PRESTOPUNDIT -- "It's a team sport, baby!"

.. and the world's leading manufacturer of sombreros is -- China. Quotable:

China's trade balance is barely in surplus: it runs a deficit with some countries and may even post a trade deficit in 2004. The only country with which China enjoys a whopping trade surfeit is with America .. China's fixed exchange rate of 8.28 renminbi to one dollar has enabled its exporters to enjoy enhanced competitiveness and surging sales as the dollar has slid during the past two years. Indeed, in the year to December 2003, China's exports to the U.S. rose by 81% .. [dare we] attribute America's ballooning trade deficit with the Middle Kingdom to Washington's deficit spending or aggressive Federal Reserve monetary easing? .. Washington fails to appreciate just how important China is in underwriting its spendthrift ways .. In effect, Beijing furnishes cheap credit to finance Washington's fiscal deficit and consumer indebtedness in America ..

underwriting America's borrowing binge does not come without hazards for China itself. As the PBOC buys dollars for renminbi, it enlarges the domestic money supply, notwithstanding efforts to "sterilize" the excess liquidity by selling Chinese government bonds. As of October 2003, the annualized increase in China's broad money supply topped 21% and domestic financial institutional lending climbed by a yearly rate of 71%. Consistent with a burgeoning boom and bust sequence, property, automobile, home amenities prices, and GDP are all accelerating at a breakneck pace[vii].

Exacerbating China's economic distortions, the country's four largest state-owned banks, which together claim 61% of the country's loans and 67% of its deposits, are saddled with mounting bad debts. By some estimates, over a third of these loans are nonperforming, which is about the same for the country's financial system as a whole, meaning the nonperforming loans may amount to 45% of GDP ..

In the autumn of 2003 the PBOC tried to gently apply the brakes by lifting banks' reserve requirement to 7% from 6%. Beijing's leaders also recently injected $45 billion into two of its largest state banks to help alleviate the fetters of their numerous nonperforming loans, the third time since 1998 the Chinese state has at least partially bailed out its largest banks ..

Nonetheless, China and by extension America, are in a dire dilemma. Chinese banks will continue to lend recklessly as long as Beijing maintains its currency peg and the attendant expansion of the domestic money supply ..

With China's finances in disarray, would the country's robust purchases of American debt instruments for dollars continue at the same rapid clip? Washington may find it much more difficult to obtain cheap underwriting for its gaping fiscal deficits and rampant borrowing ..

Posted by Greg Ransom | TrackBack