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Special report china_trade

  1. 1. Erste Group ResearchCEE Special Report: Trade between China and the West30 November 2012Trade between China and the West: threehistorical highlightsWe examine three historical periods in human history when China and Westernnations have engaged in significant expansion of trade.Maryan Zablotskyymaryan.zablotskyy@erstebank.ua Foreword Growing trade between Western nations and China has been one of the key factors to shape the world in the past decade. This is the third time in history that there has been an explosion of trade volume between East and West. Quite remarkably, two previous periods of trade expansion (206 BCE – 220 CE and 1757-1860) bear similarities in how this trade developed. Episode 1: Han and Roman Empires, 206 BCE – 220 CE The earliest boom in international trade came with the dynamic economic growth of both East and West. The Roman Empire had had its first experienceHan and Roman Empires each with modern democracy. China was ruled by the Han Dynasty, which hadhad quarter of world GDP at absolute power. Romans had the highest income per capita in the world,beginning of new era especially in the Italian peninsula. At the beginning of the first millennium, the Roman Empire a population of around 44mn, 8mn of which lived in the territory of modern Italy. According to the tax census from 2AD, China had a population of around 57mn. The empires had economies which were roughly the same size and which each represented a quarter of the world’s GDP. Inhabitants of Italian peninsula were then wealthiest people on Earth GDP levels in Roman Empire, 0 AD, international dollar of the 1990s Source: Angus Maddison: Contours of the World Economy 1-2030 AD, Essays in Macro- Economic History (2007)Erste Group Research – Trade between China and the West: three historical highlights Page 1
  2. 2. Erste Group ResearchCEE Special Report: Trade between China and the West30 November 2012 Citizens of modern Italy were twice as rich as the Chinese, while many parts of the Roman Empire also had higher income levels compared to those in Asia. What also distinguished Romans was their overwhelming military power. The infrastructure of the Romans was more focused on commerce (paved roads, bridges). The Chinese, in turn, focused on building large-scale fortifications and canals. The famous Great Wall of China was started during the Han dynasty.Roman citizens were richer that those of Asia Romans had overwhelming military power andGDP per capita, international dollar of 1990s infrastructure 810 House prices to disposable income ratio, 2004=100 Around 0 AD Roman Empire Han Empire Metal production 600 Iron 82 500 5 000 550 Copper 15 000 Negligable 450 450 Lead 80 000 Negligable Silver 200 1 Inftrastructure Road network, km 400 000 22 000 of which paved 50 000 Negligable Brigdes 931 3 China India Greece Egypt ItalySource: Angus Maddison Source: wikiversity.org The first international trade appeared between the Roman Empire and China nd in the beginning of the 2 century BCE. The main exchange: Roman gold for Chinese silk. This gave the name to the famous trade route called the ‘Silk Road’. Many countries prospered because of Chinese-Roman trade, giving rise to world’s first global foreign trade market ‘Silk route’, 206 BCE – 220 CEFirst global trade emerged fromRoman exchange of gold andsilver for China’s silk Source: Wikipedia Besides silk, China also traded teas and porcelain; while India traded spices, ivory, textiles, precious stones, and pepper. The Roman Empire primarily exported gold, silver, but also some goods, such as fine glassware, wine, carpets, and jewels.Erste Group Research – Trade between China and the West: three historical highlights Page 2
  3. 3. Erste Group ResearchCEE Special Report: Trade between China and the West30 November 2012 Silk clothing was in great demand by Roman women, although it was considered to be decadent and immoral. “I can see clothes of silk, if materials that do not hide the body, nor even ones decency, can be called clothes. ... Wretched flocks of maids labor so that the adulteress may be visible through her thin dress, so that her husband has no more acquaintance than any outsider or foreigner with his wifes body” — Seneca the Younger, 4 BC – 65 AD The Roman Senate issued, in vain, several edicts to prohibit the wearing of silk, both on economic and moral grounds: the importation of silk caused a huge outflow of gold.Demand for Chinese silk caused "By the lowest reckoning, India, Seres and the Arabian peninsula take fromhuge outflows