The crack and whine of bullets, the buzz-soar roar of automatic fire filled the air. Some people ran in blind panic, desperately trying to get away from the advancing soldiers. Others stood their ground, screaming, hurling abuse, only to be cut down where they stood... the morning hours of June 4, 1989... the day China butchered its young, its own people.

November 1998, some nine years later... and the crowds are surging again on Tiananmen Square, some on foot, some on bicycles, pressing, pushing against a wall of police which bars their way, cursing, shouting, their outrage no less heartfelt, no less impassioned. Yet this time their cause is not political, but financial, for the crowd is a sea of angry investors, demanding their money back after the commercial failure of a company. This time, the authorities, well aware of the political dangers of economic distress, seek to play down the incident, merely shepherding away the demonstrators from the government buildings where they had been trying to make their case.

Two incidents that show how far China has come, how far it must go. Two incidents that demonstrate the different allegiances and passions that have been felt by the ordinary person in China -- and how those seem to have changed radically over such a relatively short period of time. Despite the occasional bout of political dissidence, China -- at least for now -- is no longer so enflamed by political and radical ideas and ideologies. The focus now for most people is much more on the economic rather than the militant. There is a deep irony with regard to the protest of November 1998, however humble that was compared with its predecessor. The people who took to the streets in 1998 to voice their discontent were precisely those whom Deng Xiaoping had exhorted to drive the economy forward, precisely those whom China's late paramount leader had told in his revolutionary statement of the 1980s that "to get rich is glorious." These were the very inheritors of his vision for a commercially viable and prosperous China. That they were on the streets, protesting their financial losses, again demonstrates how far China has come; yet it also shows the dangers inherent with that progress.

China's government has done much to promote the "socialist market economy" as the way forward, as the ultimate compromise between the egalitarianism of communism and the economic benefits of a free-market economy. However, this too has its economic victims. Indeed, its victims are all too visible, most notably on the outskirts of all the main cities in China. And with the gathering economic slowdown in China which we continue to witness -- with some trepidation -- the number of these victims is rising. There will come a time in the not too distant future when, if that number continues to rise unchecked, a situation of economic distress could once again become political. Most in the West see the events of June 4, 1989, as specifically a rejection of the political status quo. Yet in reality the roots of June 4 were economic just as much as, if not more than, they were ever political. Indeed, to a great extent, they started out as a protest against the excesses brought on by inflation, most notably official corruption. This interlinking of economics and politics, however much the authorities might officially deny it, is a lesson not lost on the leaders of the Chinese Communist Party, lodged in their fortresslike headquarters of the Zhongnanhai. Indeed, this is most probably why the latest outpourings of economic discontent have been treated with relative care.

Stability lies at the very epicenter of what passes nowadays for ideology in China. While the need for substantial economic advancement remains, despite the successes to date, such advancement cannot be achieved without stability, so thought Deng Xiaoping. Given how he himself, and others in the upper echelons of the Party, suffered during the madness that became known as the Cultural Revolution, it is hardly surprising that he came to such a view. Indeed, as we shall see, stability and the paramount need to avoid any repetition of the chaos of the Cultural Revolution constitute a central theme of all prevailing official thought, including economics and finance, which are the main subjects of this book. Deng's economic philosophy of "feeling for rocks underfoot while crossing the river" -- or "Mo zhe shi tou guo he," in Putonghua (Mandarin Chinese) -- was specifically aimed at adopting a cautious approach to reform, avoiding the type of chaos that China has so often suffered from, in both the political and economic spheres.

The differences present between the China of 1989 and 1998 are starkly clear in the two incidents mentioned above; yet there are also similarities, recurring themes. Of these, the most profound is the most obvious -- that they both took place on or near Tiananmen Square. To the West, Tiananmen -- the Gate of Heavenly Peace -- is synonymous with the brutal events of June 4, 1989. Yet it is steeped in history. Indeed to a great extent, it is the very font of Chinese history, from which all expression and change have come. The history of Tiananmen is the history of China. In the time of the emperors, Tiananmen was the central symbol of unity, a unifying place from which edicts were issued and complaints heard. Tiananmen was the locus of power, the center of the center of the world. In the twentieth century, while still playing a leading part in Chinese history and politics, Tiananmen has taken on a slightly different role, as a focal point for Chinese popular dissent, initially against foreign and then latterly against domestic oppression. The events of May 4, 1919, caused a sea change in Chinese popular thinking when some 3,000 students protested against the terms of the Versailles Treaty, which granted German concessions in China to the Japanese. Thus, Tiananmen became the focus of protest rather than of obedience, the focus of dissent, of rebellion. In 1925, it was again the scene of protest when Beijing locals demonstrated against the killing of demonstrators in Shanghai by British troops. And again in 1926 and 1935, it was the stage for anti-Japanese demonstrations, first against the government's capitulation and then as a rallying cry for national resistance against Japan. After the war, on October 1, 1949, Chairman Mao stood on the reviewing platform of the Gate, facing the masses crowded into the square, and declared that the Chinese people had finally "stood up." In 1966, it was where the Cultural Revolution began, where hundreds of thousands of Red Guards were exhorted to purge the nation of cultural and ideological impurity. Again, in 1976, there were mass demonstrations in the square following the death of Zhou Enlai, the brutal suppression of which marked the beginning of the end for the Gang of Four. In the early 1980s, people gathered to discuss previously heretical ideas of democracy, writing their thoughts on what became known as the Democracy Wall on the edge of the Forbidden City.

