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Rein: Why China Can’t Help the World This Time Around

At the start of the financial crisis in 2008, one influential person in China told me “I am not worried. The problems in the world financial system are serious enough that America’s government will put aside partisan politics to do what is right. In another three years, we will be fine.”

Vegetable market in Zhengzhou, Henan Province of China
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Vegetable market in Zhengzhou, Henan Province of China

I too was optimistic a long-term crisis could be averted by quick stimulus to build confidence and create jobs. I also assumed America would stop wasting billions a year in military ventures abroad.

Unfortunately, three years later as a result of the debt ceiling fight, much of the world perceives the American Congress as being unable to step up to do what is right. That same influential Chinese told me after the S&P’s downgrade, “The American Congress’ irresponsible bickering is shocking and is destroying the world economy.”

After Federal Reserve Chief Ben Bernanke’s loose monetary policy, American companies are sitting on stockpiles of money yet unemployment hovers near 10 percent. Adding a third round of quantitative easing as rumor has it will not jumpstart the economy; it will only cause the U.S. dollar to lose more value and create inflationary bubbles around the world. Actions by Congress to rebuild global confidence that America will regain its position of global responsibility will help spur the economy more than any interest rate measures.

Unless Congress gets its act together soon, a double dip recession far worse than 2008 could emerge. China, which in many ways carried the global economy before, is in a difficult position to shoulder much responsibility.

China has far less room to maneuver than in 2008 when decisive policies kept the economy there humming. Central government debt then was less than 25 percent according to the International Monetary Fund. Low debt allowed the central government to launch a 4 trillion yuan stimulus program.

Three years later, total local government debt alone is 10.7 trillion yuan, around 27 percent of GDP according to Jia Kang, the director of the Research Institute for Fiscal Science under the Ministry of Finance. Concerns about off-balance sheet debt held by special investment vehicles set up by local governments that don’t show up as public debt are also high. China's debt is far from dangerous, Japan’s debt was 225.8 percent in 2010 according to the IMF, but is high enough to mean less room to maneuver than in 2008.

More importantly, China has less wiggle room because of persistent and structural inflation and the government's desire to create a middle class by raising minimum wages. Already in 2011, 13 provinces have raised the minimum wage by over 20 percent.

Chinese inflation is not at the 20 percent annual level hitting Vietnam, but it is at the cusp of becoming a serious problem. One more natural disaster like the tsunami in Japan or a war on the Korean peninsula could turn China's inflation into something along the lines of Vietnam's.
Official Inflation in China came in at 6.5 percent in July, despite price caps in the oil sector.

Food inflation is far more serious at 10-15 percent. Pork prices, the main meat staple for Chinese, has risen 50 percent in the last year. Apple prices have gone up 30 percent and yogurt 25 percent.

The government has been pushing companies not to raise prices. Even with that pressure, margins have been squeezed so much that Kraft, Estee Lauder , Li Ning and Nestle have been forced to raise prices.

If Bernanke adds a third round of quantitative easing, commodity prices will soar. With inflationary pressures hitting everyday Chinese, the government cannot pump more liquidity into the system. It will have to tighten money supply and appreciate its currency, which risks causing exports to plummet.

A double dip recession is not a foregone conclusion. The American Congress should rebuild confidence by using reason rather than partisan politics to make decisions. If it cannot do that, at the very least Congress should stay in recess so that they do not do anything to spread more fear in the markets.

Shaun Rein is the founder and managing director of the China Market Research Group (www.cmrconsulting.com.cn) a strategic market intelligence firm, and is based in Shanghai. He is the author of the upcoming book “The End of Cheap China: Economic and Cultural Trends that will Disrupt the World” published by John Wiley & Sons in the US. He does not own shares in any company mentioned. Follow him on Twitter at @shaunrein.