Opinion: Bernard Hickey wonders what alternatives the government to get the economy going if China has a hard landing

By Bernard Hickey

Prime Minister John Key is as aspirational for New Zealand as he is for himself.

Tomorrow always seems a brighter day whenever you hear our Prime Minister talk about the economy and he was similarly upbeat early this week on how China would save us again.

He said New Zealand has the resources that China wants and China will grow this century into the world's largest economy. So of course things will get better, he said.

But will they? And what happens if China can't rescue the global economy like it did in 2008?  What is John Key's plan B? In the wake of this week's fresh warnings of a global downturn and Friday's  double downgrade of New Zealand's credit rating by Fitch and Standard and Poor's he may well need one. Here's my view on why the Double Downgrade matters.

China itself warned last week that it would not bail out Europe and is reluctant to lend a lot more to the United States. China has over US$3 trillion of foreign reserves, almost double what it was before the Global Financial Crisis, but these reserves cannot be redeployed to help Europe and America. They are already stuck in US Treasuries and European bonds.

China is actually keen to diversify away from America in particular and Europe more broadly to avoid being more exposed to the long-term sovereign debt crisis that is bouncing back and forth across the Atlantic.

That's one reasons why the state-owned China Development Bank was so keen to announce this week a partnership with PwC to lend billions of dollars for New Zealand projects, including potentially Auckland's rail loop and Christchurch's infrastructure rebuild. China's sovereign wealth fund was also seen as a likely buyer in the record NZ$1 billion sale of New Zealand government bonds this week.

But investing in New Zealand and lending to our government will not help the global economy, or demand for our exports from China itself.

One reason so many investors are nervous about the current slide back into a recession by Europe and the United States is that China is very unlikely to ride to the rescue again. In late 2008 and early 2009 China very quickly unleashed massive state-funded infrastructure spending on apartments, roads and airports to help its export-focused economy cope with a slump in demand for its exports from the United States in particular.

This drove demand for iron ore, coal and copper through the roof because these commodities are all used in the steel and construction materials needed for that infrastructure splurge. That powered Australia's mining boom, which in turn helped insulate New Zealand from the worst of the Global Financial Crisis.

But there was a price to pay for this massive surge in lending and spending inside China's economy. Inflation took off and now the Chinese central government is desperately trying to cool the economy down to take the heat out of inflation, which the authorities fear could could social disruption. Its latest 5 year plan called for just such a slowdown.

There have been dozens of riots and public protests this year in China over high living costs, forced land acquisitions, corruption and pollution.

China's government has cracked down particularly hard on the booming property development sector, which in recent weeks has seen share prices and bond prices collapse on Hong Kong and Shanghai markets as they struggle to get finance. Industrial production has contracted in China for the last three months and there are a growing number of forecasts that China faces a hard landing that could halve annual GDP growth to 5% over the next 5 years.

The leading indicator of such production is the price of copper, which is used in wiring, roofing, plumbing and industrial machinery. It is seen as a proxy for future new infrastructure spending and is often called 'Dr Copper' because it is seen as a metal with a PHD in economics. Its price has slumped 20% in the last fortnight.

China generated half of global economic growth since 2008, helping to avoid a US and European recession turning into a depression. It may not be able to repeat the Houdini trick this time.

And what will John Key's trick be without the magic of China?