Foreword

What comes to mind when someone utters the word China? In recent years, global money managers, economists, and politicians have idolized China as the nation that has mastered the perfect economic model for growth. Whether this growth is sustainable is a dierent matter. A paper published by Wei Wang, Assistant Professor of Finance at the Queens School of Business, and Kee-Hong Bae, Professor at the Schulich School of Business (York University) investigates1

...whether rm name aects investor attention and thereby rm valuation. Some Chinese rms listed on U.S. stock exchanges have the word China or Chinese included in their company names - Chinaname stocks, whereas others do not - non-China-name stocks. During the China stock market boom in 2007, we nd that China-name stocks signi cantly outperform non-China-name stocks. This is not due to dierences in rm characteristics, risk, or liquidity. The China-name eect is largely consistent with the investor attention hypothesis that the price pressure caused by increased investor attention on China-name stocks during the boom period drives up China-name stocks more than non-Chinaname stocks.

This sort of speculative sentiment is ubiquitous in global markets outside of China. In our inaugural issue, Global China Review sought to depose of some of the misconceptions about Chinas growth.2 Power, growth, prosperity; Adam Smith would have been proud to describe a nation with these words.3 But has Chinas current economic and political environment really created such a serendipitous playing eld? Consider the following: Post-war West Germany witnessed a period of booming economic growth due to its contrarian approach to macroeconomic policy. For the next few decades, the German people felt a certain guilt, primarily for the atrocities committed to the Jewish people during the Nazi regime, and decidedly toned down its nationalism. But during the post-war era, by virtue of it achieving this stupendous growth, the rest of Europe, and in particular the Allies, embodied a certain fear of the resurgence of a German superstate with all the nationalist strength and power enjoyed by the Third Reich, but this time laden with economic power and wealth.4 The Chinese have an expression: ., which very roughly paraphrases into accompanying an emperor is like having a tiger as a companion. Phaedrus, Roman fabulist, echoes this sentiment:

An alliance with a powerful person is never safe.

At risk of comparing the Chinese state to the fascist regime, I propose that a successful ascension to regional and world power, economic, political, or otherwise,requires the careful management of relationships with neighbors and trade partners so that Chinas allies do not come to fear the Chinese dragons peaceful rise to preeminence, and that harmonious relations with its strategic partners are preserved.

Global China Review has capitalized on Global China Connections far-reaching network of over 55 university chapters, and the proprietary intellectual and academic horsepower of the students in said universities. We have taken a twofold approach, from both the standpoint of economics and geopolitics, to evaluate the premise above. Will its double digit growth generate suspicion about the risk of a Chinese superstate from its Korean and American counterparts? What is the likelihood of hegemonic war? Does China see that it may have to take a step back and reevaluate the consequences of its currency position? These are all questions that will be addressed in this issue of Global China Review. Sincerely,

Alexander Banh Editor-In-Chief | Global China Review Associate Director of Publications | Global China Connection P.S. A big thank you goes out to Karina Legradi, Founder and Editor-In-Chief Emeritus of Global China Review, who has, even in her newly graduated status away from Global China Connection, been a proud supporter, indispensable asset and mentor to the conceptualization of this publication.

Kee-Hong Bae and Wei Wang, Whats in a China Name? A Test of Investor Attention Hypothesis, Social Science Research Network: accessed January 14, 2012
2

Alexander Banh, Karina Legradi, et al, What is Chinas Role in the 21st Century World?, Global China Review Issue 1: accessed January 14, 2012.
3 Adam

Smith, The Conscise Encyclopedia of Economics | Library of Economics and Liberty, accessed January 14, 2012, http://www.econlib.org/library/Enc/bios/Smith.html
4

Michael Lynn, Bust: Greece, The Euro, and the Sovereign Debt Crisis (New Jersey: John Wiley & Sons, Inc., 2011), 87-91. ii

