Brad Setser

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Cross border flows, with a bit of macroeconomics

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Banker? Strategic competitor? Both?

by Brad Setser
February 20, 2005

The US borrows about 1/5 of all the money the federal government spends, and most of the borrowed money comes from abroad: foreign purchases of Treasuries in 2004 exceeded the (net) issuance of Treasuries required to finance the deficit. So a decent chunk of the Defense Department’s budget comes not from tax revenues, but rather from a loan from the world’s central banks.

Even if China is not financing the US Treasury directly, it certainly is supporting the US housing market through its purchases of Agency debt and mortgage backed securities. That helps to make W’s policy of guns (defense buildup, war on terrorism), butter (prescription drugs & the pork in the stalled energy bill) and tax cuts consistent with low interest rates and rising housing prices. Take away the “low interest rates and rising housing prices” and there would be a lot more pressure to choose among guns, butter and tax cuts.

That is why the Pentagon’s sense that China is a future strategic competitor, along with the incipient Sino-American rivalry created by China’s growing interest in financing the investment required to meet China’s growing need for natural resources, is so interesting. A sage commentator on this blog noted that Japan can hardly invest its reserves in US corporate debt, since that would finance the US rivals of major Japanese firms. Can the something similar be said of China? Will China want to finance the US government, through the purchases of Treasuries, as US seeks implement a strategy intended to contain China’s regional, if not global, ambitions? Or will it prefer to step up its own direct investment in the production of the world’s oil and other commodities, even if that means investing in places that the US labels pariahs? Will the Pentagon brass start to worry (publicly) about the United States’ financial dependence on China? Worry (publicly) about the large quantities of Treasuries that China could dump on the US market in a crisis?

Make no mistake, China acted as the world’s banker in 2004. Its total reserve accumulation of $200 billion represented about a quarter of the world’s aggregate current account surplus: the People’s Bank of China in effect determined the allocation of a significant fraction of all (net) cross border savings.

Not all of that reserve accumulation was financed by China’s comparatively modest (roughly $50 billion) current account surplus. But that only make China’s government look more like a bank. During 2004, China’s external liabilities rose by roughly $150 billion while the People’s Bank of China’s external assets increased by $200 billion. China’s government effectively uses global demand for Chinese assets to finance its own purchase of asset abroad, and in the process, determines (or perhaps distorts) the allocation of much of the world’s savings.

This is something that I would like to see “strategists” like Tom Barnett take up, but in a slightly more (financially) sophisticated way.

Barnett, author of the Pentagon’s New Map, is a big Sinophile within Pentagon circles, and a major critic of the “China as strategic competitor” thesis. He sees the US and China as natural allies, since both are winners from economic globalization (in Barnett’s terms, they are part of the integrating core). Rather than compete, they should cooperate to bring order and stability to those regions of the world that have yet to benefit from globalization (Barnett’s gap).

Barnett postulates that the US can tap into China’s growth by investing in the production, transport and distribution of the energy China will need to fuel its growth, creating a natural harmony of interest between the US and China (see p. 230 of The Pentagon’s New Map).

Nice theory. Alas, it sort of ignores the fact that the US is a big net borrower on the world stage. The US cannot finance its budget deficit and relatively modest pace of domestic investment out of its own (meager) savings. China, in contrast, invests a ton and saves even more (more than I think it should). It consequently would have a surplus of savings that it could use to finance external investments even if were not attracting large capital inflows from the world.

The US can only invest abroad if foreigners are willing to buy enough US debt to finance both the US current account deficit and its overseas investment. That is what happened in 2004: total sales of US debt abroad of $900 billion exceeded the roughly $660 billion current account deficit, leaving $240 billion to finance investment abroad. However, borrowing abroad at low rates to invest abroad may be a bit too much “exorbitant privilege” — to borrow a phrase from De Gaulle — for China’s taste. There is no guarantee that China will prefer to finance Exxon’s investments in expanding the world’s oil production capacity rather than, say, financing similar investments by its own oil companies.