The brutal crackdown on June 4, 1989, was, as Zhao Ziyang, the sacked Party general secretary who sided with students, said many times, a "mistake," though to the authorities at the time, seemingly an unavoidable one. Given China's history, however, and given the history of Tiananmen Square, it was predictable, and it is not inconceivable that it could happen again. China is not a democracy, whatever its merits, and the authorities that govern it will not go quietly -- if go they do. For the West to think otherwise is merely wishful thinking, and indeed the new rapprochement between Western governments and China suggests a new realism -- or at least a desire not to antagonize China and to get at its markets! China's more recent history has -- thankfully -- been more peaceful, with both the authorities and the people focusing on economic success rather than political conflict. This success was brought about as a result of the economic revolution launched by Deng Xiaoping at the 11th Party Congress in 1978. It is a paradox that the man who gave the orders for the Tiananmen Square crackdown in 1989 was also responsible for what is arguably one of the greatest economic successes of all time, a paradox that is a reflection both of China's past and of the difficulties and challenges it will face going forward, attempting to balance the requirements of rapid economic liberalization with an official desire to limit political development. All the same, the results of Deng's economic revolution were unquestionably astounding. China averaged over 10% annual GDP growth from the mid-1980s through the early 1990s, and Western commentators fell over themselves to herald it as the new economic superpower. "The giant had awakened," as Napoleon Bonaparte so famously predicted, and in economic circles (and no doubt political ones as well), the world did indeed tremble. Coinciding with the economic ascent of Southeast and other parts of North Asia, China's progress seemed unstoppable, its ultimate supremacy as the world's leading economy inevitable. The events of 1989 notwithstanding, the world resolved itself to adapting to a new and potentially dominant player on the world economic stage.

Growth boomed. It was led initially by the agricultural sector, freed from the restrictions of the collective system as a result of deregulation in 1979. Subsequently it was fueled by the township and village enterprises (TVEs), the first transmission mechanism from a socialist command economy to a market economy. Then the first truly private enterprises emerged in their own right, followed by heavy industry itself. Gradual liberalization of selective economic regulations, sectors and areas, such as the special economic zones (SEZs), gave the population renewed purpose and opportunity. With the rise in growth came side effects, both positive and negative. On the positive side, indicators of economic advancement, such as infant mortality, life expectancy, and diet composition, showed the requisite improvements for a nation that was seeking to attain a new and higher level of economic development. The proportion of the population that lived in a state of "absolute poverty," as defined by international organizations such as the World Bank and the Asian Development Bank, fell from around 25% in 1978 to 10% by the mid-1980s. The general standard of living, as seen both by the data and anecdotally, was clearly improving, and as throughout the world, the Chinese people sought to take advantage of their improved situation.

Consumption patterns changed radically, becoming more aggressive. And business, whether state-owned, private, or foreign, sought to change with them. The national savings' rate stayed extraordinarily high, with gross national savings as a percentage of GNP averaging 34.3% from 1981 to 1990 -- three times that of Western Europe or the U.S. Yet consumption as a percentage of total income also rose as the people felt the economic benefits of the reform process. A visitor returning to Beijing or Shanghai today, or even the likes of Shenzhen or Guangzhou, would be stunned by the enormity of change, of advancement, that China has experienced in the last two decades. To be sure, China still has the hallmarks of an "emerging market," both socially and economically. Yet the trappings of economic prosperity that the West takes for granted, indeed almost as a defining characteristic of the West and the Western way of life, are increasingly to be found in abundance in modern-day China. From neon-fronted bars, to cabaret shows, discos, and chic restaurants, it is clear that the Chinese consumer has also awakened. Leisure pursuits once frowned upon or banned outright by the Maoisu are in ever-increasing abundance. China is in part proof that the world is indeed becoming a smaller place. There are parts of the Bund in Shanghai or Wangfujing in Beijing, which are the same the world over, full of the young, the eager, and the commercial.