The Editors
ALEXANDER BANH | EDITOR-IN-CHIEF Alexander currently attends Queen's University in Kingston, Ontario, and is a member of the GCC Chapter there. At Queens, Alexander is focusing on Finance for his Bachelor of Commerce while pursuing a simultaneous dual degree in Economics, but has a keen interest in international relations. He is a founding member of an incorporated investment fund called Limestone Capital, and currently serves as the Portfolio Manager for the Energy Sector He plans to work in investment banking upon graduation. JOHN Z. BUCKLEY | ENGLISH COPY EDITOR John is a sophomore at Cornell University where he is currently working towards a dual degree in Government and China and Asia-Paci c Studies. His primary academic focuses are East Asian diplomacy and security as well as US-China bilateral relations and Mandarin Chinese. Upon graduation, John plans to work as an analyst for the U.S. Department of State or a foreign policy think tank. EMILY JO HARTLEY | ENGLISH COPY EDITOR Emily is a senior at Carleton College and a member of the school's GCC Chapter. She is pursuing a degree in English, as well as a concentration in East Asian Studies and a certi cate of advanced study in French. After graduation, Emily hopes to pursue a career in journalism or publishing, though she plans to spend at least a year teaching English in China or France before settling into the working world. CHRISTINE (MAN NI) HO | CHINESE COPY EDITOR Man Ni is currently studying in University of Michigan in Ann Arbor, Michigan. She is focusing international studies and global change program. She likes to work with dierent people and is working on a collection of friends from dierent countries. In the future, she would like to work organizations such as UNICEF in assisting the world topursue a better future. LISA YAN | LAYOUT MANAGER Lisais a second year student studying commerce at Queen's University in Kingston, Ontario, and a member of the GCC Chapter there. With GCC Management, she handles all creative projects as layout manager. Lisa is currently exploring possible career paths but currently has a strong interest in nance and accounting. Outside of school, Lisa likes to travel, play musical instruments, and try out dierent baking recipes. Upon graduation,Lisawants to work in North America and Asia to pursue her career goals. KITTY CHAN | LAYOUT STAFF Kitty is a rst year student and a member of the GCC chapter at Queens University in Kingston. She is completing her Bachelor of Commerce and plans to pursue a dual degree in Economics. Upon graduation, she plans to further her studies to become a Chartered Accountant. iii

Source: WTO, The World Bank, U.S. Census Bureau

Relative Growth in American Exports to China vs. Chinese Exports to the U.S.1

Absolute Level of American Exports to China vs. Chinese Exports to the U.S. ($b)1

At a Crossroad: The Hong Kong Dollar

Chester Lau

A look at the Hong Kong dollars current situation and the potential actions of the Hong Kong Monetary Authority.

hen activist fund manager Bill Ackman is betting 1 on the Hong Kong Monetary Authority (HKMA) to revalue the Hong Kong dollar (HKD) after 28 years of being pegged to the U.S. dollar, there can be no doubt that eyes in the investing community will be enticed to pry into the situation themselves. [Consider re-organizing this sentence: misplaced clauses might suggest Bill Ackman, not HKD, is pegged to the USD] This is especially true when Ackman advocates potential payoffs of 200 to 1 a very lucrative proposition indeed.

Evolution of the Peg The HKDs exchange rate regime has gone through a considerable amount of change and adaptation during times of stress. Between 1935 and 1972, a period known as the Sterling era, Hong Kong abandoned its silver standard due to a dramatic rise in the price of the metal that had caused Hong Kongs money supply to shrink drastically. The shift to Sterling made sense at the time, since Hong Kong was a British colony and Sterling was one of the major reserve currencies in the world. However, as Sterlings role as the international reserve currency was gradually displaced by the USD after the Second World War, Hong Kong abandoned the Sterling link in favor of a brief USD peg in 1972.

The USD peg was ultimately short-lived due to Americas internal struggles with inflation and external struggles with the ongoing Vietnam War; the HKD was once again left without a reliable anchor and thus the HKMA chose to float the currency from 1974-1983. The period of the floating HKD ended during September of 1983, when negotiations over the transfer of Hong Kong back to the mainland sparked a crisis of confidence 2. This ultimately led to the 28-year U.S. dollar peg regime that brought Hong Kong to where it is today one of the most prosperous and economically dynamic cities in Asia. Since 1983, the linked exchange rate system has kept the HKD pegged to the USD at a trading band of 7.75-7.85 HKD/USD. The HKD is allowed to oscillate in the band through a series of intervention methods dictated by the HKMA as shown below.

