China crisis would affect whole world

AS THE rest of the world still shivers from wintry recession, China wrestles with the dilemma of how to stop its economic juggernaut from overheating.

More hangs on the outcome than just the career plans of its communist leaders. A bust in China will imperil the rest of the world economy – including jobs, growth, stock markets and house prices.

Charles Dumas, chairman of Lombard Street Research, has no doubt what will follow. "The removal of China's powerful 2009 growth means global deflation."

In the past year, we have all become dependent on China to pull us out of the slump that threatened to engulf the world at the end of 2007. China responded with probably the biggest fiscal stimulus of any nation in peacetime, and a massive splurge in bank lending.

In spite of all the talk about the Bank of England and the Federal Reserve "printing money", Dumas contends that only China has really increased both credit and money supply, both by about 30 percent. "Quantitative easing" in the US and UK has merely refilled a glass part emptied by a decline in net borrowing.

The effects of China's demand boost, massively aided by a perverse devaluation of its US dollar-pegged currency that makes its exports ever more competitive, have been spectacular. China's economy is once again roaring – Lombard puts annual growth at a blistering 20 per cent – and this year it will replace Japan as No 2 in size, after the US. The Shanghai stock exchange, which reopened less than two decades ago in a converted hotel ballroom after a Maoist coma, overtook Tokyo as Asia's biggest by trading value last year, after an 80 per cent jump in average stock prices.

China also leapfrogged the US in 2009 as the world's biggest car market, after Chinese bought 13.6 million new vehicles, a status gilded by Ford's sale of Swedish Volvo to China's Geely Automobile. China has also surpassed Germany to become the world's top manufacturing exporter, extending a Great Wall of superlatives: the world's biggest bank by deposits and market value (Industrial and Commercial Bank of China), the biggest mobile operator in terms of subscribers (China Mobile), the biggest web market by number of internet users, the biggest pool of foreign reserves, the biggest holders of US government debt …

An epic demonstration is the 460 billion project to add 19,000 miles to China's rail network by 2015, of which 8,000 miles will be for high-speed trains. While Westminster MPs dither over building a high-speed east coast line from Edinburgh to London, their counterparts in Hong Kong have just approved spending 5.3bn on a 16-mile high-speed link from the territory to the southern cities of Shenzhen and Guangzhou.

The problem is that massive steroid injections cause unpleasant economic side effects. It is not just wasteful infrastructure spending, what Dumas derides as "highways to the Gobi Desert", an echo of Japan's infamous "bridges to nowhere". Like Japan in the go-go late 1980s, the opening of the credit sluice has pumped money into a mighty property bubble in the largest cities that act as magnets to the rural poor. Average prices for new homes in the year to November rose by 68 per cent in Shanghai and 66 per cent in Beijing. Whole tower blocks stand empty while flat owners wait for their values to magically levitate fuelling resentment among ordinary Chinese.

The greater an asset bubble inflates, the greater the risk of mayhem when it pops. Hyperinflation and rampant corruption rotted the regime of Chiang Kai-shek's Nationalists. Inflation and corruption also stoked discontent in China that led to the 1989 demonstrations in Tiananmen Square.

In December, Premier Wen Jiabao said the banks' 800bn lending splurge had probably been excessive. This month the People's Bank of China hiked reserve requirements, and the regulator has told banks to strengthen risk controls, and only lend to the "real economy".

"This tightening is the start of a long squeeze," cautions Dumas. The "dead-cat bounce" to world asset markets from Chinese liquidity has come to an end, and Dumas predicts the resulting pain will spread. "A global liquidity shortage could soon put pressure on the weaker links of the world financial chain. Already, we have seen minor explosions: Dubai, Greece. Next in line could be Spain and Britain."