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China's Premier Wen Jiabao has just warned that China's economy is now facing challenges, including higher-than-desired inflation and an economic slowdown.
Our guest James Rickards, the author of Currency Wars: The Making Of The Next Global Crisis, says this slowdown will be significantly worse than most people think. He believes it will trigger a policy response from the United States that will likely lead to a third round of "quantitative easing" by the Fed.
Rickards thinks China's economy could slow to a 3.5% growth rate. This doesn't sound bad, but it would be a disaster relative to the 10% growth rate of the last few decades, and it is much more of slowdown than most analysts are looking for.
In response, Rickards says, the Chinese government would likely devalue China's currency relative to the dollar, to help stimulate exports. This would counter Washington's ongoing attempts to do the same thing. Rickards believes that the U.S. would respond with another round of quantitative easing designed to produce inflation, likely through a technique called "nominal GDP targeting."
(Nominal GDP targeting would allow the Fed to explicitly focus on a target GDP growth rate that includes inflation, as opposed to trying to fight inflation by focusing on real GDP growth. Inflation would help the U.S. reduce the real burden of its massive debt load, and it might also make U.S. exports more competitive.)
A sharp China slowdown could also hammer Europe, which is already reeling from a banking and sovereign debt crisis.
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