Coping with China’s financial power

State-owned banks are financing a $35-billion plan to triple the size of Zhengzhou, capital of Henan province.

Ken Miller, president of a merchant banking firm and director of the USA Pavilion at the 2010 Shanghai World Expo, has written a level-headed, sophisticated and cautiously optimistic Foreign Affairs article about China’s financial might. Much of the article, titled “Coping With China’s Financial Power: Beijing’s Financial Foreign Policy”, rang true to me, and it wasn’t laden with hawkish bromides about China ruthlessly ruling the world and subjugating the West. He did an excellent job balancing the negative with the positive regarding the effects and influence of Chinese capital in the world.

Here’s a synopsis of his conclusions from the article:

So far, China’s financial foreign policy has been good for other countries and less beneficial for China itself than first meets the eye. China is buying U.S. debt. It is helping make orderly markets. Its FDI is helping it learn about the outside world. As for Beijing’s aid and assistance to developing countries, the amounts involved are small to begin with, and the Chinese government is generating a fair bit of resentment. Its mercantilist approach will not give the government any more real security over sources of supply than if it bought them at international prices on the open market, and in the fullness of time, as the Chinese government recognizes this, it is likely to shift its tack without external pressure. Thus, with the important exception of China’s support for regimes that the U.S. government does not like, Washington should not worry much about Beijing’s financial foreign policy.

As China stimulates its domestic demand and becomes a bigger player in international finance, its engagement will most likely contribute to healthy relations among nations. The developed economies’ need for capital and China’s surfeit of it will give China a natural path to invest in those states (even without capital account convertibility). Larger financial ownership positions in foreign companies will, on balance, be a good thing for Chinese companies and for the world, just as the United States’ stock of foreign investments has been. And if Western capitalism continues to show vitality, China will likely evolve to be even more market-oriented. After all, the Chinese appetite for profit making has survived nicely despite over 60 years of communist rule.

A little bit of patience is in order. Policymakers in the United States should remember that China emerged as a financial power less than ten years ago. With a better understanding of China’s domestic imperatives, Washington can encourage Beijing to project its financial power abroad in ways that contribute to the stability of the global economy.

However, I do wonder whether China’s current financial prowess could deteriorate in the long run. In researching my book on China’s modernization in 2006, I interviewed several Western and Chinese scholars in Beijing who fretted about the transparency and health of the balance sheets of state-owned banks. This was well before the stimulus lending of 2009. Moreover, the lending practices I witnessed in China, especially regarding local government real estate developments (see Chapter 14: Xi’an in my book), seemed highly politicized. It is news to no one that China’s use of capital is grossly inefficient.

In the long run, there are other factors, too, that could cause China’s stagnation and financial decline, including lack of domestic consumer demand, ecological challenges related to water, food and pollution, an aging population, a sluggish global economy, corruption, growing inequality, and so on. Many of these challenges could pile up, one atop the other, like a highway car crash with devastating effects.

The question is whether China can smoothly transition from fast to slower economic growth, and whether the Communist Party can manage the demands and expectations of an increasingly irreverent, tech-savvy and pluralistic citizenry.