Paul Krugman: When China Stumbles

Will China be 2008 all over again? Maybe, but maybe not:

When China Stumbles, by Paul Krugman, Commentary, NY Times: So, will China’s problems cause a global crisis? The good news is that the numbers, as I read them, don’t seem big enough. The bad news is that I could be wrong...

China’s economic model, which involves very high saving and very low consumption, was ... possible when China had vast reserves of underemployed rural labor. But that’s no longer true, and China now faces the tricky task of transitioning to much lower growth without stumbling into recession.

A reasonable strategy would have been to buy time with credit expansion and infrastructure spending while reforming the economy in ways that put more purchasing power into families’ hands. Unfortunately, China pursued only the first half of that strategy... The result has been rapidly rising debt, much of it owed to poorly regulated “shadow banks,” and a threat of financial meltdown.

So the Chinese situation looks fairly grim...

As I suggested..., however, I have a hard time making the numbers for ... catastrophe work. ...China buys more than $2 trillion ... from the rest of the world each year. But it’s a big world, with a total gross domestic product excluding China of more than $60 trillion. Even a drastic fall in Chinese imports would be only a modest hit to world spending.

What about financial linkages? ... China has capital controls ... so there’s very little direct spillover from plunging stocks or even domestic debt defaults...

But I have to admit that I’m not as relaxed about this as ... I should be. ... And if my worries come true, we are woefully unready to deal with the shock. ...

 Monetary policy would probably be of little help. With interest rates still close to zero and inflation still below target, the Fed would have limited ability to fight an economic downdraft... Meanwhile, the European Central Bank is already pushing to the limits of its political mandate in its own so far unsuccessful effort to raise inflation.

And while fiscal policy ... would surely work, how many people believe that Republicans would be receptive to a new Obama stimulus plan, or that German politicians would look kindly on a proposal for bigger deficits in Europe?

Now, my best guess is still that things won’t be that bad — nasty in China, but just a bit of turbulence elsewhere. And I really, really hope that guess is right, because we don’t seem to have a plan B anywhere in sight.