Paper or Plastic?

By Greg Rosen, Editor-in-Chief

When one thinks of China, one may conjure up the image of millions of Chinese laborers, automatons waiting to stamp “made in China” on a consumer item. This superficial spectacle seems to always make a news headline, whether in relation to tainted dog food or toxic toothpastes. China seems utterly without standards in an economy of mainly production. But few in average America, if any, concern themselves with the actual Chinese market, the expanding domain of Chinese consumers in a country that comprises over one sixth of the world’s entire population. With a population of 1.2 billion and a GDP over 1.5 trillion, China undoubtedly is an economic hegemon and an attractive market. The real question is however, a market for what?

Pass Me the Check

The true potential of the Chinese economy lies in its development of a credit system. The market for FDI and outside buying lies not in the form of labor (though it is certainly a factor), but rather in the prospect for bank evolution and subsequently, a glorious retail and consumer market.

Since the founding of the People’s Republic of China, the entire internal market was driven by cash and a poorly developed banking system. Cash carried the weight of the central economy and banks were historically a mechanism of the state. Ariana Cha comments on the fact that “until a few years ago, China’s banks essentially were agents of government social policy, keeping state-owned enterprises afloat.” The banking system was mismanaged and severely corrupt. Ever since Mao Zedong nationalized banks more than fifty years ago, “they have served as massive employment agencies, money pots for pet projects, and key props for the party apparatus. They've done everything except act as real banks.”

Recently however, developments indicate that real banks and consequently real credit are slowly making an appearance. Few actually utilize plastics, but the careful utility of a credit industry could propel the Chinese economy even further, and in turn, aid other countries such as the United States, which have increasingly networked economies. In 2004, the People’s Bank of China and the China Banking Regulatory Commission approved American Express, Citibank, and HSBC to issue credit cards to local partners in China. Since then, companies such as Morgan Stanley and American International Group have expressed overwhelming curiosity at launching their own particular credit lines. The Chinese government has allowed such developments mainly because of the fact that the state owned enterprises and their crony bank partners were bleeding the Reds dry. By 1995, SOE reform had only resulted in more damages, with a seventy billion dollar deficit and government subsidies of over fifty billion. In addition, China, since the 1970s, has been swept away gradually by privatization. Credit and investments as well as a personal accountability with regard to debt and finance have not surprisingly followed in tow. Transnational corporations have invested tens of billions of dollars into the “workshop of the world” over the past two decades, spawning a rapid growth of private enterprises needing credit. Ergo, the growth of credit is a welcomed sign for Chinese capitalists and many who simply crave green rather than red.

Booming Opportunities

Many are optimistic to say the least. According to a survey conducted by the Economist Intelligence Unit and First Data International, leading financial and banking executives see a promising future for China's credit industry, but in at least three years' time. Shanghai was the first to go ‘plastic’ and since then has never looked back. This flood of foreign investment into China’s banking sector has tremendous effects for China and the rest of the world. Since 2003, the introduction of more FDI into a credit industry has soared and the effects are astounding. First of all, China’s banks and credit sector have exploded. The main four banks saw a recent 18% annualized growth in deposits. Business Week magazine dubbed this period the “Golden Age” for Chinese banking. The thirst for such industries is insatiable. Just last year alone saw Chinese banks gobble up over 20 billion in strategic equity stakes. Just to think, a decade prior the banking industry was almost derailed, dejected, and dead.

Furthermore, China is slowly but surely accommodating to WTO regulations. With the development of credit and loans comes the important factor of trust. With trust, fiscal responsibility ensues. If China can gradually adapt to credit, of course with caution, the economy will not burst but rather climb. Moreover, the Chinese consumer will evolve as a responsible consumer and the rest of China will comply with the regulations of a global market. A fiscally reckless China will be engulfed by a Western set of economic rules and not only will the game finally be fair, but both our teams will be winning.

Michael Power, a strategist at Investec Asset Management, asserts that the growth of credit is comparable to the early 20th century birth of an automotive industry. He believes that the existing order of a broken financial sector is passing, and that "the better the Chinese banking system becomes, the more the Chinese will recycle surpluses into consumption at home rather than recycling it into US treasuries, subsidizing US consumption.” Not only that, but also such changes will bolster an expanding Chinese core, allowing emerging new markets to flourish.

Caveats for the Ages

Nevertheless, China will experience growing pains. The love affair with the financial sector could experience a slowdown, which would tremendously hurt the economy if not properly administered. The expansion of credit cannot be done precipitously but must be done carefully. Econometrix's Azar Jammine warns that if the transition is abrupt, there could be a serious dislocation of the global financial markets, with such effects as interest rate hikes and collapse of certain currencies, including the dollar. China’s government, however, is certainly aware of the problem it faces. In fact, in April of 2007, the People’s Bank of China demanded that big banks hold 11% of their deposits in reserve, seeking to prevent credit and investment from growing too quickly, destabilizing the economy.

In addition, many financial officials believe that credit has only created regulatory barriers that hinder foreign access, thus disallowing our rules and our ways to enter a shoddy, often corrupt system. Corruption is undeniably a major factor in the success of a credit industry. China’s banks are often so large that hundreds of cases of embezzlement and bribery are “shrugged off by investors”. May Yan, a bank analyst, purports that “in any other country, this kind of scale of scandal would be a big event. But in China, the scandal cases did not really have a material impact on the operations of the banks”.

Finally, the credit card is still widely undervalued in China. Many use the cards as a fashion statement, plastering their cards with animation characters and colors, rather than considering them an important financial tool. Although China has made tremendous strides, it is still a baby in a way. But with growth comes maturity. While credit will remain a risky venture for years to come, the maturation of a banking and credit industry over time will ultimately fill China’s coffers and spread the plastic in a responsible and productive fashion.