Can China Lead as the US Falters?

Concerns about the state of the global economy continue to be ratcheted up higher with each passing week. It used to be said that when the US economy sneezes, the rest of the world catches a cold; if that's the case, then we are in big trouble.

Along with much of the rest of the developed world, the American economy is struggling to recover from the deepest recession in living memory. The signs from the consumer side of the economy are worrying: retail sales are down, the housing market is weak, and worst of all, joblessness is rising fast.

With many G20 countries engaging in beggar-thy-neighbour deficit cuts and austerity programmes, what the world really needs is strong demand from the remaining region seeing economic growth - Asia. There were some promising signs recently when China appeared to accept that it must allow domestic demand to grow, coupled with a softening of its strong exchange rate policy and rising wages for China's factory workers. If the country develops a consumption-driven economy, the theory goes, we will all benefit as China's huge potential market soaks up exports from the UK and other countries, as the UK in particular shifts from a consumption- to production-driven economy.

The fly-in-the-ointment of this optimistic scenario was highlighted last weekend by Goldman Sachs' chief economist, Jim, O'Neill, who warned that China's economy is slowing, with worrying implications for us all. O'Neill fears that, with countries like Britain taking demand out of their economies to cut budget deficits, any slowdown in China's economy risks endangering global activity at a time when the US seems unable to kick-start its own economy.

China's break-neck economic expansion, fueled by exports to the developed west must be re-balanced, as many have noted, but this must not be at the expense of the global economic recovery. China, like India, is concerned not to allow its rapidly expanding economy to create persistent inflation. Monetary policy in each of these two emerging powerhouses is being tightened to protect against this danger. Many observers feel that a double-dip recession in the US and EU is inevitable. Against this backdrop, cutting public spending might be regarded as a form of economic masochism.