is the unruly stock market, which is in effect almost a casino. Will they pop the stock market bubble? Your guess will be as good as ours. Also, China may allow their RMB to appreciate more so as to cut off another supply of air against exports, which is a great contribution to the already overheated economic growth.

Whatever the specific actions that the Chinese government take, we can be sure that there will be a great impact on the global economy and financial markets. For example, we see that the Chinese central bank?s decision not to accumulate anymore US dollar reserves (see China unwilling to hoard US dollars?what?s the implication?) is consistent with this impending policy change. Also, will China?s reining in of runaway economic growth affect her appetite for Australian resources? If so, the Australian economy will be impacted as well.

China is a 800-pound gorilla that we should watch.