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Plenty of Things to Worry About in China, Bird Flu Is Not One

Daily Ticker

Fears over an outbreak of bird flu in China have sent Chinese markets tumbling to multi-month lows Monday. The illness has reportedly claimed the lives of six people, while CNN reports Chinese officials killed 20,000 birds in response. Asian airline stocks have suffered the most on concerns that the outbreak will hurt demand for travel.

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Michael Pettis, finance professor at Peking University in Beijing and senior associate at the Carnegie Endowment for International Peace, shrugs off the threat.

“Oh no not again,” Pettis, tongue-in-cheek, tells The Daily Ticker at the 2013 Wine Country Conference benefiting the Les Turner ALS Foundation. “The tendency is for us to get overly excited.” Pettis, who lived in China during the SARS scare last decade, says there's a better chance of dying of pneumonia in New York than of SARS in China.

Avian flu aside, there are plenty of real concerns Pettis is watching when it comes to China’s economy.

“I don’t think it’s either averting a disaster or heading for one,” Pettis says. “What I think we’re going to have is a decade or more of much, much lower growth.” Here’s what he’s keeping his eye on:

  • How quickly growth adjusts. Pettis wrote a piece arguing the speed with which China’s GDP growth slows in 2013 will show us how determined Beijing is to rebalance the economy. (The idea being that China’s economic model built on government investment and exports is not sustainable, and that the country has to move towards more reliance on internal consumption.) Pettis expects growth to drop sharply, perhaps coming in close to 6% during the second half of 2013 if Beijing is on top of the problem. If not, he expects growth to remain above 7% during this period, which would worry him. “The key thing to watch is growth rate of debt, and I think everybody’s very worried about that,” Pettis tells The Daily Ticker. “When credit is growing very quickly you’ll get more GDP growth and when it’s slowing down you’ll get less.” In other words, all growth isn’t good growth.
  • Inflation. Pettis argues we actually want to see inflation rise. He says it’s a positive indicator for China’s rebalancing. It would mean consumption of manufactured goods is rising faster than production. The more you repress household income growth, the more you divert resources, especially through cheap financing. This tends to be disinflationary, he argues.
  • Financial Scandals. According to Pettis, the Chinese financial system doesn’t really “do” defaults. When borrowers are unable to repay the debt, the problem is usually dealt with by forcing losses on some other entity. Also, when these problems arise they tend to be immediately suppressed, so information doesn’t leak out. So when you hear stories of bank defaults and bank runs – even small ones – this is a red flag. Pettis says they are coming out almost weekly, suggesting credit in China has been unsteady.

Not only is Pettis a China scholar and author of The Great Rebalancing: Trade, Conflict, and the Perilous Road Ahead, he also runs his own indie record label in Beijing and a music club to feature the acts. (This writer is told it’s a real hotspot, in fact.) So Pettis has firsthand insight into doing business in China and he says many preconceived notions of the Chinese business world are wrong.

According to Peter Schiff, CEO of Europacific Capital, there is “more capitalism in communist China than there is in America." Others argue that corruption and fraud are the top challenges for American companies operating in China, as this report from Control Risks, a global business risk consultancy firm, found.

“It’s definitely not more capitalist than the U.S.,” Pettis says of China. “It’s quite tough to run a small business or any kind of business for a variety of reasons. The big saving grace of my club and CD label is that we don’t ever expect to be profitable. It’s easy to be successful if you don’t have to earn anything.”

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Pollution in China is another concern we routinely hear about in Western media. A study from the Health Effects Institute, funded in part by the Environmental Protection Agency, found that Chinese pollution caused 1.2 million premature deaths in 2010, while the Financial Times reports “airpocalypse” has sent expats fleeing.

On pollution, Pettis says “it’s absolutely terrible. To be fair, every country including the U.S. goes through this process of very, very rapid investment-driven growth.”

Pettis says getting rid of pollution is a political question that will require a significant portion of the urban middle class getting upset about it. He says in the last year, for the first time in the 11 years he’s been living in China, he’s seeing this type of substantial opposition in Beijing and Shanghai. Still, he notes, it’s likely to take many, many years to address the issue.

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