Barnett is aware of these tensions, even if he exaggerates China’s need for financing from Wall Street and understates the United States’ need to tap into Chinese savings to finance its budget deficits. His recent call for a grand bargain between the US and Iran, where the US lets Iran build nukes in return for Iranian recognition of Israel, is premised on the assumption that China and India will invest in Iran’s oil no matter what, and thus efforts to stop Iran’s nuclear program will ultimately fail …

One small aside: most savings stays at home, so by world’s savings, I am talking about the savings that flows across borders (the global current account surplus). A fair critique would argue that gross flows matter more than net, as the net is often the difference between two much larger sets of gross flows that partially offset. China’s share of the gross flow of savings is clearly much smaller than its share of the world’s net flow of savings. That said, the net flow is not exactly irrelevant either.


  • Posted by steve kyle

    I dont claim to be knowledgable about China, but the following are thoughts that occur to me late Sunday night and perhaps should be better filtered but what the hell.

    It is also important to look at what is happening INSIDE of China. The “normal” thing to be doing for a country at China’s stage of development would be to be a capital IMPORTER rather than the exporter that they are. That is to say, one would have thought they would be borrowing from the r.o.w. to build their infrastructure and industrial base so as not to have to squash their consumption too much while so doing.

    So why are they not doing this? The standard explanation is that they are focused on keeping their currency down and continuing to encourage growth in their export zones. But sooner or later there will have to be a change. As coastal cities grow, so will their demand for all sorts of products that are made elsewhere in the country, most notably food, but also they will need more and more imported inputs. The needed changes can happen in two ways – they can revalue, making the imports cheaper and/or they can invest in domestic productive capacity for the things that they can produce themselves. (e.g. food for all those urbanites)

    To fail to invest in the domestic non-export economy will eventually result in inflationary pressures as increasing demands cant be satisfied by the stagnant prodcutive capacity in large parts of the country. This will cause a real appreciation of the currency which will eventually do from the inside what failure to revalue would do from the outside.

    In fact, the current situation ought to be doing this to some extent already. In all of the discussion about China I rarely hear anyone talking about inflation and what it is doing to the real exchange rate – I would have thought that would be an issue even without resorting to arguments about failure to invest in the domestic economy. And not just an issue but a very important channel for relieving some of the pressures that are building up from what is happening in the international accounts.

    But on the other hand its late and maybe I just ought to sleep on it

  • Posted by brad

    Both Ronald McKinnon of Stanford and Stephen King of HSBC (and I suspect, Andy Xie of Morgan Stanley) have argued that higher inflation in China/ lower inflation in the US (i.e. an inflation differential) is the way to correct China’s real undervaluation. All believe that it would be a mistake to change the peg. McKinnon points to the example of Japan in Bretton Woods 1, where inflation differentials produced a sustained real appreciation of the yen.

    I see a few problems with this — the most important, though, is that apart from 2003 and 2004, inflation (at least reported inflation) in China has been lower than inflation in the US, so China’s real exchange rate has tended to depreciate, not appreciate. At least that is my read of the data in the King/ HSBC report. There are a range of plausible explanations for this, but it still seems a bit odd to me.

    Other potential problems: pegging v. the dollar is not quite the same thing as exchange rate stability, it can lead the renminbi to depreciation v the euro, the yen, the won, etc and thus overall real depreciation of the renminbi (see 02-04) — this is a real problem in particular if rising productivity in China suggests that overtime china needs a real appreciation against the world, not just the US; adjustment via inflation differentials is slow (see Argentina); and given China’s size and rapidly expanding productive capacity, there is no guarantee that the adjustment will come about through inflation in China rather than say deflation in the US …

  • Posted by Movie Guy


  • Posted by anne

    There are times of nationalist emphasis in which China’s media and so Chinese people, especially students, express criticism of America. Still, for all the cold war legacy, there is a history of friendship and admiration that has extended from the 1930s and before. Lately there has been a strain in American writing that treats China as an inevitable growing treat to America, but I can not understand why this should be so.

    The trade off between China and America is not what might have been expected a few years ago. We are vastly stronger in military terms than China and our technology is far advanced. Spending will keep the military lead, while research openness and flexibility are likely to keep our lead there. Why then should we not feel secure? Ah, the trade deficit. We have a balance of trade deficit, especially with China, that makes it difficult for us to be as competitive in international resource development as we should be. Interesting problem.

