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China: When hot turns sour
China's massive economy could slow down soon. Can this derail the global economic recovery?
May 19, 2004: 2:32 PM EDT
By Mark Gongloff, CNN/Money senior writer

NEW YORK (CNN/Money) - What happens when one of the world's biggest economies, barreling along at 80 miles an hour, slams on the brakes? We may soon find out.

China's economy is the sixth or seventh-largest in the world, depending on whom you ask. But adjusting China's undervalued yuan to give it purchasing power parity with the U.S. dollar, China's GDP is actually bigger than that of Japan, according to the latest World Bank data, making it No. 2 in the world.

And that economy, which has been growing at a blistering pace since forever, has begun to overheat, according to recent data:

  • China's GDP grew 9.7 percent in the four quarters ending with the first quarter of 2004
  • Its consumer price index (CPI) grew at an annual rate of 3.8 percent in April, the highest rate in seven years
  • Its money supply grew 19.1 percent in the past year

Take such numbers with a grain of salt -- many Western economists think growth could be even stronger than the Chinese government is reporting. But most economists, East and West, agree it's just too hot.

"China's economy is in trouble," Virendra Singh, senior economist at Economy.com, wrote on Monday. That same day, Carl Weinberg, chief economist at High Frequency Economics, wrote in a research note of "a heightened sense that things are getting out of control."

Though both economists were unimpressed with the government's response to the latest data -- a curb on loans -- the consensus is still that China's economy will enjoy a nice, smooth slowdown.

Even a noted pessimist, such as Morgan Stanley chief global economist Stephen Roach, believes China can reign in runaway growth without killing the economy, citing occasions in the recent past that worked out OK, including an inflationary eruption in 1993, the Asian financial crisis of 1997 and the global recession of 2001.

"The West always seems to expect a hard landing in China," Roach wrote in a recent note to clients. "Yet in three instances over the past decade, China has proved the doubters wrong."

This is not just an academic exercise -- the rest of the world will feel the pain if China suffers a hard landing. In fact, it could suffer some pain even if there's a soft one.

"I think that the soft or hard landing debate is misleading," Andy Xie, Morgan Stanley's chief economist for the Asia-Pacific region, wrote in a separate note this week. "Financial markets usually have hard landings regardless of how an economy lands."

From a rave to a waltz

"A China crash would be huge," said Frank Holmes, CEO and chief investment officer at U.S. Global Funds, which operates the China Region Opportunity Fund, which has about $56 million in assets.

Most ominously, Holmes suggested Japan could respond to a hard landing in China by curbing its purchase of U.S. Treasury bonds. Both China and Japan have been big buyers of U.S. debt, a way to help keep their currencies low. If their appetite for U.S. bonds were to dry up, then interest rates would shoot higher.

"That's the real bear case -- rates rise in the United States, exasperating home and car sales," Holmes said. "For the government to bail the economy out, there would be more massive deficit spending."

Still, Holmes agrees with the consensus, that this scenario is the least likely. Instead, he expects China to keep maturing and growing, even if there's some short-term turmoil in process.

"What's happening is they're going from dancing to rave music, with 1000 beats per minute, to waltzing in China," Holmes said.

What's more, if China is successful in slowing its economy down, commodity prices, including oil, would cool. A revaluation of China's currency -- a commonly prescribed treatment -- would make U.S. exports more competitive in China. On the other hand, U.S. prices for goods made in China would rise.

Another Asian financial crisis?

A revaluation of the remnibi would also make Chinese investments more expensive and slow a steady inflow of foreign money. Higher U.S. interest rates could also pull money out of China, as the "carry trade" players -- people borrowing at cheap rates in the United States and pumping the proceeds into China -- close up shop. China could raise its own interest rates, putting added weight on an already shaky banking sector.

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Xie and some other analysts believe this could have a significant short-term effect on other Asian financial markets, which -- as the 1997 Asian financial crisis proved -- could have profound effects on the U.S. economy.

"That mucked up trade flows, affected our economy and brought an unexpected easing by the Fed," said Robert Brusca, chief economist at Fact and Opinion Economics. "I wouldn't downplay the risks out of China."

Countries around the globe that send electrical components, copper and other materials to China -- including Australia, Chile and Thailand -- would feel the pain of a China slowdown, said Singh of Economy.com. And big trading partners such as Japan -- the world's No. 2 economy -- could be hit hard.

"East Asian trading partners will be most affected," Singh told CNN/Money. "The country in the most precarious situation is Japan, followed by South Korea."  Top of page




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Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.