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China is in a perfect position -- to fight the previous economic war.
Unfortunately, this global economic slowdown is a lot different from the one China battled so successfully in 1997-98. In that crisis, big increases in spending on infrastructure ensured that China's economy rebounded quickly from the downturn caused by the Asian currency crisis.
This time, though, infrastructure spending won't be enough. To prevent a slump in growth to 7% -- that's a slump when your economy has been growing by better than 11% a year -- in 2009 China will have to get the country's consumers to spend. That's a much tougher job, especially because the Beijing government has been almost uniformly unsuccessful in recent years in stimulating consumer spending.
The duration and the depth of the current global slowdown -- which is deep enough to qualify as a recession in the United States, Europe and Japan -- and the long-term health of the global economy after this slowdown hinge on China's ability and willingness to fight this new war.
Self-inflicted slowdown
Certainly China has plenty of weapons to fight an economic slowdown.The country is awash in dollars, with foreign-exchange reserves of $2 trillion by the official count.
Having ratcheted up interest rates and tightened lending rules in 2007 and the first half of 2008 to slow inflation and runaway growth, the country has room to cut interest rates and spur lending.
Because key points in China's economic and financial systems are controlled by the government rather than the free market, Beijing is able to keep exports cheap by controlling the price of its currency, the yuan, and to support the troubled real-estate market by telling banks to keep lending and to eschew foreclosure on stressed borrowers.
And because much of the economic slowdown is self-inflicted, China's officials know exactly what first steps to take to reverse the trend.
China had slowed its growth rate in an effort to fight inflation that had soared past 7%. A combination of factors took growth in the Chinese economy down to an annual rate of 9% in the quarter that ended in September. These include interest-rate increases, increases in the amount of money that Chinese banks were required to keep on reserve with the Peoples Bank of China, cuts to subsidies for exports and limits on how much China's banks could lend. The Chinese economy grew 11.9% in 2007.
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When economists began predicting that growth would drop to 8% -- or lower -- in 2009, the government reversed course. China needs growth of 7% just to generate enough jobs to absorb increases in new workers from population growth and migration to the cities from the countryside.
Economic growth of 7%, moreover, wouldn't do anything to reduce the country's supply of unemployed and underemployed workers. With the country already experiencing a rising level of domestic protest caused by the growing gap between incomes in the cities and the country, letting the economy slow further was just too risky.
China's September cut in interest rates was the first in six years. The latest cut, on Oct. 29, was the third in six weeks, and the benchmark one-year lending rate fell 0.27 percentage point, to 6.66%. Economists are projecting the Oct. 29 cut will be followed by as many as five more by mid-2009.
Export subsidies, reduced earlier to slow the nation's economy, have been increased. Costs for real-estate transactions have been reduced. And the Chinese government has stopped an appreciating yuan dead in its tracks: The currency gained less than 0.1% in value against the U.S. dollar in October. That keeps the price of Chinese exports steady and isn't an insignificant advantage at a time when a soaring yen is making Japanese exports increasingly dear.
China's reserve requirements have been lowered by half a percentage point for the country's biggest banks and 1.5 percentage points for all other banks. The Chinese central bank has started to regularly inject cash into the economy. The bank added $9 billion in the last week of October after injecting about $6 billion the week before. The government has also suspended a tax on interest income.
Fewer bridges, more flat screens
Taking a page out of its Asian currency crisis playbook, Beijing has also announced $292 billion in infrastructure spending on the country's railroads through 2010. That's roughly a $50 billion increase from previous estimates. In all, China is expected to put an additional 1% of its gross domestic product into infrastructure spending in 2009.That's similar to what China did in 1998 to help keep the economy growing after the Asian currency crisis. Similar, but less. In 1998, China put 1.3% more of GDP into infrastructure spending.
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Why less spending on infrastructure in what is arguably a much more dangerous crisis?
Two reasons, China experts say. First, the country has invested so much in infrastructure over the past decade -- and has already allocated plenty for infrastructure in its 2006-10 plan -- that it's hard to find new infrastructure projects that provide decent returns on the investment.
China has watched carefully as Japan has repeatedly failed to jump-start its economy, despite massive spending on infrastructure, because so much of that spending went to politically motivated, make-work projects without benefit to the national economy. China doesn't want to go down that road.
Second, the big gains, long term and short term, are on the consumer side of the economy. Beijing will get more bang for its stimulus yuan by investing in the consumer economy rather than by investing in more infrastructure.
Continued: Spreading the wealth
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