CHINA'S INPUT INTO THE FINANCIAL CRISIS, CHEAP YUAN

The Peoples Republic of China(PRC) is viewed as an emerging super power. The commissars of the socialist republic centered in Beijing rule over a land area of nearly 10 million square kilometers (the third largest country) and a population of 1.3 billion souls. What happens in this vast terrane where one fifth of the world population reside has a great impact on the rest of us---and on the world economy. And though they appear insulated from us..they affect us and we have our impact on them as well.

Take the financial crisis on Wall Street. According to Michael Schuman posting in http://www.time.com/, (Oct 23, 2008) as little as a few months back, China appeared well insulated from the gathering financial storm due to its vibrant economic growth (12% in 2007),limited exposure of Chinese banks to American-style-banking-excesses, and its nearly $2 trillion in hard currency reserves which could be drawn down if needed in an emergency. But in a short few weeks in October gaps in their protective wall have appeared. Schuman reports on data released by China's National Bureau of Statistics which indicate that China's $3.5 trillion gross domestic product or GDP (converted here into US dollars) has declined in the last quarter by 9%, or by more than $300 billion dollars. While estimates for next year suggest a GDP growth of only 8%. This seems a paltry decline, when viewed from the perspective of western developed nations (e.g. France, the seventh largest economy in the world reports a GDP of $2.6 trillion..France just putter's along at about 2% annual GDP growth rate) but this mere one percent decline for China puts it back to the growth rate they experienced way back in 1999.

What's causing China's downturn? Globalization, the complex interweaving and integration of the world's economies appears to be the underlying culprit. While the proximate reason is that China is heavily dependant on manufacturing and exporting. This sector of its economy accounts for 43% part of its over-all economy. And since more than forty percent of the products China makes are sold to Europe and the US---where the financial mess started and where a massive downturn is in progress, it's not likely that that manufacturing component of its economy can be sustained.

But as noted above, China is big and it may have other fish to fry. Today a report published in China Daily (chinadaily.com.cn) indicates how the leaders in Beijing plan to respond to the economic challenge of the financial crisis in the west. The answer is a massive one trillion yuan (@142 billion dollar) domestic aid program to spur the Chinese housing market. Housing? Yes, it is hoped that growth in that sector may soak up some of the slack caused by the lay-offs from the global decline. To spur growth, the plan calls for a reduction in taxes on home buying, abandoning the property stamp tax and cutting mortgage rates by as much as 30%.

Back in April 2008 Joe Lazzaro posted a blog on bloggingstocks.com which focused on the fact that China had just modified its currency stance in order to gain control of an inflation problem (related to its overheated economy) at that time running at about 8.7%. Historically China has kept the yuan arbitrarily low (presently at @7 yuan to the dollar) to stimulate expansion of its economy. The low yuan keeps the cost of Chinese exports cheap, stirs demand for products abroad and results in increases in output, higher productivity, etc. The cheap yuan has been a major factor in generating China's surging manufacturing-export revenue and as well, the raging inflation associated with rapid growth. According to Lazzaro's informants, if Beijing let the yuan float freely it would appreciate to 5 or even 4.5 yuan to the dollar. In response to past complaints from the US and other trading partners (rightly concerned with rising trade deficits with China) the PRC has argued that the value of the yuan was a domestic matter, and that rather than pointing a finger at China, the US and others should encourage their consumers to buy less and save more-- and solve their trade-deficit problems that way.

Back in April 2008 Lazzaro and others warned that the global and commodity price boom that China's cheap yuan-based exports have helped to create may turn around and bite them---and today that is what seems to have happened. But perhaps their policies (in this global economy) helped to take a bite out of us too.

This past April, commodity prices such as grains, minerals, and especially oil had surged to record levels in part due to the pressures of a weak yuan (cheap imports helped promote and sustain the housing bubble in the USA, and the manufacturing boom in China, while increasing the world-demand for commodities resulting in rapid fuel price rise). Now in October, we know how those rising prices, especially of fuel, worked to generate what appears to be a deep global recession.

Looking back now, in some way the cheap yuan and the burgeoning Chinese economy may have had an effect on initiating the financial crisis. China's cheap monetary policies helped sustain the housing bubble here in the US and its strong economy raised unsustainable demands on commodities, especially fuel. Certainly this latter factor figured in the calculation. Perhaps the fuel-price surge was the straw which broke the sub-prime mortgagee's back and that led to the collapse of Wall Street. Of course, if it were not for certain elements in the USA, such as Greenspan's penchant for cheap money and unwise deregulation, exotic mortgage-based securities, credit default swaps, sub prime loans, and market practices such as 'buying short' what the Chinese did or did not do might have had little effect. One thing we can say with certainty, in the future the USA and our global trading partners must understand the nature of the close interdependence they are engaged in. China's money policies are not a strictly internal matter if they affect global trade and commodity consumption, and yes, the lack of wise oversight of Wall Street traders can have an impact on distant Beijing.

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