Remember the 1994 movie Speed? It's the one where a madman (Dennis Hopper) takes a bunch of bus passengers hostage and then rigs the vehicle to explode if its speed falls below 50 mph. That's a pretty good way of thinking about China right now. The Chinese economy is all about speed. It's growing at about 10 percent a year, as it seems to do year after year. But if the economy slows just a bit, lots of bad things will very likely happen. While China is often portrayed as an unstoppable economic juggernaut, the mixed Chinese economydescribed by some as "Leninist corporatist"is full of stresses, inefficiencies, and imbalances. For example, the World Bank has estimated that if Chinese GDP growth fell by just 2 percentage points, 60 percent of the country's bank loans would become nonperforming. A sharply higher yuanthe goal of U.S. "fair trade" proponentsmight have just that effect. And this is an economy that needs to create 24 million new jobs a year to keep up with the flood of peasants continuing to pour into cities looking for a better life. Social unrest is already rising in China, and a slowdown would surely make things far worse. China may seem like a homogenous Borg-like entity to many westerners, but it's not. Back in the early 1990s, after the 1989 Tiananmen Square massacre, one Pentagon study predicted that China could break up into a dozen or so smaller countries like one mega-Yugoslavia. But even continued fast growth is not enough. The country needs to get its ever wealthier consumers to save less and spend more in order to make the economy less dependent on investment-led growth. As Morgan Stanley economist Stephen Roach wrote after this week's big drop in the Chinese stock market:
"The basic premise of this story is that Chinadespite its remarkable successes on the economic development frontnow has a seriously unbalanced economy. The main problem is a runaway investment boom. By our estimates, in 2006, fixed asset investment exceeded 45 percent of Chinese GDPa record for China and, in fact, a record for any major economy in the world. By comparison, Japan's investment ratio in the 1960sthe period of maximum rebuilding from the destruction of World War IInever exceeded 34 percent of GDP. China's annual growth in fixed asset investment has averaged 26 percent over the past four years. Should the investment boom continue at this pace, the odds of capacity excesses and a deflationary endgame will only increase. That's the very last thing China wants or needs. "
Given all that, just imagine the effect of a trade war kicked off by a future president and Congress slapping a 27.5 percent tariff on Chinese goods, an idea that has already been suggested by U.S. senators such as Charles Schumer and Lindsey Graham as a way of battling America's huge trade deficit with China. The Chinese economy would tank, as would the economies in Asia that export heavily to China. All that slowing of global growth might well push the U.S. economy into a recession. Making things worse, U.S. interest rates would shoot up as Chinese demand for our government bondsChinese already own more than $300 billion worthdissipated. That would make any slowdown even worse. So are you still wondering why concerns about the Shanghai stock market might contribute to market downturn on Wall Street? What happens to the economy over there matters greatly to the economy here.
I was listening recently to a speech by China expert Orville Schell where he pointed out that China has some 160 cities with more than a million people each. Yet Schell himself admitted, "I don't even know three quarters of them." Even so, that's certainly a much better performance than most of us could muster. We probably couldn't get past Beijing or Shanghai, and it's somewhat doubtful many of us could pinpoint those world-class cities on a map. But we might want to learn so the next time a China mini-crisislike the 10 percent drop in the Shanghai stock marketspooks U.S. financial markets, we'll at least have a pretty good picture of where the trouble started. This week's U.S. market plunge will hardly be the last time a little trouble in big China gets blamed for problems over here. Now, given my analogy that China is like the bus in Speed, a wise guy might say that Americans are the hostages in this cinematic scenario. Hey, no analogy is perfect. Not only do Americans benefit from low-cost goods assembled in Chinawhich also helps keep inflation lowbut China's growth contributes to overall global growth. And as China gets richer, citizens there will buy more and more American consumer products helping finally dent that trade deficit. But will Americans and their representatives in Washington be that patient?