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As America crash lands, the world looks east

By Heather Stewart and Ruth Sunderland

With Wall Street in crisis and banks begging for cash, the West has lost its swagger. Can China step in and keep the global economy on its feet?

What links Hu Jintao, president of the People’s Republic of China, with the following people: an American mom shopping at Walmart, former Citigroup boss Chuck Prince, and Federal Reserve supremo Ben Bernanke? And how is Ralph Herndon, a retired car assembly-line worker from Otisville, Michigan, connected to Mr Yu, who runs a handbag factory in Guangdong? It is the financial world’s version of six degrees of separation; the current economic crisis has revealed the close connections and interdependencies between the US, the world’s biggest capitalist economy, and communist China.

The huge glut of savings built up in Hu Jintao’s China allowed that nation to lend billions of dollars to the US, which meant American consumers could embark on a borrowing and spending spree. But too many of those loans went bad, banks racked up huge losses, and CEOs like Chuck Prince paid with their jobs. When the stock market caught on to what was happening, shares tanked on fears that the US would fall into recession. That prompted Ben Bernanke to slash US interest rates by an extraordinary three quarters of a per cent last Tuesday. As the US economy has shifted away from traditional manufacturing to service industries, car plants like the one where Ralph Herndon worked have closed, because of cheaper competition from lower-waged economies like China. The Americans now hope that China, and other emerging countries with cash reserves, will bail out troubled banks and the world economy. But as Mr Yu has found to his cost, Guangdong is not immune to US troubles - 70 percent of his American and Canadian customers are not paying their bills on time.

The current crisis has raised fundamental questions about the merits of the American model. For many years, the US has lived beyond its means: borrowing heavily to gobble up cheap Chinese consumer goods; splashing out the proceeds of a decade-long housing boom; and preaching the benefits of liberated markets.

Now the rest of the world is anxiously glancing eastward, in the hope that as America slides towards recession, the rising economic powers of Asia - in particular, China - will help to forestall a full-blown global crisis. But as Mr Yu would attest, the hope that the Chinese dragon can slay the American bear is a pretty vain one.

A few decades ago, looking to China as the driver of global growth would have been unthinkable. Henry Kissinger, Nixon’s Secretary of State, who was instrumental in opening up the channels of communication with China in the early 1970s, told the World Economic Forum in Davos, Switzerland, last week that he had no idea at the time that Beijing could emerge as an economic competitor.

In Otisville, Herndon and his former colleagues at General Motors know all too well what it feels like to be on the sharp end of competition from China. Flying into Detroit, 70 miles away, planes soar above mile after mile of rusting cars, girders and industrial scrap in what looks like the biggest junkyard on earth. Herndon, who worked for GM for 30 years, says he was struck by a realisation last year. ‘I thought to myself, they are paying these guys in China $3 a day to do what I have done all my life. No matter what cutbacks we offered the management, there is no way we can match that. I guess we are finished.’

Now it is the turn of the banks to feel the growing muscle of the Chinese. There could have been no more potent symbol of the shift of global power than the spectacle of America’s mightiest banks begging for cash from government-backed sovereign wealth funds from China and the Middle East to cover the vast losses they have clocked up through reckless lending.

But America has relied on Asian cash for years, locked in a bizarre financial embrace with the country that has become the world’s factory, and in many ways its banker. Like many nations with a strong export sector, China has earned more than it could spend and has accumulated vast savings in the past decade.

Much of this cash has been sucked into the US, as Beijing opted for the dollar as the safest currency in which to keep its reserves. In effect, it has been lending billions of dollars to the American government.

This wall of Asian cash has helped to keep the cost of borrowing down throughout the rich world and contributed to a series of asset price bubbles, in housing and in shares. The enthusiasm of sovereign wealth funds for buying up chunks of US banks - and a range of other companies - is the latest manifestation of this phenomenon.

But economists have become increasingly nervous that the world is out of kilter, with some countries borrowing and spending too much, and others too little.

Optimists argue this will not matter, because over the past decade there has been a beneficial ‘decoupling’ in the global economic train: America is no longer the sole engine of international growth.

In its assessment of the economic prospects for 2008 this month, the World Bank set out a rosy scenario in which emerging markets would continue to expand strongly, despite the credit crunch and the slowdown already under way in the US. China, it predicted, would slow almost imperceptibly, from 11.3 per cent GDP growth in 2007 to 10.8 per cent this year.

But the worldwide stock market rout at the beginning of last week, which spread through Asian markets and back to the US and Europe, suggested investors, at least, are not convinced that ‘decoupling’ is really here. The idea of ‘recoupling’ is suddenly in vogue.

Although China has begun to generate expanding consumer demand of its own, its decade of 10 per cent annual growth has been largely on the back of an explosion in exports, so it is vulnerable to downturns elsewhere.

As he contemplates the future over a working lunch, Li Xihao, senior manager at garment manufacturer Shanghai Eswell, which exported $10m of its garments last year, is hoping that US troubles will not have knock-on effects in Sydney and Melbourne.

‘We are worried about the American economy and it’s very difficult to tell what the outlook is,’ he says. ‘At the moment our major market is Australia and that still looks OK, so hopefully the business will not be affected.’

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