So, what is the current global economic game?
The world is sloshing with US dollars which has led to the rise of China and the sub-prime crisis. Both are separate issues. China arose from excess funds being invested in China as well as the ability of Chinese goods to compete. The sub-prime crisis came from excess funds being lent to low-grade borrowers, especially consumers who are caught up by the asset bubble and consumption.
The sub-prime crisis will affect China growth insofar as it will affect the demand for Chinese goods. Even if the Chinese goods are the most competitively-priced, the overall demand will be affected by the growth of economies including the US.
The real critical factor is the global inflation.
The global inflation reflects the situation that global demand thanks to China has gone up one notch vis-a-vis supply. It is an illusion that global prices can be reduced by increasing global supply, because to do that it will have to push prices even higher as additional investment is needed for expansion.
But current higher global prices will reduce real demand, given nominal income. There is a real threat that higher global prices will result in slower growth.
The Greenspan-type policy trick is to keep expanding the money supply so that nominal income will rise to feed the inflation in the hope of maintaining output growth.
The question now is whether the Greenspan trick has come back to roost - that there is now so much inflation with so much excess cash that we are in what Keynes call a "liquidity trap."
The way out is for China to use the excess global liquidity and move the China economy one notch up in value-added. This will mop up the excess liquidity by paying China workers more, justified on better education and higher productivity growth. In order words, China will have to consume the output it produces. This will be genuine improvement of the lot of China society.
Europe will revive with China, as the more affluent China people will go for luxurious Europeon products. European inflation will be relentless, interest rates will rise and threaten a recession in other parts of the economy as the production of European luxurious products could be bound up by inelastic family-oriented production.
Economies like Malaysia will continue to do well in the commodity sector. This will disguise inefficiency in other parts of the economy. The central bank will continue to drive out cash with low interest rate in order to "contain" inflationary pressures. Politicians will intensify their fight for public funds which are diminishing as a result of the decline of the non-commodity sectors. The asset bubble is burst. Stock prices cannot hold up with weak fundamentals. Property prices cannot hold up with high vacancy rate, although speculators will try to stay optimistic on the argument that construction costs are now higher. In the end, even property prices must face the reality of demand and such trivial matters are rentals. This analysis can be extended into prime properties and sub-prime properties. But the point being made here is that the economy has been running away with asset inflation, and that self-defeating internal domestic game could be over. The real game is outside in the global economy.
At the end of the day, fundamentals of the economy will prevail, depending on how long the inflation mongers can keep up with their act of easy money policies. (Economic historians can remember that central banks were first established to curb the tendency of power manaics of overspending.)
Fundamentals: Produce things that will improve productivity growth which in turn will pay more to the people who work.