Doubts are beginning to be heard about how sustainable is China’s economic miracle, particularly the relentless emphasis on exports and investment spending by hundreds of state-owned enterprises (SOEs) and local governments. Beijing, of course, has its supporters, including banker turned academic Stephen Roach, non-executive chairman of Morgan Stanley Asia as well as a faculty member of Yale University, who assert that China is different, bigger, special, the superpower that will defeat all the odds.

Fraser Howie is a leader of those who raise questions about China’s economic miracle. He’s an investment banker, too, and he has lived in China, speaks the language fluently, has a Chinese wife, and has written two books about important financial aspects of China’s economy. If you want an antidote to China fever read “Red Capitalism: the fragile financial foundation of China’s extraordinary rise,” written with fellow investment banker Carl Walter.

In appearance, Howie looks some way south of the South Pole of a typical suited and booted investment banker, no sharp suit and tie, but a rather garish blue and purple casual shirt. His stubble of several days highlights his rapidly receding hairline, but, OK, he is off-duty today. His views are sharp and public-spirited in contrast to most bankers who keep their heads down and make money, unless they raise their heads above the parapet to praise their client state, as Roach has done several times.

“Carl (Walter, his coauthor) and I have always started from having worked and lived there,” Howie says. “You find that the closer you are to the source, the more cynical you are. We were the first to say that China is not all it is cracked up to be and to raise a few red flags. This splurge in lending if you look at it financially, of course it is stimulus, is ultimately not sustainable and is going to lead to a great revival in nonperforming loans. If you look around China you see an incredible infrastructure binge and fixed asset binge, which is probably unwarranted and almost certainly mispriced and miscosted.”

He admits that China’s very size and ancient history makes it difficult to grasp. “Who could not be mesmerized by the numbers of China, whether it is the population, the foreign currency reserves? This is especially so if look where they have come from. In the 1980 financial crisis China had $150 billion of external reserves and its external debt was $130 billion to $140 billion, so it was touch and go, Now, the reserves are 20 times the size. From that perspective, these seem incredibly large numbers and seem unstoppable.”

He cautions that Asians should remember that, “We have seen this before, 20 years ago in the case of Japan. China seems different because there are so many more people. There are no miracles happening in China in the sense that somehow the rules of economics somehow don’t work. They work just as well in China as they do everywhere else. If the government can seem to be doing noneconomic things or things that other governments won’t do, you also find that there is a cost. They are spending a lot of money in the hope that it pays off, even though if you cost it, it is not an economic or viable proposition.”

His words tumble out like a waterfall, and occasionally snag on a rock or a boulder of a new thought before he picks up one or other theme and continues. His Scottish burr also gives him an edge. Howie takes issue with a million and one commentators who believe that it is only a matter of time, whether 10 or 50 years — or may be even five — before China takes over from the United States as global MegaPower. “I fundamentally don’t believe that China will ever achieve superpower status in the way that the United States has in terms of cultural influence and general domination. I feel confident because if nothing else the Chinese culture itself is exclusionary. The whole language is structured around inside and outside, and it’s about …” His waterfall of words hits a rock before he continues: “Chinese systems are all designed to run Chinese people. No one else is going to take this sh** garbage from their government. People are not rallying round the world ‘Bring me no freedom of assembly; bring me no religious freedom.’ That’s not to say that America does not have its problems, but nobody rallies round, ‘Give me a one-party state; I want my civil rights taken away; I want corruption in my government; I want my bank savings to be taken and interest rates to give preferential treatment to SOEs.’ “

Howie warns that in the next year or so, it will be difficult to get even straightforward decisions out of China because of the political jostling as President Hu Jintao and Premier Wen Jiabao step down, probably to be replaced by vice president Xi Jinping and by vice premier Li Keqiang, who will be the fifth generation of Chinese leaders. “I am not a political analyst, but from what I can see of this new fifth generation, the bios of each of them look the same on the National People’s Congress website. These are very tricky people who have come through the system. One thing does seem to be lacking — where is the clear strong leadership? In the past decade China has suffered from poor leaders, with a lot of consensus decision-making, a lot of political factional infighting.”

Politics and economics interact, especially with the building up of the giant SOEs, whose chief executives, Howie points out, “have ministerial-level power. And so you have a question of who’s the government here? Is the government the politicians or the government the businessmen, because they are holding the same level of power? This has led to factionalism and patronage cliques or business groupings, and led to poor decision-making, inefficient decision-making and failure to grasp the nettles of reform — as many hard decisions are rolled over for the next generation of leadership. I don’t see that fundamentally changing.

