China with the diplomatic coup of the Asian Infrastructure Investment Bank appears on a hot streak. However, the economic and financial problems appear bigger and bigger everyday.
Hainan has admitted to major debt problems. Haikou, the capital of Hainan, estimates total revenue of 21b rmb with 15b rmb of debt maturing this year.
The McKinsey Global Institute notes that total Chinese debt is 282% of GDP while the debt laden Americans and Germans come in at a more frugal 269% and 258% respectively. With credit growth continuing to expand rapidly and a loosening of requirements for second homes, there is little evidence of deleveraging.
Now China seems intent on exporting its problems. The enormous glut of Chinese steel with iron ore prices a long term lows, has prompted some Chinese steel makers to export surplus capacity abroad with scant evidence of demand of size. Even crazier is that the Chinese government seems intent on supporting this strategy with various forms of financial capital.
Three quick economics lessons for China. First, if there is surplus capacity globally, moving that surplus capacity from one country to another still leaves surplus capacity. Second, Chinese subsidies to move loss making Chinese steel producers abroad subsidizes foreign consumers. Third, steel and iron ore are global commodities. Chinese steel producers producing in foreign countries still have to compete in a global market. If the market price is below their break even, they still lose money and the foreign country can buy on the world market.
It seems destined to get worse before it gets better.
Diplomatic circles have been have been fluttering with intrigue over which countries would join the Asian Infrastructure Investment Bank as founding members. The United States has been leaning on allies to refrain for what it claims are environmental and financial governance standards though geopolitics is undoubtedly the driving reason. The Obama Administration has been as successful in convincing allies not to join as they were in convincing the world Yemen was a success for US foreign policy. US foreign policy on the AIIB appears small minded and working very hard to defend an incredibly weak position.
Little thought however, has been given to the other side of the equation: the role of China at the AIIB. To China may I caution: be careful what you wish for.
The Chinese creation of the AIIB is designed to extend both its hard power via financial capital and its soft power via its influence and institutional leadership. However, in neither case does China have a positive track record of success to build upon.
As has increasingly been noted, China went on a enormous lending spree to other emerging markets over the past few years. This was done in an effort to both secure access to commodities and gain influence. The result of this financial largesse is a wave of impending defaults, write downs, or restructuring. Nor are domestic Chinese banks exactly a model of prudent lending. In other words, the Chinese record of state sponsored lending leaves something to be desired.
However, Chinese interest in the AIIB is driven as much soft power influence building as hard power. The Chinese record isn’t much better here. Whether it is their constant drum beat of xenophobic saber rattling aimed at Japan or its south China Sea neighbors, the current Chinese government has little understanding of or ability to exercise soft power influence. The minister of education railing against the threatening influence of western values fails to demonstrate any understanding of the concept of soft power.
The New Zealand Prime Minister has already stated their desire to influence bank policy and it is likely other founding members like the environmentally conscious Danes are going to seek similar input. Critiques of US influence at the World Bank overlook its relatively minimal 15% shareholding, compared to the 50% holding of China in the AIIB. This has the potential to create soft power diplomatic headaches for many years for Chinese bankers and diplomats. Other countries, especially developed and democratic countries, do not respond well to rule by fear.
Given the Chinese inability to project hard or soft power: be careful what you wish for.