Global capacity adjustment - not just a China PR stunt

Over the last two decades, the PRC political establishment have been very successful in learning how to sell China to foreign investors and importers. Its efforts have put all other nations' commercial chambers and trade departments to shame. Its job has become greatly complicated by the Western orgy of debt, fueled by China and other large-trade-surplus countries' currency targeting success. OPEC, Germany and Japan have been the biggest offenders, along with China, but much of East Asia follows this "Japan formula."

The reference article refers to a bold, environmentally conscious effort at industrial re-engineering. It does give a hint to the degree of panic felt in Beijing but tries to dodge this, as its State news source would have reasonably instructed. What it gives away, however, is the degree to which the collapse of the export sector has disrupted a carefully planned industrial transformation - at a critical point. Chinese officials are acutely aware that all successful social revolutions - like the one they begin celebrating on 1 October - began when a period of increasing prosperity was interrupted enough for the poor to join forces with the disenchanted middle class to overthrow the elite. A revolution of that scale is not is the offing now, but significant social disruption and a subsequent economic shock could be.

Command-economy planning has always encouraged overproduction in the name of employment management and overall growth. By chasing the export sector so aggressively (doubling its share of GDP in ten years to 42%), state planners have exposed the economy to infrastructure bottlenecks, trade friction and increased risk of oversteering.

Their bigger risk is social fragmentation of the sort compounded by ethnic discrimination in Tibet and Xinjian over the last few years. More pressure on the social transformation process will arise if there is a realization by the outside buying and investing world just how fragile China's social balance is at the moment. The government was caught with a flying tackle from the US debt implosion just as it was in the middle of its last great leap forward - one that could be delayed by importing external financial instability.

The idea of prohibiting certain types of construction, investment or lending had become less common in China, as regulators began to use incentives and indirect signals to stimulate a market mechanism and the collective efforts of popular will. But last year saw an increase in the use of this command mechanism, first central bankers (1Q08) and then every other conceivable ministry began issuing dictates - often reversing course after less than 6 months.

This kind of hard steering is typical when the market mechanism is still only partly developed and the mandarins are used to high-precision shaping of the growth trajectory. Of course, the results have never been as impressive as the PR, but they have been exceptionally good - until this year. But regulators and foreign investors have underestimated the extent of shock to system China is suffering now.

In spite of its own tough talk (excellent PR technique, by the way) about US government negligence and the need to replace the US Dollar, China's elite had an equal hand in the making of this global debt balloon. To take the risk of sprinting to the finish line, by accelerating GDP growth through ballooning exports, was perhaps an act of arrogance. But the Japanese made a similar mistake in the early 1980s, by assuming that the world had an inelastic demand for its production and an inelastic supply for associated import surge.

We must certainly hope that Beijing's mandarins continue to be much more capable than those in Washington, DC. However, any risk-management strategy must prepare for the chance (significantly higher than zero, now) that they will trip up this year or next. If we do not, then the lemming-like rush for the exits could be as bad for China as it was in 1997-98 for the rest of Asia. But the back-splash now will force a deeper second dip in this recession than might otherwise occur. Self-insurance is the only insurance at this stage.