KEY POINTS:
What links Hu Jintao, President of the People's Republic of China, with the following people: an American mum shopping at Wal-Mart, former Citigroup boss Chuck Prince, and Federal Reserve supremo Ben Bernanke?
And how is Ralph Herndon, a retired car assembly-line worker from Otisville, Michigan, connected to Mr Yu, who runs a handbag factory in Guangdong?
It is the financial world's version of six degrees of separation. Economic woes have revealed the close connections and interdependencies between the US, the world's biggest capitalist economy, and communist China.
The huge glut of savings built up in Hu Jintao's China allowed that nation to lend billions of dollars to the US, which meant American consumers could embark on a borrowing and spending spree. But too many of those loans went bad, banks racked up huge losses, and CEOs such as Chuck Prince paid with their jobs. When the stock market caught on to what was happening, shares tanked on fears that the US would fall into recession.
That prompted Ben Bernanke to slash US interest rates by an extraordinary three quarters of a per cent last week.
As the US economy has shifted away from traditional manufacturing to service industries, car plants like the one where Herndon worked have closed, because of cheaper competition from lower-waged economies such as China. The Americans hope that China, and other emerging countries with cash reserves, will bail out banks and the world economy.
But as Yu has found to his cost, Guangdong is not immune to US troubles - 70 per cent of his American and Canadian customers are not paying their bills on time.
The current crisis has raised fundamental questions about the merits of the American model. For many years, the US has lived beyond its means: borrowing heavily to gobble up cheap Chinese consumer goods; splashing out the proceeds of a decade-long housing boom; and preaching the benefits of liberated markets.
Now the rest of the world is anxiously glancing eastward, in the hope that as America slides towards recession, the rising economic powers of Asia - in particular, China - will help to forestall a full-blown global crisis.
But as Mr Yu would attest, the hope that the Chinese dragon can slay the American bear is a pretty vain one.
A few decades ago, looking to China as the driver of global growth would have been unthinkable. Henry Kissinger, Nixon's Secretary of State, who was instrumental in opening up the channels of communication with China in the early 1970s, told the World Economic Forum in Davos, Switzerland, last week that he had no idea at the time that Beijing could emerge as an economic competitor.
In Otisville, Herndon and his former colleagues at General Motors know all too well what it feels like to be on the sharp end of competition from China. Flying into Detroit, 110km away, planes soar above mile after mile of rusting cars, girders and industrial scrap in what looks like the biggest junkyard on earth. Herndon, who worked for GM for 30 years, says he was struck by a realisation last year.
"I thought to myself, they are paying these guys in China US$3 ($3.87) a day to do what I have done all my life. No matter what cutbacks we offered the management, there is no way we can match that. I guess we are finished."
Now it is the turn of the banks to feel the growing muscle of the Chinese.
There could have been no more potent symbol of the shift of global power than the spectacle of America's mightiest banks begging for cash from Government-backed sovereign wealth funds from China and the Middle East to cover the vast losses they have clocked up through reckless lending.
But America has relied on Asian cash for years, locked in a bizarre financial embrace with the country that has become the world's factory, and in many ways its banker. Like many nations with a strong export sector, China has earned more than it could spend and has accumulated vast savings in the past decade.
Much of this cash has been sucked into the US, as Beijing opted for the dollar as the safest currency in which to keep its reserves. In effect, it has been lending billions of dollars to the American Government.
This wall of Asian cash has helped to keep the cost of borrowing down throughout the rich world and contributed to a series of asset price bubbles, in housing and in shares.
The enthusiasm of sovereign wealth funds for buying up chunks of US banks - and a range of other companies - is the latest manifestation of this phenomenon.
But economists have become increasingly nervous that the world is out of kilter, with some countries borrowing and spending too much, and others too little.
Optimists argue this will not matter, because over the past decade there has been a beneficial "decoupling" in the global economic train: America is no longer the sole engine of international growth.
In its assessment of the economic prospects for 2008 this month, the World Bank set out a rosy scenario in which emerging markets would continue to expand strongly, despite the credit crunch and the slowdown already under way in the US. China, it predicted, would slow almost imperceptibly, from 11.3 per cent GDP growth in 2007 to 10.8 per cent this year.
But the worldwide stock market rout last week suggested investors, at least, are not convinced that "decoupling" is really here.