Caught Between Two Worlds HKs current peg has survived the handover of sovereignty from Britain to China, the Asian financial crisis, and repeated attacks from speculators, but it is not without its own problems. The HKMA has been quick in highlighting the pegs stability 3 in its defense of the system under the current scrutiny it is facing. After the S&P downgrade of the U.S. in August, the HKMA has had to reevaluate the legitimacy of pegging the HKD to the dollar. In the wake of what seems to be the eventual long-term depreciation of the U.S. dollar, Hong Kongs risk of higher inflation leading to an asset price bubble will only continue to heighten. QE2 driven liquidity inflows have already exacerbated the situation in Hong Kongs asset markets, and compounded with the accelerated pace of aggressive mainland Chinese investment, property prices have continued to overheat. Hong Kong has overtaken London as the worlds most expensive city for office space 4, with office rents increasing by 32% in the past year. Outside the realm of commercial real estate, Hong Kong homes are said to be overvalued 5 by a total 53.7%.

With the acceleration of inflation and public unrest 6, HK seems helpless in its current situation as it continues to keep interest rates low when monetary conditions need to be tightened. CPI inflation was at 5.15% during the second quarter of 2011, with money market interest rates maintained at a dismal 0.13%. Hong Kong finds itself between two very different worlds: the faltering economy of the United States and the dynamism of China, which is arguably the leader of growth in emerging market economies. Fulfilling the need for Hong Kong to curb inflation while being forced to import the loose monetary policy of the Fed has proven to be no easy task; so what are Hong Kongs current options, and is Ackman right about his bet?

The Options Going Forward The prevailing thoughts on Hong Kongs potential future actions follow four main tactics: re-pegging the HKD to the USD at a stronger level, pegging the HKD to a basket of currencies, pegging the HKD to the RMB, and returning the HKD to a floating exchange rate regime. While a one-off revaluation is the best-case scenario for speculators like Ackman, this strategy going forward would not be much of a benefit to policymakers. The revaluation would dampen CPI inflation and reduce current and capital account surpluses, but it would not tackle the fundamental problem of linking the currency with the USD. Hong Kong will continue to follow American interest rates if the USD depreciates and in current conditions, this is where the USD seems to be heading. Therefore, the revaluation would put only a slight pause on Hong Kongs current reflationary tide. Instead, Hong Kong could choose, like Singapore, to peg its currency to a basket. On the surface, this seems like a good idea since the new peg would minimize fluctuations against trading partners on average, and allow the HKMA some measure of monetary independence. However, a look at the potential currencies around the world that could appear in the basket the U.S. dollar, the Euro, and the Pound Sterling reveals that they all currently have very low interest rates. Even together they would not be enough of a restraint to curb credit growth and inflation in Hong Kong. Furthermore, since Hong Kongs trade basket is very different from Singapores, the basket approach is actually a very impractical option going forward.

Currently, Hong Kong gets nearly half of its trade directly from China, so a peg to a basket would in effect be a soft peg against the RMB. This presents another issue altogether since Chinas capital account is still not fully open, despite the states fervor in internationalizing the RMB; this is especially apparent in the use of Hong Kong as an offshore RMB center 7. Aside from the tight capital controls from China that make pegging the HKD to the RMB out of the question, authorities are still wary to move in this direction since the U.S. still plays a vital role in Hong Kongs business cycle. While it is true that Hong Kong is increasingly affected by the mainland, the economic cycle of an international trade intermediary like Hong Kong is still driven by demands from overseas markets, especially the U.S. Furthermore, on a global level, the economic and financial environments are still to a great extent affected by the U.S.; as an international financial center, Hong Kongs economic cycles are heavily influenced by the global environment. If Hong Kong begins to import Chinese monetary policy in times of a global downturn, it could set Hong Kong on a path of deflation, exactly the opposite of what is happening now. In other words, for Hong Kong, importing monetary policy from either China or the U.S. will prove to be ineffective if both economies are on divergent paths. Allowing for total monetary independence through a floating exchange rate is another option, but as an alternative it is no better. Since Hong Kong is a small and externally oriented economy, allowing the HKD to float will only bring about economic instability. When times are good, the float will entice hot money to flow into the region, weakening Hong Kongs competitiveness and failing to help curb inflation; when times are bad, capital

