Beware a trillion dollars lying under Chinese mattress

Beware a trillion dollars lying under Chinese mattress
William Pesek
August 16, 2010 - 7:51AM
Now that's one big mattress.

Last week, we learned China's households hide as much as 9.3 trillion yuan ($US1.4 trillion) of income not reported in official figures - 80 per cent of it by the nation's wealthiest. This massive pile of stashed cash is equal to about 30 per cent of gross domestic product.

There may be both good and bad news in the above study conducted for Credit Suisse Group AG. The good: it lends credence to the domestic-demand story for Chinese growth. It turns out, the average urban disposable household income is 32,154 yuan, or 90 per cent more than official figures. The bad: China's rich-poor gap may be much bigger than we realise.

China's "Gini coefficient," a statistical measure of wealth equality, has long been too high. In May, the Economic Information Daily, a government-affiliated newspaper, said the figure reached 0.47, higher than the recognised "warning level" of 0.4.

Things may be far worse in the most populous nation. A widening wealth disparity will lead to trouble down the road for 1.3 billion Chinese and investors betting on stability in an economy that may already be the second-largest.

Nothing spooks the Communist Party like social unrest. Its conviction to snuff it out whenever and wherever it occurs was behind the 4 trillion-yuan stimulus package in 2008. Reducing income disparities is a top goal of President Hu Jintao and Premier Wen Jiabao to stave off riots, strikes and other unrest that might threaten the party's six-decade rule.

Harder, Faster

They need to work much harder and much faster. The risk is that they may start believing their own press.

The story getting the most mileage is China's economic brawn. Its $US2.5 trillion of currency reserves is viewed as a nice insurance policy against trouble in markets. News that China bought $US20 billion more Japanese bonds than it sold in the first half of 2010, the fastest pace of purchases in at least five years, is seen as a passing of the torch in Asia.

In a way, it is. Japanese officials have done a poor job of disguising their glee over China supporting their debt. Government and Bank of Japan officials are concerned about their own nation's ability to finance a widening budget deficit. The desperation was fairly clear in a recent advertising campaign that suggested Japanese women are attracted to guys who invest in government bonds.

China's Fragilities

Investors haven't gotten rich betting against China. Yet China's fragilities need tending to, and now, if its development is to be sustainable.

The condition of China's state-owned banks is a concern for investors, and rightfully so. China plans to stress-test banks to assess how a big drop in property prices would affect the financial system. Officials should make sure the process is more thorough and transparent than in the US, Europe or Japan.

Social unrest is a bigger risk. Much of China's hidden income may be "illegal or quasi-illegal," according to the Credit Suisse study, published by the China Reform Foundation.

It should be no surprise that a nation growing 10 per cent has a healthy gray economy running in parallel. That's what happens when an all-powerful, top-down government mixes with vast supplies of capital. Crony capital thrives, be it kickbacks from construction projects, gifts to officials at weddings, payoffs from state monopolies such as the tobacco industry or spreading profits from land transfers.

Corruption's Price

This corruption comes at a huge price. The inefficiencies it breeds feed disparities in economic opportunities, income and the distribution of assets, such as property. The degree of social conflict inherent in China's rise is becoming more apparent. Just ask the folks at Toyota Motor Corp and Honda Motor Co dealing with strikes and demands for higher wages.

The most dangerous aspect of China's trajectory is how, well, American it looks. The concentration of wealth among the richest Chinese helps explain a surge in spending on luxury goods. As Japanese sales wane, posh brands can't open Chinese stores fast enough. Last year, Gucci opened one in Shijiazhuang, the capital of Hebei province, selling $US4000 snakeskin purses. That's about twice the city's official annual per-capita income.

China's social fabric is under pressure. This year's employee suicides at Foxconn Technology Group are a case in point. So is the spate of deadly attacks on schoolchildren, which press reports suggest are related to grievances with local governments. Last week, the New York Times reported on growing violence against doctors in the northeastern city of Shenyang.

China has done a remarkable job raising living standards for millions. The reason it sucks up so much attention and investment is genuine progress. While its challenges are many, China is leaving India far behind in tackling poverty. Now, its wealth balance is heading in the wrong direction.

You can censor Google Inc.'s search engine. You can't hide the fact that a handful of Chinese are getting very rich from the billion-plus workers being left behind. Anger will rise, tempers will flare and things could get out of control. Try stuffing that under a mattress.

Bloomberg