Growth Imbalances May Overheat Chinese Economy

China is leading the global economy into recovery with 8% growth target for 2009. However, the third largest economy in the world may overheat before it reaches a sustainable growth. Indeed, Chinese officials are not thinking in the long-term and a fixed exchange combined with a poor management of China’s monetary policy will damage domestic consumption and possible trigger a global slowdown.

In one hand, China’s growth in 2009 is largely a result of 4 trillion yuan stimulus package directed mostly to infrastructure projects and lending. In fact, since state controlled banks began the lending spree, China's wide M2 measure of money supply grew almost 30% year on year. Looking further, investment contributed 7.3 percentage points to the 7.7% increase in GDP over the first nine months. On the other hand, although putting a lot of cash into an economy during a slowdown may stop job losses, boost confidence and stimulate growth, can also create excess capacity and boost imperfection across the financial system.

In addition, China is keeping the value of its currency yuan pegged to the US dollar at very low levels.  And with the greenback depreciating at a record pace during the last few months, the trade-weighted value of Yuan is also declining, making foreign goods more costly in China. So, under these circumstances Chinese companies are likely to raise prices to cover costs which will inevitably trigger a wave of inflation and depress spending among Chinese consumers.

Anna Fedec,
11/20/2009 6:55:20 PM