will quickly flow elsewhere while depreciating the HKD. Such great swings in the exchange rate will not provide the stability necessary for citizens and businesses to engage in the world economy, something that is absolutely vital for a city so connected to the rest of the world. Holding the Fort Given that none of the options Hong Kong currently has makes sense for policymakers, authorities will likely try to ride out the existing reflationary tide. Through the use of administrative measures to cool property prices, the HKMA has required that all banks reassess their business plans and funding strategies for the rest of 2011. In addition, fiscal remedies like the $6000 HKD 8 given to every Hong Kong permanent resident will allow authorities to stall until Chinas growth begins to slow. A cooling China may not seem so far away either, especially with current developments in Chinas continued clampdown on the domestic real estate market. Evidently, China has been adamant in containing its inflation, and all Hong Kong has to do now is wait for the effects of mainland policies to take hold.

Further Reading Pershing Square Capital Management Linked to Win Why the Link is Important Hong Kong Monetary Authority

Steve Schaefer, "Bill Ackman's Hong Kong Currency Bet, And How You Can Play It," Forbes, September 14, 2011, http://www.forbes.com/sites/steveschaefer/2011/09/14/bill-ackmans-hong-kong-currency-bet-and-how-youcan-play-it/ 2 "Black Saturday (1983)," Wikipedia, May 1, 2010, http://en.wikipedia.org/wiki/Black_Saturday_(1983) 3 "Why the Link is important to Hong Kong," Hong Kong Monetary Authority, August 15, 2011, http://www.hkma.gov.hk/media/eng/publication-and-research/background-briefs/hkmalin/05.pdf 4 "Office Rent," The Economist, September 3, 2011, http://www.economist.com/node/21528295 5 "Hong Kong phew-whee," The Economist, March 3, 2011, http://www.economist.com/node/18285595 6 "Hong Kong too-y," The Economist, March 7, 2011, http://www.economist.com/blogs/banyan/2011/03/protests_hong_kong 7 Chester Lau, "Hong Kong: An Offshore RMB Center," DayOnBay, February 12, 2011, http://www.dayonbay.ca/index.php/foreign-exchange/hong-kong-an-offshore-rmb-center.html 8 Xinhua, "Each HK permanent adult resident to get HK$6,000," China Daily, March 2, 2011, http://www.chinadaily.com.cn/china/2011-03/02/content_12103351.htm
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GLOBAL CHINA REVIEW

Issue 2 | January 2012

Where Are Chinas Consumers?

Alastair Su
On September 17th 2011, Apple opened its fourth store in Shanghai its largest yet in China drawing over a hundred thousand customers in its opening weekend. Amidst the doom and gloom of todays global economic crisis, the scene was a welcome one. The image of eager Chinese customers ocking to the iconic American store has more than just novelty value; it is a symbol of our shared economic future, where goods are not only made but sold in China. In a time where aggregate demand is contracting in Europe and North America, the remedy for the current crisis surely lies in building a new generation of consumers, of which a billion potentially come from China.

Figure 1: An elated Chinese customer holds up his prize. (Photo Credit: Getty Images)

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Issue 2 | January 2012

nfortunately, the reality of a made in China, sold in China economy is still a distant one. Compared to other major world economies, Chinas private consumption (Figure 2) share of GDP is the lowest at about 34 percent. Chinas trade surplus actually grew in the period following the nancial crisis of 2008, in spite of hopes that it would reduce its dependence on exports in favor of domestic demand. 1 Therefore, despite the governments promises this year that restructuring would be on the cards, the status quo of a lowconsumption economy has still persisted. When will consumption in China take o? More speci cally, what are the factors that prevent China from unleashing the worlds next generation of consumers?