  • Posted by c

    Wage inflation is i think a more logical number to look at and that was significantly higher in China than in the US IIRC

    Also China’s banks are bankrupt and needs inflation to rescue them

  • Posted by anne

    China’s economy is growing rapidly, a middle class is finally well formed and expanded, so there is every reason for wages to be increasing rapidly.

    The Chinese are using dollar reserves to shore up the banking system, and there is every reason to believe the essential effort will be successful.

  • Posted by brad

    Anne — re “There is every reason to believe the essential effort will be successful.” Could you flesh out your thinking a bit more.

    I would argue that there are three reasons to think the plan won’t work.

    1) Dollar assets don’t solve the underlying mismatch between renminbi deposits and renminbi assets. Dollar assets, in renminbi terms, are likely to fall in value over time, while the renminbi denominated hole created by past bad loans, at best, will stay constant. Dollar assets strike me as a natural way of offsetting losses on dollar deposits, not a natural way of offsetting renminbi losses on renminbi deposits. China seems to be using dollars because it has dollars, not because that is what the banking system needs (if someone knows more about this, do chime in).

    2) The increase in dollar reserves is only being partially sterilized — leading to rapid monetary growth, contributing to rapid credit growth, etc. all that risks feeding existing bubbles (such as the real estate bubble in shang hai) and creating new bad loans. moreover, by forcing the banks to take sterilization bonds at below market prices, the government is in effect forcing the banks to absorb losses — or at least make less (in the short-run) than they could lending to china’s private sector rather than the central bank. I am not sure how either solution — forcing the banks to hold below market sterilization bonds or not sterilizing an enormous reserve inflow and thus accepting a surge in the money supply in an environment where lending rates are controlled — improves the banks’ underlying solvency much.

    3) Usually, with overvalued currencies, you worry about a mismatch between dollar denominated loans and local currency revenues. with undervalued currencies, though, there is cause to worry about renminbi denominated loans and dollar revenues — i.e. firms that are borrowing like mad to invest like mad to build up their export capacity in the expectation that the renminbi will stay at roughly its current level and chinese exports to the uS will continue to grow at 25% y/y. in the big paper i did with nouriel, we forecast out what the US and chinese economies might look like if that kind of export growth (for China)/ import growth (for the uS) continued for four more years — suffice to say it ain’t pretty. try (1.25)^4 * $200 — it is almost $500 b. Does any one really think the US will be importing that much from china in 2008? Something will have to give. hopefully, that capacity can be redirected toward meeting china’s domestic demand.

    Like you, I have been impressed by China’s economic dynamism. But by holding on to their peg for too long, I worry that they are accumulating a set of vulnerabilities under the surface that will cause serious damage to China’s future prosperity — too many dollar reserves, too much credit extension, too much investment in the export sector (when Chinese export growth likely will slow over time … )

  • Posted by Yusef Hydrogaster

    The rest of the world saves so that the US can spend. Is it possible that the US can spend MORE than the rest of the world saves? If it is the case that the US currently soaks up more than 90% of the world’s savings, and it is impossible for the US to spend more than the rest of the world’s saves, is this “system” more likely to collapse on the basis of this impossibility than due to strategic realignments ?

  • Posted by brad

    Yusef — good point, Nouriel and I have tried to make a similar argument, with a few twists related to current “savings” from central bank reserve accumulation. General Glut has argued (as have others) that our Pacific allies (Japan, Taiwan, and to a lesser extent, Korea — they don’t exactly see eye to eye with us on north korea all the time) will keep the system going in part for geopolitical reasons. That leads you to China — it is central to the overall international economic and monetary order, particularly in the Pacific but also globally. And it is not exactly a US ally. That creates some interesting fault lines.

    But it is not at all clear how they all break.

  • Posted by Jeff Fisher

    Can USA consume more than the world saves?
    Inflation and Capital Consumption go hand in hand. Inflation masks capital consumption, providing the illusion of profits when in reality there are losses.