of gold and silver our Empire 100 millions of sesterces every year: that is how much our luxuriesfrom Roman Empire and women cost us." — Pliny the Elder, 23 AD – 79 AD Romans had to pay in gold and silver as there was little demand for the goods they produced. This was due to protectionist policies from China, which emerged from its views on being a self-sufficient state. Historian Charles Hucker, in his book on China’s imperial history, writes:Chinese governments tried to “In keeping with their domestic policies, the Chinese dynasties of the earlycontrol foreign trade imperial age did not generally encourage foreign trade. It was not considered either proper or safe for Chinese to have private intercourse with uncivilized people, indeed unofficial travel beyond the frontiers was often deemed treasonable”. Still, high demand for Chinese products and the significant military power of its neighbors made the Chinese government think that it was safer to allow restricted forms of trade under government supervision. To maintain the self- sufficiency of the state and still allow foreign trade, China officially traded only with states it considered to be its vassals. Roman merchants claiming to be diplomats from often nonexistent states visited Chinese government officials in order to get permission to trade. Charles Hucker says: “Tributary missions from vassal states were commonly allowed to include traders, who thus gained opportunities to do business in the capital markets. No doubt a large proportion of what the Chinese court chose to call tributary missions were in fact shrewdly organized commercial ventures by foreign merchants with no diplomatic status at all.” What was supposed to be a protectionist policy against foreign goods turned into a corruption scheme. Chinese government officials benefited from usingChina’s state control on foreign their control over foreign trade by allowing deals with western merchantstrade caused corruption among disguised as ‘diplomats’. As a result, China did experience a huge boom inofficials and positive trade trade, but with most of the proceeds, in the form of gold and silver, going tobalance with Western world bureaucratic elite and little import of goods into the country. Since the elite was afraid of losing their position and of criminal prosecution, they opted to hoard gold and silver within their estates. There was so much inflow of precious metal that it was used for making statues. Meanwhile, peasants were banned from merchant activity. Additionally, peasants suffered pressure from large landowners; in the following years, many peasants lost their land and were forced into the service of the elite.Erste Group Research – Trade between China and the West: three historical highlights Page 3
  4. 4. Erste Group ResearchCEE Special Report: Trade between China and the West30 November 2012 Gold and silver drained from the Roman Empire due to the negative trade balance between the two empires. Soon Rome was finding it hard to pay its soldiers. In addition to gold outflows, Romans were facing increasing pressure from the tribes populating its northern borders. The debasement of currency was one of the key ways that Rome found to pay its soldiers. As even that was not enough, soon Rome began to rely more on barbarian mercenaries and started giving out rights to collect taxes on its territory. That turned into a cycle which eventually destroyed the state.Romans debased currency to increase soldiers pay Inflation soared due to currency debasementSource: http://www.zerohedge.com/ Source: http://www.zerohedge.com/ The resulting fall of Rome was nothing less than a catastrophe. Both output th and population declined markedly. It was not until the 17 century that the Mediterranean region saw levels of economic activity comparable to those during the first two centuries of the first millennium. This statement is based on levels of world lead production (a side product of silver mining) and the number of shipwrecks found at the bottom of the Mediterranean.After currency debasement, economy collapsed World lead production recovered 1500 years laterUrban population, shipwrecks, World lead production 800 14 100 90 700 12 total urban population shipwrecks, city size 80 600 10 70 500 60 8 400 50 6 40 300 200 4 30 2 20 100 10 0 0 0 5 BCE 4 BCE 3 BCE 2 BCE 1 BCE 1 CE 2 CE 3 CE 4 CE 5 CE 750 BCE 650 BCE 550 BCE 450 BCE 350 BCE 250 BCE 150 BCE 50 BCE 50 CE 150 CE 250 CE 350 CE 450 CE 550 CE 650 CE 750 CE 850 CE 950 CE 1050 CE 1150 CE 1250 CE 1350 CE 1450 CE 1550 CE 1650 CE 1750 CE shipwrecks size of biggest city, tsd total urban