China and Hong Kong Are Headed Toward Collapse

by ITÔ Kiyoshi

In its 1993 report titled Global Economic Prospects and the Developing Countries, the World Bank predicted that the combined gross national product of China, Taiwan, and Hong Kong would reach $9.8 trillion by the year 2002, outstripping the United States to make the "Chinese economic area" the world's biggest economy. This was, needless to say, music to the ears of the leaders in Beijing, since it stripped Japan of the right to speak of the twenty-first century as the "age of Japan," making it instead an age of Chinese prominence. The report went on to speak in glowing terms of an Asian growth region encompassing Hong Kong, Indonesia, Japan, Malaysia, Singapore, South Korea, Taiwan, and Thailand. It seemed as if East Asia had established a firm position as the growth center of the global economy. All the world began gazing intently at the region, anticipating that the next century would be an "age of East Asia."

It was on July 1, 1997, with the reversion of Hong Kong--one of the biggest diplomatic events marking the end of the twentieth century--that the Chinese government's fine spirits reached a peak. But on July 8, before the excitement had time to subside, the Thai baht collapsed, marking the start of a currency crisis that swept across East Asia, upset financial markets, and left economic turmoil in its wake. Such was the scene in East Asia just four years after the World Bank's optimistic report.

The staff of the World Bank includes many first-rate economists, and not a few of them had doubts about the prediction from the start. First is the question of whether a "Chinese economic area" including Taiwan will really come into being. The bank's report is based on the premise that Taiwan, like Hong Kong, will essentially act as a part of this area by 2002, but while God may know the answer to that, we mortals do not. How realistic this premise is remains very uncertain.

Next is the question of why the bank used purchasing-power parity in its calculations of GNP sizes. The PPP measure is useful for ascertaining the level of China's prices, but it is not suited to judging the comparative international power of countries. For that you must calculate GNP using market exchange rates. And when you do that, you find that China will not have the largest economy in the world in 2002 even if it has absorbed Taiwan.

In the current circumstances, it may be best to say nothing about the World Bank's other prediction of a rosy future for East Asia. At the time of the report, there seemed many good reasons for pinning hopes on the region, but they have suddenly faded away. Given the power of the bank's "divine revelations" to influence the world economy, one would wish that they were always right on the mark, but it looks today that they have frequently gone astray. Last February 6 the bank proclaimed that East Asia's currency crisis was winding down. That, let us hope, is an accurate evaluation.

DOES THE WORLD EXIST FOR CHINA?

Founded in October 1949, the People's Republic of China is about to reach its fiftieth anniversary. The pendulum's swing toward economic modernization began in December 1978, when the Eleventh Central Committee of the Chinese Communist Party met in its third plenum. While the socialist planned economy had been based on the principle of self-reliance, the CCP decided at that point to switch to reliance on outside help, and it started promoting reform and opening policies and embraced the market economy. I call this reliance on outside help because the Chinese asked those outside to supply capital and technology, supplying only land and labor themselves.

With the suppression of the democracy movement on Tiananmen Square on June 4, 1989, China's reform drive suffered a temporary setback. But momentum was regained in February 1992 when prime leader Deng Xiaoping went on a tour of the southeastern region and praised its accomplishments. When the rosy outlook for China appeared in the World Bank's report a year later, the expectations of the Chinese market rose much higher. Money poured in from the industrial nations and Asia's newly industrialized economies (Hong Kong, Singapore, South Korea, and Taiwan), particularly from overseas Chinese. This ushered in a breathing spell as business perked up, and China moved from the status of one of the world's poorest countries to one that was getting by not too badly. Per capita GNP rose above $500, and while some commentators scoffed that that was still a paltry sum, Beijing's authorities began to get excited. In the eyes of lovers, the world exists for them; as the leaders in Beijing began to see it, the world exists for China.

