Image RemovedJust 12 days before the Three Mile Island nuclear reactor disaster, in March 1979, a movie called ‘The China Syndrome’ was released. The title comes from the idea that if the core of an atomic reactor melted down, it would burn its way through to China. Thanks in part to the accident, the film became a blockbuster.

29 years later, America has triggered a global financial meltdown, from which China thought for a while that it might be immune. Not so. What did not happen in the film, is happening to the real-life economy of China. Factories are closing at astonishing rates, including in the Pearl River Delta – “the factory floor of the world,” and whole areas of business, such as scrap metal, are contracting or collapsing.

In Guangdong province, the engine of China’s export economy, the rate of annual export growth has slowed from 22.3% to 13.5%, and the overall economy has slowed to 8%, setting alarm bells ringing in Beijing. Of course, any western economy would be grateful for any growth at all, but China’s economy really needs to grow at double digit rates to stave off serious social unrest.

Thus the fact that the US meltdown has now flowed into China is potentially disastrous for this most populous nation, but as its exports shrink and its factories shut, the meltdown is starting to flow back to America again, making an ugly situation even worse.

This vicious cycle is playing out in interconnected ways. Reduced Chinese exports to the US mean that the Chinese have less foreign currency to lend back to America, which further exacerbates the credit crisis and tends to tighten the money supply, making it more difficult for Americans to buy Chinese exports (or anything else).

The reaction of the Chinese is to encourage the development of a free-spending consumer economy at the very time when that system is failing and being seriously questioned in the West. At least two observations, with far reaching consequences can be made.

One: China has subsidized its economic development by destroying its environment on an unparalleled scale and this will start to compromise its ability to keep growing fast, even without the looming global economic depression. The Chinese leadership appear to know this and show signs of being very worried. China has in many ways become the eastern anchor of globalization, and yanking it up, will cause even more global economic destabilization.

Two: a lot of the Chinese manufacturing export channels that have been built up so fast are collapsing, and some will not return soon or at all. Where the Chinese have been making absolutely vital goods for the West, there will be real pain until alternatives supply chains are rebuilt more locally. This will be no easy task in this climate of frightened and constrained capital. In many respects, it will require the rebuilding of the American and British manufacturing economies (less so the European), along with the supply chains to feed it and the return of the knowledge and skills to recreate it and run it.

It is hard to see how this can happen without massive government intervention, particularly from the US. Let us hope that President-Elect Obama wants Americans to start making vital goods once again. Otherwise, the world might find out the hard way that meltdowns happen and they flow both ways.