China Needs to Hit the Brakes; US Needs to Step on the Gas

The two most important economies in the world seem to have vastly different goals.

The dichotomy between the world's two greatest economies is the tension most impacting the financial markets and geopolitics today. The U.S. wants to add to already substantial amounts of indebtedness to avoid deflation and to stimulate the economy by dint of lower interest rates. China, on the other hand, wishes to dampen its economic growth and stifle growing inflation by raising its interest rates, which it just did this week. Two opposite paths to avoid crisis, and another violent battering of financial markets.

Ben Bernanke hopes quantitative easing will increase the flow of credit to the domestic economy and stimulate job creation. China's Zhou Xiaochuan, governor of the People's Bank of China, is plainly worried about asset bubbles forming in real estate and other activities in China.

Zhou sounds the opposite pole from Bernanke; domestic credit expansion still remains strong. "There are potential risks from cross-border capital flows," Zhou said Thursday. "Macroeconomic risks linked to excessive liquidity, inflation, asset bubbles and a cyclical rise in bad bank loans are rising significantly."

Irony of ironies is that China is flat-out worried about the excess liquidity flowing from the rest of the world, driving up inflation and threatening bubbles. America is flat-out anxious about how to get its excessive credit to get invested at home and create jobs. Getting all of this wrong would be a nightmare for other Asian nations dependent on exports to China, and on U.S. manufacturers praying for double the level of exports.

China can't afford to blow up, because its next five-year economic plan must concentrate substantial resources on "social well-being," spending on household income and social welfare for the poorest Chinese, who are being moved from rural areas to urban centers. Its extraordinary 10% rate of growth is bound to slow to 8% due to the 12th Five-Year Plan, just in its inception stage.

China will also be constrained by other developments as well. New policies to tighten the real estate market and dampen speculation were introduced in late September. For example, mandatory down payments for commercial residential housing were raised to 30%, and banks must prevent consumer loans from being used for the purchase of housing. That's wise in view of what took place in the U.S. from 2007 onward.