Despite recent efforts by the U.S. Government to help stimulate its battered economy, the country will continue to battle the stagnation sparked by the subprime mortgage crisis, Chinese international economics experts said.

The U.S. Federal Reserve announced on January 30 that it would slash the federal funds rate to 3 percent, the lowest since June 2005. About a week before this move, it had lowered the rate from 4.25 percent to 3.5 percent following stock market stumbles in Asia and Europe. The federal funds rate is the rate that banks charge each other to borrow money overnight. Lower interest rates make it easier for businesses and individuals to borrow money for purchases and other activities that help stimulate the economy.

On January 24, the U.S. Congress reached an agreement on a tax relief package that will give most taxpayers refunds of $600 to $1,200. The rebates, which are expected to be issued in June and cost some $150 billion, will benefit about 116 million U.S. families as well as businesses.

"These measures reflected Washington's concern over the U.S. economy," said Zhou Shijian, Standing Councilor of the China Association of International Trade. "The magnitude of the economic slowdown at home has far outweighed the Iraq issue. The Bush administration will make every effort to rescue the economy, especially in the run-up to the presidential election at the end of this year."

While the U.S. economy is growing at a low rate, it is too early to conclude that there is an economic recession, Zhou said. The series of policies adopted by the U.S. administration will help revitalize the

country's economy, but they will not take effect until the second half of the year, he said.

Some Chinese economists pointed out that the economic slowdown in the United States has far-reaching implications for China and the world at large. The U.S. subprime mortgage crisis has brought about great changes in the international financial landscape, giving rise to more uncertainties in the world economy, they said.

International repercussions

There is no doubt that a recession of the U.S. economy would adversely affect the world economy, said Jiang Yong, Director of the Center for Economic Security Studies at the China Institutes of Contemporary International Relations. The United States is the most important engine for the world economy. It is not only the world's largest consumer market, but also contributes greatly to the development of the global economy as a major technological innovator and source of foreign investment, he said.

If the U.S. economy goes downhill, the global economy will have to face severe consequences, Jiang warned. For example, sales of foreign products in the United States would drop in the wake of a slowdown of the U.S. economy. If American financial institutions run into problems, they would not be able to provide the world with top-quality financial services, he said.

For all these potential risks, Jiang said he finds it reassuring that the global economic structure has become increasingly diversified in recent years. The European economy has retained sound growth, thanks to its fruitful efforts to adjust its economic structure. Japan also has bid farewell to its economic stagnation. Most importantly, emerging markets such as China, Russia, India and Brazil have become the new engines driving world economic growth. Although they are not comparable to the United States, these countries will be able to help mitigate the risks resulting from a U.S. economic slowdown or recession, he said. "Given the positive role of emerging markets, robust economic growth in Europe and Japan's recovery, the impact of a U.S. economic recession should be neither underestimated nor exaggerated, " he said.

A conventional theory says that as China's economy "decouples" from the U.S. economy, the U.S. economic slowdown will not have much effect on the Chinese economy.

Zhang Ming, an assistant research fellow at the Institute of World Economics and Politics at the Chinese Academy of Social Sciences, pointed out that this theory has overlooked the close correlation between U.S. consumption and Chinese export and the fact that the American financial market can directly impact China's capital market given the capital flows in the context of financial globalization. Once the U.S. economy slows down, Chinese exporters may suffer losses because of the decline in U.S. consumption, Zhang said. Moreover, U.S. financial market turbulence may fuel fluctuations in China's asset prices.

"The recent U.S. economic slowdown has already taken a toll on China's exports. Chinese statistics show that the year-on-year growth of the country's exports to the United States continued to decline from the first quarter to the third quarter in 2007," said Zhou.

The United States is China's largest overseas market by country. Usually, an 1-percentage-point decline in the growth of the American economy will translate into 5-percentage-point reduction in China's exports to the United States, Zhou said.

In recent years, China not only has canceled export tax rebates for products whose manufacture causes heavy pollution and consumes huge amounts of energy and natural resources, but also has imposed export tariffs on them to control their export. Against this backdrop, the U.S. economic slowdown will further constrain China's export. "Chinese exporters will have a hard time in 2008," Zhou said.

