How Can China Support America

by Larry Mongoss, guest blogger

When China lowered its interest rate on October 8^th, people outside of China attributed the action to an attempt to fall in line with what the central banks in Europe and the United States had done. There was actually no reason given for the change, and it was done in conjunction with a reduction in reserve requirements, suggesting that the effort was part of an attempt to buffer the Chinese banking system rather than really fall in step.

(photograph by Maple Xu, ©2008, all rights reserved)

Regardless of the motivation, however, there was some negative reaction inside China on the grounds that China should forge its own path, and not follow the lead of the West. When later there was a rumor that the Chinese were considering injecting $200 Billion into the US financial system by buying Treasury notes, that reaction heightened immensely. Unfortunately, I have to bug other people to look at Chinese web sites so I never really got to the bottom of where that rumor started, though I do find it ironic that adding $200 billion to the current Chinese holdings would give the central bank $700 billion, just matching the size of the bailout plan.

More to the point, though, people started asking the question what China should do to help in this crisis. The very fact that people are asking that question is breathtaking to me. Some ten years ago, during the Asian Financial crisis, China did its best (pretty successfully for the most part) to simply avoid the pain. The current attitudes are a testament to the progress China has made economically, its own housing boom, and the much higher reach of the internet. People not only hear about, but talk about, almost everything and almost all of them are thinking about home ownership.

The most prevalent answer, if you are curious, is no, the Chinese should not be worrying about the rest of the world. Not a big surprise, most concerns are closer to home, quite literally. There is more interest in figuring out whether the experience in the US housing market has some lesson in it for the people in China. If past experience worldwide is any indicator, the answer is almost certainly yes, but almost none will learn it.

What is really interesting about all this though is that the real lesson may be exactly the other way around. The US, and European governments responded loudly, and hopefully effectively, panic stricken that the financial markets would collapse and leave everyone jobless. To look at the Shanghai Stock Exchange Index, which dropped from 6000 last October to 2000 this October, you would definitely conclude that China is headed into a depression. Not so. Nobody is talking about anything except for abnormally low, which is to say less than 10%, growth in the next year. While things may yet turn out less rosy than people expect, the connection between stock prices, and housing prices, is much weaker in China than it is in the US. Part of this is relative size – a much bigger portion of the US economy is represented by these two things – but part of this disconnection is the command nature of the Chinese Economy.

Though many people are calling for the Chinese government to do something about the stock market, it has not been quick to take drastic action. I have no doubt though, that should producers find demand dropping away for their product, the government would step in. Certainly such steps would be clumsy, the norm for a command economy, but they would be strong. The knowledge that this would be done might very well be enough to mean the action never needs to be taken. McCain and Obama talk about hatchets and scalpels. What the Chinese government holds in reserve is more like a bulldozer. That level of control is often problematic, but at times like this it comes in handy.