Friday, November 14, 2008

Credit Crisis: China is ready but not the US

By China Watcher

The credit crisis over the past few months has one major telling factor – the gradual decline of the US influence economically and the importance of China in the global financial system.

In short, are we saying that the US had lost its economic leadership status to the Chinese? No, not yet. Let us get real. The US is still the dominant economic power with a US$13 trillion Gross Domestic Product (GDP) clearly well ahead of the second largest Japanese Economy at US$4.5 trillion. China’s GDP is expected to surpass the German’s economy to become the third largest with a US$3.4 trillion size by the end of 2008.

The US is currently the biggest debtor, owing creditors – both domestic and foreign - at almost the same level of its present GDP size of US$13 trillion. In fact, most of the world’s exports are being shipped to the US, a strong engine of growth for the world’s economy for the past 40 years.

With the credit crunch affecting liquidity in the US that has now spread across the Atlantic to the closely knitted European Community, the attention is now focus on China, which currently hold almost $2 trillion in foreign currency reserves. Certain national leaders had urged China to become a more responsible stakeholder while undertaking a leadership role in shaping the new world’s economic order. This will be one of the many important agendas in the coming special G20 meeting in Washington, initiated by the US to discuss affordable and feasible solutions to prevent the world’s economy from sinking into a deep depression.

But China also has its own share of problems and it is not completely insulated from the economic woes. The slowdown in orders from abroad has already resulted in the closure of many small to middle sized factories which inevitably will affect the growth of the Chinese economy and the loss of thousands of jobs that are critical for maintaining social order in the developing country. The good news is that the inflationary fears have more or less abated.

By announcing a fiscal stimulus package of US$586 billion to face the effects of the financial troubles coming from the US and also, perhaps on a bigger scale from Europe, China has prepared itself socially and economically, to bear the full impact of the recession. The fiscal amount announced represented 18% of China’s GDP, which may be sufficient to tie the Chinese through the tough period ahead.

On the basis of comparison, I am of the opinion that the U.S. is still not fully geared up to handle the problem, as the financial packages announced so far totaling US$700 billion constituted only 6% of its GDP, which is perceived by analysts to be inadequate to cope with the magnitude of the credit crisis. An adequate stimulus program would need to be in the range of 10% of the GDP, let say, at US$1.3 trillion.

China's stimulus program is meant for injecting money into the real economy like in infrastructural constructions and not into the balance sheets of troubled financial institutions while the US funds raised are more for bailout of illiquid financial institutions. The US is moving into a stage of the crisis in which the real economy needs direct intervention and not merely buying into the equities of US financial institutions. Unless there is another new pledge of funds going into the direct components of the economy, the recession could get worse.

There is also a fear in China that the present US government budget which is already in double digit deficit every month would go much higher with some analysts predicting that it will balloon to well over US$1 trillion for this fiscal year. It was reported that the US holds 8,133.5 tonnes of gold reserves valued at US$188.23 billion. Printing more money and issuing more debt instruments logically will continue to weaken the US currency, and that is why, there is an urgent need to expand its real economy to generate exports and bringing it the hard earned currency to lubricate its economy.

Just a few months ago in the run-up to the Olympics, right activists and Western governments were actively demanding more human and religious rights reforms in China but the tone now has changed to one, in which they are praising China for its existing efforts to stabilize the global financial system and hope that it could do more.

Let us face the fact that it is difficult for one nation alone to resolve the problem considering the size and it may require a concerted effort from the largest economies and trading nations at the G20 meeting to ensure the imminent recession from getting any worse than it is and, if possible speed up the recovery from its current state.

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