China Has Dodged a U.S.-style DepressionSo Far

China's position in the global economy is much like that of the U.S. in 1929. But exports to the U.S. are keeping the Middle Kingdom going

Did we have a global trade bubble? If so, as it pops, which country gets hurt worst?

Over the past decade world imports and exports have skyrocketed, going from 23% of the global economy in 1998 to an astounding 32% today. But it now is clear that globalization came with an unwelcome partner: soaring global debt. The huge trade surpluses in such countries as China, Japan, and Germany created a flood of liquidity that pushed up asset prices and encouraged borrowing around the world. In turn, the high debt levels boosted consumption and investment and fueled demand for imports. Moreover, cheap credit made it easy for importers and exporters to finance their globe-spanning transactions.

The collapse in credit has triggered a deep and perhaps long-lasting contraction in trade. The latest trade data for the U.S., released Jan. 13, showed a steep decline in both exports and imports. Adjusted for inflation, imports of goods into the U.S. dropped almost 7% from October to November, as credit-deprived consumers and businesses closed their wallets. Virtually every other country also is showing a significant drop in trade. The World Bank predicts global trade will contract by 2.1% in 2009, but the actual pullback could be much worse.

The question, though, is who will bear the brunt of an extended global trade slump. One possibility is that the country that benefited the most from the trade bubble—China—will also suffer the most. In many ways, the closest analogy is the U.S. in 1929. Like China today, the U.S. was then the most dynamic country in the global economy, with a trade surplus. So when the Depression came and other countries cut back on imports, the U.S. was rocked especially hard.

A "REAL RISK"?

Michael Pettis, a finance professor at Peking University, worries that something similar might hit China as U.S. import demand falls. Writing in YaleGlobal Online, he argues that "the U.S. is so much larger than China, and it is adjusting so rapidly, there's a real risk that the Chinese economy will be overwhelmed."

But here's a different possibility: China may take market share from other countries as the appetite for imports wanes. So far that matches the data. U.S. imports from China dropped 5% over the past year, a far cry from the recent rapid growth. But U.S. imports from Germany and Japan fell a much bigger 12% and 19%, respectively.

China's own trade stats tell the same story. Chinese exports to the rest of the world in December were down by 2.8% over the past year, measured in dollars, and down 9% in yuan. That's not good—but it's better than export declines of 42% in Taiwan and 27% in Japan.

For now, the Chinese export machine is holding its own. But the global trade bubble still has not let out all its air.

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