Executive Briefings

Step Aside, America: China Coming Through

Plenty of American workers are wishing that China would just go away. They're hoping that all those predictions about it becoming the world's largest economy are fantasies. Remember when Japan was supposed to crush the West with its manufacturing and trading prowess? Why can't China fizzle out in the same way?

In a word: people. China's population of more than 1.3 billion dwarfs Japan's 128 million. And it's more than four times the United States' 307 million. That's a potentially dominant workforce and consumer market, all wrapped into one.

All right, you say - but what about China's banking system? Isn't it posed to topple at any moment, burdened by overheated growth and a horrible balance sheet of non-performing loans that the nation has managed to hide from the world until now?

Dream on, says Benjamin Wey, president of New York Global Group, an adviser to mid-market companies doing financial deals with China. Among his many credits, Wey has served as personal consultant to the Research Institute of the state-owned People's Bank of China, so he might not be the most objective observer on the scene. Nevertheless, he makes a compelling case why China will indeed become the world's greatest economic power - and how the U.S. is helping it to achieve that lofty goal.

Start with a basic difference in the way that U.S. and Chinese banks have generated revenues. In recent years, American institutions have increased their dependence on investment banking deals and complex derivative products. We've all seen what those risky instruments can do to a supposedly resilient economy. At the same time, U.S. banks have cut back sharply on their commercial lending, especially to the small and medium-sized businesses that rely on their aid, and account for most of the jobs in this country. "If this were in China," Wey says, "banks would be loaning money to companies with real assets, instead of seeking quicker money on Wall Street."

China's banks, by contrast, continue to focus on more traditional banking practices - taking customer deposits, making loans and turning a profit on the interest-rate spread. Derivatives represent a comparatively minor piece of the balance sheet. "I would argue that Chinese banks are relatively more stable than U.S. banks because their earnings tend to tie into the real economy, rather than the performance of stock markets," says Wey.

That "real economy" grew at an average rate of 10 percent between 1990 and 2004, generating plenty of capital to keep loans current. Even if China's rate of gross domestic product growth drops permanently into the single digits - as the laws of mathematics say it eventually must - the banks are in little danger of mass defaults, Wey says. "I would say that the vast majority of Chinese commercial banks' loan portfolios are quite stable."

China isn't immune to economic realities. A large portion of loans issued by Chinese banks are collateralized by hard assets such as commercial property. So if China experiences a collapse in its real estate market, there will be pain. But it won't be enough to bring down the nation's economy, Wey says.

China faces more serious and immediate concerns in developing its domestic market, he says: the twin specters of unemployment and inflation. These are "the two single most important factors driving Chinese policies." A high rate of unemployment would threaten the nation's political structure. (One can only hope.) And rampant inflation, which is already on the rise, would destroy much of the wealth that China has stacked up over recent decades. China's goal, therefore, is to stimulate domestic demand while lessening its reliance on exporting, which currently accounts for about 40 percent of total economic activity, according to Wey. Armed with some $2.85tr in foreign exchange reserves, China can afford to pump up its domestic economy to a degree that makes U.S. efforts look puny by comparison.

Meanwhile, the U.S. finds itself saddled with crushing debt, both at the government and individual levels. Our own attempts to spur economic revival through increased spending, while necessary in some sectors, have had the effect of further weakening the dollar. Ironically, the U.S. is asking China to reduce the value of its own currency, in order to make American exports more competitive. Wey notes that the yuan appreciated 5 percent against the dollar last year, not enough to satisfy U.S. traders. Stronger-than-expected growth in the American economy this year will be necessary to strengthen both currencies, he says. (That's not an impossible scenario, given that the yuan's value is pegged to a basket of foreign currencies, not just the dollar.)

So, from the American point of view, is the situation hopeless? Not quite, says Wey. China has had limited success in developing its own consumer brands for domestic and global distribution. It's working hard to cultivate home-grown producers in areas such as automobiles and household appliances, anticipating the emergence of a middle class with real purchasing power. Such companies will no doubt be springing up in great numbers in the years ahead, but the U.S. has one major strength in reserve. "I am a firm believer," says Wey, "that innovation comes out of a free society." American democracy provides far more fertile soil for the kind of creative thinking that captures and dominates new markets. Maybe China's recipe of capitalism, authoritarianism and utter lack of civil liberties has its limits after all.

Provided, of course, that the U.S. gets its own economic house in order. For now, we continue to enable China's growth through our massive trade imbalance and the willingness of China and other countries to go on financing our debt. "We cannot afford to run the kind of budget deficits we are running today," says Wey. "Every year we have a deficit, we are indirectly helping China to become stronger."

