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Quick: which country is the fastest-growing market for U.S., Japanese, and Korean exports? Which country consumes so much that it is pushing up prices for oil, soybeans, and steel? Which country is helping to lead a synchronous global recovery? China. China is hot, perhaps too hot. With all the good news buoying the international economy -- rising corporate profits, low inflation, strong stock markets -- one worry is the possibility that China might overheat and bring on an unanticipated crisis in 2004.
Odds are the Chinese will successfully manage their way through their financial troubles, as they have in the past. But to do so, Beijing should move faster to neutralize the bubbles building in real estate, steel, and autos. Efforts to create a modern, private banking system have been slow. The recent $45 billion capital injection into two of China's largest government-owned banks to prepare them for going private is a positive step. But Beijing has already spent tens of billions of dollars to bail out banks to little avail. It must insist that banks transform their lending culture and base the granting of loans on risk management rather than political connections.
There is certainly plenty of money sloshing around China's financial system. The central bank is buying billions of dollars to keep the yuan pegged to the U.S. currency, and Chinese corporations are taking in billions of dollars from their exports. Much of this dollar inflow winds up boosting the domestic money supply. And Chinese households are putting an average of 33% of their earnings into banks for safekeeping. All this added up to a jump of 20% in the money supply in 2003, helping to transform a 1% deflation rate into a 3% inflation rate. Banks already holding bad loans are still lending to state enterprises to build new steel mills and auto factories. Standard & Poor's estimates that true levels of bad debt could run as high as 45% of outstanding loans, or more than $850 billion.
Beijing hosts the summer 2008 Olympics, and China is racing to modernize itself, in part, for that event. In doing so, it is acting, along with the U.S., as a key locomotive for world growth. But unless Beijing chills down the economy soon, it could derail itself and the global recovery as well.