Speaker: Pieter Bottelier, Adjunct Professor of Johns Hopkins University, School of Advanced International Studies
Date: July 27, 2011
Interviewer: It is my pleasure to welcome Dr. Pieter Bottelier who is a senior adjunct professor of China Studies at the Johns Hopkins University School of Advanced International Studies in Washington, D.C. where we are conducting this interview today. Dr. Bottelier is an international economist, China scholar, and a consultant. He has taught as an adjunct lecturer at Harvard University’s Kennedy School of Government, Georgetown University’s School of Foreign Service, and now full time at the Johns Hopkins University since 2005. Dr. Bottelier worked at the World Bank from 1970 to 1998. He served as Senior Advisor to the Vice President for East Asia from 1997 to 1998. Pleasure to have you here.
Q1: Let’s just start off by talking about the United States, having been a leading economic and political superpower, obviously for many many decades. We’re wondering now, what message has the debate in Congress over the U.S. debt issues, regardless how it’s solved in July August of twenty eleven, how is the debate over the debt issue affected the message sent to the world about America’s ability to anchor the global economy?
A: The current stalemate I think hasn’t helped to back its image internationally, though simply have reaffirmed a fairly widely held impression around the world that America’s relative political and economic power in the world is declining. It’s relative power.
Q2: Well what’s the message in China, how have they been receiving it? What have they been thinking about this political gridlock here in the U.S. and the possibility that the U.S. could or could have defaulted on its debt?
A: Well the Chinese are very concerned for a variety of reasons. When Deng Xiaoping started the market reforms in the late 1970’s, the U.S. was undoubtedly one of their models to aspire to, except of course for the political aspect. Now that the financial crisis has exposed many weaknesses in the American financial system that we and the Chinese were unaware of, and also exposed very serious weaknesses in the supervision of the system, the regulatory, the implementation of the regulatory framework, the Chinese are having very profound second thoughts of the usefulness of the U.S. economic model. The U.S. has lost an enormous amount of stature in China as a result of the crisis, as a result of the Madoff scandal, as a result now of the inability of the political system to deal with the very massive and acute problems that we are facing.
Q3: Do they have any plans to do something about this that you know of?
A: If they do I don’t know. I think they have very little options, very few choices, they are the largest foreign creditor of the U.S., they are holding well over a trillion in U.S. debt, of which the treasury part is the largest. Probably over a trillion is treasury debt, but they hold significant amount of Fannie Mae and Freddie Mac, and corporate debt also. They are naturally worried about what is going to happen to this Washington drama over the debt and the rehabilitation of the fiscal system.
Q4: I want to ask about China’s own internal financial stability. The 2008 global economic crisis originated in the United States, and was used as evidence by many Chinese economists to represent the superiority of state capitalism over free markets. But now, is this correct that the recent reports on the extent of hidden municipal debt in China, raising questions on the health of China’s own economy, What about that?
A: Well, to frame the context, China was hit very hard by the international financial crisis. Their exports collapsed in the last part of 2008, they had to lay off some 20 million people in the export sector. They were very worried that the massive decline in the economic growth would generate massive social problems in China that might be beyond the control of the system. It was then that they launched a massive stimulus program, they call it the fiscal stimulus program, it was largely debt financed actually, which was so large, and so quick and well implemented that it restored economic growth momentum within one or two quarters. By the second half of 2009, China’s economy was beginning to overheat. Now we of course by now realize that most of that was triggered by a massive expansion in credit from the banking system, and also outside the banking system. Some of which actually was so large that it was outside the control of Beijing. Now we know better what actually happened than we did at the time, and it is evident that many parties in China borrowed far more than they should, and that the quality of the projects that were implemented this much of that money was questionable in some cases. One of the, the finger has been pointed that local government debt as the big problem. It’s quite clear that local governments in China, through their local government owned investment company, have borrowed huge amounts, far more than the government ever intended them to borrow. Some of it ended up in speculative real estate investments. Some of it ended in basically good quality infrastructure projects. The total amount of the local government borrowing is still in question. Even in China there is much debate on this. The National Audit Agency has recently completed a very detailed study which they claim involved some 40,000 auditors. And the conclusion of that was that the total amount of debt outstanding by local governments or corporations owned by them was something of the order of 10.7 trillion RMB, it’s about 1.6 trillion dollars. Far more than anyone had believed.
Q5: This has an oddly familiar ring to it. May I ask could China become like the US?
A: Well, the question I think, we’d have to ask first is, a., can we rely on the numbers because some people say that’s it’s even larger. KPMG for example has come up with estimates that put it some 30% higher, and Moody’s has suggested that it may be higher also. That’s the first question. The second question is: Is the amount as reported by the government, or even the higher estimate, a potential problem for China? Could this undermine the stability of the financial system?
Q6: Well what do you think?
A: I don’t think so. I think, at the macro level for the economy as a whole the total- the total level of debt- that is owed by the central government and all local governments even if you take the higher estimate is still pretty modest. Given the fact that the state controls China’s economy to a much larger extent than in the US, all local government does in fact ultimately carry an implicit central government guarantee. Given the overall, the estimate of the overall level of debt there is no serious debt problem in China. That does not mean there is no problem. There could well be problem for individual municipalities and for local banks that have overextended themselves for local projects. I’m not belittling the problem, but at the Macro level there is no serious problem- debt problem- in China like there was in the US.