Yet just around the corner from that Irish bar in Shanghai, that Jamaican restaurant in Beijing, remain stark, painful reminders that China, whatever its remarkable triumphs, still has a long way to go. Large economic disparities still exist, and the reform process itself has resulted in a significant number of social and economic casualties. For along with the positive side effects of growth, there have also been negative ones, the first notable example of which was rampant inflation. Aside from endangering the cause of long-term economic stability and growth, inflation clearly threatened China's fledgling banking system, and was duly dealt with necessary ruthlessness through fiscal austerity from 1993 to 1994. Since the beginnings of the economic reform process in 1978, China has gone through a series of increasingly harsh economic cycles, characterized most notably by excessive credit expansion and deteriorating national budget accounts. Offsetting the budget deficit has been a booming trade surplus. However, as Chapter 1 of this book describes, the Asian crisis could well hit Chinese export growth, reducing China's total current account surplus. As the ASEAN nations now know to their cost, deterioration in both the budget and the current account is a potentially lethal combination.

Growing unemployment has also been a negative side effect of the drive toward a market economy. The restructuring of the state-owned enterprises (SOEs), announced at the 15th Party Congress in September 1997, will itself put a further 25-30 million people out of work. Given that the SOEs effectively act as mini welfare states for their workforce rather than just businesses, losing one's job could mean losing one's flat and whatever meager benefits the company offers. The social ramifications of rising unemployment and little or no safety net are all too clear, particularly against a backdrop where the Party's only legitimacy nowadays is to make people better off. In sum, China's economic success story of the last two decades, as stunning as it has been, is flawed, at both the macroeconomic and the microeconomic level -- just as with the ASEAN and other parts of Asia which were devastated by the Asian crisis of 1997 and continue to suffer from the aftereffects.

China's economic flaws are serious, fundamental not only to its own future economic health, but also to that of the global economy as a whole. Not so long ago -- and even in some cases still to this day -- renowned economic commentators were describing China as "number one," as inevitably and inexorably becoming the largest economy in the world. Today it is clear that China is undergoing a significant and wrenching economic slowdown -- a process that Chapter 2 addresses in detail, at both the macroeconomic and the microeconomic level -- while simultaneously attempting to complete in record time one of the largest industrial restructurings in world economic history. Yet most of what we hear and read about China's economy remains remarkably bullish, seemingly overlooking the fundamental negatives within the economy which at the least have yet to be ironed out and at the worst are potentially life-threatening. There are clear reasons why the U.S. is the world's largest and most powerful economy, and there are equally clear and fundamental reasons why China is not and will not be for a considerable time -- if ever. Just as there were those who argued that Asia was "different," and did not necessarily have to obey the same fundamental economic rules prevalent in the West -- the folly of this thesis being proved conclusively in 1997-1998 -- there are those who stubbornly argue that China also is somehow "different." Interestingly, China's economic leaders themselves are not among the advocates of this argument, instead portraying China's development as typically characteristic of an emerging nation, albeit one with the world's largest population.

China on the Brink: The Myths and Realities of the World's Largest Market is meant as an antidote to the many books and commentaries that unquestioningly lavish praise on China's economic progress but that do not ask why China's slowdown -- which began in 1992-1993 -- is accelerating, potentially threatening the global economy if it cannot avoid a crash landing. At its most ambitious, this book is offered as an attempt, amid all the hype, at a higher degree of realism, an evenhanded response to the arguments of the China bulls. It is not intended as a snapshot of China or indeed as a static view of how China works or where it has come from. There are plenty of such works already, many by authors with considerably more expertise in the fields of Chinese history and social development than this author has achieved. Instead, China on the Brink is an attempt to show where China's economy is heading, an attempt to discover and analyze the fissures and fault lines that lie beneath the surface of economic history's most stunning recent success. Amid the aftermath of the Asian currency and debt crisis of 1997, many still see China unscathed, safe behind its self-imposed regulatory barriers. Yet just as the bricks of the Great Wall were not able to hide the Middle Kingdom from the gathering hordes of old, so its regulatory and legal walls will not completely save it from what some see as their modern equivalent, the unfettered forces of free-market capitalism. Thus, the answer to China's present economic problems must not be to rely merely on such regulatory defenses. Nor is the answer to revert to past economic and political practices, reversing free-market reforms and moving back to a more command-oriented model of economic and political freedom, a tempting move in times of difficulty which would in reality return a great nation to the dark ages. Rather, the answer lies in increasing and broadening the reforms from within, improving the internal structure and making it more able to deal with free-market forces, while maintaining at least some defenses until such time as that structure is strong enough to fully withstand such forces.

