China set to lead the rest of the economies

08:28, November 23, 2010      

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In the past, developing countries depended on the growth of the advanced economies. Today, they depend on the growth of China. Threats to China's growth are also threats to the developing world, the rise of Asia and the global recovery.

The global financial crisis has seen Asia emerge as a global economic powerhouse. In another half a decade, Asia's economy could be as large as that of the United States and the European Union combined.

The rise of Asia is predicated on the sustained growth of China, which is helping support growth and poverty reduction in much of the developing world, as well as the fragile global recovery in the advanced world. But nothing in economic development is inevitable. The growth of China depends on a stable and peaceful international environment.

Despite the slow and fragile economic recovery, the global financial system remains in a period of significant uncertainty. Advanced economies are facing the difficult challenge of managing a smooth transition to self-sustaining growth, while stabilizing debt burdens under low and uncertain economic prospects.

In contrast, emerging economies have proven resilient to recent turbulences, but are vulnerable to a slowdown in mature markets and face risks in managing sizable and potentially volatile capital inflows.

As the leading economies in the advanced world are drifting into a "liquidity trap", many central banks are opting for new rounds of quantitative easing (QE). But since increased liquidity seeks for high returns, QE will drive "hot money" (short-term portfolio flows) into the high-yield emerging economies, which can inflate dangerous asset bubbles in the emerging Asia and elsewhere.

Despite the "strong dollar" rhetoric in the US, the dollar fell by one-third against major currencies between early 2002 and this summer. During the two months before the Federal Reserve's (Fed) QE decision, the dollar dropped an additional 7 percent.

For all practical purposes, new waves of QE would mean further decline in the dollar's value, which would penalize the major holders of US Treasury securities. As a result, massive US debts would be inflated.

In contrast to the developed world, recovery has proved relatively solid in the emerging world. While the leading advanced economies have exhausted the traditional instruments of monetary policy, the major emerging economies are only beginning to use them.

Recently, People's Bank of China (PBOC) raised its one-year deposit and lending rates to 2.5 percent and 5.56 percent. The Reserve Bank of India raised its benchmark short-term interest rate to 6.25 percent. Brazil's interest rates are already close to 11 percent.

Soon PBOC will raise the deposit reserve requirement ratio for banks by 50 basis points - the fifth such increase this year and the second this month.

Today, a deepening global divide sets the slow-growing US and other advanced economies against many emerging economies and commodity producing nations. The former are coping with deflation; the latter are struggling with inflation. The worldwide impact of the QE is only aggravating the chasm, as indicated by Germany's critique of US monetary policies and other rifts among the G20 nations.

After their gains in the US midterm election, leading Republicans have expressed "deep concerns" over the Fed's moves to stimulate the economy. The European Union is struggling to contain the debt crisis and sustain the euro. In Japan, public debt already accounts for more than 200 percent of GDP.

Only a decade ago, the advanced economies of North America, Western Europe and Japan drove the global growth. Today, the G7 nations are navigating into unchartered waters, with the potential of unpredictable outcomes and unprecedented collateral damage.

In the 1990s, emerging and developing economies were still dependent on the growth of the G7 economies. Global growth was predicated on the growing prosperity of the leading Western nations. In the past decade, this relationship went through a reversal. Today, the developing countries are dependent on the growth of China that, along with a handful of other large emerging economies, drives global growth.

Consequently, the emerging and developing economies - and especially those that have lower export similarities with China - have a vested interest in the gradual evolution of China's exchange rate, as noted by the Organization for Economic Cooperation and Development.

It is not in the interest of the developing world that China would be pushed into a disruptive, deflationary currency appreciation - which is what happened to Japan.

Between 1971 and the mid-1980s, the yen more than quadrupled relative to the US dollar. Then, the leading advanced economies agreed to allow the US dollar to depreciate in relation to the Japanese yen by intervening in the currency markets.

A few years later, Japan drifted into a long deflationary slump, a near-zero interest rate and heavily impaired bank balance sheets. It is still struggling to overcome the liquidity trap.

Such a future is not in the interest of China, or in the interest of the poor-income countries, which have greatly benefited from China as an engine of their recent growth. If anything, the decline of China's growth would significantly undermine poverty reduction in the emerging world.

The best way China can help support the world economy is through efforts to strengthen its own sustained growth. What is at stake in China's growth is not just national prosperity, but the future of poverty reduction in the developing world and the continued well-being in the advanced world.

The rest of the world of the world will take the same road that China takes.

The author is research director of International Business at the India, China and America Institute (US) and visiting fellow at Shanghai Institutes for International Studies (China).

By Dan Steinbock, China Daily


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