China GDP Growth Trumps Arms Dispute

The People’s Republic had a particularly nasty reaction to the US plan to sell $6.4 billion in arms to Taiwan. China threatened to suspended military cooperation with America and sanction the US manufactures who made the arms which will be sent to Taiwan.

The dispute is part of a growing friction between the world’s No.1 and No.2 economies, depending on whether China has moved ahead of Japan in annual GDP. The recent problems with cyberattacks on Google (NASDAQ:GOOG) and the search company’s threat to stop censoring results in China is on top of a number of arguments over tariffs that grew late last year.

The core of the differences between China and the US are much more basic than arms and search engines.

China’s purchasing manufacturing index hit 57.4 in January up from 56.1. Factory activity in China moved higher for the 10th consecutive month. That almost certainly means that China’s first quarter GDP will be above 10%. That has caused concerns about inflation as national banks have flooded the market with liquidity and the costs of raw materials have risen with factory output.

One the other side of the Pacific, the Congressional Budget Office has forecast GDP growth well below 3% for the next government fiscal. Pessimistic economists such as Nouriel Rubini put the expansion number as low as 1.5% for the second half of 2010. The recovery in the US could collapse completely under the weight of unemployment and lack of credit for small businesses.

China is pushing the West as hard as it reasonably can on issues of trade and its right to be a nearly unchallenged military power in Asia. The People’s Republic knows that its economic health is better than nations in North America and Europe.  Favorable policies to get exports into those regions will rely on China’s willingness to close its markets to Western goods and services forcing a sort of trade quid pro quo. In the meantime, China can cut many of its military ties to the US as retaliation for weapons sales to Taiwan. The American military sees cooperation with the Chinese as a strategic necessity to support harmony between the two large armies that could reach points of friction without regularly contact and negotiations.

The Chinese will use the leverage of the US need to do business in the world’s most populus nation and the desire of America to keep the peace in Asia to pull any advantage it can get in the race for economic expansion.

Douglas A. McIntyre