The Shark of the South China Sea

Andrew Stiles

During the summer of 1977, a new Chinese leader emerged who would bring China forward into the modern age. His name was Deng Xaioping, and with all of the Communist Party leadership finally unified under his control, he would open China’s markets up to the world. Almost 40 years later, China is now among the front-runners of world power. Another Chinese Communist Party president, Xi Jinping, has once again solidified absolute rule over his party, and is directing his country’s hunger for expansion toward the South China Sea.

In recent months, China has asserted its claims over the nearly 300 islands and reefs scattered throughout the South China Sea. Many of these are submerged and barely qualify as islands, but what China is doing to them would give the EPA a collective heart-attack; China is building naval fortresses on these islands to gain military control over the region. Technically, many other Asian nations have claims to these same waters. Taiwan, Malaysia, Vietnam, the Philippines, and other nations all have conflicting territorial claims - but when the world’s largest military is building bases in your backyard, complaining is unwise.

Many are asking: what can China gain from owning the South China Sea (SCS) besides military territory and salt water? The answer is: a lot.

For starters, the SCS has subsea crude oil reserves of over 11 billion barrels. It also has natural gas reserves of over 190 trillion square feet - think about that number for a moment. Most of China’s giant onshore oil fields including the famous Daqing reserve have reached their productive peaks, and are declining as the country continues to grow. The South China Sea holds the fuel to sustain this growth, which is the key to all economic, political, and military doors.

Oil doesn’t just come out of the SCS, it moves through it; 50% of the world’s natural gas and roughly 30% of the world's crude oil are transported through the SCS via tankers. Additionally, many manufactured products such as clothing, electronics, and other goods are transported through this global shipping artery. China is Malaysia’s largest and most profitable trading partner, and is a prominent consumer of goods for other Asian nations. All of India’s goods must travel from the Persian Gulf through the Straight of Malacca, which brings traffic right into Singapore – just on the edge of the SCS. The country that controls the SCS just as well controls water-borne shipping for all of Asia.

 

Source: U.S. Energy Information Administration

Source: U.S. Energy Information Administration

The third (but by no means the last) major industry that China stands to dominate upon occupying the SCS is commercial fishing. Over the last few decades, China’s middle class boom has catalyzed fish consumption to skyrocket, while China’s fish yields have fallen in the East China Sea. The South China Sea produces roughly 10 percent of the world’s yearly catch, and controlling these waters is vital to feed the nation’s ever growing fish consumption.

As China continues to expand into the SCS, they are claiming valuable resources that many other Asian nations need, which will likely aggravate existing political and economic tension with Taiwan, other Asian countries, and even their western allies. In other words, there will be blood.

No Sympathy for Shadow Banking in China

Andrew Stiles

When China’s stock market bubble burst in 2014 and 2015, many people of China’s labor class lost their life savings. While the government fully reimbursed investors with money in state-owned banks and investment firms, the Chinese Communist Part [CCP] offered no relief to investors purely in the private sector. This is largely due to the rise of shadow banking in China – that is, investment firms that are able to circumvent the strict regulatory standards that most Chinese investment institutions follow. Growth in the number of these new Chinese firms peaked just before 2011, but has drastically declined since 2013.

Over the past few decades, China has rapidly become privatized, and a significant portion of the population runs personal finances through the private sector, as opposed to state-owned banks. This portion of the population has suffered severe financial losses without any form of loss insurance. China has a mandatory retirement age of 50 for women and 60 for men, so citizens who are near or above this age are panicking, now that their nest eggs are gone.

Many of the affected citizens are taking to the streets to demand assistance from the government. Wall Street Journal reporter Chuin-Wei Yap followed a Chinese citizen named Yang Bao Yu, who had lost his $37,000 retirement savings when a Chinese shadow banking firm closed in 2014. Chuin-Wei wrote that the firm had promised returned of up to 18%, which attracted millions of ‘mom and pop’ investors. After losing his retirement savings, Yang Bao Yu joined hundreds of protestors demanding that the government aid them, but the CCP sent police forces to disband the protestors.

As more Chinese citizens realize that the government will not take responsibility for their failed private sector investments, investor confidence in China could continue to destabilize. Chinese regulators are attempting to solve this problem by eliminating shadow banks, and the government has jailed many of the firms’ executives for trying to subvert regulatory standards. The CCP may be able to purge the markets of these shady firms, but this does little to improve the financial security of millions of small investors who were irrevocably damaged when Chinese markets collapsed.

 

Economic Growth Goals in China

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Carlos Fineman

Can China continue its economic growth?  Chinese President Xi Jinping supposedly has the answer. He states that China’s economy is capable of creating 10 million jobs throughout the country this year and more than 50 million before 2020. This increase in employment would allow China to continue to expand its gross domestic product by 6.5% per year in order to accomplish China’s goal of doubling its economy of 2010 by 2020. 

Many economists in China, and around the world, fear that the increase in debt needed to support that level of growth might stimulate China’s economy but at the cost of small businesses.  Government-owned businesses in China have significant advantages over, and are more reliable than, private businesses. However, some public sector jobs at mines and steel mills are in danger of being cut.  Premier Li Keqiang was not definitive about how many individuals the government would lay off, but assures that it will provide as much as $15.3 billion in support funds for these workers.

The central bank of China has outlined several reforms that it must undertake to continue to keep the economy growing. Chinese economists and political observers believe many of these reforms will never be actually implemented; nonetheless, China will begin to institute a tax on banks. One tax in particular is a 6% tax on the interest that a bank collects on loans.

