Worries are that a further downturn of the U.S. market in the coming year will intensify cash flow shortages and spur more economic losses, resulting in a complete decline of the U.S. market and therefore slowing down the world economy. Another theory has surfaced assuming that China and the United States are the double-barreled engines of the world economy. As China's influence spreads, it will have to complement the United States to rid the world of this crisis. Ding Yifan, Deputy Director of the Institute of World Development under the Development Research Center of the State Council, has made clear China's growing impact on the global economy. However, as Ding wrote to the Global Times, a Beijing-based daily publication, the knockdown effect of the mortgage crisis is apparent, and emerging markets look even more vulnerable because of it. Excerpts follow:

Hard currency advantage

For many years, the U.S. economy has maintained an absolutely leading role in the world. It has been a belief that when the U.S. financial market suffers a cold, global capital markets begin to sneeze. Backed by a strong growth momentum, U.S. consumers have been able to continue heavy purchases as long as they could. As a result of the decades of easy credit that has fueled U.S. massive consumption, the global manufacturing industry was driven forward. Because of this, the U.S. Government has had to issue more treasury bonds to hedge credit accounts. These mounting dollar-denominated financial assets flew into overseas markets. To date, U.S. foreign debts have amounted to more than $9 trillion, and it has had to borrow billions of dollars overseas every day to balance its accounts. Dollar-dominant global financial markets, in addition to high interest rates, make foreign funds scramble to buy into American treasuries to earn against the margin. Rising prices of domestic assets, though always bubble-driven, also stimulate large amounts of foreign capital to flow into the United States. In the 1980s, the Ronald Reagan administration lured foreign capital through high interest rates and a strong dollar. When former President Bill Clinton presided over the country in the 1990s, the dotcom bubble was a major incentive to plenty of overseas funds, pushing the exchange rate of the U.S. dollar to continuous new records.

After the burst of dotcom bubble at the turn of the 21st century, foreign funds flew out of the U.S. stock market and its currency depreciated sharply. The Federal Reserve then raised interest rates to prevent market risks. The poor who have little wealth and weak payback capability went bankrupt and thus triggered the recent subprime crisis involving most financial institutions. If the United States cannot win back the confidence of foreign investors, it will be harder to hedge against the credit funds. Without a consumption boom, the U.S. economic engine is very likely to stall and precipitate a global decline.

China's climbing imports and rapid growth have created a rosy economic picture. Statistics from the World Bank reveal that the total value of China's imports is expected to witness a 17.5-percent increase in 2007. But one thing is sure: China also is challenged by insufficient domestic demand. Consumption contributes only 30 percent to the growth of China's gross domestic product (GDP), compared to 70 percent in the United States. The country mostly imports semi-finished products such as raw materials, energy resources and component parts, and sells them to developed markets after they are processed. This is the reason why the United States cannot be replaced by China in terms of consumption.

But the passion of U.S. consumers is largely affected by wealth, meaning that if the value of their belongings (property, stocks and securities) rises, they will spend more extravagantly. On the contrary, if their assets devalue, they are reluctant to spend. When the burst of the Internet bubble hit, they cut down on expenditures, and now it is the same with the housing bubble. A shrinking U.S. market has also lowered China's foreign trade level.

China needs to boost consumer spending, but not through credit consumption like the United States, because U.S. dollar is hard currency that is accepted worldwide. The Chinese currency is not yet that popular. And it is risky for China to take in huge speculative funds through large consumption based on its present economic status.

Tight money

The U.S. Federal Reserve had to bail out investors by offering loans after the burst of dotcom bubble, and subsequent excess liquidity has given rise to the housing bubble. When the new bubble blew out, the subprime crisis tightened cash flows. The injection of huge amounts of capital by the Federal Reserve and frequent cuts of interest rates have done little to pick up the treasury market. Some equity funds have failed to survive because of bad debts and the broken capital chain.

The Federal Reserve is contemplating further cuts to interest rates to create more liquidity. Those who opposed to the loose money policy, however, are doubtful of the move's role in rebuilding financial institutions' confidence. They also blame it for increasing inflationary pressure in the market, where economic stagflation like in the 1970s would reoccur if credit squeeze remains despite growing money supplies. Faced with this dilemma, the Federal Reserve has to raise interest rates to curb inflation through a tighter monetary policy on the one hand, while on the other, capital bailouts are necessary to help investors survive the crisis.

Against the backdrop of globalization, American companies do business the world over. But as liquidity evaporates in credit markets, parent companies have to withdraw overseas investment to ensure an adequate money supply at home. China's bullish stock market has lured a number of speculators, and it will certainly drop as foreign institutional investors leave. If the Federal Reserve's current monetary policy takes effect and spurs more liquidity, most U.S. capital will choose to stay in China.

Trading factors

China's total foreign trade volume hit $1.76 trillion in 2006, occupying 65 percent of its $2.7-trillion GDP. A growth pattern over-dependent on foreign trade brings with it more financial risks.

If exports to the United States structurally decline, China will take a breath from the enormous pressure to appreciate its currency. Commodities originally produced for export will be sold back into the domestic market, and inflationary pressure will be eased through lower prices.

It doesn't seem bad for Chinese consumers to purchase more and spend less, but it will certainly be a disaster for Chinese manufacturers, who will suffer losses because of reduced profits and rising mortgages.

China's fast economic growth is also heavily dependent on imported resources to sustain its energy supply. The Federal Reserve's easy-credit monetary policy will push prices of commodity futures up due to a dollar-calculated pricing system. Commodity prices periodically increase and decline as the value of dollar-denominated financial assets (securities and bonds) fluctuates. When American bonds yielded higher profits in the 1980s, the currency was strong and reined in the overpricing of commodity futures. In the late 1990s, large foreign capital absorbed by the Internet bubble stabilized the dollar's value. But soon after President George W. Bush took office, dollar-denominated financial assets fell sharply along with a declining IT industry. The financial situation has worsened after the September 11 terrorist attacks in 2001 and the U.S. war in Iraq. An ever-deflated U.S. currency has resulted in the runaway increase of oil prices. The recent oil price hike has created widespread public concern out of fear that an oil crisis like the one that struck in the 1970s could come again. China is an export-oriented market without much pricing freedom, and domestic manufacturers will earn much less if commodity prices surge.

Despite its growing role as a contributor to world economy, China is far less able to take the world lead by replacing the United States economically. Only when the Chinese economy becomes more export-independent and based on a solid hard currency will China not be as affected by the outside world.