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China is Not Going to Bail You Out

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BEIJING: A flurry of stories have circulated the past few days speculating about how China could be the savior of the global financial mess. While it is a bit of a stretch to think the West will go cap in hand to China, it's an even greater one to think China would dole out a significant portion of its nearly $2 trillion in foreign reserves.

Without economic or political concessions from the U.S. and Europe, China isn't going to budge from its position of relative strength. More likely it will use some of those reserves to buy into assets in its own backyard to give itself a more powerful position in Asia. There's already talk of a bailout fund being established in Asia to boost investor confidence here shattered by the falls on Wall Street and fears of what a recession will do to exports. It will be interesting to see how much China puts into this fund if it turns to reality.

Another area to watch is if China turns its focus to major economies of Japan and South Korea (and in its territory of Hong Kong) as places to snatch up cheap stakes in institutions that would give them economic and political leverage. They may look to solid economic assets in the U.S as well, but probably not on a grand scale. China seems to already be testing the waters this way in Europe, though Europe has its problems too.

All said, China is in an advantageous position thanks to its $1.81 trillion in foreign reserves and could emerge as a provider of loans to governments and institutions struggling with budget problems, but it's hard to foresee any messianic bailouts. More likely it could follow Russia's example with Iceland and loan struggling periphery countries bailout packages in return for greater access to their markets or political leverage.

China is putting on a confident public face about its economic health amid the global financial crisis, and it rightly should. For the most part, the global credit crunch has bypassed China.

After years of double-digit growth, China could slow to a rate as low as 9 percent toward the end of the year and perhaps a bit lower next year. Even with slowing growth, China accounted for one-third of worldwide GDP growth in the first half of 2008. Growth next year will likely be kept above 8 percent and fiscal stimulus plans by the government - tax cuts and investment in infrastructure development - will help it stay there. China's large and increasingly educated labor pool and potentially vast domestic market provide great hope for the future of China's economy.

But most important to China at the current moment is shoring up its position at home. There are a number of "inherent contradictions and problems" with the Chinese economy that are putting its rulers on edge. High energy costs, inflationary pressure, a drop in export volumes, a deflating property market, slowing industrial growth, recent drops in auto sales - all of these are areas of concern. There have been signs that even consumer demand is slowing (what the government hopes will help it ride out the storm) and the 64 percent decline of the CSI 300 Index over the last year is another worrying trend.

China is trying to boost domestic demand to ward off the ill effects of the global economy turning sour. But Chinese consumers need to save a little less and spend a bit more for that to happen, and economists are urging the government to tell people to loosen their grip on their yuan. While they may be spending more, Chinese are still not at the consumption level of their Western counterparts. Current domestic spending is only about one-third of GDP. If there is a significant slow of exports, consumption would have to rise by around 25 percent to make up the difference. It would take a dramatic, almost impossible change in consumer attitudes for that to happen.

Neither will China cave in to U.S. demands to let the yuan appreciate at a much faster rate. Recent signals from the government have been that they might even reel in appreciation even further so it doesn't erode export profits more than it has.

Another factor is that China has its own property worries to contend with. After its boom year in 2007 that saw the highest rise in residential property in the world, property sales in some major cities have dropped by 50 percent and prices have been dropping between 10 and 30 percent. Some analysts say that this doesn't mean China is facing a nationwide property meltdown, though it is certainly in for a slowdown. Others do believe that China faces a significant sub-prime crisis of its own, and if that bubble bursts, the impact could be huge.

The good news is that banks in China aren't as affected by a slowing property market largely because Chinese homeowners aren't mired in debt (household debt is 13 percent of GDP in China, compared to 100 percent in the US), though there could be impacts if property developers go bust or if banks made large numbers of risky loans to new homeowners that are currently hidden due to a lack of transparency in the system.

A global recession will hit China's exports hard, though they'd already been slowing over the past several months. In the third-quarter, orders for overseas shipments dropped to their lowest level since July 2005. With the US economy going south for what could be an extended period, China's economy might be in for significant long-term structural changes.

China's export centers in the south are a place to keep a particular eye on. Over half of the toy export companies have had to close this year. Exports slowed, material costs rose by about 40 percent on the year, salaries doubled in the past four years, and appreciation of the yuan ate away from 3 to 4 percent of profits. Guangzhou Customs statistics show that about half of shoe exporters became insolvent in the first half of the year and garment exports dropped by 31 percent year-on-year over the first seven months.

These are real economy woes hitting an area far from the center of power in Beijing - a region where political unrest in the past has helped spark revolution. Rebounding inflation, widespread job losses and increased poverty that could lead to political tensions are all at the top of the government's list of situations to avoid.