Will the Chinese Economy Save the World?

07/04/2009 05:12 am ET | Updated May 25, 2011

Like a pilgrim seeking the altar of St. Jude, patron saint of hopeless causes, U.S. Treasury Secretary Timothy Geithner journeyed to China in search of salvation. It is not spiritual healing that Geithner seeks but the most material form of assistance: sovereign loans to finance the growing debt of the United States, in the form of purchases of Treasuries.

Geithner symbolizes the collective desperation of elites throughout the crippled global economy, who look to China as the only and best hope for solving the global financial and economic crisis. And by focusing on specific economic data in a highly selective manner, analysts and economists are able to find glimmers of hope to salivate over. While the global economy overall will undergo collective contraction for the first time since World War II, the Chinese economy is expected to grow by at least 6% in 2009. Recent trends reveal some areas of increase in domestic consumption, such as purchases of automobiles. There has been in several instances an increase in manufacturing output, contributing to a rise in certain commodity prices as China's appetite for raw materials grows. However, look beyond the spin-doctors and a somewhat different economic picture emerges.

Where domestic consumption has increased, this has been in large part due to tax incentives being offered by the authorities in Beijing to stimulate demand. This is a short-term fix, and not indicative of a sustained trend. More importantly, China must maintain a very high rate of annual growth in order to keep employment levels steady. A growth rate in the range of 6%, a figure that would be considered miraculous in much of the rest of the world, is insufficient to prevent a rise in unemployment. Since the onset of the Global Economic Crisis, more than 25 million migrant workers have lost their jobs, as factories by the thousands that depended on export markets are shuttered.

Another question mark is the state of China's banks. Largely still controlled by the state, there has been a process of liberalization underway, and thus far the Chinese banking system appears to have weathered the economic storm better than most. However, only a few years prior to the onset of the global financial and economic crisis, China's banks were rife with corruption and mismanagement, leading to a vast accumulation of toxic assets on their balance sheets. In 2002, it was estimated that Chinese banks carried a half trillion dollars in non-performing loans; it is not clear what that number is currently, or how vulnerable Chinese banks are to their own nation's potential real estate bubble.

Much of the world is betting on the success of China's own stimulus spending program, which equals nearly $600 billion. However, despite the impressive aggregate size of the Chinese economy, per capita income still ranks very low, standing at 107 out of 179 nations, or about $2,000. The capacity of the economy to compensate for demand destruction in its principal export markets through comparable increases in domestic consumption does not appear to be sufficient enough to create a basis to hang the global economy on. What is more likely is that China will spend what it can, borrowing from its sovereign wealth funds and reserves, to inhibit the growth of unemployment so as to maintain social cohesion.

As for Geithner's agenda, his number one priority remains China continuing in its role as America's principal banker. Like large debtors everywhere, the U.S. Treasury Secretary and Obama administration actually believe they have China over a barrel. The U.S. was just a larger version of AIG or Citigroup in their framework; too big to fail, as China's major export market. For a time, it appeared that China's political and economic leadership reluctantly agreed. Recall the words of Luo Ping, a director-general at the China Banking Regulatory Commission, who told journalists back in February that, "Except for U.S. Treasuries, what can you hold? U.S. Treasuries are the safe haven. For everyone, including China, it is the only option. We hate you guys. Once you start issuing $1 trillion to $2 trillion [of Treasury bonds] we know the dollar is going to depreciate, so we hate you guys, but there is nothing much we can do."

Now, however, there are growing indications that a major reassessment is underway among China's principal economic policymakers regarding their country's huge investment in U.S. government debt, currently in the range of $1 trillion. A growing number of Chinese officials are on record as believing that the U.S. dollar will eventually lose its role as the world reserve currency. And while in the short-term China will continue to purchase U.S. Treasuries, its own domestic needs and financial limitations are likely to restrict those investments to a level that represents only a fraction of the vastly exploding U.S. government borrowing requirements.

Ultimately, China does not see itself as the St. Jude of America, but as a sovereign nation with an old civilization, downtrodden for the last two centuries by Western powers and Japan, but which is on the verge of emerging from the Global Economic Crisis as the preeminent world financial power. It therefore will make decisions on how it allocates its resources and financial reserves, not based on America's desperate borrowing needs to finance its profligate budget deficits, but on serving the supreme long-term national and strategic interests of the People's Republic of China.