This may seem surprising from a purely capitalist viewpoint. In our modern world of freely-floating exchange rates, the prevailing doctrine is that only the markets can decide and arbitrate and thus currency pegs of all types must eventually go (to be sure, Europe appears to be taking a different view on this). However, were it not for the fact that the renminbi is not yet convertible on the capital account, China's banking system would have melted down, gone the way of Indonesia and Thailand amid a mountain of bad debts and overleverage, the result of decades of politically driven credit policies. Were it not for these very restrictions on capitalism within China, much if not all of the progress that China has made in the past two decades would have been wiped out. In short, those in the West who call for full, immediate, and unfettered liberalization of the financial markets in China do not know what they are talking about. That said, the reform process still has a considerable way to go if China is ever to become the global economic leader anticipated by so many. The restructuring of the SOEs, as hazardous as that is, comes not a minute too soon. Equally, the decades of politically directed credit from state banks to the SOEs has resulted in a national banking system that is technically bankrupt, though, to be sure, still supported by the state. The solution to this must be to cut even more jobs; yet this will inevitably, as Chapter 3 seeks to demonstrate, cause increasing social tensions, leading to clashes with the authorities and potentially, as Chapter 4 elucidates, a political backlash against the prevailing forces of reform. The outskirts of Beijing, Shanghai, and Guangzhou are already clogged with the human casualties of the reform process, the homeless, the jobless. It would not take much for the "left" -- those few in the Party who remain opposed to the central doctrines within the reform process -- to mount a spirited campaign of support for these "dispossessed," thus potentially destabilizing President Jiang Zemin's hold on the reins of power and thus the reform process itself.

From a Western perspective, many saw China's opening as a new opportunity for plunder -- to be sure, not the same type of plunder as practiced by the Western powers in the nineteenth century, but economic plunder nonetheless. At the start of the 1990s, Western manufacturers regarded China as a gold mine. Companies "had to be in China," and set about creating joint ventures and manufacturing plants -- and in the process ignoring the fundamental tenets of business. Who, after all, was going to buy their products? Who was wealthy enough to do so? What about their cost base? And meanwhile, just down the road, a Chinese company was copying their production technology. These modern-day plunderers found a new and infinitely more skilled host, wise through experience, a host that extracted its full pound of flesh and more for any potential return the Western companies might make. When I first went to Asia, there was a disquieting and embarrassing murmur among economic and business circles -- no one was making money in China. Indeed, most Western manufacturers were losing a lot of money. How could this be so? Because they had not done their homework. For sellers of products, there have to be buyers. Yet the majority of China's population when the first Western companies arrived were still startlingly poor. In addition, China was rightly determined not to allow itself to be exploited again in an imperialistic fashion.

Western manufacturers' near-term expectations for the China market are now considerably more sanguine than previously, and the same is gradually becoming the case with regard to Western fund managers' expectations for returns in the Chinese capital markets. This is no bad thing. However, it is the fundamental argument of this book that in the short term these expectations will have to be ratcheted down even further. Indeed, there remains the potential in China for complete financial and economic collapse. This could in turn pressure the Chinese government into allowing a devaluation of the renminbi in an attempt to provide relief for the ailing economy. China's exporters would potentially benefit from such a devaluation, as it would regain them lost trade competitiveness resulting from Asian currency devaluations of 1997 and 1998. Chapters 5 and 6 seek to address the crucial question of how much economic pain China is prepared to tolerate before it considers letting go its currency. The stakes over the next 2 or 3 years could not be higher -- for China and for the global economy as a whole. Naturally, such issues will have a profound impact on Hong Kong, China's prodigal son returned to the fold. Fundamentally, there is no reason why Hong Kong should suffer from a renminbi devaluation. Indeed, as most of its exports are in fact reexports from Guangdong Province, its trade account should benefit considerably. So much for theory. It could be an entirely different matter in practice as speculative forces would seek to force the Hong Kong Monetary Authority to depeg the Hong Kong dollar and allow it to devalue.

