In February, after 18 years as America's top banker, Dr. Allan Greenspan will step down as Chairman of the Federal Reserve. While many economic observers are very interested in the views of incoming Chairman Ben Bernanke, they often overlook another central banker — in Beijing — who will have a major impact on the global economy in the years ahead. 

Few in the West will recognize the name Zhou Xiaochuan, the governor of the People's Bank of China, but he has the twin tasks of managing the Middle Kingdom's fast growing economy while at the same time satisfy international critics, who are demanding further appreciation of the Chinese yuan. 

Mr. Zhou is under enormous international pressure to orchestrate a steady appreciation of the yuan versus the dollar, while at the same time managing an underdeveloped financial system in an economy plagued by overcapacity and falling prices With growing signs that China's real estate boom (especially around Shanghai) is coming to end, he must also continue reforms to keep bad loans from ballooning at the state—run banks.

If Mr. Zhou's reforms fail in any of these areas, he could lose the confidence of President Hu Jintao, and strengthen the hand of Marxist reactionaries.

As did the Asian Financial Crisis of 1997, a meltdown of China's financial system would be likely to send shock waves radiating throughout the global economy. As with Mr. Greenspan, currency traders hang on Zhou's every word, given the $769 billion pile of foreign currency reserves over which he watches.

Mr. Zhou has responsibility for a financial system that is riddled with numerous structural problems and inconsistencies.  China has $400 billion, give or take 50%, in bad loans on the books of its banks. The country's bad loans, whatever their precise sum, are equivalent to a good chunk of the country's foreign reserves. Even Mr. Zhou probably no idea what the true number is.

By keeping the Chinese currency non—convertible and fixed in value around eight yuan for every greenback for the past decade, Beijing has basically 'outsourced' its monetary policy to Mr. Greenspan, by piling up massive surpluses and investing them mostly in federal debt.  In effect, Washington runs the Chinese money supply.

China has committed to the World Trade Organization to open the banking system to foreign competition in December.  This will erode the state—owned banks' monopoly on deposits in the country, which has allowed them to take advantage of the high savings rate, accumulating a massive pool of capital. The state banks then lent this capital to state—owned enterprises (SOEs).

This lending served two purposes. It kept the money in the family, assisteing Beijing in maintaining control of the broader economic and political system. Because loans were disbursed frequently and at subsidized rates — and banks did not insist upon strict repayment — the state was able to guarantee ongoing employment to the Chinese masses working at the often—bloated SOEs.

This last point was — and remains — of critical importance to the Chinese Politburo: they know what can happen when the proletariat rises in anger. That is, after all, how they became the Politburo in the first place.

Strategic Partner or Strategic Competitor

Instead of supporting Mr. Zhou, some in Congress are making his job more difficult.  On November 29, Senators Schumer and Graham reintroduced an ill—conceived bill that would impose a massive 27% tariff on all Chinese—made goods that move across the Pacific. 

Last Spring, even President Bush fell into the protectionist trap and imposed import quotas on some kinds of Chinese—made clothing.  Many Washington observers rightfully viewed this move as a shameless attempt to win support from labor unions and encourage the Chinese to speed up currency reforms. 

With the Communist need to stand up to the West, foreign pressure is more likely to hinder Mr. Zhou's reform efforts and give the Marxist reactionaries a great reason to drag their feet even more.

After pondering the wider implications for the global economy is it really wise for Westerners to pressure China, given all its internal weaknesses , to push up the value of the yuan at this time?

Count Your Blessings

With the American economy showing impressive GDP growth and consumer confidence rebounding during the Christmas shopping season, Washington should just sit back and count its blessings.  Many in Washington should be careful what they wish for.  Let us assume for a moment that Mr. Zhou gives Senators Schumer and Graham a holiday gift and announces an increase the value of the yuan by 20%. 

Will the huge bilateral trade deficit that America has built up in recent years suddenly disappear?  Hardly. 

Will textile factories in South Carolina start announcing re—openings? Never.
 
The most likely scenario of such a yuan appreciation is further damage to the overheated property market in China, already showing signs of stress. Portions of the billions of yuan that foreigners (led by the Taiwanese and residents of Hong Kong) have invested in the real estate in recent years will be withdrawn, as owners enjoy their instant 20% currency windfall.       

If there is a 'hard landing' in some critical manufacturing industries, then a slowdown in China may be imminent. How painful is anybody's guess, but some experts say the figure could dip as low as 5 percent next year and 3 percent in 2007.

As for Mr. Zhou, the billions of dollars in Treasury bonds that he watches over suddenly become worth fewer yuan.  With an aging population and a crumbling health care system, Beijing needs every last yuan in the years ahead to satisfy the masses and maintain social stability.  

Will China's Savings save Us?

Many American conservatives have rightfully complained about the GOP's reckless spending habits.  With its high savings rate and export earnings, China is helping finance reckless fiscal policy in the West.  But can central bankers in Asia save us from fiscal doom? 

If it can maintain reasonable economic growth and social stability (which is a big if, as the recent violence between government security forces and farmers in the southern village of Dongzhou illustrated), new research seems to indicate China can continue for generations to come to supply us the capital we need.

In late October, BusinessWeek noted a study entitled Will China Eat Our Lunch or Take Us Out to Dinner by two German researchers, Hans Fehr and Sabine Jokisch, that concluded a flood of Chinese savings over the next forty years could turn the anticipated capital shortages into capital gluts instead —— not just in America, but in Europe and Japan as well.  

Assuming the American dollar remains relatively strong, this savings glut could finance the massive social security entitlement promise made to the baby boom generation. BusinessWeek concludes:

According to their calculations, the potential impact of China is so large that global interest rates could drop by as much as a third by 2050, even with all the expected government borrowing. Those lower rates, in turn, could finance more business investment, boost productivity, and raise national incomes across the developed world.

Some American economists have claimed the methodology that Washington uses to calculate the national savings rate, which does not take into account many types of capital gains, underestimates the nest eggs of millions baby boomers.

But we are really taking a gamble if we think we can depend on Mr. Zhou and the other Beijing autocrats.

Nervousness Leads to Saving

While Chinese exports to the West generate billions of dollars in earnings, China's high household savings rate is a sign of weakness, not strength.  A new report from McKinsey Quarterly says just 37 percent of those surveyed agreed or strongly agreed with the statement "I feel confident about my financial future."

While respondents confirmed that they saved a quarter of their family income, the survey results support the view that China's savings rate is high because the country's social safety net is thin and most Chinese must pay for health care and pensions out of their own pockets.

With the Shanghai and Shenzhen stock exchanges plagued by corruption and poor oversight, the average Chinese family has thousands of yuan stashed away in the state—run banking system earning little, if any, interest.  

Conclusion

Despite the rhetoric coming from Senators Schumer and Graham, President Bush seems to have rediscovered his free trade principles.  Just as everyone was preparing to ring in 2006, he quietly rejected a request to place quotas on steel pipe imported from China, saying the cost to American consumers would outweigh the benefit to domestic producers. 

While it may win a few more labor union votes, Washington should stop bashing Beijing's economic policies.  In many cases, it does more harm than good.  America's prosperity does not rest on a foundation of others' poverty and backwardness. Our flexibility, creativity, and responsiveness to market signals, along with our traditions of hard work and the rule of law will keep us ahead.

Compared with some of the other hardliners that have claimed power and influence in the Middle Kingdom, America should be grateful that it has an ally in Mr. Zhou and do everything we can to keep China on the path toward greater economic prosperity. 

Brian Schwarz publishes the website China Challenges, and is based in Shanghai.