population, mn Source: http://www.historum.com/ Source: http://www.historum.com/ Exactly at a time when the Roman Empire began the strong debasement of its currency, China faced the start of the Yellow Turban Rebellion (184-205 CE). This rebellion was caused by the corruption of government officials, peasants losing their land, high taxes, and forced labor on grand state construction projects. While the rebellion was eventually defeated, the military leaders and local administrators gained self-governing powers in the process. This hastened the collapse of the Han Dynasty in 220. In the aftermath of the revolt and the fall of the ruling dynasty, China suffered economic collapse. The nd population decreased from 50mn in the late 2 century CE to 7.5mn in 280 CE.Erste Group Research – Trade between China and the West: three historical highlights Page 4
  5. 5. Erste Group ResearchCEE Special Report: Trade between China and the West30 November 2012 It should be noted that there are at least four recognized theories about the demise of Rome. The negative trade balance with China and resulting outflow of precious metals from Rome was one of the contributing factors. The one thing that is clear is that Romans could not keep up with rising military expenses, while the Han Empire collapsed due to civil unrest. The next period when trade between Western World and China resumed on large levels, was th not until the 18 century. Episode 2: China, Europe and Opium Wars, 1757-1860 With the development of shipbuilding technologies, Western nations greatly expanded trade across the globe. China again came into focus, especially for Britain, which saw high demand for Chinese products. The first trade that existed with China was for silks, porcelain ("fine china") and, most lucratively, tea. China continued to restrict trade with Western Nations based on the age- old view of China being prosperous and self-sufficient. The ruling Qing Dynasty viewed foreign trade with suspicion.China’s official policy was to “Our land is so wealthy and prosperous, that we possess all things. Thereforeallow only payments with silver there is no need to exchange the produce of foreign barbarians for ourand gold for exported products own…China is the centre of the world and has everything we could ever need and that all Chinese products were to be bought with Silver.” Chinese Emperor Qianlong (1711-1799 CE) China implemented the so-called Canton System in 1757. The Canton System limited the ports in which European traders could do business with China. It also forbade any direct trade between European merchants and Chinese civilians. Instead, the Europeans, generally employees of major trading companies (most importantly the British East India Company) had to trade with an association of Chinese merchants known as the Cohong. The Cohong was a Guild of thirteen merchants authorized by the Chinese Central Government to handle trade, particularly rights to trade tea and silk, with the West. They were the only group at the time authorized to do this, making them the main controllers of all foreign trade in the nation. The Canton System limited trade to only one port and exclusively with the government appointed guild of merchants The canton system ports, 1757-1842Chine restricted trade to onlyone ports of Macau and HongKong Source: WikipediaErste Group Research – Trade between China and the West: three historical highlights Page 5
  6. 6. Erste Group ResearchCEE Special Report: Trade between China and the West30 November 2012 th Britain had been on the gold standard since the 18 century, so it had to purchase silver from continental Europe and Mexico to supply the Chinese appetite for silver. The British East India Company faced a trade imbalance in favor of China and invested heavily in opium production to redress the balance. British and US merchants brought opium from the British East IndiaDue to ban on legal imports, Companys factories in Patna and Benares, in the Bengal Presidency ofWestern merchants started British India, to the coast of China, where they sold it to Chinese smugglersselling opium to compensate who distributed the drug in defiance of Chinese laws. Aware both of the drainfor outflow of gold of silver and the growing numbers of addicts, the Daoguang Emperor demanded action. Officials who advocated legalization of the trade in order to tax it were defeated by those who advocated suppression. In 1838, the Emperor officials came to Guangzhou where they arrested Chinese opium dealers and summarily demanded that foreign firms turn over their stocks.China banned all