Sun, Oct 19, 2008 - Page 8 News List

The Sino-US reciprocal relationship

By Holmes Liao 廖宏祥

Regardless of whether the massive US bailout of Wall Street with huge capital injections into the banking system will work or not, the world has seen the end of laissez-faire, free-market economies. If the US financial and monetary systems are not salvaged or partially rebuilt, the US may lose its credibility and status as a financial superpower.

In comparison, the Chinese economy was growing at an annual rate of 9 percent before the financial crisis, generating astronomical foreign reserves. China currently holds about US$1 trillion in US debt, including US$460 billion in US Treasury bills. Before the US Congress passed the bailout package, there were reports that the Chinese threatened to reconsider their policy of buying US debts unless Washington moved to stabilize the markets.

With so much at stake, Beijing appears unlikely to stop buying Treasury securities or start selling their US holdings because such actions would not only throw the world market into deeper chaos but would also reduce the value of Chinese holdings in the US.

China is not without its own looming financial problems. In the globalize world, a deep US downturn will hit China, whose growing economic clout has been largely dependent on its exports to the US. A US recession accompanied by the shrinkage of the insatiable appetite of US consumers will most definitely induce a significant reduction in China ’s GDP. But a Chinese slump will also lower commodity prices.

While US citizens have been horrendous spenders, by comparison, Chinese have been meritorious savers. In the past 10 years, US savings declined from 5 percent to virtually zero, while Chinese savings surged from less than 30 percent to nearly 45 percent. To add fuel to the fire, traditional forms of savings in the US were abandoned in favor of leveraged speculation in both stock and real estate markets. Such activities brought about a tremendous explosion of debt in the US.

A quick glance at history tells us that the British pound used to be the world’s No. 1 currency, in which most financial transactions were made. Sterling nevertheless slid from close to US$5 before World War II to near par in 1980s. The reasons were the huge deficits incurred from fighting two world wars and the UK’s underperforming economy, which lasted for decades.

Is the US heading down a similar path with its geopolitical and financial hegemony being edged out by China?

In a 2005 Goldman Sachs report, China was projected to overtake the US in GDP by 2040. Before this wave of financial turmoil, the date had been brought forward to 2027. Now, some analysts say the date may come even sooner.

Despite all of these factors, we should not simply write off the US and prophesy that the 21st century will belong to the Chinese. In the last two weeks, the US stock market plummeted 22 percent but its Chinese counterpart suffered an even more appalling 55 percent freefall.

If Washington is able to avert a fresh wave of banking failures and credit meltdown, the world will likely see the US emerge with its geopolitical eminence significantly enhanced, much like after the Great Depression in the 1930s and the Great Stagflation of the 1970s.

As the world still considers US government debts as “safe haven” in uncertain times, we’ve seen the dollar rally rather than sag further, even before the US$700 billion bailout package was passed by the US Congress. Fund injections from around the world will provide sufficient ammunition to help the US recover.

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