Chinese Finger Trap

It is typical for Americans nowadays to be increasingly pessimistic about the future prosperity of our nation.  After all, the current economic recession is blatant proof that free market capitalism is fatally flawed and that centrally-planned economics is the way of the future.  It is also typical for Americans to believe that we are increasingly forfeiting our sovereignty to countries like China, who used to sell us much of our debt.  Their appetite for American debt is shrinking, so they pretty much have us over a barrel.  I wonder if American sentiment towards China might be exaggerated.  The following analysis is from Stratfor:

 

Modern China has turned to a state-centered finance model for this. Under the model, all of the scarce capital that is available is funneled to the state, which divvies it out via a handful of large state banks. These state banks then grant loans to various firms and local governments at below the cost of raising the capital. This provides a powerful economic stimulus that achieves maximum employment and growth — think of what you could do with a near-endless supply of loans at below 0 percent interest — but comes at the cost of encouraging projects that are loss-making, as no one is ever called to account for failures. (They can just get a new loan.) The resultant growth is rapid, but it is also unsustainable. It is no wonder, then, that the central government has chosen to keep its $2 trillion of currency reserves in dollar-based assets; the rate of return is greater, the value holds over a long period, and Beijing doesn’t have to worry about the United States seceding.

Because the domestic market is considerably limited by the poor-capital nature of the country, most producers choose to tap export markets to generate income. In times of plenty this works fairly well, but when Chinese goods are not needed, the entire Chinese system can seize up. Lack of exports reduces capital availability, which constrains loan availability. This in turn not only damages the ability of firms to employ China’s legions of citizens, but it also removes the primary reason the disparate Chinese regions pay homage to Beijing. China’s geography hardwires in a series of economic challenges that weaken the coherence of the state and make China dependent upon uninterrupted access to foreign markets to maintain state unity. As a result, China has not been a unified entity for the vast majority of its history, but instead a cauldron of competing regions that cleave along many different fault lines: coastal versus interior, Han versus minority, north versus south.

China’s survival technique for the current recession is simple. Because exports, which account for roughly half of China’s economic activity, have sunk by half, Beijing is throwing the equivalent of the financial kitchen sink at the problem. China has force-fed more loans through the banks in the first four months of 2009 than it did in the entirety of 2008. The long-term result could well bury China beneath a mountain of bad loans — a similar strategy resulted in Japan’s 1991 crash, from which Tokyo has yet to recover. But for now it is holding the country together. The bottom line remains, however: China’s recovery is completely dependent upon external demand for its production, and the most it can do on its own is tread water.

 

We therefore shouldn’t be surprised that there seem to be signs that China is falling apart.  The current Uigher uprising can probably be passed off as an irrelevant regional conflict, or it can be interpreted as a symptom that the Chinese economic wonder of the last decade is screeching to a halt.  The problem for China is that if the dollar is significantly devalued, it might set off a financial crisis in China that will make our crisis look insignificant.  It’s hard to say who has who over a barrel.  It is probably more likely that the relationship between the Chinese and American economies is more like a Chinese finger trap.