Hong Kong, around the time of its handover to China, succumbed to speculative fever, and stock and real estate prices went through the roof. Voices of warning were raised, but they were drowned out by loud talk from China about how it would, if necessary, devote the $130 billion it had built up in foreign-currency reserves to propping up the Hong Kong dollar. The cause of the Hong Kong bubble may reasonably be said to have been the influx of Chinese funds into the territory, which the authorities in Beijing either deliberately countenanced or chose to ignore. The political agenda Beijing was working on was to show the world that it could successfully absorb Hong Kong by means of its "one country, two systems" policy. Among the sources of the funds were Chinese enterprises owned by the state and other public bodies--that is, those among them with a good business record--along with entrepreneurs who had managed to amass fortunes by twisting the country's reform and open-door line to their advantage. Funds from some Hong Kong nouveaux riches also fueled the speculation. Unfortunately, there are also many Chinese suffering from "socialist senility" who have been deluded into thinking that investment in stocks and property (actually, speculation in them) is a sure way to make a profit. This helped to feed the speculative boom and inflate the "reversion bubble."

THE STOCK EXCHANGE CASINO

I have no intention here of probing into the contradictions of a "socialist market economy," but I would like to say a word about the half-baked nature of China's market economy. The flimsiness of this structure is not just of concern to China. Given the socialist market economy's reliance on outside help, a Chinese economic collapse would have immediate ramifications throughout East Asia and among the industrially advanced countries, and could even ignite an economic crisis of global proportions. First, though, I wish to take a somewhat unusual route toward putting the Chinese economy into international perspective. Specifically, I will try to shed light on capitalism in East Asia through comments on Japan's sôkaiya, the racketeers who blackmail companies.

In economic terms, the Meiji Restoration of 1868 marked a shift to the capitalist system of the West, and it led to the introduction of the modern stock company. In the course of 130 years of "Japanese-style" development, however, the shareholder known as a sôkaiya--a term that has become familiar even to people overseas these days--came into being in Japan alone among the industrial countries. According to the Kôjien dictionary, a sôkaiya is "a person who owns a small number of shares, attends shareholders' meetings, and engages in practices like extortion." To put it more plainly, this is someone who threatens to tell shareholders about their company's vulnerabilities, especially any illegal or unfair practices it has engaged it, in order to obtain money illegally and unfairly. The existence of these racketeers is a disgraceful aspect of the Japanese stock company and the Japanese version of capitalism.

The pattern of East Asian development is often likened to the formation of geese in flight. Japan flies in front; the four Asian NIEs are not far behind it; Indonesia, Malaysia, the Philippines, and Thailand follow them; and China and Vietnam are in the rear. It is revealing, though, that while the stock companies in other East Asian countries have sloppier management than Japan's companies and more weaknesses and other problems that shareholders ought to object to, they do not have sôkaiya. Indeed, they do not even pay much attention to shareholders' meetings. This is because speculation rather than investment is the motive behind share purchases. To put this another way, owner-managers take their companies public only because they see this as a way of raising cash from the populace. They give little thought to returning profits to their shareholders, and the shareholders, anticipating that the stock price will soar, give little thought to dividends. The stock markets of East Asian countries are, to put it in a nutshell, casinos.

As controversial as this may sound, I would submit that the sôkaiya, though they may look strange in foreign eyes, have played a role of curbing illegal and unfair managerial behavior. In this light we can say that Japan, even though it is still not up to the standards of the West, is more of an "advanced country" than its Asian neighbors, because it has sôkaiya while they do not. East Asia's countries tend to be "developmental dictatorships" in which commercial codes and other laws may exist but do not function effectively. This is the root cause of the recent currency and financial turmoil. And we can imagine what the situation must be like in China, a country that is the prime practitioner of rule by people rather than by law, with its one-party communist dictatorship.

THE TRADITION OF BRIBERY

Though China has embraced the market economy, it must be said that its slipshod managerial practices, whether in state, public, or private firms, outshine those of all other East Asian companies. Fighting between residents and the police once broke out in Shenzhen, which is next to Hong Kong, when there was a scramble for tickets giving those who held them the right to purchase shares. A superstitious belief in the ability of stock to produce profits without fail triggered this clash. Many Chinese still have no idea that some of the companies they have invested in may go bankrupt. In this respect, the speculators of East Asia are a breed apart. As long as this loose way of thinking prevails, growth in the size of the Chinese economy will mean only that when it falls apart, the impact will reach wider, possibly beyond what we can imagine. Ironic as it may sound, I would say that China is in need of some sôkaiya to rein in the excesses of corporate management.

