On Tuesday, Fitch Ratings downgraded China’s long-term local currency debt one notch, from AA- to A+. The primary reason for the move was the country’s too-rapid expansion of credit, one of the “underlying structural weaknesses” the agency cited in its announcement. Many analysts in fact think the debt resulting from then Premier Wen Jiabao’s borrowing binge, which began to accumulate in earnest in late 2008, is now China’s number one economic risk. There are, of course, other risk factors now undermining the country’s economic growth. Among them are an eroding environment, unfavorable demographic trends, and persistent internal discontent. Yet the events since early last month in North Asia—the tearing up of the Korean War armistice, Pyongyang’s promises of pre-emptive nuclear strikes on the U.S., and the deployment of North Korea’s mobile missiles, to name just a few of them—suggest the biggest threat to the Chinese economy may be the least discussed one: turmoil in the region. As Fitch carefully noted in its explanation of Tuesday’s downgrade, “The ratings assume there is no significant deterioration of geopolitical risk, for example a conflict between China and Japan or an outbreak of war on the Korean peninsula.” North Asia looks like the world’s most volatile region at the moment. An assertive China is working to push America aside, grab territory from an arc of nations from India in the south to South Korea in the north, and close off the South China Sea so that it becomes an internal Chinese lake. Last month, while Chinese leaders talked about enhancing cooperation in the region, two Chinese vessels attacked a Vietnamese fishing boat, setting it on fire. There are many reasons for Beijing new assertiveness, but one stands out: slowing GDP growth, evident since the early summer of 2011. The economic problems in particular have created a dangerous dynamic, trapping China in a self-reinforcing—and self-defeating—loop. In this loop, the slumping economy is leading to a crisis of legitimacy, the legitimacy crisis is causing Beijing to fall back on nationalism and increase friction with its neighbors, and the increased friction is aggravating the country’s economic difficulties. Caught in a trap of their own making, Beijing leaders will continue to blame foreigners for the problems evident in Chinese society and then lash out, as they did in September against Japan, over the uninhabited Senkaku Islands in the East China Sea. And as they lash out, they are making their problems worse. The anti-Japan protests in China last fall, for instance, are resulting in Japanese industry reducing its commitment to China by shifting investments into Southeast Asia, as Nissan announced at the end of October. That, in turn, could push the Chinese economy past the tipping point. Moreover, the North Korean crisis, which Beijing has been aggravating behind the scenes, is not helping the Chinese economy either. Commerce between China and the North seems largely unaffected, as various reports from the border crossings indicate. But the Kim regime in Pyongyang seems to be targeting the South Korean economy with its threats, and that is beginning to have some effect. “The North Koreans are now using the propaganda in an extreme form to try to damage foreign direct investments into South Korea,” says Tom Coyner, author of “Doing Business in Korea,” to the New York Times. “They are, in a sense at this point, winning in an asymmetrical psychological warfare, attacking the economic strength of South Korea.” And as the Times points out, South Koreans know “their globalized economy has much more to lose than the North’s isolated and already highly sanctioned economy.” Yet Pyongyang leaders may be taking down more than just the South. In an interconnected world, they may be damaging the other networked economies in the region, those of Japan and China. All three economies—South Korea, Japan, and China—have integrated themselves into the others, for instance making the others part of the global supply chains of their companies. In these circumstances, it is unlikely that only South Korea will be damaged. The South is China’s third-largest trading partner, and it is China’s fifth-largest source of foreign direct investment. Trade between China and South Korea increased 40 times in 20 years. It rose 18.6% in 2011 to $245.6 billion, a record high. So South Korea’s troubles will eventually becomes China’s. Ultimately, Beijing’s strategy of making itself a danger to its neighbors cannot be good for its economy. Worse, China is making itself an adversary of its most important customer, the United States. Last month, Director of National Intelligence James Clapper elevated cyber attacks above terrorism as the most serious national security threat. China, of course, is America’s number one cyber adversary. Being named your biggest customer’s biggest threat is not smart strategy. And there is a broader issue. For more than four decades, Washington has sought to “engage” Beijing and bring it into the international community. Inside the existing geopolitical order China prospered, and in the past quarter century the people who have benefited the most from the American-led system are not the Americans but the Chinese. In a peaceful world the Chinese manufactured and traded their way up through the ranks of nations and, as a consequence, transformed their country for the better. Yet their leaders no longer accept the world as it is. Once deft, subtle, and patient, Chinese diplomacy has, especially since the end of 2009, become shrill and hostile. And Beijing has increasingly set itself against America—as well as its generals and admirals. We are now hearing war talk in the Chinese capital from civilians, such as new leader Xi Jinping, and flag officers alike. Unfortunately for Chinese policymakers, the resulting controversies are occurring in conjunction with others, both internal and external. As Fitch suggested last week, more geopolitical risk is the one factor, during this period of economic fragility, that could push the Chinese economy over the edge. Follow me on Twitter @GordonGChang
Reported by Forbes.com 6 hours ago.
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