Analysis from AdvisorAnalyst.com

Cheap Goods and Labour are not China's only leading exports

China is lauded as the most significant contributor to the world's economy, printing 8.9% GDP growth during the third quarter. Its massive stimulus is helping to lift the world out of its economic funk.

Or is it?

China's chief export may no longer be just cheap goods or cheap labour, but controversy, over whether its policies are inflationary or deflationary for the developed world.

Critics believe China now poses the greatest risk to the world economy. Instead of being allocated to ramping up social programs such as pensions and healthcare that would free Chinese consumers' disposable incomes over the longer term, the stimulus appears to be allocated to more urban export-sector improvements.

Telegraph U.K. columnist Ambrose Evans-Pritchard argues on the deflationary side of the debate: "The reality is that much of Beijing's $600bn stimulus has been spent building yet more plant and infrastructure so that China can ship yet more goods, or has leaked into property and stocks. Credit has exploded. Allocated by Maoist bosses for political purposes, it has become absurd.

"China is rolling as much steel as the next eight producers combined. It is churning more cement than the rest of the world. Fixed investment is up 53pc this year," writes Pritchard. He adds that, "Hunan authorities have torn down two miles of modern flyway so that they can soak up stimulus by building it again" and "the newly-built city of Ordos is sitting empty in Inner Mongolia."

Bill Gross, co-CEO, PIMCO Asset Management, agrees and recently told Bloomberg that, "China is gearing up for export that doesn't find an end consumer – that's the real problem in China."

Bloomberg columnist, Caroline Baum's argument, on the other hand, echoes Jim Rogers' take on inflation. She says all the easy money, created by the quantitative easing and zero interest, has forced, and allows China to follow suit, printing yuan to maintain balance as it stockpiles dollars. This much liquidity is unsustainable though, ultimately inflationary, and bubble-forming for China and all it buys.

Baum wrote recently, that "China's M2 money supply is growing at a 29 per cent year- over-year rate, which, in economist parlance, is "unsustainable." She added that U.S. "M2 money supply has shown no growth since June," that U.S. "banks are hoarding over $1-trillion in excess reserves," while "bank credit has been falling almost consistently for the last 13 months."

Political will, on either side of the Pacific, for the Yuan to float higher, appears rhetorical. China does not seem willing yet to suffer the pain of withdrawal from its export dependency. Instead, China is benefiting competitively in even greater fashion relative to non-dollar countries from its doubly-cheap currency during the economic crisis, by leaving its currency pegged around 6.83 per dollar since July 2008.

In doing so, Beijing is dumping its unemployment abroad – "stealing American jobs", says Nobel laureate Paul Krugman. As long as China does it, other tigers must do it too. Pritchard adds, "China is still exporting overcapacity to the rest of us on a grand scale, with deflationary consequences."

Pritchard and Gross are most compelling on deflationary arguments that China's spending spree on supply-side infrastructure comes at a time when the demand is either not there, or constricted by credit market tightening. Its hard to know who's right, however, the deflationist's take right now is that it is too early in the cycle to make a call on inflation.