Recently a string of revelations of bribery involving Japanese companies and top-ranking bureaucrats has been making headlines. On learning that the wrongdoing includes mandarins in the Ministry of Finance--the cream of the crop in the Japanese bureaucracy--even overseas observers began watching with interest. In one case it was revealed that MOF personnel were wined and dined at a nô-pan shabushabu restaurant--where skimpily clad waitresses with "no panties" serve shabushabu meat dishes--an episode that has turned nô-pan shabushabu into one of the fad terms of 1998. It was an embarrassment for the Japanese people to learn that among the "superelite," those with law degrees from the University of Tokyo, some had fallen that low. This is another disgraceful aspect of Japanese capitalism and society. But how does this compare with the situation in other East Asian countries with an even wider status gap between the authorities and the people? Except in Singapore, which is known for its harsh fines and penalties for misbehavior, collusion between government and business and the giving and accepting of bribes are everyday affairs. In "advanced nation" China, you cannot conclude a deal on any level from the top to the bottom without applying some oil. Foreign businesses moving into that country have learned to list entertainment costs and money passed under the table as necessary expenses.

The People's Liberation Army used to brag that its members "would not accept even one needle from the people." But if today's Chinese heard such talk, they would burst out laughing. Among the major cases of corruption in recent memory, I might cite the downfall of Chen Xitong, a member of the CCP's Central Committee and its Political Bureau, as well as the secretary of Beijing's Communist Party Council, at the time of the fifth plenum of the Fourteenth Central Committee in September 1995. The communiqué released by the Central Committee accused Chen of "having a degenerate and extravagant lifestyle, abusing his power to secure unjust profits for his family, and accepting expensive gifts." But an indictment of this sort could be brought against almost any of the top authorities in China's government. What apparently happened is that Chen became a victim of the power struggle between the Beijing and Shanghai factions when it reached a critical juncture. If we can believe the rumors that were then circulating in Beijing, Chen's corruption and degeneracy went far beyond what any MOF mandarin could contemplate.

With its movement in the reform and opening direction, China is experiencing increasing problems of corruption among public officials. The case of Chen is but the tip of the iceberg; the fact of the matter is that bribery is part and parcel of China's traditional culture. Traditional culture cannot be easily set aside merely by introducing the principles of the market economy, which uses supply and demand relationships for guidance and depends on fair competition. For this reason people have come to speak of the "Chinese-style" market economy. We need to be aware that pure market principles will not prevail in a China that is still under the sway of connections, favoritism, and bribes. All of us, not just the World Bank's economists, need to analyze the Chinese economy and the other circumstances of the country in full awareness of China's distinguishing characteristics.

PROSPECTS FOR THE YUAN

When the characteristics of the Chinese economy are taken into account, we can only be pessimistic about the prospects for China and Hong Kong. Beijing saw to it that the Hong Kong stock and real estate markets prospered around the time of the handover, both to gain acceptance for its one-country, two-systems formula and to help its state and other public enterprises to raise cash for their reorganization as stock companies. The result was the reversion bubble. Then, in October 1997, not quite four months after the reversion, Hong Kong's Hang Seng stock index lost half its value, plummeting from the 16,000 level to the 8,000 level, while property prices took a battering in the range of 30% to 40%. In the background was the East Asian currency crisis, but also involved was the popping of the reversion bubble, together with the overvalued level of the Hong Kong dollar.

In response to the currency crisis, the Chinese government repeatedly stressed that the yuan would not be seriously affected since it is not a currency that can be exchanged for the currencies of other countries, and it promised that the it would not be devalued. This was, however, just jawboning; China had no other effective tools at its disposal. And the "inconvertible" yuan had in fact been flowing into Hong Kong in great volumes, where it became the principal cause of the reversion bubble.

The Chinese government claims that it keeps tight control over foreign-currency movements, but China is a country where every measure from above is met by a countermeasure from below. To illustrate this point, let me mention a countermeasure used by Taiwanese investors to extract profits from China.