Q7: I’d like to talk in a moment about the political situation in China coming up about the same time as the political changes that may be coming in the US. But before we do that can we talk about the RMB, the currency? What is the future of it? Do you suspect that it will ever become an internationally currency. Used widely in the international trade? Replacing the dollar even perhaps as some have suggested?
A: There is little chance that the RMB will replace the dollar, but the pressure for reform in the international financial system to reduce reliance on the almighty US dollar I think is building up, and the crisis of 2007-2008, compounded by the debt and fiscal crisis that we are now facing in this country, they only have been intensified international sentiment for and pressure for reform of the international financial system. The Chinese went up front in the beginning of 2009 proposing a basic reform of the international financial system, making the RMB part of the currencies that would underpin the special drawing rights of the IMF. That proposal went nowhere and the Chinese are no longer pushing it. About a year later the Chinese began to push an alternative scheme that is to internationalize the international currency- the RMB or the Yuan- and that is actually in full swing right now. But that does not mean the RMB will become an international reserve currency like the dollar or the Euro or the sterling or the Japanese yen anytime soon.
Q8: What is the biggest obstacle to that? I assume it’s politics within the Communist party?
A: Well politics may be the ultimate root cause of it, but at a more technical level the root cause is that the Chinese currency is not convertible. If you want to take money in and out of China beyond a certain level you need all sorts of licenses. The Chinese control what we call a capital account very tightly. Part of that capital control is an undervalue system to keep the RMB relatively low relative to the US dollar- relative to international currencies generally but especially to the US dollar. If the Chinese were to push the RMB in an international role beyond the straight settlement, which is basically the limit of the present scheme, then they would have to essentially remove all capital controls and make their currency freely convertible currency for anybody for any amount.
Q9: What is the downside for China?
A: Well, that the, that’s an interesting question. Will the Chinese political system permit such a change? Because the implication of removing all capital control is that they would also have to give up all controls on domestic interest rates. That is lending rates and deposit rates in the banking system. They would have to move completely their system of monetary policy to something more akin to what we have in this country. It would be the end of artificial financial repression in China, which is a system by which the government keeps the cost of money artificially low, underpaying the depositors in order to be able to make financial resources available at a relatively low price to favored borrowers, particularly state enterprises.
Q10: So this is a patronage system?
A: It has much to do with that. The Chinese political system would stand to lose a lot of power internally if they give up the whole system of financial repression, which is related to the system of the exchange rate management and the control of deposit rates in particular, moreso than lending rates. Lending rates are essentially uncontrolled, but the deposit rate is the key intervention rate in China.
Q11: So your prediction is it will be some time before the Chinese currency, the yuan, becomes even a reserve currency within china, let alone internationally?
A: I’m pretty sure that there are many technicians in China’s central bank who would love nothing better but to push for the complete internationalization of the currency, like the US dollar. And essentially I believe it would be good for china, and it would also be good for the world, because it would add an element that might generate more stability for the international financial system. Whether the political bosses are ready for to give up these elements of control over the Chinese economy is another question that I cannot answer.
Q12: Can we talk about the political situation coming up in China, there are some political changes coming, elections coming up within the central committee, the Politburo, the standing committee, is that correct? And when would these happen, by chance they are going to happen in 2012, the same year as what promises to be a horrendous election year in this country?
A: Yes that is correct, this is the first time that there is going to be major political change in China and in the US coincident in time. By the way this is only the second time in Chinese history since 1949, since the Communist takeover by Mao Zedong, that we expect a fully orderly constitutional transition of power to a new group of people. So exactly what’s going to happen, particularly the effects of the coincidence between political change in China and in the US is hard to predict. This is the first time that this is a coincidence. Second time that we have an orderly- expected orderly- fully orderly political change in China. Under the Chinese political system now we have strict term limits for all senior political bosses. The maximum period for the Premier or for the President of the Republic are 10 years- 2 five year terms. And that period is up by the fall of next year, 2012. The exact year of the party congress that will actually elect the new leaders at various levels has not been set yet, but it may well coincide more or less with the American elections.
Q13: Well, we have to wrap up here, Dr. Bottelier, but what is your short-term political and economic outlook for China at this time?
A: Well, let me start with the economic outlook. They’ve done extraordinarily- they’ve been extraordinarily successful in dealing with the consequences of the international economic crisis. Actually in many ways more successful than they ought to have been or should have been because they lost control over the credit expansion, which is now generating of course lots of problems on the side. But by and large they have managed the recovery masterfully. The problems that have been generated by the excess in the credit expansion, in terms of the real estate prices going through the roof, and relatively high level of consumer inflation, are of course serious problems. But I don’t think they will bring the system down. I think by and large the system will be brought under control. Having said that, I should add that it is very probable that the overall growth rate of the economy will come down. In fact, the Premiere, the government, set the official target for the current 5-year plan, which started at the beginning of this year, at 7%. The first half of this year, we had 9.5 or 9.6% growth, so we have to go way down to 7% even to reach their own target. I think that it is probable that they will move towards that target next year and beyond. For all sorts of reasons, including demographic reasons, the overall growth rate of China will come down. But I don’t think that there is a good chance of economic collapse, as many people have been predicting. I think that all indications are that they are getting the real estate bubble under control; the inflation probably has peaked in June; July numbers will still be high but for the second half of this year, inflation will probably be lower than the first half. Having observed these Chinese managers for some time now, I am inclined to think that they will bring this beast under control.
Interviewer: This beast.
Bottelier: Yes, sir.
Interviewer: Dr. Pieter Bottelier, thank you so much for being with us.