The idea of "recoupling" is suddenly in vogue.
Although China has begun to generate expanding consumer demand of its own, its decade of 10 per cent annual growth has been largely on the back of an explosion in exports, so it is vulnerable to downturns elsewhere.
As he contemplates the future over a working lunch, Li Xihao, senior manager at garment manufacturer Shanghai Eswell, which exported US$10 million of its garments last year, is hoping that US troubles will not have knock-on effects in Sydney and Melbourne.
"We are worried about the American economy and it's very difficult to tell what the outlook is," he says. "At the moment our major market is Australia and that still looks OK, so hopefully the business will not be affected."
Nariman Behravesh, chief economist at consultancy Global Insight, expects US consumer spending growth to halve, from 3 per cent in 2007 to 1.5 per cent this year - and warns that China will be unable to escape completely unscathed.
"The US is too big not to be having an effect on the rest of the world."
Yu in Guangdong would agree. More than 1600km north, shoppers are snapping up clothes and accessories in Beijing's department stores. But his factory has thrived by aggressively marketing exports and has little to gain from the purchases of its compatriots.
"We export mainly to America and Canada and because of the economic crises about 60 to 70 per cent of our bills haven't been paid on time. Even our old customers have all kinds of excuses. The exchange rate is dropping as the lending rate is going up and the salary for workers has also been increased, so it is getting more and more difficult to earn money."
Stephen Green, an economist with Standard Chartered specialising in China, agrees that prospects are clouded in the short term.
"Inflation in China hasn't got better and the US situation is looking serious, so there's going to be a hit. But China is going to continue growing. We see it slowing from 11.5 per cent growth last year to 9.5 per cent this year and 8.2 per cent next year. A large part of that is from the trade side."
But the linkages of international trade are not the only mechanism for propagating the crisis. When rumours emerged that the People's Bank of China would have to write off a quarter of its U$7.95 billion of sub-prime securities last week, it underlined the importance of global financial markets in transmitting woes around the world.
Hugh Young, MD of Aberdeen Asset Management Asia, warns that foreign investors nursing losses are likely to respond by taking a more cautious approach and bringing their cash home. That could exacerbate the market plunge in Asia, and make it harder for companies there to raise cash.
Since the liberalisation of the Thatcher and Reagan years, reining in the world's banks has become a taboo. But the damage wrought on ordinary borrowers and businesses by reckless lending could be felt for years.
Philip Augur, a former investment banker and author of The Greed Merchants, which looked at the banks' role during the dotcom crash, believes it is time for financial institutions to be more firmly controlled.
"Deregulation seems to have become 'unregulation'. Financial services institutions are too large and powerful to be left to their own devices." Joseph Stiglitz, a Nobel prize-winner and former chief economist at the World Bank, says: "This is the third crisis for American financial markets in 20 years, and that should tell us something. The sub-prime issue is about predatory lending, but it has gone badly wrong. The situation has been created by financial institutions that have run amok."
According to Stiglitz, the banks "talked up" their ability to manage risk, but the liquidity squeeze shows "they didn't know what they were talking about".
He adds: "The banks' incentive schemes need looking at. We thought these structures were about maximising corporate profits, but it seems they were more about maximising the profits of senior bankers and chief executives ... "
The UK, which under Gordon Brown's chancellorship (when he was finance minister) deliberately mimicked the US approach, looks particularly vulnerable to both prongs of the current crisis - the comeuppance of consumers and governments living beyond their means; and the retrenchment of an over-mighty financial sector.
In Davos, Stephen Roach, the bearish Asian president of Morgan Stanley, criticised Alan Greenspan for failing to rein in the boom several years ago: "The Fed's attitude is that it is here to clean up after bubbles burst, not prevent them from happening ... this is a dangerous, irresponsible and reckless way to run the world's largest economy."
When the cash taps have been turned on so long, it can be hard to turn them off. As Graham Turner, of consultancy GFC Economics, says: "We caused this problem by having runaway credit growth, now we're trying to solve it by cutting interest rates. It's rather like a heroin addict: you can say they shouldn't have got addicted, but once someone is addicted, you don't take away their drugs overnight."
The big question now is whether the US - and the UK - will finally have to go cold turkey.
- Observer