Figure 2: The "consumption paradox.". Although consumption share of GDP is falling, per capita consumption is increasing rapidly. (Source: Kroeber (2011))

Consumption: Already Growing? Before further analysis is made, the rst thing to realize is that to some extent, consumption in China is already expanding rapidly. Surveying data from 1995 to 2010, Arthur Kroeber of the research consultancy Dragonomics notes a consumption paradox although the consumption share of Chinas income has decreased since the late 1990s from about 44 to 34 percent, private consumption per capita actually increased at about 9 percent per year over the past decade (Figure 2).2 Consumption in China, in other words, increased in absolute per capita terms, but the consumption share of income decreased due to the relatively higher pace of real GDP growth. It is misleading, then, to focus ones attention solely on Chinas consumption to GDP ratio, since it underplays the fact that consumption has actually grown, and at an impressive rate at that. Of course, this should not disguise the fact that consumption in China is still relatively low, both in historical and comparative terms. A report by the McKinsey Global Institute shows that even when consumption dipped in the United States to support the war eort in World War II, it never fell below the 50 percent mark.3 Raising its consumption ratio is in Chinas interests, since a persistently low consumption ratio suggests an unhealthy dependence on investment and external demand. If China is to sustain its impressive run of growth, it must take serious eorts to increase its consumption share of income. Exploring Policy Options To achieve this, the government should embark on two main policy goals. First, it should adjust its scal tools to lower precautionary saving, particularly among urban households. Following pension reforms and the

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Issue 2 | January 2012

privatization of housing, healthcare and education in the late 1990s, many households reacted by raising precautionary saving to anticipate possible expenditure in social goods. Consumption was adversely aected, and households have continued to bear the costs of social insurance ever since. To its credit, the government has responded in recent years by increasing expenditure on social goods, as shown by a 1.5 percent increase in spending as a percentage of total GDP from 2005 to 2010.4 To this eect, there have been some instances of success in lowering precautionary saving Barnett and Brooks show for example that for every 1 RMB spent on healthcare, saving by urban households fell by 2 RMB.5 Apart from that, however, there has been little sign of improvement, as comparable results were not recorded in other areas of social welfare expenditure. The underlying cause is that much of social welfare spending is funded by employee contributions instead of corporate or government saving, resulting in a net transfer of wealth from households to the government.6 If this was altered such that households bore less of the burden for nancing social expenditures, it is highly likely that precautionary saving would decrease, thereby encouraging consumption. Second, the government can also promote greater consumption by changing its monetary policy, speci cally by tightening interest rates. So far, to support its exchange rate regime of an undervalued currency, the government has suppressed interest rates to lower the costs of sterilization operations. There is no doubt that an undervalued RMB has been essential to Chinese growth, increasing export competitiveness and stimulating employment. However, if China intends to transition into the next phase of its economic development, its position on monetary policy ought to be seriously reassessed. To begin with, a gentle appreciation of the RMB will help to raise the real income of China consumers. Especially when domestic in ation is high, currency appreciation will allow Chinese households to divert to cheaper imports, raising aggregate consumption and obtaining welfare gains. A stronger RMB will also win goodwill with Chinas trading partners, who have long criticized Chinas continued insistence on a weak RMB. A second reason why interest rates ought to be raised is nancial repression. By xing interest rates at an arti cially low rate, the government imposes an implicit tax on households that severely restricts their ability to consume. Nicholas Lardy at the Peterson Institute estimates that in 2008, nancial repression cost households as much as RMB 255 billion a staggering 4 percent of GDP because of the negative real interest paid on deposits.7 Since private consumption is a function of household income, it is evident that reducing nancial repression would help to reverse the trend of a falling consumption ratio. Historical and Demographic Forces In analyzing the policy options available, one must also realize that there are limits to how much policy can achieve. Some analysts mistakenly assume that the task of increasing private consumption in China rests solely upon government action, when consumption growth is dependent on other factors as well. To begin with, China is still very much in the trajectory of economic development where a low consumption ratio is to be expected. Performing a comparative analysis of Asian economies, Kroeber notes that a falling consumption ratio is characteristic of an economy undergoing rapid industrialization (Figure 3).8 While industrialization in China cannot go on interminably, expectations for China to transition into a consumer-based economy resembling the U.S. within the next 10 years are equally unrealistic. As the share of service industries in China overtakes manufacturing in total GDP, this will naturally be accompanied by a rise in the consumption ratio.