It is presumed that the Taiwanese have invested hefty sums in China, but no precise figure can be obtained, partly because there is a thriving underground economy and also because people leaving Taiwan are allowed to take up to $5 million with them. Taiwanese officials estimate that 60% of the investments in China have produced losses, 20% have broken even, and the remaining 20% have earned only small profits. But the question is how to get the profits out of the country. Beijing encourages the reinvestment of profits domestically and bans their repatriation using foreign-currency controls. Taiwanese merchants get around this by means of tie-ups between Taiwanese and Chinese travel agencies, making payments in yuan to the Chinese agency instead of the Taiwanese agency for their "travel expenses" in China, then having the Taiwanese agency put an equivalent sum in their own bank accounts. The key point in such transfers of funds, which are widely employed by the overseas Chinese investors of East Asia, is the exchange rate used for moving funds from country to country. This rate is linked to the dollar. On the Taiwanese side, use is made of the official rate set by Taipei for the Taiwan dollar; on the Chinese side, the rate is customarily set midway between Beijing's official rate for the yuan and the black-market rate. In this way the yuan can be converted into other currencies, and its flow into Hong Kong in particular has been prominent.

The Chinese government allows people going to Hong Kong to carry, at the most, only 5,000 yuan with them, but this is another case where countermeasures from below offset measures from above, and in practice anybody can take out as much money as he or she wishes. The only problem is that Hong Kong money exchangers have little confidence in the yuan and use an exchange rate low enough to offset the risk of its loss of value. Here we find evidence that the yuan cannot avoid being influenced by the East Asian currency crisis no matter how much Beijing talks about its invulnerability.

Earlier this year I visited Shanghai, Guangzhou, Hong Kong, and Taipei, and I found that the yuan was being traded at a black-market rate of about 9 to the dollar, some 10% weaker than its official rate of 8.25. All the economists and businesspeople I spoke with in China and Taiwan agreed that the gap would bring strong pressure to bear for the yuan's devaluation. For such reasons the world is now watching to see when East Asia's surging currency and financial waves will wash over Hong Kong and roll on into mainland China--or perhaps hit the mainland first and Hong Kong later. The mainland and Hong Kong clearly cannot claim to be safe havens.

ELIMINATING THE PEG TO THE DOLLAR

Hong Kong has traditionally had close economic ties to the mainland, and they have grown closer yet since the handover. At this time of concern about possible currency volatility and financial chaos, attention has focused on the peg of the Hong Kong dollar to the U.S. dollar. Back in July 1995 I discussed the potential dangers in the peg system in an article in Chûô Kôron. Today they are much nearer at hand.

Hong Kong is one of East Asia's leading international financial centers. In such a center, currency is more important than anything else. Lacking a central bank, the Hong Kong government mints coins by itself while commissioning the printing of bills to three banks: Hong Kong and Shanghai Bank, Standard Chartered Bank, and Bank of China. This setup began under British rule and is still in use. Over the years there were various episodes of sharp climbs and steep falls in the value of the Hong Kong dollar. The last big crash occurred in September 1983 when, during talks between London and Beijing over Hong Kong's future, rumors spread of the territory's eventual reversion. In October that year the Hong Kong government instituted the peg in a bid to stabilize the currency. It settled on a fixed rate of 7.80 Hong Kong dollars per U.S. dollar, and it required the banks to deposit US$1 with the financial authorities for every HK$7.80 of currency they issued. The monetary system is thus essentially based on a "dollar standard."

The dollar being the world's key currency, it gained in value when many East Asian currencies recently tumbled. Being pegged to the dollar, the Hong Kong dollar inevitably followed it up. But the climb of the Hong Kong dollar to an overvalued level put upward pressure on prices, undercut international competitive power, and robbed this free port of much of its attractiveness. One of the most conspicuous results was a sudden decline in Japanese tourists. The reversion boom had been so vigorous that the ensuing recession came as a great shock. On walking the city's streets, I was struck by the many real estate offices that had closed their doors and by a general lack of the normal vivacity of the commercial districts. The quickest way to get business humming again would be to devalue the Hong Kong dollar. Because of the peg, however, that cannot be easily done.

