China’s economic boom is creating growing pains

dachang, china -- The phones are ringing off the hook at Yang Yuming’s office these days. The general manager of Tianpu Meat Processing Co. says he can barely keep up with rising orders from Holiday Inn and other hotels and restaurants in Beijing wanting more ribeye, tenderloin and strip loin steaks.

Orders are up 30% this year, and with more Western and wealthy Chinese visitors expected for the 2008 Summer Olympics, he says, demand for beef is going to grow even faster. But Yang isn’t rolling in dough or looking forward to the new year.

Meat prices have jumped nearly 40% in recent months, and the rapid increase has left Yang and dozens of other beef and mutton processors struggling to make ends meet. When asked about his company’s profit, Yang drew a big circle with his finger.

His customers won’t allow him to pass on the full increase, he says, so with every extra order, Yang struggles to break even. “No, I’m not celebrating the Olympics,” the 42-year-old said while wearing a thick parka in his cold, bare office.

Surging inflation, and problems with product quality and China’s breakneck economic growth, were dominant themes in China last year -- and they weigh heavily on the minds of policymakers, businesses and consumers as the nation heads into its long-awaited year of the Olympics. Last year also marked China’s arrival on the international investing scene.

The August games are the first with China as host, and are being touted as a seminal moment for the rising Asian powerhouse. Undoubtedly, they will be a grand spectacle.

Economically, though, the Olympics will matter little outside Beijing, experts say. Though they will boost consumption a bit and give a lift to tourism, “the Olympics are likely to be irrelevant to the economy,” said Andy Rothman, China strategist for brokerage firm CLSA in Shanghai.

Beijing says it is plowing $34 billion into building up for the Olympics -- five times what Sydney spent for the 2000 games -- but Rothman notes that is still just 2.4% of China’s investments for land, plants and equipment in 2006.

Rothman and most other economists see China’s gross domestic product growth slowing in 2008 from last year’s torrid pace of about 11.5%. How much may depend on the extent of the U.S. and global economic retreat after the sub-prime mortgage meltdown and resulting credit crunch.

A softer U.S. economy will constrain American consumption, in turn pinching Chinese exports. But the European Union is now China’s biggest market, and trade with other Asian countries has become increasingly important, so those developments could soften the blow.

What’s more, China’s investment in land and factories -- a key driver of the economy -- shows few signs of letting up. That should keep prices of commodities such as metals high and keep mining operations from Australia to Arizona busy.

Beijing has been trying to curb excessive spending on plants and other projects that are causing an oversupply of goods, harming the environment and soaking up resources. The central government has repeatedly tightened bank credit and raised reserve requirements to discourage lending.

But that hasn’t had much effect, and analysts point out that further bank restrictions might not matter because companies are flush with cash and have plenty of informal channels to finance new factories and expansions.

This year also will bring a reshuffling of local Communist Party officials, as happens every five years. If the past is any guide, that will generate a burst of spending on construction and building projects as new leaders seek to make their mark.

“China’s economic situation is just like before,” said Cao Jianhai, an economics expert at the Chinese Academy of Social Sciences in Beijing. “Growth is largely led by investment in real estate and infrastructure, heavy and chemical industries, as well as exports. The fundamental structure of the economy has not changed.” One area in which Beijing seems to be having more success is encouraging Chinese companies to expand globally, and that is likely to continue in 2008.

Investments in U.S.

In October, China’s Citic Securities said it would acquire up to a 9.9% stake in Bear Stearns as part of a $1-billion joint-venture deal. The same month, China Minsheng Banking Corp., the nation’s seventh-largest bank by market value, agreed to buy a 9.9% stake in United Commercial Bank, a leading Chinese American lender based in San Francisco.

China’s new sovereign wealth fund -- China Investment Co., with assets of $200 billion -- last year made significant investments in Blackstone Group and Morgan Stanley.

“2007 is the turning point,” said Donald Tang, the Los Angeles-based vice chairman of Bear Stearns and a key player in the Citic deal. For Chinese financial services, he said, “it’s the first time outward investment is bigger than inward investment.”

Most analysts expect the sovereign wealth fund to become more aggressive in buying stakes in companies worldwide.

