Wednesday, January 05, 2005

Inflation an indicator of false prosperity

This seems to be the most debated and hackneyed debate raging from the corporate boardrooms to B Schools to the ubiquitous coffee house.THE CHINESE DRAGON!
But the article below throws the interesting dilemma of forceful supression from appreciation of the yuan by the chinese government and the impact of such measure on the global front,especially the US and the effect on this on its domestic economy.Is this prosperity being discussed by the common people to the academicians worldwide sustainable over a long period of time or is it going to bust up sometime very soon?I believe the reality will come come out sooner than later and China would not seem to be the exciting Dragon as it seems to be on the papers until the government takes in some corrective measures.
Time would only present the true picture and tell us whether such policies by the state sponsored capitalist country could be applicable to other nations or not.
The debate continues and this article presents just the tip of the glacier.

China’s recent wave of inflation has exposed the false prosperity of the country’s economic growth during Jiang Zemin’s decade-long rule, says Jiang Zhongnan, a member of the German Economic Association and a senior economist, in a recent interview.
Jiang believes that Yuan should be devalued because, under a government policy of financial expansion and increased bank loans, real production is less than the money supply and serious corruption runs rampant in all levels of government as well as large- and medium-sized state enterprises.
Jiang said that 13 years ago, the Industrial and Commercial Bank of China, the Agricultural Bank of China, the China Construction Bank, and the Bank of China had a combined net asset of 13 trillion yuan. Since then, over 100,000 state enterprises have gone bankrupt and have taken bank loans down with them. The net assets of these banks have been all but completely depleted because of bad loans.
The banks still have a large sum of money, including individual deposits of about ten trillion yuan. But, according to internal reports, over four trillion Yuan in individual deposits are in accounts with assumed names and are likely from embezzlement and bribery. Since August, many rich depositors have started to withdraw money and move funds overseas, as the Chinese government started a new round of crackdowns on corruption.
Jiang said that these banks have been struggling under mountains of bad loans and that technically their net assets are now negative. Many people trust state-owned banks and don’t realize that these banks are no longer secure. In an unpublished speech, former Premier Zhu Rongji said that the Chinese banking system needs 800 billion yuan to ensure liquidity. If there were an inflation-triggered run on the banks, the banks would be forced to close.
He predicts that the prices of goods in China will continue to rise, resulting in hyperinflation by the end of the year. A vicious cycle will lead to a 50% increase in the overall prices by the first quarter of next year.
Jiang explained his views from the following angles:

The Yuan Was Overvalued And Its Depreciation Has Just Begun

The prices of basic necessities, industrial raw materials such as iron, steel and real estate have risen in China this year. The real estate price hikes have been the most dramatic, with a three-fold increase in cities such as Qingdao, Dalian, Shanghai and Beijing in just 3 years. The steel price is 40% higher compared to a year ago. The prices of basic necessities such as rice, flour, and cooking oil have risen 20-50% in big cities such as Beijing. Looking at it in another way, the Yuan has lost value. It is estimated that this year alone, the Yuan has devalued by 20%.
The Chinese economy enjoyed a golden era between 1995 and 1998 but has gone downhill since 1999. The government has beautified big and medium-sized coastal and inland cities such as Beijing, Shanghai and Qingdao to a splendor never seen before, but at what cost? The beautiful cities were constructed with the blood and sweat of workers and peasants as well as with foreign investments. These cities are display windows that demonstrate to both Chinese and foreigners how wonderful China has become.
The propaganda apparatus has been heaping praises on the Chinese economy. As a case in point, the U.S. government suggested to the Chinese counterpart that the Yuan should have market-based floating exchange rates because the current fixed exchange rates have caused seriously unfair competition in the world trade. Yet the Chinese propagandists distorted the suggestions to their favor and interpreted the U.S. criticism into a supposed high regard of the Yuan in the world market and a push for appreciation of the latter. The truth is that the Yuan is overvalued and would depreciate in view of the economic reality in China. The current wave of inflation reflected some, but not all, of the reality that points to a possible need to depreciate the Yuan.

Inflation Will Continue And Runs On Banks Hard To Avoid

The price hikes in China have been tolerable so far. However, the prices will continue to rise due to chain-reactions. For example, the sugar price will go up when the raw agricultural materials for making sugar become more expensive. Higher raw steel prices will push up the prices of steel products. If the government is unable to stop the chain reactions, the latter could lead to a vicious cycle. It is estimated that the inflation will become serious by December and the prices will go up 50% in the first quarter of next year.
As the prices go up, individuals are likely to withdraw money to buy things. More seriously, even factories and businesses will accelerate their purchases of raw materials. The buying sprees would cause liquidity problems for banks and purchasers would then be unable to pay. Of course, the government could take harsh measures such as restricting bank withdrawals by individuals and businesses.
Serious corruption has lead to ballooning government expenditures and heavy debts. All levels of government in China spend a lot of money each year; dining, wining, and even sightseeing have consumed large amounts of government funds. In 1998, the State Bureau of Auditing found that central and local governments, state-owned enterprises, and local government-owned enterprises spent one trillion Yuan in cash, when the GDP of China was only 8.5 trillion Yuan.
Severe and systemic corruption in China is truly astounding. Under an expansionist fiscal policy, large amounts of funds have been swallowed by corruption instead of being used for increasing production. Local governments waste huge amounts of money and resources by starting many inefficient and redundant projects, which lead to high production and economic growth with unsold products piling up.
Jiang Zhongnan believes that the Chinese government has been borrowing from the future assets of citizens by liberally issuing long-term and short-term national bonds to fill the widening budgetary deficit gaps.
Corruption, creative accounting, and other potential crises have been plaguing the government, businesses, and banks. The state enterprises have been trying to transfer their problems to banks or the stock markets. False numbers have diluted the GDP. Beautiful skyscrapers in big cities and official positive propaganda had covered up these serious problems, which are beginning to rear their heads in the current wave of inflation.

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