“There must also be a concern as well from the Communist Party that the system is pretty unstable in many ways, social stability is a problem. It is a problem of their own making: by not addressing genuine reform, by not addressing corruption, by not addressing real accountability — and the whole democratic question is one of accountability and holding people responsible — they have got this very unstable system. Who wants to rock the boat?”

Howie is sympathetic toward former premier Zhu Rongji, but Zhu’s own great failure was in not cementing the foundations of reform at the time of great opportunity when China joined the World Trade Organization is 2001. Rebalancing the economy then, “when China was barely on the global radar screen and did not have the burden of $3 trillion in foreign exchange reserves,” notes Howie, would have made it easier to head off problems before they started festering.

Exporters who do not want to see the renminbi substantially revalued have gained political clout as the Communist Party opens up membership to booming business executives. In addition, strident nationalists don’t want China to be pushed around by the U.S. On top of that there is an often badly directed global searchlight. Howie cites “interest rate hikes in China, which really have very little to do with the global economy, are all the headlines on CNBC. Markets move because China moves rates. Interest rate hikes in China might as well be interest rates on the moon or on Mars for all the direct impact they are going to have. You can’t easily get into renminbi, and you can’t easily get out of renminbi, so the impact on global markets is minimal.”

For all his skepticism about the Chinese miracle, Howie pulls back from predicting imminent disaster: “I have real problems in envisioning a scenario where you somehow have a collapse of China, and that’s what we shy away from in the book. We sort of push toward it because that’s the natural conclusion, but then you remember that things can go on for a long time, especially in an environment where you can’t short the government, you can’t take an opposing position against the government. There is very little foreign debt. It’s all domestic.”

When the government talks about the economy, it is talking about SOEs, Howie points out, “never about the small capitalist trader or the exporter sector even, as important as that is. If you are looking at the major sectors of the economy, the SOEs are dominant, and a lot of retail and others is populated by divide and rule. Steel, the airline industry, coal, power, telecommunications, are all in the hands of the national champions. That is all defined as strategic.

“Much of the rest of the economy is populated by these millions of small businesses. There is obviously a lot of overlap as well and they now accept capitalists into the Communist Party, so you are getting growing links between the two. But it is still very much a dog on a leash. Even if you are in the private sector, you are still on a leash. And if you are playing inside China you are on a leash and the government can always pull it and rein you back in. So many in the private sector want to work more with the government sector because that’s where the favorable policy, favorable laws, favorable deals come from. It clearly isn’t the private sector on one side of the barricades and the state on the other.”

Howie expresses optimism that China is still seeking the direction of reform. He resorts to a battery of jumbled metaphors, describing it as “a bit of a pinball, you are going to bounce this way and then come back that way, a bit of progress here, then delayed, then forward, back again, then bong, oops, fell off the chair… There seem to be a lot more hills, and so therefore it is going to take a lot longer to get there than you think. It is a direct flight but we seem to take a lot of roundabout twists and turns to get there. And maybe they actually won’t get there. There is no guarantee that China must succeed, whatever that means.”

Even though some Western-educated Chinese see China as the potential savior of capitalism, Howie points out that the Communist rulers of Beijing have drawn their line and will not give up state ownership of the strategic heights of the economy. The system is full of inefficiencies, not least because banks’ chief executives have the rank of vice ministers, whereas SOE chiefs are full ministers. It’s clear who is in charge. No one got fired for lending to SOEs; or got promotion for refusing a loan.

He notes the predilection for new buildings, many of questionable quality, but construction of which boosts GDP. “If you build a worthless building, that adds to GDP because you use cement, workers, whatever. If you knock it down, that adds to GDP as well because you need to employ people to knock it down. And then you build another building, and that adds as well. Construction seems to be the classic GDP generator. Let’s just build something. Let’s build something big. You look at so many of the projects, such as town halls or police headquarters, even in villages, 10-stories high.”

He hones in on the extravaganza of last year’s Shanghai Expo: “They have got limited resources in China, still a poor country on a per capita basis, lacking all sorts of resources. What are they doing with their limited resources? They are bussing people in from the countryside, so they can have the highest number of people ever to go to an expo. Talk about misuse of resources.

“Have you been to the countryside? Have you see the health care status in the countryside? Even in the cities, one of the biggest problems is that if you get ill the medical expenses and the bill (will be so high) that if you were not already in poverty, you will be kicked back into poverty. It is a dreadful scenario. Primary health care is really bad in China in the big cities. If you have got money, it’s fine.”

