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There is something scarier than Greece. Jim O’Neill, the famed Goldman Sachs economist who coined the natty BRIC acronym, said in September that a Greek default might not necessarily sink world growth but an inflation outbreak in China certainly could.
Modern republican China was born 100 years ago this month and inflation was present at many of the country’s turning points since then: the 1949 revolution, Tiananmen Square, to the key overhauls of the economy in the 1990s. It is the ancestral enemy of the Chinese Communist Party and the authorities watch it like a hawk.
If the economy continues to threaten overheating on speculative construction and the cost of housing and staples such as pork inflate their way through the roof, it is likely that the authorities will constrict bank lending more, raise rates again and again and take the risk of a growth-slowing hard landing that would send a shiver around the world – with Canberra the first spine it would reach.
One important sidebar is the trouble a China slowdown would cause for China’s own debt pile, the $US1.7 trillion owed by its local governments which have been driving China’s investment binge.
Part of China’s strategy for nursing this huge debt through any economic slowdown would be to continue resisting a float of the yuan to its real strength. With a non-fully convertible yuan, it is easier for Beijing to shuffle off local government liabilities around the state-owned Chinese financial system without setting off a capital flight.
But an undervalued yuan is also a serious bottleneck in global recovery. With the modern mix of free and floating currencies, those able to manipulate their currency can keep their exports cheap and offload the impact of the downturn onto others.
But the wider effect of this is to prevent the global economy from starting to rebalance itself.
Our crises were driven originally bv fundamental imbalances between exporters and savers, and importers and spenders. What should be happening now is creditor nations such as Germany and China boosting their economies – China switching from constant expansion of production to personal consumption, for example – and letting the sorry debtors trade their way out. Countries rushing to keep their currency the cheapest are dragging that process back.
Europe has a currency straitjacket all of its own. It was the euro that dramatically accelerated European indebtedness in the first place by starting out on low rates and allowing the southern European nations to borrow like Germans, without German ability to work off debt. When the inevitable bust did come, the rigidities of the euro concentrated the full force of the downturn on the weakest members of the group, unable to use their currency as the traditional shock absorber.
These weaknesses were well canvassed when the euro was created. But only in nightmares would anyone in 1999 have seen the debts of its smallest members blowing back into Europe’s biggest banks with the force that they have. The fear of returning post-Lehman bank contagion has finally spurred European leaders to act, borrowing an essentially American plan to first protect the banks by recapitalising them – having rejecting any need two months ago – then ring fencing Spain and Italy with a huge fund that can buy up unlimited numbers of their distressed bonds to stop fear spreading and with those precautions in place finally letting Greece default. The plan has the advantage of ending the fiction that Greece is ever going to repay, which has robbed all earlier plans of any credibility.
Even if southern Europe is stabilised, there is a long haul to come. Competing economic theories now offer governments a choice of cutting their way to growth or borrowing their way out of debt; the former politically ugly, the latter very hard to continue anyway.