Several months ago in this Atlantic story, I explained what some economists thought was the biggest danger in the Chinese government's response to the world business collapse. Obviously the Chinese government had to do something to offset the tens of millions of layoffs happening all at once. Its predicament was in a way like America's at the start of the Great Depression: having had an abnormally large share of the world's manufacturing jobs and export earnings when times were good, it had more of them to lose when demand crashed. But China's situation was worse, because it is so much poorer than America was, and because exports represented a bigger share of its employment base.

So China had to do something. The danger, as with the US recovery measures now, came from the long-term implications of the necessary short-term damage-staunching measures. And here the main fears were: (a) that the government would try to maintain its huge trade surplus (through subsidies, Smoot-Hawleyesque trade barriers, "buy Chinese" rules, etc) even as foreigners were forced to cut back on their buying, thereby triggering understandable resentment and retaliation; (b) that its stimulus efforts would aggravate trade-imbalance problems in the future, since so much was devoted to new productive capacity which could further glut world markets; and (c) that the stimulus would lead to a big destabilizing bubble, since a lot of it was propelled by China's version of sub-prime loans. (Ie, shaky, under-collateralized, dubiously repayable loans to sweetheart or shady companies).

These are problems to keep watching, and toward that end, two worthwhile resources: The first is this essay by R. Taggart Murphy, longtime investment banker in Japan and now a finance professor there. (The link opens a Word .DOC file for download.) Murphy -- for the record, a friend from my Japan days -- compares China's nascent attempt to prop up its trade surplus to what Japan did in the 1970s. He says:

"If the parallels continue with the 1970s, what might we expect?  First, hostility directed away from the United States and towards China. ... Once your economy is so large that whatever you do affects global economic architecture, the "free rider" option [of permanent trade surplus] begins to close.  If you manage your economy in such a way as to maximize exports and trade surpluses at a time when global growth is sluggish or non-existent, you are willy-nilly forcing other countries to run trade deficits.  What happens if they refuse to go along?"

He suggests some cautionary answers to that last question. Also, we have yet another illuminating item from Guanghua School of Management's Michael Pettis, about the pitfalls built into the stimulus package. Here. Worth reading as a complement to this week's "Strategic and Economic Dialogue."

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