China's Rebound Is a Keeper

09/21/2009 10:46 am EST

Focus: MARKETS

Knight Kiplinger

Editor-in-Chief, The Kiplinger Letter, Kiplinger's Personal Finance, and Kiplinger.com

Knight Kiplinger, editor in chief of The Kiplinger Letter, says China’s economic recovery will remain strong, but there are some clouds on the horizon.

How sustainable is China’s recovery? America’s health depends on the answer.

China is the third biggest customer for US exports. Beijing is also America’s largest foreign creditor. Its Treasuries purchases help keep interest rates low.

[You can] count on robust [Chinese economic] growth for two years—about 8% to 9% this year and again in 2010. That’s much better than most other nations will do.

To get there, Beijing will rely on its stimulus—government [is] spending the equivalent of 15% of gross domestic product. Beyond that, though, the outlook is cloudier.

China needs exports to extend its recovery: Foreign sales and related investments account for 30% of its GDP growth, and wages from construction jobs created by Beijing’s stimulus won’t make up for those that were lost to lower world demand for manufactured [goods].

How many of the higher paying factory jobs return, and how quickly, depends on global economic recovery. Beijing must also boost private consumption. Current efforts aren’t working. Low wages and no safety net keep most Chinese from spending, despite jumped-up government outlays on pensions and education plus tax breaks and rebates for buying TVs, cars and household appliances. Until Beijing finds a way to change that, economic growth will rely on state-driven investment and exports.

US businesses are seeing little direct benefit from the Chinese stimulus. A “Buy China” provision mandates that government-funded infrastructure projects use materials that come from China—with no exceptions. Despite the restrictions, some firms—in architectural services and specialized machinery, for example—have made inroads. But they are few and far between, a major disappointment for US makers of earth movers plus other construction equipment and materials.

Meanwhile, Beijing’s recent moves carry the seeds of future troubles. Stimulus spending contributes to overcapacity. There’s already a surfeit of highways, ports, airports, and power plants. The country’s other big beneficiaries of government largesse—heavy industries such as steel, industrial-strength glass, and aluminum—have spare capacity as well.

The risks of deflation are rising. Any unprofitable projects will cause bad loans to mushroom. And state banks may require a second massive bailout, just a few years after the first, to stay afloat.

The government is aware of the problem, but it has to tread carefully. Clamping down too hard on bank lending could smother the nascent recovery. Efforts to consolidate factories have already led to a surge in violent protests by workers who stand to lose their jobs as inefficient plants are shut down.

Bottom line: Strong economic growth is safe for now but at risk after 2010.

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