A decision to devalue should be a decision to terminate the dollar link. Some say that the peg might simply be reattached at a somewhat lower level, but that would only invite further exchange rate adjustments in the future. It would make more sense to throw the peg away. But then the Hong Kong dollar would be stripped of much of its credibility and become simply a piece of paper. Thus while the peg has plunged Hong Kong into one kind of hell, its removal would plunge it into another. Why not in that event just wait for the storm to pass and hope for the best? Further complicating matters is that the peg system is stipulated in Article 111 of the Basic Law, Hong Kong's "miniconstitution." Since an amendment of this law would be required, we can see that shooting down the territory's high-flying currency will not be easy.

If currency is the blood of the economy, the peg system is the pacemaker guiding the blood's flow. But the mouse Hong Kong and the tiger America are hooked together on the same pacemaker, and its beat is set to the tiger's needs, not the mouse's. After the institution of the peg in 1983 all went well for quite some time, thanks to factors like the Plaza accord of 1985 on joint intervention to adjust currency levels. But then East Asia's crises struck, and the beat of the pacemaker became a danger for Hong Kong's economy. Here it should be added that Japan's cumulative investment in Hong Kong stood at some ¥18 trillion at the end of 1995, while the total assets of Japanese financial institutions in Hong Kong stood at an estimated ¥64 trillion--larger than the total in any other overseas economy--in May 1997. If the Hong Kong dollar takes a pounding, touching off financial instability, the backlash will hit Japan far harder than have the crises in such countries as Indonesia, South Korea, and Thailand.

A PRESSURE COOKER READY TO EXPLODE

After the Tiananmen incident of 1989, China launched a campaign aimed at countering moves to overthrow its communist regime by means of peaceful tactics. The rhetoric reached a crescendo on July 1, 1991, in a speech delivered by General Secretary Jiang Zemin to celebrate the seventieth anniversary of the founding of the Chinese Communist Party. Thereafter the talk was gradually toned down, and it ceased to be heard after Deng's southeastern tour of February 1992. But as the reform and open-door policies went forward, the forces backing a peaceful change of regimes continued to mount.

The drive to reform and open amounts to an attempt to internationalize the Chinese economy, in which case China would become a part of the capitalist system centered on the Western market economies.

Beijing is resisting this outcome with talk of a "socialist market economy with Chinese features." But there is no way that such an economy could pass muster in an international economic system led by the industrial nations of the West. China is hoping to gain membership in the World Trade Organization, but for that it will have to move its domestic economic systems closer to the Western model. It must at the least abide by the rule of fair competition in international trade, one of the key market principles, and this means it cannot prop up public enterprises with subsidies from the state. But most of these enterprises are operating in the red; with CCP members latched on to them like parasites, they cannot survive without infusions of blood. To gain WTO membership, Beijing is seeking to transform these enterprises into stock companies operating in the private sector. But down this road lies a peaceful replacement of the existing regime, a critical danger for the government and the communist establishment.

This danger to the CCP and the Chinese government apart, there are very grave perils in the currency and financial instability in today's East Asia. After Thailand, Indonesia, and then South Korea were forced to ask for international help, it was observed that what the three countries have in common are excessive reliance on foreign capital and premodern financial institutions. In that regard China, having chosen to rely on others, has built up $120 billion in external debts, though it brushes off warnings about danger to its financial system with fine talk of the $130 billion in foreign-currency reserves it has amassed.

Also of concern is that all of China's financial institutions are run by the state or local public bodies, that they are among the most backward financial institutions in East Asia, and that they lend freely on the basis of borrowers' personal renown. Not even the central government has a firm grasp on the extent of the nonperforming loans these institutions have in their portfolios.

In the fall of 1997 foreign investment in China began to taper off. In the background was excessive capacity in export industries, especially in clothing, toys, and shoes, which are the three leading export items, along with a surplus in the supply of real estate. Also involved was the East Asian financial turmoil, which prevented overseas Chinese from making new investments. When the currencies of its East Asian neighbors were marked down one after another, moreover, China inevitably found the competitiveness of its export industries sharply decreased.

What all this means is that forces pushing the yuan in the downward direction will mount not too long from now. This will usher in a Chinese currency crisis that may develop into a financial crisis. China today has become a pressure cooker that is ready to explode.

Translated from "Chûgoku, Honkon keizai no hatan wa fukahi da," in Seiron, April 1998, pp. 264­72. (Courtesy of Sankei Shimbun)

© 1998 Japan Echo Inc.

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