A storm is brewing and the media and public are starting to hear the first rumbles of thunder. The American economic slump is running into the Chinese economic slump, creating the conditions for a face-off between Beijing and the US Congress, possibly leading to destabilisation of the world's most important bilateral economic relationship.
If a clash is to be averted, the US must find a way to make the Strategic Economic Dialogue and other discussions with China more productive while channelling trade complaints into more frequent use of the WTO and WTO-compliant enforcement mechanisms. Otherwise, first American, then global, protectionism could spiral out of control.
Realising Chinese weakness
As recently as two months ago, it was a common view that, not only could the People's Republic of China (PRC) weather the global financial crisis, it would be a source of relief to some hard-hit economies. This position was never sensible.
China's slowdown began in October 2007 when the Shanghai stock bubble burst. From its peak on October 16 of last year to October 16 of this year, the Shanghai composite index fell by 68 per cent. The next domino was real estate: sales of residential buildings began to drop in on-year terms as early as December 2007. Tied to the gigantic construction, steel, and aluminum industries, property is at the heart of the Chinese economy. Property is also used as a store of value for investors who enjoy few domestic financial options and cannot easily send money overseas. When stock and property values contract simultaneously, the pinch on wealth is substantial
This pinch manifested itself in declining growth. According to revised data, Chinese GDP growth peaked in the second quarter of 2007 at better than 12 per cent. By the third quarter of 2008, it had slipped to 9 per cent. While this is still excellent, the trend was clearly and significantly down. Moreover, the 9 per cent figure was an exaggeration.
The other shoe has now dropped. Front-page stories in the December 11 Wall Street Journal, Washington Post, and Financial Times conveyed shock that China's trade volume had contracted outright in November. Such shock is misplaced. Electricity production is a crucial measure of internal economic activity. On-year growth in electricity production peaked at close to 17 per cent in September 2007. It has declined steadily since, to the point of a record 7 per cent contraction in November. In addition, the purchasing manager's index survey of manufacturing activity set successive new lows in August, October, and November of this year.
Authentic stimulus lacking
There is potential for significant deflationary pressure in China. Consumer inflation has rapidly declined from an April peak due to cheaper food and energy, which is not by itself worrisome. Harmful deflation, however, could result from sustained supply in excess of demand.
As the economy has weakened, personal savings have soared. In October 2007, on-year growth in savings deposits was 3.7 per cent; in October 2008, it was 26.7 per cent. That rate of saving all but guarantees demand weakness. In the past, Chinese enterprises have been slow to reduce supply when confronted with weak demand. This helps create a vicious cycle where too little money is chasing too many goods, prices decline, consumers prefer to wait for even lower prices, they spend less, and so on.
Announced in November, the much-hyped RMB4 trillion stimulus appears to be a response to such economic concerns. Yet, the stimulus is not what it appears to be. More important, it reflects well-worn and now especially unhelpful Chinese policy tendencies. What Beijing calls "domestic demand" usually does not involve the consumer. In this case, if lending and investment in infrastructure does rise, it will bring greater use of steel, cement, and similar materials but no short-term consumer benefit. The same is true for interest-rate cuts, because formal borrowing is dominated by firms, not individuals.
In the same vein, China has acted to stimulate exports, which reflect local supply, instead of imports, which reflect local demand. As the decline in growth became clear in July 2008, the yuan's appreciation against the dollar stopped. Since the global crisis erupted in September, there have been three major increases in tax rebates on production for export.
Of course, the Communist Party can simply declare all is well and fabricate economic data accordingly, as it has done in difficult situations in the past. A helpful response is more difficult to come by: for the first time, global demand is not available to replace lost Chinese demand. Thus, any successful stimulus must focus on consumers, not industrial investment. There has been talk of tax reductions as the core of a second, genuine effort at stimulus. This is untrodden ground for the PRC, with an uncertain gain, but at least it would be the right type of action.
The oncoming train
If China is unable to reach consumers or otherwise boost import demand, the outcome could ultimately be devastating for an already reeling world economy. Lost in media reports of a November export decline for the first time in seven years was a monthly trade surplus of US$40 billion - the fourth consecutive monthly record. Under such circumstances, it antagonises China's trade partners to bolster exports while imports collapse.