Precarious Prosperity?
U.S. and Chinese economies now depend on each other
"China holds all the cards." It's a back-of-the-envelope geoeconomic analysis that you find more and more these days on talk radio and in blogs. Seems logical enough at first. China's central bank does, after all, hold a whopping $400 billion in U.S. treasury bills, bonds, and notes. Hey, when Americans buy $288 billion of your stuff—as happened to China in 2006—you've got to stash all those Benjamins somewhere. (For its part, China bought $55 billion of U.S. goods.)
Of course, all that bond buying in Beijing has helped keep U.S. interest rates low and enabled consumers to keep spending despite the deflating housing bubble. But the trade deficit can make it seem as if Americans are slowly losing control of their own economic destiny. Peter Morici, former director of economics at the U.S. International Trade Commission, argues, for instance, that while the Federal Reserve can tweak a short-term interest rate from time to time, "that rate has little effect on long-term rates because China keeps buying longer-term securities."
And China's economic influence extends far beyond its massive accumulation of U.S. debt, not to mention the $1.3 trillion in total foreign exchange reserves—dollars, euros, yen—it owns. To a great extent, China is the main driver of growth in the global economy. "It is impossible to overestimate China's positive impact on the buoyancy of world growth this decade," says a recent analysis by investment bank Goldman Sachs. While the advanced economies—the United States, Europe, and Japan—are expected to grow at a solid 2.7 percent pace this year, China is racing forward at a blazing 11 percent or so.
All of which forces the obvious question: What if China's economy should stumble big time? It would have to be something worse than February's brief "Shanghai Surprise," when the Chinese stock market plunged 9 percent, sending the Dow Jones industrials down 3 percent. Instead, consider something more like the fallout from the 1997 Asian currency crisis, when Chinese growth cooled from its usual 10 percent annual pace to around 8 percent for four years. By recent Chinese standards, that's pretty much a recession. And with the Chinese economy more than twice as big today as it was a decade ago—virtually tied with Germany for third largest behind the United States and Japan—such a slowdown would be a gut punch to the global economy.
"China used to be interesting," says economist Donald Straszheim of Roth Capital in Los Angeles. "Now it's interesting and important, and any kind of real setback there would affect everyone."
Unrest. What could cause China to slow? Probably not a meltdown in publicly-traded shares in major Chinese companies such as Baosteel or Daqin Railway. "If the equity markets there fell 50 percent, it would reduce the wealth of the Chinese by a trivial amount," Straszheim says. It's trade, not Chinese consumers, propelling the Chinese economy. That's why Straszheim is far more worried about disruptive social unrest—protests are up 10-fold in China since 1993—than "if some commercial bank has a meltdown." Other disruptive possibilities include a SARS-like epidemic or even a trade conflict between Washington and Beijing over China's weak currency.
A U.S. consumer boycott would also damage trade, a scenario bestselling author Tom Clancy explored in his 2000 book The Bear and the Dragon. Clancy depicts a world trade boycott of China after a Vatican official is killed trying to prevent an abortion in that country. A bit more plausible is a sharp consumer reaction to flaws in Chinese product safety. "If the quality problems continue, even multinational corporations with manufacturing operations in China could suffer a loss in reputation," argues Minxin Pei, China expert at the Carnegie Endowment for International Peace. "China exports would suffer, and its economic rise would slow down."
But the most likely scenario is a disastrous economic daisy chain in which a sharp recession here slows growth there. In turn, China would buy fewer treasury bonds, forcing up U.S. interest rates, making the American economy even worse, and creating a vicious circle. "That sort of financial unraveling would really magnify the effects of a Chinese rough landing," says global economist Jay Bryson at Wachovia.
"Unraveling"—that's a helpful metaphor. It recognizes, whether Americans like it or not, that the U.S. and Chinese economies are woven together and likely to become ever more tightly bound, as China continues to grow. But growth in one economy also pumps up the other. Does China hold all the cards? It's more that both countries have pretty good hands.
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