trade, which When they refused, China stopped trade altogether and placed the foreignled to war with Britain in 1839 residents under virtual siege, eventually forcing the merchants to surrender their opium to be destroyed. In response, the British government sent expeditionary forces from India, which ravaged the Chinese coast and dictated the terms of settlement.Britain had huge trade balance deficit with China British and American merchants sold opium toBritish East India Trade company balance compensate for the outflow of gold and silver mn. pounds Opium Exports per capita from India to China 6 (in number of chests) 5 4 3 2 1 0 1761 1766 1771 1776 1781 1786 1791 1796 1801 1806 1811 1816 1821 1826 1831 Exports ImportsSource: Wikipedia Source: http://www.nber.org/ The Chinese emperor failed to see the wisdom of his ancestors back in the times of Han Empire, who allowed trade with West because they feared itsLacking modern military military power. Because they had prohibited imports and were thus deprivedtechnology, China lost two of modern military technologies developed in the West, China lost the war toconsecutive wars to Britain Britain. The Treaty of Nanking, which ended the war, opened the way for further opium trade, but ceded territory, including Hong Kong. The treaty abolished the monopoly of the Thirteen Factories on foreign trade and instead five ports were opened for trade, where Britons were allowed to trade with anyone they wished. However, Chinese officials continued to obstruct foreign trade, which led to the Second Opium War (1856-1860). The final Treaty of Tientsin was signed with the following key points:China gave up Hong Kong and • Eleven more Chinese ports would be opened for foreign tradeallowed trade with West • Right of foreign vessels, including warships, to navigate freely on Yangtze River • Right of foreigners to enter internal regions of China for purpose of travel, trade or missionary activities.Erste Group Research – Trade between China and the West: three historical highlights Page 6
  7. 7. Erste Group ResearchCEE Special Report: Trade between China and the West30 November 2012 The loss of two consecutive wars, the widening technological gap with Western nations and increasing number of drug addicts came to be known asChina regained Hong Kong The Century of Humiliation. The Century of Humiliation was one of the mainfrom Britain in 1997, new trade themes in the propaganda of the nationalist and communist movements whichboom with the West started later toppled the Qing dynasty in the 1920s. China regained Hong Kong from Britain in 1997 and Macau from Portugal in 1999. These are now the only two Special Administrative Regions of China. With the return of key trading ports, China immediately experienced a new trade boom with the West. Thus began the third period of trade expansion of the Western World with China, a period through which we are currently living. Episode 3: China, EU and United States, 2000-now Immediately after Hong Kong joined China, trade between Western nations and China exploded. Chinese exports rose 2.5 fold from the 1990s to 2000s (adjusted for US inflation). During the next decade, the exports growth rate doubled compared to that of the ’90s.Since 2000, China’s exports growth accelerated Western nations ran into large trade deficits, AsianChina’s exports economies went into big surpluses Current account balance USD bn, adjusted for US CPI 700 500 400 600 300 200 500 100 0 400 -100 300 -200 -300 200 -400 -500 100 -600 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 0 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 Advanced economies Developing AsiaSource: IMF Source: IMF Export growth has been largely stimulated by government intervention. The Chinese government has implemented artificial obstacles for rural areas: bans on loans to municipalities and small enterprises, social care only madeChinese government artificially available for those living in cities. This gave great advantages to companies instimulated exports while large cities, who could use cheap workforce to actively compete on foreignlimiting imports markets. Additionally, the Chinese government has kept its currency exchange rate artificially low to make sure that its exports are price competitive, while few imports come into country and large savings are made. With the surge in savings, China has been making vast investments in infrastructure. These investments often include large-scale projects such as dams, roads, bridges and vast amounts of social housing. The investment share of the Chinese economy has rapidly expanded, while household income growth has been lagging behind GDP. The model of favoring cheap exports and trade balance surpluses has been copied by other Asian economies, but typically not to such an extreme extent.Erste Group Research – Trade between China and the West: three historical highlights Page 7
