Global Policy Forum

By Ian Williams

What happens when two bubbles collide? Do they both burst, or do they coalesce and become an even bigger bubble - which will eventually burst even more spectacularly? That is the question posed by the growth figures from both the US and China, whose growth rates are tied in ways that neither seems to want to admit too loudly.

Even before this week's figures on China's explosive 9.1 percent growth in 2003, which many commentators thought actually understated the reality, the United Nations' annual economic report had identified the People's Republic of China as the locomotive for growth in Asia (with a nod to India), and added that the US with its 4 percent growth rate will do the same job for the industrialized world. But once again, the question must be asked - will these two Chinese and US engines run in the same direction indefinitely, or will they begin to diverge? Indeed, even more scarily, will they have a head-on collision and involve the world economy in the mother of all train-wrecks?

The problems have been noted. The UN report cited "the rapid rising weight of China in the world economy and its role in the present recovery," but it also warned that UN economists see a need for the US to reduce its government deficit. That echoed the very trenchant International Monetary Fund (IMF) report that described the deficit as "perilous" in the long run, posing "significant risks" to the rest of the world. IMF economists also cautioned that one should add to the short term a US$500 billion deficit that the US administration is running, a further US$47 trillion in unfunded long-term commitments for US Social Security and the federally funded Medicare health program for the elderly and indigent. And the IMF pointed out that there were additional liabilities from cash-strapped local governments, forced to borrow to compensate for federal cutbacks.

On the American trade deficit, the IMF also warned ominously, "The United States is on course to increase its net external liabilities to around 40 percent of its GDP within the next few years - an unprecedented level of external debt for a large industrial country." The report suggested that this situation would push the dollar even further down.

On the other side of the Pacific, perhaps it should not be regarded as a token of maturity that the money managers who poured funds into AOL, MCI, Enron and Tyco - all with problems, to say the least - are now pouring millions into Chinese IPOs with the same enthusiasm. It is difficult to see any more economic rationale in the 1,600-times oversubscribed China Green Holdings than the Internet Bubble of the last decade.

And now US investment banks are licking their chops at the prospects of taking Chinese Banks public. However, the $45 billion that Beijing has put into two of the Big Four government-owned banks can be seen as a mature appreciation of their problems - or as a symptom of the continuing cronyism and lack of democracy and transparency in the system and a down payment on what Standard & Poor's estimates could be up to $600 billion needed to bail out the bad loans. But that little detail probably won't stop Wall Street from rushing to buy if the banks are floated, as Beijing plans.

The China Bubble is expanding dangerously

At one time, China's autarkic economy protected it from outside influence. But along with this week's figures on economic growth came another ominous big number. From once being nearly self-sufficient in oil, China is now the second biggest oil importer in the world - and is on the verge of needing massive coal imports as well. The China Bubble has expanded to a point where it will soon reach the sharp edges of infrastructural capacity and reckless over-investment to the point of over-production. That is when bubbles burst.

Most publicized American forecasters tend to be Panglossianly bullish. They only ever see the upside, usually of the American economic prospects, but many of their China watchers seem to be wearing the same rose-colored glasses, seemingly oblivious to how co-dependent the two economies are. For a more detached viewpoint, to look at the two economies separately is like looking at the two wheels of a bike without looking at the frame that connects them. Looking at the US-China bi-cycle in motion exacerbates the separate notes of caution that international agencies have sounded against each country. In fact, there is an inherent and additional precariousness in this double bubble act.

Veteran New York money manager Arnold Schmeidler - who did not invest in dot.com IPOs - warns, "We are in a period unlike anything since the 1930s when the world is confronting deflationary forces." The president and founder of A R Schmeidler & Co Inc asks how sustainable it is that "American auto companies are selling their production at zero interest rates, because there is excess capacity. But China is building auto plants to make hundreds of thousands of vehicles, so we have extra capacity being brought into a market where we already have excess capacity. So the trend is towards 40 cents an hour wages and top quality competing against the US."

Schmeidler concludes, "The single greatest force for deflation is when you have open trade between nations that have the ability to import the most efficient manufacturing expertise into a low-wage-base society, and so can produce products of the same quality as the high wage economy. The price pressure on the product allows consumers to get more for their money and they benefit. But it is disinflationary, if not deflationary." In fact, of course, China currently is lending the US the money to buy Chinese production. For example, as the "boom" of President George W Bush takes off, puzzled American commentators are asking where are all the extra jobs that the apparently positive indicators should be creating. In fact, they are being created abroad - mostly in China.

China recycles trade surplus into US Treasury bonds

American companies may have forgotten what Henry Ford propounded when he first built his Model T: If you do not pay high enough wages to your workers, they can't afford to buy your product. One simple basis for that Bush boom is that China is recycling its US$100 billion-plus trade surplus with the US back into dollars, and especially into US Treasury bonds. Almost half of the US Treasury bonds are now owned in Asia. So China is financing Bush's bold economic experiment: running two or more wars simultaneously with a huge budget and trade deficit, and equally huge tax handouts for the richest Americans.

One has to question the long-term economic rationale for China of putting its long-term assets into very low-interest bonds in a currency that has already dropped recently by a third - and is going to drop even more. It certainly makes strategic sense: if push came to shove over, for example, the Taiwan Strait, all Beijing has to do is to mention the possibility of a sell order going down the wires. It would devastate the US economy more than any nuclear strike the Chinese could manage at the moment. But far from wanting to devastate the dollar, China is more concerned to maintain its currency's parity with the dollar, even as it devalues massively against the Euro or the Yen. Indeed, without those Sino-dollars flowing back, the dollar would have tanked even more.

There is a big multiplier effect here. China only accounts for 3 percent of the world's GDP, but for from three to five times as much of the world's growth. And its economy is disproportionately trade-oriented. So its double act with the US - both the seller of consumer goods on a huge scale and the financer for US' purchase makes it even more important. It does not help that the US, which has the experience, certainly shows no signs of using it to assess longer term dangers, and even if China had that foresight of perils ahead, Beijing lacks the experience to act effectively.

Dangerously, the global economy is faced by an addictive combination of China - a developing country with many problems of social instability - and the US - which the recent IMF report hints is a rapidly undeveloping country - whose fiscal irresponsibility is compounded by a political immaturity that tends to ignore geopolitical and economic reality. If the US economy sinks and Americans stop buying Chinese goods, then it will compound the US slump as China first stops buying US bonds that have inflated the American bubble and then moves on to selling them. On the other hand, if the Chinese economy falters and it stops recycling dollars into the US economy, then the boom stops anyway. Indeed, it seems that China increasingly will need more of that cash to pay for energy imports anyway.

But New York money manager Schmeidler, and others who remember that economics is the dismal science, realize that it is still better science than politicians drumming up votes and investment bankers drumming up business seem to understand. The West is in the red, and if it crashes, the East may join it.

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