The last year was also a turning point for Liu Dong, general manager of Laiwu Yongchang Food Co., a maker of ginger products in Shandong province. Like many other food exporters, Liu’s sales began to tumble around last spring, when thousands of dogs and cats in the U.S. were sickened and died after eating pet food containing tainted Chinese-made ingredients.

“Even though ginger wasn’t a product with problems,” Liu said, “my exports to the U.S. dropped at least 30% [during that time] because of extremely strict inspections and the uncertainty.” He doesn’t see things getting better in 2008.

China’s food and toy exports combined account for less than 5% of the nation’s total exports in 2007.

Recently, Chinese officials closed plants that produced shoddy goods and arrested hundreds of people to reassure foreign consumers about the Made-in-China label. And Beijing signed an agreement to give American officials greater access in inspecting Chinese plants that produce food and drugs for the U.S.

Product scare is risk

But another big product scare could turn product safety into a hot issue on the U.S. presidential campaign trail and further damage China’s reputation and sales in the States.

He Bing, manager of Zhejiang Hexin Toy Co. in Zhejiang province, the entrepreneurial region in the Yangtze Delta, says he expects a shakeout in 2008. He predicts that at least 10% of the 700 toy factories in Yunhe County, where Hexin operates, will shut down or go into a different line of business next year. “Many cannot see profits under the current circumstances,” he said.

He’s company, known for making wood and bamboo toys, plans to invest more in stores to increase sales to Chinese buyers. “The domestic market is becoming more and more mature as the consumption level of people increases and more babies are born in recent years,” he said.

Retail sales in China accelerated this year -- to almost 20% year-over-year growth in recent months -- but consumer consumption remains a relatively small component of the nation’s economy. Chinese officials are trying to boost that and thus diminish reliance on exports.

But inflation is a threat. Consumer prices rose 6.9% in November, the highest jump in 11 years. That was due mostly to an 18% jump in food prices, led by the nearly 40% surge in meat and poultry costs -- a phenomenon related to higher grain prices and an outbreak of blue ear disease at pig farms that cut into pork supplies.

Most analysts don’t think inflation will get out of hand in China because it is mainly confined to food, but many businesses and consumers are worried.

“Oil prices soared, food prices rose, then all the other products are more expensive,” said Zhi Hehong, general manager of Jinjiang Transportation Co. in Wuhan, in Hebei province. “Because things are more expensive, our salary to staff must rise too. It’s a chain reaction now,” he added. “Our cost is getting higher and higher, and our profit thinner and thinner.”

Higher incomes, inflation

Rising prices have helped boost many farmers’ incomes. But in Dachang, an area of about 110,000 people near Beijing that has been a processor of beef and mutton since the Ming Dynasty (which ruled from 1368 to 1644), people complain that soaring inflation is hurting them.

Meatpackers say they haven’t been able to pass on the increased cost of cows and sheep to their customers. Mom-and-pop retailers say they’re in the same pickle, complaining that their customers can’t afford to buy meat anymore.

“Olympics don’t matter, but inflation does,” said Ma Guangzhong, 76, who was sitting forlornly at his family’s corner store selling dried beef, hung like large coats on metal hooks. “Now people come into my store, ask about the price, and just walk away.”

Some economists believe that the nation’s currency, the yuan, is undervalued and say that is a big culprit behind the inflation. The yuan doesn’t float freely against other currencies but trades within a narrow range controlled by the government.

That has allowed manufacturers to sell their goods more cheaply in overseas markets than they would have otherwise, they say. That has contributed to a record trade surplus -- about $238 billion through November -- which in turn has dumped massive amounts of dollars into the Chinese economy, on top of mountains of “hot money” pouring in from speculators betting on an appreciating Chinese currency.

The ever-swelling money supply makes more funds available to lend for industrial production, which churns out more products, keeps prices low and supports exports, continuing the cycle.

In 2007, the yuan rose by almost 7% against the dollar, and sharper gains in recent days suggest that Beijing may allow a quickening of appreciation of the yuan this year in an attempt to curb inflation.

Yet analysts say that may trigger greater inflows of hot money, adding massive amounts of money into an economy already awash in cash.

--

[email protected]