It is so nice when a consensus forms among economic commentators. There is going to be a recession in US, the pack says, and probably in Britain too, for they have both sinned with their debt, deficits and soaring house prices. But the world as a whole won't suffer, as the great emerging economies of Asia -- China and India -- will carry on booming regardless. News that China's output expanded by an extraordinary 11.4 percent last year, its fastest rate for 13 years, only strengthened this view.
When a consensus is so clear, it is always time to wonder whether it might be wrong. That contrarian instinct was reinforced this week by the way that Asian stock markets, including those in Mumbai, Shanghai and Hong Kong, reacted to markets in the US and Europe by going through wild gyrations of their own. A widely followed measure of such shares, the MCSI Emerging Asia Index, was at one point this week down 25 percent from its October high.
Why should that be, if Asia is just going to boom on regardless? The answer is, in part, that stock market traders are wild, emotional creatures, and we risk going mad if we try to understand their every move. But another part of the answer is that the sanguine consensus is likely to be only half right. The half that is wrong offers good reasons for concern about Asia.
NO LONGER DEPENDENT
The half of the consensus view that looks right is the half that says that China, India and the surrounding countries are no longer dependent on exports to the US, and neither are they dependent on foreign capital. Exports to the US account for about 8 percent of China's gross domestic product and only 2 percent of India's, so while a big drop in those exports would have some effect, it is not going to be crippling. Moreover, it has already been happening: exports to the US from China have been declining for several months now, but overall growth keeps barreling on.
The reason is that capital is abundant, and it is being spent on new buildings, roads, stadiums, bridges, airports -- you name it. In economic crises of old, the developing countries got hit twice over: by the loss of their export markets in the West, and by the withdrawal of capital by panicky international bankers and investors. In the past decade, the tables have been turned: China, other Asian economies (though not India) and the Arab oil producers have been the providers of capital to the West, not the receivers of it.
One of the most extraordinary statistics about the Chinese economy is that capital investment accounts for 45 percent of GDP -- the equivalent for the US and Western Europe is 15 percent to 20 percent. That investment is being financed by China's own savings. So subprime losses in the US, bank fraud in France and panic in London are irrelevant to developers in Beijing or Shanghai.
As long as those developers keep on investing in new roads and buildings, the Chinese economy will keep on growing. Perhaps declining exports to the US and Europe could reduce China's growth rate from 11.4 percent to, say, 9 percent. But that is still pretty good, and would still mean that China offers a strong market for its Asian neighbors.
That is the correctly judged half of the consensus. It doesn't really apply to rich Japan, for its domestic economy is weak and so the loss of exports to the US will injure it more. Things are a bit different in India, which does need to import capital -- unlike China it runs a deficit, but it too has an investment boom, and so far its companies have been finding it easier to raise capital since the credit dramas began last August, as investors desert the loss-making markets of the West.
Where the consensus is likely to be wrong, however, is in its implicit assumption that these Asian economies are not going to be facing problems of their own -- problems that do have some link to the difficulties facing the US and Europe. Chief among those problems is inflation.
WORRIES
Rising prices for food, energy and other commodities, partly caused by strong Asian demand, lie behind the high interest rates and inflation worries that were spooking the Bank of England, the European Central Bank and, until its big interest cut last week, the US Federal Reserve. They are also a big worry for India and, even more so, China.
In recent years China has followed a policy of keeping its currency cheap against the dollar in order to help exports. To do that, its central bank has had to focus its monetary policy on the currency and not domestic inflation, building up vast foreign exchange reserves (today, at US$1.4 trillion, the world's largest) and allowing credit inside China to be ultra-cheap. Hence all that investment in buildings and, by speculators, in Chinese share markets. But hence, too, rising inflation.
Now, consumer-price inflation has topped 6 percent. Wages are also rising rapidly. The last time inflation got badly out of control in China was in 1988 to 1989, which encouraged workers to join the student protests in Tiananmen Square. To avoid any repeat of that, government policy is beginning to change.
The currency is being allowed to appreciate more rapidly against the dollar, thus reducing import prices. Interest rates are being raised. The revaluation is likely to accelerate, the clampdown on credit growth to get tighter. The danger is that China's investment bubble could then burst.
The best parallel for China today is Japan in 1970. At that time, Japan had been using a cheap yen to boost exports, cheap capital encouraged an investment boom and environmental degradation prompted popular protests (remember Minamata disease -- actually mercury poisoning).
Then, in 1971, Japan was forced by then US president Richard Nixon to revalue the yen, and in 1973 the global oil shock brought inflation. The result? Not in fact a disaster for Japan, but a wrenching change: Revaluation and rising industrial costs forced the economy to shift from the era of the motorcycle to that of the microchip.
China faces the same sort of pressures now: currency revaluation, inflation, environmental damage. It now needs to move its economy sharply upmarket. As Japan showed during the 1970s, it can be done. But it won't be easy. Which is why those stock market traders in Asia were right to turn a bit wild and emotional this week.
Bill Emmott is a former editor of The Economist. His new book, Rivals -- on the power struggle between China, India and Japan -- will be published in April.
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