If the U.S. Government takes more effective measures to stimulate the economy, the slowdown may be only temporary without having any significant effect on China's economy, Zhang said. But if an economic recession emerges in the United States, it will pose severe challenges to China's export sector and capital market, he said. An economic recession would lower consumption in the United States, thus reining in China's export growth from the demand side, he said. It may also heighten trade protectionism in the country, leading to more anti-dumping and anti-subsidy investigations against Chinese products and making them less competitive in the international market. A decline in the profitability of the export industry would severely affect China's economic growth and employment, he said.

In addition, Zhang said if the U.S. economy entered a recession, more short-term venture capital would surge into China, aggravating China's asset price bubble. However, whenever the U.S. economy has an economic recovery and the federal funds rate begins to go up, the capital tends to flow back to the United States, breaking the asset price bubble in China. A financial crisis usually breaks out in emerging markets after hitting developed countries, Zhang said. He believes China should be highly alert to this risky trend. China's benchmark interest rate for one-year deposits currently stands at 4.14 percent, 1.14 percentage points higher than the U.S. federal funds rate.

Financial uncertainties

There is evidence to show that the U.S. subprime mortgage crisis has resulted in financial turbulence, but whether the turbulence will persist remains in question, Jiang said. Since July 2007, global markets have plummeted from time to time, foreign exchange markets have taken a roller-coaster ride, the prices of financial products have soared and large financial institutions such as Citibank and Merrill Lynch have suffered severe losses.

"To date, the measures taken by the United States and some other Western countries to address the subprime mortgage crisis have not worked well," Jiang said. The United States is at risk of an economic recession, he added.

The subprime mortgage financial crisis started in the United States in the fall of 2006 and prompted a sharp rise in home foreclosures. The crisis began with the bursting of the housing bubble in the United States and high default rates on "subprime" mortgage loans made to higher-risk borrowers with lower income or lesser credit history than "prime" borrowers. Within a year, it developed into a global financial crisis.

Since the collapse of the Bretton Woods system of international monetary management in 1971, financial turbulence has become the norm. If it becomes a persistent problem, it tends to have major implications for the global economy, Jiang said. Financial turbulence leads to an increase of speculative hot money and a decrease of mid- and long-term investment, thereby driving up the cost of resource allocation, he said. It also increases the cost of international trade because of the fluctuations in exchange rates.

All these factors add to the uncertainties and risks in the world economy, Jiang said.

The subprime mortgage crisis in the United States provides evidence for the changes in the international financial system, he said. The influence of International Monetary Fund (IMF) on the international financial system has declined partly because of its promotion of the controversial Washington Consensus, a market liberalization policy package that proved a failure in developing and transitional economies. It also has declined because many emerging markets with large foreign exchange reserves are forming regional cooperative arrangements without resorting to the IMF or developed countries, he said.

The influence of the Group of Eight (G8) is also on a downward spiral, Jiang said. The major industrialized countries that comprise the G8 now can exert some influence only by holding an outreach session with major developing countries, he said. The Organization for Economic Cooperation and Development, a rich countries' club, has also seen its influence over the world economy decline, he added.

As changes take place in the international financial arena, the United States can no longer dominate the system, Jiang said. Instead, the country seeks to transfer many of its own risks to the international market, making it ever more turbulent, he added. The ongoing international financial market turbulence has exposed the flaws in the Western financial system, he said. Western financial giants such as Citibank, HSBC and Merrill Lynch are not immune to corporate governance problems.

Given these changes, Jiang stressed the need to monitor the risk transfer of the United States and other Western countries. Western financial institutions have long been coveting the high profitability and huge financial assets of emerging economies. At a time of international financial turbulence, Western countries are likely to push the emerging countries even harder to open their financial markets, he said.

Because Western financial institutions have grown weak following the U.S. subprime mortgage crisis, the role of China and other emerging countries in the international financial market has become more pronounced. China can take this opportunity to enhance its standing in the international financial system and seek a bigger say on international financial issues, Jiang said.

Zhou at the China Association of International Trade believes this is an occasion for China to balance its international trade and increase overseas investment. If China's exports decline because of the economic slowdown in the United States, its currency will face less pressure to appreciate, he said. Against the backdrop of a sluggish world economy, the prices of energy products such as oil are projected to drop. China can increase its oil imports to boost its strategic oil reserves. It also will be able to purchase more hi-tech products. The growth in imports will help China strike a balance in its international payments, he said.

Given the lack of funds in the international market, China Investment Corp., the country's sovereign wealth fund that was set up in September 2007, can make more investments in foreign nations, thereby contributing its part to the world economy, Zhou said.