China’s Political Stability

By Feb 11, 2011, 12:06 PM Author's Blog  

China’s economic rise increases the odds that its currency is destined to become a global currency, according to The New York Times. “No one expects that to happen immediately,” the article carefully adds, even if the writing is on the wall. “The RMB is likely to become a reserve currency in the future, even if the government of China does nothing about it,” economist Robert Mundell predicts. Perhaps, although the story also recognizes the political risk that still haunts China.

“China needs to assure investors that its political system is stable and that its economy still has plenty of growth ahead,” the Times advises. The warning resonates these days as Egypt sways to and fro under the winds of revolution, writes Barry Eichengreen, professor of economics and political science at Berkeley.

Eichengreen opines that upheaval in Egypt and Tunisia of late is less about economic growth per se. Rather, “the problem is that the benefits of growth have failed to trickle down to disaffected youth.” On first glance, that may not appear to present a comparable threat in China, “but the warning signs are there.” As Eichengreen explains,

Given the lack of political freedoms, the Chinese government’s legitimacy rests on its ability to deliver improved living standards and increased economic opportunity to the masses. So far those masses have little to complain about. But that could change, and suddenly.

First, there is the growing problem of unemployment and underemployment among university graduates. Since 1999, when the Chinese government began a push to ramp up university education, the number of graduates has risen seven-fold, but the number of high-skilled, high-paying jobs has not kept pace.

Indeed, the country is rife with reports of desperate university graduates unable to find productive employment. Newspapers and blogs speak of the “ant tribe” of recent graduates living in cramped basements in the country’s big cities while futilely searching for work.

Eichengreen is hardly alone in worrying about China’s political stability. The risk consultancy Maplecroft recently analyzed such hazards for China. The country “is categorized as ‘extreme risk’ across several areas,” according to Maplecroft, “including: civil and political rights, judicial independence, democratic governance, labor rights, and human rights violations committed by members of the security forces. Companies which are deemed in any way to be supporting a government or its agents in stifling democracy, liberty and human rights may suffer reputational damage, which will ultimately impact the bottom line.”

Meanwhile, Reuters reports that “Egypt’s uprising may prompt renewed focus on political risk in emerging economies at a time of rising food and fuel prices, raising investor fears of unorthodox or repressive policy moves.”

Ely Ratner at the RAND Corporation and a research fellow with the National Asia Research Program considers the future for China and concludes that there are a number of potential trouble spots. Writing in the latest issue of the Washington Quarterly, Ratner discusses the complicated rise of China in the 21st century:

Beijing’s permissive attitude toward non-democratic principles and singular focus on domestic economic development have become potential sources of blowback, including the specter of international terrorism as just one example. This threat, which is one of the most serious challenges facing Beijing, is aggravated by the fact that China’s integration into the global economy has naturally meant a growing number of Chinese companies and expatriates in foreign lands—or in other words, an ever-expanding target set for those wishing to attack Chinese assets. From pipelines in Kazakhstan to refineries in Nigeria to ports in Sri Lanka, soft power begets soft targets.

Meanwhile, The Globe and Mail ponders what might happen if North Korea implodes:

There is more political risk in China than many investors realize. Just last year China justified its support of North Korea by saying that if North Korea collapsed, hundreds of thousands of refugees would stream over the border into China. But deeper interviews revealed that China viewed the North Korean regime’s survival as key to its own: “North Korea is our East Germany,” a senior Chinese security official told The Washington Post. “Do you remember what happened when East Germany collapsed? The Soviet Union fell.”

What if the North Korean regime faced a revolt like the ones in Tunisia and Egypt? What happens to China then – or to Chinese stocks and ETFs?

It’s easy to overestimate the potential for trouble, of course. But it’d be a mistake to dismiss the possibilities for instability in China. No one’s predicting another Tiananmen Square protest, although it’s worth reminding that few expected that event. That’s the nature of political risk: It surprises, and not often in a good way. The best we can do in real time is assess the odds. Most of the dire forecasts won’t pan out. But it’s the ones that do that are the problem.

Yes, China’s currency is probably destined to become a global currency. Just don’t bet the farm on it just yet. Getting from here to there could be rocky.

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