Exploring The Turmoil -- Is the dragon scared...?

You spin my head right round, right round
When you go down, when you go down down...

It's been a while but I am slowly getting back to my newspapers and mags. The financial turmoil still hogs the headlines as they did the last time I was reading the papers. Seems like we are stuck in a time-warp. Something very significant that's come up recently is China's insistence to make SDRs the reserve currency instead of the dollar.

Some say that this is China coming of age. Let's try to analyse the impact of this one such movement if it were to happen anytime soon...

1. China's trillion dollar investment in US treasuries.....down the drain....if people stop buying the dollar, do you really think this trillion dollar investment will be worth even 50 bn USD? I don't think so. is China willing to lose so much of investment. Don't think so. So, logically speaking, we may see China moving from long term treasury bonds to short term investments and slowly moving out of them to some extent. 
2. Yuan is part of the SDR....and if not, it will be. This would mean that people would buy the Yuan to suport their reserves. This would lead to appreciation of Yuan which would, in turn, lead to Chinese exports becoming more expensive and a further impact on the Chinese economy. The era of Yuan as a managed float will end very soon... 

Is China willing to take such drastic steps during these uncertain times? I am not very sure. Hence, there seems to be a sense of desperation in the tone of the Chinese Central Bank governer. They seem to have lost the plot somewhere in the quest to have "competetive" (to speak modestly) exports. There may just be a little panic behind the yellow curtain. 

Having said all this, i personally believe this is a step in the right direction. This takes them one step closer in becoming an economy running on consumerism. I have always believed that the Chinese have to stop relying on the US economy to keep up that growth. It is expected that with these fundamental changes, the GDP growth will hit some serious bumps but that is expected and required. These may be termed as a few "necessary corrections" that will be good for the Chinese economy moving forward. Again, let us not be fooled into believing that China is an export driven economy. It is not. Exports contribute roughly 15% of Chinese GDP, which is to say the least, not very much. But this 15% today supports millions of cheap labour which is rapidly getting unemployed. So the concern is more political than economical really. Though the Chinese society is not known for demonstrations et al, it is never wise to underestimate the reaction of a man who is unable to put food on the table. We are currently hearing about the 500+ bn dollar stimulus package that china had announced. Well, this sounded more of a talk and very little substance. 

You spin my head right round, right round
When you go down, when you go down down...(damn! i love this song!!)

If one were to look at the nos, China today has a per capita GDP somewhere in the range of 3K USD, which is quite good really keeping in mind the huge population it has, but (with no statistics to really confirm this) the wealth seems to be concentrated in major cities and there is a growing divide between the hinterlands and the towns and cities in terms of economic prosperity. In short, this is another classical case of "India Shining" not really impacting the common man living in the hinterlands of China. India lost a government owing to this. Will China see any disturbances....? 

Here again there will be several Keynesian proponents ( is there anyone who is not) who will talk about how the stimulus-induced infrastructure projects are expected to bring economic prosperity to these regions. But I believe that there are a few additional things China must start looking into. So, let's talk about certain rather abstract steps which are required to be taken in order to bring a more balanced growth into the Chinese economy...

1. Artificially low wages to keep exports cheap needs to be stopped. These are the millions who will finally become the massive consumer base in the years to come. 
2. Encourage entrepreneurship. A government is not supposed to run enterprises but create the environment for people to think. In India, it's the opposite- we see entrepreneurship exists despite government efforts not to provide the required infrastructure!

Next time, let's talk about Obama's efforts to save the US economy.