Comment on This Article

Plenty of American workers are wishing that China would just go away. They're hoping that all those predictions about it becoming the world's largest economy are fantasies. Remember when Japan was supposed to crush the West with its manufacturing and trading prowess? Why can't China fizzle out in the same way?

In a word: people. China's population of more than 1.3 billion dwarfs Japan's 128 million. And it's more than four times the United States' 307 million. That's a potentially dominant workforce and consumer market, all wrapped into one.

All right, you say - but what about China's banking system? Isn't it posed to topple at any moment, burdened by overheated growth and a horrible balance sheet of non-performing loans that the nation has managed to hide from the world until now?

Dream on, says Benjamin Wey, president of New York Global Group, an adviser to mid-market companies doing financial deals with China. Among his many credits, Wey has served as personal consultant to the Research Institute of the state-owned People's Bank of China, so he might not be the most objective observer on the scene. Nevertheless, he makes a compelling case why China will indeed become the world's greatest economic power - and how the U.S. is helping it to achieve that lofty goal.

Start with a basic difference in the way that U.S. and Chinese banks have generated revenues. In recent years, American institutions have increased their dependence on investment banking deals and complex derivative products. We've all seen what those risky instruments can do to a supposedly resilient economy. At the same time, U.S. banks have cut back sharply on their commercial lending, especially to the small and medium-sized businesses that rely on their aid, and account for most of the jobs in this country. "If this were in China," Wey says, "banks would be loaning money to companies with real assets, instead of seeking quicker money on Wall Street."

China's banks, by contrast, continue to focus on more traditional banking practices - taking customer deposits, making loans and turning a profit on the interest-rate spread. Derivatives represent a comparatively minor piece of the balance sheet. "I would argue that Chinese banks are relatively more stable than U.S. banks because their earnings tend to tie into the real economy, rather than the performance of stock markets," says Wey.

That "real economy" grew at an average rate of 10 percent between 1990 and 2004, generating plenty of capital to keep loans current. Even if China's rate of gross domestic product growth drops permanently into the single digits - as the laws of mathematics say it eventually must - the banks are in little danger of mass defaults, Wey says. "I would say that the vast majority of Chinese commercial banks' loan portfolios are quite stable."

China isn't immune to economic realities. A large portion of loans issued by Chinese banks are collateralized by hard assets such as commercial property. So if China experiences a collapse in its real estate market, there will be pain. But it won't be enough to bring down the nation's economy, Wey says.

China faces more serious and immediate concerns in developing its domestic market, he says: the twin specters of unemployment and inflation. These are "the two single most important factors driving Chinese policies." A high rate of unemployment would threaten the nation's political structure. (One can only hope.) And rampant inflation, which is already on the rise, would destroy much of the wealth that China has stacked up over recent decades. China's goal, therefore, is to stimulate domestic demand while lessening its reliance on exporting, which currently accounts for about 40 percent of total economic activity, according to Wey. Armed with some $2.85tr in foreign exchange reserves, China can afford to pump up its domestic economy to a degree that makes U.S. efforts look puny by comparison.

Meanwhile, the U.S. finds itself saddled with crushing debt, both at the government and individual levels. Our own attempts to spur economic revival through increased spending, while necessary in some sectors, have had the effect of further weakening the dollar. Ironically, the U.S. is asking China to reduce the value of its own currency, in order to make American exports more competitive. Wey notes that the yuan appreciated 5 percent against the dollar last year, not enough to satisfy U.S. traders. Stronger-than-expected growth in the American economy this year will be necessary to strengthen both currencies, he says. (That's not an impossible scenario, given that the yuan's value is pegged to a basket of foreign currencies, not just the dollar.)

So, from the American point of view, is the situation hopeless? Not quite, says Wey. China has had limited success in developing its own consumer brands for domestic and global distribution. It's working hard to cultivate home-grown producers in areas such as automobiles and household appliances, anticipating the emergence of a middle class with real purchasing power. Such companies will no doubt be springing up in great numbers in the years ahead, but the U.S. has one major strength in reserve. "I am a firm believer," says Wey, "that innovation comes out of a free society." American democracy provides far more fertile soil for the kind of creative thinking that captures and dominates new markets. Maybe China's recipe of capitalism, authoritarianism and utter lack of civil liberties has its limits after all.

Provided, of course, that the U.S. gets its own economic house in order. For now, we continue to enable China's growth through our massive trade imbalance and the willingness of China and other countries to go on financing our debt. "We cannot afford to run the kind of budget deficits we are running today," says Wey. "Every year we have a deficit, we are indirectly helping China to become stronger."

Comment on This Article