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U.S. crashes - China breaks By Michalis Firillas Tags: china News from America is bleak. Earlier this week the Federal Reserve came to the rescue and backed a deal for the sale of a paragon of Wall Street culture, Bear Stearns, to JP Morgan Chase, for a mere $2 per share. Lehman Brothers, another major investment bank, was also felt to be tottering. Responding to the crisis of liquidity - the availability of money for banks to loan, primarily to other smaller banks and then on to Joe in the street - the Fed dropped the rate by a further 0.75 percent. After weeks of dire financial instability, and months of efforts by Fed Chairman Ben Bernanke to stem the downward spiral sparked by the subprime collapse, mostly by repeated cuts in the interest rate, the question on everyone's lips is one of anticipation: How long will this go on? Perhaps they should also be asking, "How much worse can this get?" Even the most optimistic forecasts do not exclude the possibility that a recession, or worse, stagflation (high prices on top of no jobs), will go on for many months. Realists will also tell you that unless the legacy of former Fed chief Alan Greenspan, primarily of averting recession by adding cash to the economy through interest-rate manipulation and lax lending regulation, is adjusted to the current international conditions, we are all in for lean times. The condition of the number one economy in the world will obviously affect the rest of the world. But as you watch America tumble into what may be the biggest economic crisis since World War II, from an international perspective, China is the one to keep an eye on. Let's state the obvious: China is the world's most populous country; on average its economy is the fastest-growing one in Asia; its economy is a mixed bag of reforms and strict state controls; and it is not a democracy. Managing this problematic combination of factors is a complex task to say the least, but more important, it is not something that can go on indefinitely. Moreover, these factors have also contributed to three parallel processes that have matured and are now converging in China at this critical juncture, when the American economy is in a downward spin. The impact of this convergence may mean that the biggest domino in the world economy will also fall over, and this is a crash that will not only be heard around the world, but may also turn bloody. Advertisement The first process is the enrichment of China. The opening of the Chinese economy to foreign investment made it part of the global capitalist economy, bringing in billions of dollars from exports of consumer goods and contributing to the emergence of a middle class. The insatiable hunger of the developed world, particularly the United States, for inexpensive Made in China products transformed the country into what is essentially a lender of money. China has the largest foreign reserves in the world, estimated at a staggering $1.4 trillion dollars, nearly 70 percent of which is held in U.S. dollars. Even with the gradual, yet significant, adjustments of the yuan's value during the past two years, the dollar's dive means that Chinese laborers are working harder to sustain the Americans' high standard of living, which for years has relied on borrowed money - not on American production. A financial meltdown in the U.S. will affect China and its accumulated wealth badly. Secondly, China is constantly in search of resources. The explosive growth of the Chinese economy has made the need for fuel and raw materials a priority, sending the price of commodities internationally sky high. Coupled with the declining value of the dollar, the main currency of international trade, not only are essential commodities, like oil and grain, enormously expensive, but this past year the situation has been exacerbated by growing concerns that climatic changes may result in serious global shortages in basic foodstuffs. This past month alone, the cost of foodstuffs in China rose by approximately 24 percent. Inflation and scarcity, particularly of basic necessities, including heating fuel, is the stuff public unrest is made of. The third process is socio-political. The decision of the Chinese leadership, since 1989, to increasingly open up their society economically, and allowing it to grow into a significant component of the global economy, created openness on various levels, notwithstanding the efforts of Chinese officials to keep the clamps of centralized control in place. Such controls are impossible to apply perfectly. As such, Chinese society is becoming increasingly unequal, with a growing disparity between classes, and also growing unease, as the public has greater access to information and means with which to express dissatisfaction. Adding to this complex situation are minorities, comprising nearly 9 percent of China's 1.3 billion citizens, whose ethnic and cultural identities have for decades been oppressed in a process the Dalai Lama recently described as "cultural genocide." Even though China is most often described in the U.S. as a "rival," in great part due to the lack of transparency endemic to its one-party system, in reality it is at this time much more of a partner. Indeed, over the past five years, the two states have been locked in a bear hug: each is too deeply reliant on the other for maintaining its economic ethos that a separation would be detrimental to both. The logic has so far been that the infusion of American dollars into China, and their return to the U.S. for investment (mostly in Treasury bills), is what is keeping the economies of the two countries afloat. What happens if that balance fails? How much devaluation of the dollar can China accept? How will Beijing weather a sustained depression in the U.S., with fewer buyers for its consumer products? This is a precarious time for a Chinese political system that abhors instability. Will it make an audacious turn and break free of the American financial embrace, risking its economic growth and potential domestic upheaval? Will this not exacerbate the already dour economic conditions in the U.S., forecast to spread elsewhere? We will have to watch and see. Michalis Firillas, an editor at the Haaretz English edition, blogs at http://firillas.blogspot.com. 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