China ignores IMF warnings, continues massive stimulus spending

As China moves closer to overtaking Japan as the world's second-largest economy, it's flexing its new found muscle and ignoring warnings from the International Monetary Fund regarding its credit growth rate and the value of the yuan. China began a 4 trillion yuan ($586 billion) two-year stimulus in November 2008 and plans to continue on that path.

Since China ties the yuan to the U.S. dollar, that stimulus is essentially being done at our 0% interest rate -- reasonable in our weak economy, potentially dangerous in China's surging one. Many worry that inflation will take off if China doesn't put on the brakes sooner. Others worry that China could be heading into an asset bubble that could magnify its problems down the road. But right now, China is enjoying a high level of investment in desperately needed infrastructure improvements. In fact, 7.3 percentage points of its 7.7% increase in gross domestic product came from investments in infrastructure improvements in the first nine months of 2009.
China expects to meet its 8% growth target for 2009. Moody's outlook on China is bright. On Monday, it raised its outlook for Chinese lenders to positive from stable, including state-owned lenders Industrial & Commercial Bank of China, China Construction Bank, Bank of China and Agricultural Bank of China. Moody's credited the strong government support and the likelihood that Beijing will continue to support the institutions as the primary reason for the upgrade.

The International Monetary Fund was not as positive on China's stimulus plans for 2010. Tarhan Feyzioglu of the IMF told China at a conference in Beijing that it was time to slow the rapid credit growth to ward off inflation. But right now, inflation is mild in China. Feyzioglu also warned that excess credit growth could lead to excess capacity and, eventually, nonperforming loans.

A Rising Yuan Could Lift All Boats

Of even greater concern to the IMF and other nations is the value of the yuan. The U.S. and the IMF continue to push for China to allow the yuan to float against other international currencies rather than keep a virtually fixed rate based on the U.S. dollar. The IMF believes the yuan is "significantly undervalued." Japan, Brazil and European countries joined the call for the yuan to be allowed to appreciate.

China, of course, doesn't want that to happen. If the yuan appreciates, the cost of its exports will go up in price, especially in its largest market -- the U.S. -- which would likely result in fewer exports being sold. A drop in exports could quickly bring China's economic advance to a halt. Also, a rising yuan would make imports into China much cheaper and could encourage more spending on foreign goods. That, too, could hurt consumption of goods produced in China.

Right now, economists think China has too much investment, too much savings and too little consumption. This type of credit binge on infrastructure investment, if done too rapidly, can result in an asset bubble that bursts, just like we saw in the U.S. It was the U.S. credit binge that created the financial crisis we're all living through right now. Think of all those foreclosed properties in the U.S. in both residential and commercial real estate; China's future could resemble our present if it grows too fast without allowing its currency to float.

Lita Epstein has written more than 25 books, including The Complete Idiot's Guide to Foreign Currency Trading.

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