China grew at a 7.9% annualized pace in the second quarter this year.  How can it do this?

One of the reasons is massive, and some say unsustainable, lending by banks.  This is a mirror image opposite of the U.S. and Europe right now.  The government simply orders Chinese banks (many owned or controlled by the government) to lend, and they do.

In the United States, political leaders debate the extent to which the government ought to intervene in the financial market. In China, there is little debate. The government simply orders banks to lend — and it happens almost instantly.

This is a subsidy.  If a company has a cash flow problem… it gets money to cover.  If a company wants to build a new plant or upgrade to new equipment… it gets money to cover it.  If they don’t pay the money back… there are very seldom consequences.

The lending spree is three times the pace of last year.  Massive.

This unprecedented move to stimulate the economy through bank lending now appears far more ambitious than the $586 billion economic stimulus package that Beijing announced last December.

The major point for the U.S. is that you cannot have "free trade" with a non-free trading nation.  If the trading partner is massively subsidizing industry for exports, and we are not, free trade simply cannot exist.  It is silly and destructive to analyze the relationship in free trade terms.

The lending has risks for China domestically.

“They opted for a very quick fix,” said Stephen Roach, an economist and chairman of Morgan Stanley Asia. “Surging investment, fueled by the most rapid bank lending in history, accounted for nearly 90 percent of China’s G.D.P. growth in the first half of this year. And that is worrisome.”

Mr. Roach said China’s growth remained too heavily weighted toward investment, rather than consumption, creating unhealthy, imbalanced growth.

What does this mean?  Imbalanced growth? 

Think of it this way.  GDP consists of only four components:  (1) consumption (2) investment (3) government procurement and (4) net exports.  These four components should be in some balance.  Not necessarily equal, but there is an optimum balance range.

China relies too heavily on investment (by the state) and net exports (facilitated by the state).  They consume too little. 

The U.S. is the opposite.  We rely to heavily on consumption for about 70% of our GDP.  A world record.  Consumption should be, perhaps, at about 64% of GDP with investment being higher and net imports transformed to net exports.

We can’t credibly recover from the recession without doing this.

Our failure to balance the components of GDP will provide another jobless recovery.  The stock market may rise, but people will not go back to work.  Chronic unemployment because we import much of what we can produce and because investment is directed offshore so we don’t produce.

But the key driver for the Politburo is this:

Still, Beijing seems unlikely to tighten monetary policy sharply. The government needs to keep the economy on pace for 8 percent growth this year, quickly enough to create jobs and prevent social instability, particularly before celebrations this October on the 60th anniversary of the founding of the People’s Republic of China.

Without sufficient growth, the people revolt.  If Chinese are out of work, they have time to consider all the other inequities of their society.  Its a real problem for them.

The Arab world is a case in point.  Unemployment is high, human rights are low, and the attraction to more radical organizations is thus far greater.  These were the findings of a recent UN report.