  8. 8. Erste Group ResearchCEE Special Report: Trade between China and the West30 November 2012Investments took greater share of GDP in China China became world leader in savingsInvestments, % of GDP, China China’s FX reserves 43% USD bn 41% 3500 39% 3000 37% 2500 35% 2000 33% 1500 31% 29% 1000 27% 500 25% 0 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010Source: IMF Source: IMF Money no longer means gold, as the USD has taken over this role. For theChina is again global leader in third time in history, China has become the leader in global savings of thesavings main means of exchange. The country currently possesses the largest stock of foreign exchange reserves, worth USD 3.2trn. Quite symbolically, in 2012, China is likely to become a leader in global gold consumption for the first time th since the 19 century. The huge bulk of Chinese FX reserves are by their nature either deposits in commercial banks or loans to governments in other countries. Chinese savings made it much easier for banks and governments to get cheap funding. Chinese savings may well have contributed to the deteriorating asset quality and lower standards of credit in Western countries. In addition, competition with cheaper imports from Asia made life difficult for many businesses in the developed world. Chinese demand for investments, particularly in the construction sector, has pushed up commodity prices andRising trade deficit between further widened the trade deficit in more advanced economies. China’s risingWest and East was an savings and their likely contribution to the banking crisis of 2008/09 wereimbalance that likely facilitated definitely not the sole reasons for the Great Recession. The economic crisis ofeconomic downturn the recent years is a broad and complicated phenomenon. But the rising trade deficit between West and East was one of the imbalances that likely facilitated the economic downturn.Lucrative lending soared in US since negative trade Energy prices skyrocketed on growing demandbalance with China expanded from ChinaUS subprime mortgages, USD bn Energy price index 250 200 150 100 50 0 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010Source: http://emlab.berkeley.edu/ Source: IMFErste Group Research – Trade between China and the West: three historical highlights Page 8
  9. 9. Erste Group ResearchCEE Special Report: Trade between China and the West30 November 2012 Summary There are three known historical periods during which trade between Western and Eastern worlds has gone though explosive growth (206 BCE-220, 1757-During three historical periods 1860, 2000-now). Each time the West has seen widening trade balanceof expanding trade, China deficits and China ran trade surpluses. During three historical periods ofbecame global leader in expanding trade, China become the global leader in savings of the mainsavings of main global medium global medium of exchange (be it gold, silver or the reserve currency). Chinaof exchange (gold, silver or sustained its positive trade balance via government intervention, which camereserve currency) at a cost to people’s income. In each of the three episodes, China has used its proceeds from foreign trade surplus for large-scale construction projects inside the country. The Great Wall of China and the vast difference between the prosperity of Hong Kong and Mainland China are remnants of two previous failures of the West to create sustainable and balanced economicBoth EU, United States and relations with East. In previous history, no country received greater damagedeveloping Asia may put from China’s restrictions on trade than China itself. The Chinese people werethemselves on path of great dissatisfied with their incomes and the whole country lagged in technologyprosperity should the trade compared to the West. In the past, this has led to revolts in China. Sincebecome free and thus break the 2010, the Chinese government declared a change in its policy, promising totwo thousand year old change the economic structure more in favor of domestic consumption.unsustainable economic model Should this actually be done, the negative trade balance may diminish and the West will find much more demand for its products. The EU, United States and developing Asia may find themselves on the path of great prosperity should trade become free and thus break the two-thousand-year-old unsustainable economic model.Erste Group Research – Trade between China and the West: three historical highlights Page 9