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Figure 3: China's consumption ratio in comparative perspective. (Source: Kroeber (2011))

Demographics also constitute another important dimension, especially on the matter of saving rates. Population models predict a rise in Chinas dependency ratio from about 39 percent to around 65 percent over the next 40 years as the current generation of workers ages. If these predictions eventually pan out, the government will naturally want to accrue savings as it anticipates expenditure on future social costs.9 On a related note, Chinas high saving rates may largely be attributed to its worker boom, which saw the proportion of workers rise from 56 to 73 percent of the population.10 Because life-cycle patterns demonstrate that workers tend to save a proportionately higher fraction of their income to smoothen post-retirement consumption, as the working share of the population decreases, so will aggregate saving rates. Conclusion Returning to the original question of when Chinese consumption can expect to take o, it is important to note that consumption in China has already grown signi cantly in per capita terms although this fact is often masked by a falling consumption share of GDP. As to when China will transition from export-led growth to a consumer-based economy, it is clear from the analysis that this will take some time. This process will in turn depend on how much the government chooses to revise its approach to scal and monetary policy, as well as on underlying demographic patterns.

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1 World 2 3

Bank, China Quarterly Update, World Bank (April 2011), 3.

Arthur Kroeber, Chinas Consumption Paradox: Causes and Consequences, Eurasian Geography and Economics 52 (May-June 2011), 330.

Dennis Tao Yang, Junsen Zhang and Shaojie Zhou, If Youve Got It, Spend It: Unleashing the Chinese Consumer, McKinsey Global Institute (August 2009), 9.
4 5

Kroeber 343.

Steven Barnett and Ray Books, China: Does Government Health and Education Spending Boost Consumption?, IMF Working Paper WP/ 10/16 (Washington: IMF, 2010), 8. Bai Chongen and Qian Zhenjie, Who Is The Predator; Who Is The Prey?' an Analysis of Changes in the State of Chinas National Income Distribution, Social Sciences in China 30 (November 2009), 179.
6 7 8 9

Nicholas Kardy, Financial Repression in China, Policy Brief PB08-08 (Washington: Peterson Institute for International Economics, 2004), 3. Kroeber, 332 Ibid, 341. Ibid, 335.

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Alastair Su is an economic history major and a board member at the GCC chapter at Harvard College. His academic interests include international economics, monetary policy, political economy, and U.S. and China relations. He was born and raised in Singapore, a cosmopolitan country that allowed him to witness both the virtues and problems of modernization. Contact Alastair at alastair.su@gmail.com

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Global China Connection is a 501(c)3 nonpro t organization dedicated to international relationships through student-produced events and media that focus on China. Funded by private and corporate donors, GCC leads over 55 international university chapters to meaningfully engage their counterparts in China.

EDITORS NOTE
As Associate Director for Publishing, I am pleased to publish our second edition of Global China Review. It is our hope that the articles above have encouraged you to think further about the issues facing China at the dawn of this new century from a multidisciplinary perspective.Global China Reviewis a semiannual publication produced by the members of Global China Connection, re ecting our goal to foster connections, dialogue, and understanding between China and the rest of the world. Global China Reviewfocuses on a wide array of issues such asbusiness, international relations, environment policy and sustainable development, scienti c research, education, and culture. While the topics may vary, all articles are written for, and by, university students who share a global perspective and believe that Chinas global role will continue to expand.

If you have any inquiries about any of the pieces above, or would like to contribute. Please email the editor at: alexander.banh@gmail.com, or contact your local chapter. Please e-mail your article, essay, or blog entry with the subject heading Global China Review Submission. We will review and respond to your submission within one week and hope to feature it in the next outgoing issues of Global China Review. GCC appreciates the time, eort, and thought that is committed into producing and polishing a written piece for Global China Review. We are grateful for both your dedication to the organization and enthusiasm for our mission, and thus cash prizes will be awarded to select contributors based on the quality of submissions. For additional information on how to become involved with GCC or regarding GCCs upcoming events, please e-mail info@gccglobal.org.

Alexander Banh Editor-in-Chief | Global China Review Associate Director of Publishing | Global China Connection

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