He takes a sideswipe at Japan for technology sales to China, praying that it will lead to more orders, “When what happens is that the Chinese steal the technology, call it Chinese and then sell it to the rest of the world… It also begs the questions about this economic miracle and about your strategy for China. You may look at your growth numbers, but where is the slide that shows what happens when technology is stolen and copied and you are in competition with China in five years time?”

Howie says China still has a long way to go. “There is ambition in China. They are clearly not a lazy people, and there is certainly no lack of imagination in a broader sense. They have a large vision of where they want to be and who they want to be — which is obviously important for anybody who is trying to grow or become something.

“But that doesn’t necessarily translate into achievement. They want to have the world’s best universities, so they throw lots of money into education. They build lots of big university campuses. What they don’t try to do is reform primary school education and move away from rote learning system and standardized tests. China recently came top recently in some global standardized test. That’s great: but I have never seen anything in life which is a standardized test, nor in business. So unless you can move the world to a standardized test for business and life, that’s of limited benefit.”

He adds: “China’s has gone for the trophy events, like the Olympics, the Expo, the Asian Games, huge monumental things. And yet traffic in Beijing is still very bad, air pollution in Beijing is bad, the quality of life is somewhat dubious, the Chinese people are not happy. Would you rather be happy or have the Olympics? It seems ironic that with all of China’s 3,000 years of history, the biggest tourist attraction in Beijing is the Bird’s Nest Stadium, which has never been used for another sporting event, which is a bigger money earner than even the Forbidden City.”

He is also pessimistic about China’s $3.3 trillion in foreign exchange reserves: “All they can do is keep buying U.S. government bonds. There is nowhere else to put your money. No one’s going to sell you Brazil or Nigeria or (mineral rich) Western Australia. All non-Western Australians and most Western Australians would be upset being the 32nd Chinese province. I don’t think Zambian miners would be too keen either. China is discovering that its methods of management don’t necessarily work outside China, and Africa is just as difficult place to do business if you are Chinese as it is if you are a Westerner.”

Howie pours scorn on the idea of a Beijing consensus or a Beijing model to take over from the Washington consensus. China is not unique. It is following a model started in Japan and Korea, and China’s very size has been a factor in shaking the world. But the Chinese experience is not replicable by other emerging countries, even if they were prepared to embrace the lack of freedoms in the Chinese system.

“If you were on the back streets of Nairobi , you would probably find dollars most useful,” says Howie, probably not yen or Swiss francs, and certainly not renminbi. “No one bestows the (role) of reserve currency from somewhere on high. It is ultimately what the market, what the man on the street thinks. Is the yen a reserve currency? Sort of, in a distant sort of way, and yet it is a fully free and tradable currency. China is nowhere near to ticking half of the boxes to get to the stage where you can talk of the renminbi being a reserve currency in any substantial way.

“I also doubt whether China is in any way politically ready to accept the scrutiny that comes with running a reserve currency. Think of the number of commentators, basically any man and his dog, from your plumber to your servant’s tennis partners, everyone has a view on Ben Bernanke, Tim Geithner and whether they are right or wrong, what they should do, what they shouldn’t do — and they are all high profile people, Jim O’Neill, Roubini. Do you think the Chinese are going to suffer that level of scrutiny and the vitriolic attack that comes with being the world’s central banker? There’s no way that they are going to put up with that. And if it doesn’t come, what does that tell us about the global economy — that we are all defaulting to the Chinese because we have to give the Chinese face. You cannot be given face if you are a central banker. There has to be serious scrutiny, dialogue, debate, some of it extreme, across the whole spectrum.

“I don’t see the Chinese are anywhere near ready to raise themselves to that level of public criticism or exposure and accept it. Mattel complains about lead in toys made in China, but it’s not the Chinese factory’s fault, it is Mattel’s fault and they must apologize to the 1.3 billion Chinese for insulting them. This is ridiculous. If you want to take on that superpower mantle, there’s a whole host of things that come with it in terms of disclosure.

When, where and how is China going to be forced to face the need for thorough reform and change? Howie concludes: “Maybe the change comes from some sort of external shock in terms of an internal shock, such as inflation that you cannot get under control. Maybe it comes from a fall off in the export sector again due to the global economy. Maybe the shock comes from some North Korean crisis that shuts shipping lanes — or whatever — and that real hard action that needs to be taken really to bring things under control again. But it is going to be very difficult when you look at the huge expansion of credit over the past few years. Postponing the decisions makes them ultimately more difficult.”

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