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World haunted by heavy reliance on China

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Traders work on the floor of the New York Stock Exchange on Aug. 11. China's surprise devaluation of the yuan that day jolted the global markets.   © Reuters

TOKYO -- The fortunes of the global economy are ever more intertwined with those of China. And the world is coming to the realization that the Chinese economy is not as invincible as it once seemed.

     Misconceptions are complicating matters. The Chinese central bank on Aug. 11 abruptly devalued the yuan in a move widely seen as an attempt to expand exports, amid a stock market collapse and slowing gross domestic product growth. This triggered a series of currency devaluations in other emerging economies and threw their stock markets into confusion.

     The impact probably rattled China more than anyone. This is because the decision by the People's Bank of China was part of an effort to get the yuan into the currency basket that underpins the International Monetary Fund's Special Drawing Rights, alongside the dollar, euro, pound and yen. The idea was to allow the yuan to move more flexibly. The IMF called the yuan's devaluation "a welcome step."

     Some might wonder why Beijing is so intent on being part of the SDR basket. President Xi Jinping sees the move as a step toward global recognition of China as a major power in the international financial market. But China did not clearly communicate its reasoning, and the sudden change in currency policy caused serious jitters. 

     There have been other sources of confusion. In the U.S. government bond market, word began to circulate in late August that China was unloading Treasurys. China's foreign exchange reserves decreased by nearly $100 billion that month, bringing the outstanding balance to the $3.5 trillion level -- down from nearly $4 trillion at the end of June last year.

     Among market players, there was speculation that Beijing was intentionally stepping away from Treasurys. In reality, China's selling of Treasurys is mainly attributable to an outflow of private capital from the country. Since currency transactions are controlled by the authorities, the central bank provides dollars to private institutions when they want to purchase greenbacks. To do so, the central bank needs to sell Treasurys held as foreign currency reserves.

     The selling, therefore, does not signal an intentional shift but rather narrowing room for currency management.

Overcapacity, debt

China's fundamental problem is the diminishing power of investment and overseas demand to drive growth. Excess capacity and debt are dragging on the economy. 

     When the global financial crisis deepened with the 2008 collapse of Lehman Brothers, China weathered the storm with stimulus measures totaling 4 trillion yuan (about $585 billion at the time). It went on to surpass Japan as the world's second-largest economy. But China is now saddled with excess steel production capacity of 400 million tons, equivalent to four years of Japanese output.

     Then there is the debt time bomb. Chinese debt totaled 149 trillion yuan in 2014, a 260 % increase from 41 trillion yuan in 2007. The total equals 234% of the nation's GDP, up 81 percentage points during the period.

     The ratio of corporate debt to GDP is 157%, higher than the roughly 140% seen during Japan's bubble era.

     The Xi administration had the right idea in seeking to transition from an investment-driven economy to one powered by consumption. But the government squeezed investment before stronger consumption kicked in.

     In any case, the administration's efforts to propel stock prices -- meant to generate a wealth effect and increase consumer spending -- were akin to the fictitious Baron Munchausen's claims of having pulled himself and his horse out of a swamp by his own hair.

     The bursting of the Chinese stock bubble has only exacerbated the situation.

200 million individual traders

Individuals account for more than 80% of all stock transactions in China. Since institutional investors carry out less than 20%, many economists say the steep decline in share prices does not seriously affect the Chinese financial system.

     But look at it another way: Amid the surge in share values until June, the number of stock trading accounts opened by Chinese individuals topped 200 million. More than 90% of individual investors earn no more than 16,000 yuan ($2,511) a month. Many of these people likely began investing in the hope of helping to make the "Chinese dream" come true.

     At a meeting of Group of 20 finance ministers and central bankers in Ankara in early September, People's Bank of China Gov. Zhou Xiaochuan referred to the stock market bubble three times. He, of all people, should be aware of its significance.

     The collapse of Japan's economic bubble, which swelled after the Plaza Accord of 1985, led to two "lost decades." Despite considering Japan an example of what not to do, China appears to be headed down the same road. And this time, a large number of emerging and resource-rich economies have come to depend on Chinese purchases. This is starting to backfire, and the ramifications are chilling.

     The U.S. Federal Reserve Board in September put off raising interest rates due to the fog enveloping emerging nations. This, too, unnerved market players. 

     As long as China's economic management remains hard to decipher, uncertainty will loom over the world economy. Planning for a rainy day is advisable.

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