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While many analysts are focused on deciphering every development concerning the potential actions of the Federal Reserve to try and stimulate the economy, such as initiating a third round of quantitative easing, it is important to keep in mind the impact of potential government action for the second largest economy in the world: China. In fact, the Chinese government is well-positioned to enact significantly more proactive stimulus measures in light of recent economic developments.

Of course, this is hardly China's first brush with economic stimulus. In fact, the Chinese government has, historically, exhibited an aggressive approach to government stimulus in times of economic challenges to the Chinese economy. Take, for example, China's unrolling of stimulus after the Asian financial crisis in 1997. Or look at China's massive 2008 4T yuan stimulus package that is credited with helping to significantly alleviate worldwide economic concerns. This whopping round of stimulus, worth $586B and constituting 16% of China's then-GDP, was spread over the course of two years and was effective in part due to the Chinese government's unique ability to exercise significant influence over various investment trends in the Chinese economy, stimulating consumer spending and thus the economy. This unique ability is a tantalizing factor not only in the weighing of future stimulus actions by the Chinese government, but also to investors eager to ride on another wave of stimulus.

Another factor that could play a significant role in further stimulus decisions by China is deflation, which would provide the Chinese government with ample room to implement monetary easing policies that would in turn lead to inflation. Yesterday, China's July Consumer Price Index came out at up 1.8% YOY. Although this figure is higher than the consensus of 1.7%, it is still extremely low. In fact, it's actually a 30-month low for inflation, which seems to be roughly following in the footsteps of China's weakening economy. As further indication of the easing inflation, China's PPI plunged 2.9% YOY, marking the fifth straight month of decline for the Producer Price Index. As noted by Qu Hongbin, chief economist at HSBC China, the data "has highlighted the grim facts of sluggish market demand, shrinking business orders and continuing destocking."

It should be noted that China's government is currently hardly in a state of apathy concerning the Chinese economy; in fact, the government has recently been undertaking stimulus-like measures to address increasing concerns about its slowing economy. It has freed up approximately 1.2T yuan for bank lending to increase credit liquidity, implemented two rounds of interest rate cuts (historically rare for the People's Bank of China).

Yet this is not enough. China has experienced a slide in growth for six successive quarters and is expected to post its slowest full year of growth since 1999. Annual growth in China's factory output slowed to its weakest in more than three years in July and economists have rolled back their estimates for annual export growth in China to 8.6 percent. As noted by Alistair Thornton, a China economist at IHS Global Insight in Beijing, "the government needs to transform its current stimulus push into a stimulus punch."

Another significant catalyst for Chinese stimulus action that is often overlooked by analysts is the sociopolitical aspect of continued strength in the Chinese economy. Economic growth is the opiate of the Chinese masses and the main vehicle by which the Chinese government can placate potentially significant unrest. In fact, the majority of Chinese citizens are content with the tradeoff of fundamental human rights such as free speech for increasing living standards; a significant slowdown in the Chinese economy could cause reconsideration of this tradeoff. Moreover, the Chinese government sees sustained economic growth as essential to achieving solid economic gains by building a prosperous developed country with an affluent middle-class. With the increasing prospects of a slowing economy, the Chinese government would be hard-pressed not to act decisively.

Overall, there is significant impetus for the Chinese government to unleash a sizable stimulus package. For one, it maintains significant control over investment trends in the economy which in turn provide it with flexibility in terms of allocating stimulus money to portions of the economy. The Chinese economy is also continuing its slide despite various measures the Chinese government has enacted, a development which might force the government to weigh more drastic options. The threat of deflation also allows the government some breathing space in terms of implementing stimulus measures while the social aspect of a slowing economy is always in the back of its mind.

Source: A Potential Chinese Stimulus Package