Should you have your eye on China?

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In the midst of a global recession that left many industrialized nations reeling and several near collapse, one nation seems to have sidestepped everything. China responded quickly with a large stimulus plan, and projections suggest that 2010 will yield a massive 8% growth in GDP. In 2008, China surpassed Japan as the largest holder of US treasury securities. China also has the largest foreign exchange reserves in the world at more than $2 trillion.

China’s Prime Minister detailed his expectations for China’s future. Speaking before the legislature in the Chinese equivalent of a State of the Union  address, Wen Jiabao was confident that the country could increase lending, social spending, and investment in strategic industries. He   also repeated the commitment to gradually wind down the economic stimulus of last year.

Most economists would agree with his confidence in China’s projected growth for this year. In 2009, the country achieved an 8.7% rise in GDP, and the last quarter of 2009 was the highest. Mr. Wen attributed this to the power of China’s socialist system that allows them to have a managed economy. The Prime Minister enjoined the legislature, “We must make best use of the socialist system’s advantages, which enable us to make decisions efficiently, organize effectively, and concentrate resources to accomplish large undertakings.”

Not everything is so optimistic, however. The speech also recognized the need to clamp down on speculative real-estate buying that could lead to a Chinese housing bubble. The Prime minister also recognized that risks in banking and public finance are increasing. Even as he recognized these risks, however, he also committed the nation to increase money supply by 17% this year. Some economists warn that this could lead to an avalanche of bad debt and climbing inflation. The prime minister also warned of a $154 billion budget deficit in the next year (3% of projected GDP).

China’s foreign-exchange regulator said that the country would limit its purchases of gold in the future, since its huge investment in the past thirty years has not yielded exceptional returns. Contrary to recent indications, he also said that China will continue to invest in US treasuries. However, China has a demonstrated history of doing the opposite of what it says. Some commentators regard the comment as an opportunity for China to lower the price before buying. There is really no way to know what this announcement indicates for sure. Most likely, the only thing that can be known with confidence is that China will continue to add to its extensive foreign exchange treasuries, while also expanding its own money supply.

Keep a careful eye on forex charts in the next few months, and expect to see a rise in the Yuan over the next year. At the same time, expect to see strong growth as the nation rapidly industrializes. In the long term China will have to address fundamental problems in its economy and social sector in order to maintain this kind of performance. Some pundits predict that China’s growth will slow by almost half in the next decade. China must also begin to address significant corruption, economic disparities, and environmental problems if the country is to go forward. Mr. Wen might be right in saying that there are advantages to a managed economy, but it also seems that the disadvantages will become more pressing as China’s economy grows. It will be fascinating to see what all of this looks like over time.

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