  10. 10. Erste Group ResearchCEE Special Report: Trade between China and the West30 November 2012ContactsGroup ResearchHead of Group ResearchFriedrich Mostböck, CEFA +43 (0)5 0100 11902 Research, SlovakiaMajor Markets & Credit Research Head: Maria Valachyova, (Fixed income) +421 2 4862 4185Head: Gudrun Egger, CEFA +43 (0)5 0100 11909 Martin Balaz (Fixed income) +421 2 4862 4762Adrian Beck (Fixed income AT, SW) +43 (0)5 0100 11957 Research, UkraineBenedikt Blum (Quant, Euro) +43 (0)5 0100 11961 Head: Maryan Zablotskyy (Fixed income) +38 044 593 9188Hans Engel (Equity US) +43 (0)5 0100 19835 Igor Zholonkivskyi (Equity) +38 044 593 1784Christian Enger, CFA (Covered Bonds) +43 (0)5 0100 84052 Treasury - Erste Bank ViennaMildred Hager-Germain (Fixed income Euro, US) +43 (0)5 0100 17331 Saving Banks & Sales RetailAlihan Karadagoglu (Corporates) +43 (0)5 0100 19633 Head: Thomas Schaufler +43 (0)5 0100 84225Peter Kaufmann (Corporates) +43 (0)5 0100 11183 Equity Retail SalesStephan Lingnau (Equity Europe) +43 (0)5 0100 16574 Head: Kurt Gerhold +43 (0)5 0100 84232Elena Statelov, CIIA (Corporates) +43 (0)5 0100 19641 Fixed Income & Certificate SalesRonald Stöferle (Equity Asia, Commodities) +43 (0)5 0100 11723 Head: Uwe Kolar +43 (0)5 0100 83214Thomas Unger; 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  11. 11. Erste Group ResearchCEE Special Report: Trade between China and the West30 November 2012Published by Erste Group Bank AG, Neutorgasse 17, 1010 Vienna, Austria.Phone +43 (0)5 0100 - ext.Erste Group Homepage: www.erstegroup.com On Bloomberg please type: EBS AV and then F8 GOThis publication has been prepared by EG Research. This report is for information purposes only.Publications in the United Kingdom are available only to investment professionals, not private customers, as defined by the rules of theFinancial Services Authority. Individuals who do not have professional experience in matters relating to investments should not rely on it.The information contained herein has been obtained from public sources believed by EGB to be reliable, but which may not have beenindependently justified. No guarantees, representations or warranties are made as to its accuracy, completeness or suitability for any purpose.This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument or any other action and will not formthe basis or a part of any contract.Neither EGB nor any of its affiliates, its respective directors, officers or employers accepts any liability whatsoever (in negligence or otherwise)for any loss howsoever arising from any use of this document or its contents or otherwise arising in connection therewith. Any opinion, estimateor projection expressed in this publication reflects the current judgement of the author(s) on the date of this report. They do not necessarilyreflect the opinions of EGB and are subject to change without notice. EGB has no obligation to update, modify or amend this report or tootherwise notify a reader thereof in the event that any matter stated herein, or any opinion, projection, forecast or estimate set forth herein,changes or subsequently becomes inaccurate.The past performance of financial instruments is not indicative of future results. No assurance can be given that any financial instrument orissuer described herein would yield favourable investment results.EGB, its affiliates, principals or employees may have a long or short position or may transact in the financial instrument(s) referred to herein ormay trade in such financial instruments with other customers on a principal basis. EGB may act as a market maker in the financial instrumentsor companies discussed herein and may also perform or seek to perform investment banking services for those companies. EGB AG may actupon or use the information or conclusion contained in this report before it is distributed to other persons.This report is subject to the copyright of EGB. No part of this publication may be copied or redistributed to persons or firms other than theauthorised recipient without the prior written consent of EGB.By accepting this report, a recipient hereof agrees to be bound by the foregoing limitations.Copyright: 2012 EGB AG. All rights reserved.Please refer to www.erstegroup.com for the current list of specific disclosures and the breakdown of Erste Group’s investment recommendations.Erste Group Research – Trade between China and the West: three historical highlights Page 11