Chapter 7 examines China's changing role in the world -- its increasing economic and political importance, the danger and the opportunity that it represents, for both the world as a whole and its own people. China has never in its history been more important than it is today, never had such an impact on world affairs as it does right now. One could never have imagined even 5 years ago that world financial markets -- and thus real economies -- would hang on the every word of Chinese economic officials, and yet that is indeed the present situation. The global economy is being profoundly affected by the inclusion of the Chinese workforce, the rising Chinese trade surplus, and the stability or otherwise of the renminbi. China itself is seeking to be a force of stability amid the carnage of the Asian crisis; yet it is uncertain that China will be able to maintain this position. The consequences of it not being able to do so could be catastrophic -- and not just for China.

While all this may seem extremely bearish, in the final analysis there remains much to be optimistic about -- optimistic in a hard-headed, realistic manner as opposed to being "maximum bullish." For one thing, in the long traverse of the "stream," as Deng Xiaoping put it, China's leaders have seen, by the mistakes of others, where not to tread, where the eddies and strong currents are, the dangers that lurk beneath. The crucial weakness of external overreliance, noted in my book Asia Falling: Making Sense of the Asian Currency Crisis and Its Aftermath, which led to explosive C/A deficits and external debt mountains, will be avoided. Indeed, China's Ministry of Finance has already made very clear that it will maintain an extremely cautious approach to borrowing. China has come a long way and that is largely the result of a combination of the ingenuity and industriousness of the Chinese people and the quality of China's economic leaders. The challenges of 1978 were substantial, and yet China managed to cope with them and even excel. Chapter 8 looks at the likely strategies that will be undertaken to cope this time with the economic slowdown and the individuals who will lead them. The last two chapters examine the fundamental need to streamline capacity and build institutional and "real" (bricks and mortar) infrastructure, and finally make some personal forecasts about how I expect China to fare in the coming decades.

In the next few years, China will continue to experience considerable economic and social pain, pain that cannot be avoided if real and meaningful economic development and progress are to be achieved, pain that will pose fundamental social and political questions as well as economic ones. With their economic successes of the past two decades, China's leaders have shown they are fully capable of reaching the other side of the stream. The challenges, in this context, are manageable; yet they should not be underestimated either. Time and again, following the initial phase of the Asian currency crisis, I saw economists and journalists say that China was "safe," that China was a "different case." It is partly because of such snake-oil scholarship that the Asian currency crisis happened in the first place.

Economics is not (as some would have it) a science, but there are some fundamental tenets that hold true. The fact that Asian current account deficits and large external debt loads caused a currency collapse was nothing new in terms of economic history. Such an event has been seen many times before in other parts of the world. Equally, many of those who now say China is different are the same ones who initially said Asia was different -- that Asia lived by different rules and did not have to abide by the same economic and social (and even political) tenets as did the West. Asia was and is no different, and China is and will be no different. The Asian currency crisis of 1997 was a typical macroeconomic response to previous imbalances. To use the subject of Asian values to claim some special exception to the central tenets of economics is not only unjustified but untenable. Asia is learning its lesson -- a very painful one to be sure, but a necessary one. China will have to do the same. Having seen the examples of the bubble economies of Japan and the ASEAN, it starts with a considerable advantage; yet failure will have ramifications for more than just the Middle Kingdom.

As the title of this book suggests, China is once more at a pivotal stage in its history -- "on the brink" either of continued economic slowdown or even potential collapse or, alternatively, of rebirth, of moving on to a new and higher stage of development. Observers will look back and see the next few years as having been fundamentally crucial to China's future -- and potentially the future of the world itself -- for if one thing is certain, it is that China will continue to play an ever-increasing role in global matters. An economically weak China, with the resulting social and political implications of that, will present a very real threat to global stability. Conversely, should these pivotal years of restructuring produce a China whose economic fundamentals are sound, healthy, and improving, the world will be a much better place for it. There are still elements in the West which see China as a "frontier" state, as the last "gold rush," ripe for plunder. It would befit Western leaders to look beyond such superficial -- and easily countered -- analysis and see China for what it could be, for the benefit of all -- a leading source of world growth for the global economy in the twenty-first century. There has been much talk of constructive engagement with China, but as yet there has been little action and one might say little sincerity. It is time the West treated China with the respect and dignity that it deserves; yet as someone who believes profoundly in the principles of freedom and democracy, I am bound to say that it is equally time for China to admit that the events of 1989 were indeed a mistake and that, however cautious and gradual, the path to eventual universal suffrage has been taken. Only when both sides take up their responsibilities will mutual suspicion and distrust start to wane and the potential for prosperity and growth truly open up.