China cannot afford to see a dip in economic growth or a decrease in exports.  If China continues to be forced to cut into its foreign exchange reserves - which have already fallen by as much as a third during the past three months - then production will stagnate and foreign investment will fall.  Many foreign investors are already wary of Chinese monetary policies and the country’s ability to set its own currency value.  Foreign investors will continue to seek other countries in which to invest until they believe that China can produce the same type of growth that it has in the past.

Chinese Foreign Investment

Carlos Fineman

China has prided itself on its economic development over the last decade. China’s ability to generate a huge amount of foreign currency from international trade has allowed it to be prosperous and elevate its international credibility. In 2015, China held $4 trillion in foreign currency from other countries. In the past, China has been able to pump this money into infrastructure and other building projects. This rapid growth encouraged foreign nations to also invest in these projects. However, in recent months China’s reserves have fallen - approximately one third of its reserves have dissipated in the last three months.

Now, however, China’s economy has begun to slow down, and foreign countries have begun to divert their investments in other countries (e.g. Japan). Other developing countries are beginning to become competitive with China’s cheap labor and export advantages. Foreign countries are now looking to other places as China has become more developed but more expensive to invest in.

All of this is contributing to China’s recent struggle to maintain its currency value. Many people believe that the People’s Bank of China will let the Yuan (also called Renminbi) depreciate instead of taking more out of their reserves. This is crucial to China’s ability to stay competitive in the labor market, and so Chinese officials are limiting Chinese banks from lending Yuan in order to maintain control over the amount of currency in circulation. China has also begun tightening its own foreign investment, hoping to maintain control over the outflow of Yuan.

China has always had a tight control over the valuation of its currency. Until now, it has been able to successfully maintain the Yuan’s value, and encourage the large inflow of foreign investment. Now that this has begun to slow, investors are concerned about how long China can dip into its reserves until it will be forced to devalue its currency, which will further drive away foreign investment.

What's Golden

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Andrew Stiles

The world economy is struggling, and investors are now rushing to buy a commodity that has a history of retaining its value during hard times: gold.

 

Gold is traded through futures. When the markets are bearish, gold is often considered a safe asset, and investors cherish it. The logic behind gold’s stability is related to its ability to function as an alternative currency; it has a high value relative to its weight, and supply is extremely scarce.

It is considered so reliable that at one point in history, the United States backed up every single dollar of currency with the same weight in gold. Although this is has changed, investor attitudes toward the metal have not.

The sense of security that this precious metal emits is once again influencing investor decisions in global markets. With oil now consistently trading below $30/barrel, technology industry stocks falling in value, and emerging markets struggling, the price of gold has skyrocketed during the past month. What seem like peripheral issues are actually directly influencing its value. Gold Futures began February at $1128.00, and have since jumped over 10% up to $1247.80. Year-to-date, Gold has increased in value by 16.75%.

Gold has leveled-out in the past few days, as news leaked that the United Arab Emirates energy minister, Souhail Al Mazroui, said that OPEC is “ready to cooperate” with other oil market players on production cuts. Countries such as Russia have been negotiating with OPEC to try to curb oil production, but talks have thus far failed.

Cutting oil production would lower oversupplies of oil, and help push its price back up. An increase in the value of oil futures might draw investors away from gold; however, yesterday, details of the production curb were announced, and have disappointed many investors. Perhaps gold still has room to climb.

Full Speed Ahead for India

Henry Whipple

As turmoil continues in China’s economic markets, their position in the center of the global economy is fading, and producers in China’s once booming manufacturing industry are seeking other countries in which to operate - namely India due to its surging economic growth.

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In fact, much of India’s recent success is due to China’s shortcomings across a variety of sectors. While China’s foreign direct investment has decreased by 1.3% from 2014 through 2015, India’s soared upwards by 46% over that same period. Additionally, wages for blue-collar workers in China have skyrocketed over the past decade, and the government’s military displays of force throughout the fall of 2015 have led to concerns that it is too risky a location for business. In contrast, India currently offers both significantly lower wages (a much more attractive prospect for manufacturing companies) as well as a seemingly stable democracy.

Citing the Reserve Bank of India’s policy rate cut last year, PricewaterhouseCooper (PwC) is already forecasting India’s growth for 2016 at 7.7% for the second consecutive year. Increased household consumption and recovering investment across many South Asian nations has helped spur similar progress, as well as falling levels of inflation due to the drop in gasoline prices. Such forecasts along with the competitiveness of these emerging markets have prompted many analysts to consider the possibility of India becoming the world’s next economic power of the 21st century. 

Despite the optimism surrounding India’s robust economic growth in the manufacturing sector, some components of its economy give cause for hesitation. In late 2014 current Prime Minister Narendra Modi launched his “Make in India” campaign, an initiative that focused on almost exclusively on improving infrastructure and creating attractive opportunities for foreign investors and manufacturers. Yet, since that time, little progress has been made outside of major corporations, leaving many inadequate roads, rail lines, and ports unfixed. The country is also dealing with levels of urban air pollution that surpass even those of China, and they will only increase with the continued increase in manufacturing growth.

There are still positive signs for investors and manufacturers looking to operate in India. With Indian officials’ emphasis on the importance of manufacturing in their country, as of late 2015 there are around ten million young workers joining the labor force each year, and the median worker’s age is nearly ten years below that in the United States or China. Both figures suggest that even if India’s soaring economic growth is unsustainable, the nation’s working population will help to put it in a better position. Ultimately, India’s fate might solely depend upon China’s ability to recover from its economic downward spiral. Analysts don’t expect China to relinquish its market share easily, but without a sooner-than-expected recovery, China will have difficulty putting India’s success on hold.