  • Posted by gillies

    i wonder if this is considered relevant to current deficits?


    “Finally, some internationally-recognized mechanisms should be developed for dealing with the recurring problems of excessive and insupportable sovereign debt. General rules for creditor committees (including, for example, voting systems which, while requiring super-majorities to approve restructuring agreements, make it impossible for small creditors to unduly delay or derail them) should be established. While it may be true that sovereign debtors don’t go bankrupt, the establishment of a general mechanism for dealing with restructuring sovereign debt will provide the necessary context in which creditors can estimate the degree of loss which they might sustain. This would make it easier to assess the degree of risk that should be attributed to sovereign debt when setting capital adequacy standards for banks.
    Underlying all these proposals is the notion that, if global financial markets are to operate efficiently, there must be mechanism for preventing and rapidly dealing with the kinds of excessive debt burden which can paralyze banking systems and pour sand in the gears of commerce, as is currently the case in East Asia.

    Greater transparency will make it clear sooner when debt has reached unsustainable levels; a greater readiness to force firms or banks into bankruptcy — or sovereign debtors into restructuring — will enable those debt levels to be extinguished by means of partial payments and transfers of equity; and the existence of these procedures and the experience gained as they are implemented will enable creditors to make more informed assessments of the risks they are running. Most importantly, these procedures will allow capital and productive assets to be quickly returned to a condition in which market forces can reallocate them to their best and highest uses.

    – If this is to work on a global scale, then nations can no longer make distinctions between debt and equity investment by foreigners. In other words, if foreigners are allowed to lend money to a nation’s businesses or banks, then they must be allowed to hold equity in them as well, generally on the same terms as domestic investors.”

    ( from the website of the project for the new american century.)

  • Posted by brad

    Gillies — much as I am attracted to the notion that the US looks all too much like an emerging economy, i don’t think the general debate on the soveriegn debt restructuring mechanism has much relevance here. emerging economies have to restructure their debts b/c there debts are denominated in a foreign currency (dollars or euros), and they can run out of foreign currency (see argentina) — and b/c in a crisis, their citizens shift out of local currency assets into foreign currency assets, creating massive capital flows (again, see Argentina).

    The US borrows in its own currency. It won’t default, at least not in the conventional sense. It can simply erode the real value of the dollar debts held abroad by letting the dollar depreciate. The risk facing the US is much more simple: it may not be able to continue to borrow from abroad at current interest rates for much longer, and if the interest rates foreign savers demanded went up, that would have a big impact on the US. The uS is a far more “credit” dependent economy than a typical emerging economy, and is less used to volatility in dollar interest rates.

    one other thing — sovereign debt does not become “equity” in the sovereign when a sovereign defaults; there is no shift in control …

    (but hey, i may just be disappointed you drew on the project for a new american century for insights into sovereign bankruptcy rather than the book nouriel and I wrote on the topic!)

  • Posted by Steve

    While talking geopolitical considerations, it’s worth noting that there’s more at issue than players in the US and Asia. From today’s GEF (Eric Chaney and Richard Berner):

    “…With Saudi Arabia now firmly in control as swing producer and the global economy showing much more resilience to elevated prices than previously thought, we believe that the OPEC cartel is happy with quotes near $40/bbl.  Indeed, it appears that OPEC is now aiming at operating with reduced inventory levels — about 10% lower than previously, or 50 days’ supply — which will leave the markets more vulnerable to shocks.”

    “Only if and when the global economy shows clear signs of weakness would this position change, and that’s unlikely soon, in our judgment.  We believe that the global economy is less vulnerable than in the past to oil price hikes, for three reasons.  First, higher specific taxes and increased energy efficiency have made many of the industrialized countries less sensitive to specific oil price hikes.  Second, appreciating currencies until 2004 shielded many consuming countries from the rising price of crude, which is priced in dollars.”

    “Third, and more intriguing, in many developing economies that are big energy consumers, price controls on refined products or active tax management shield consumers from price increases at the wholesale level…”

    When oil prices spiked last year, it was widely discussed that the contractionary effect of high energy prices reduced pressure for tighter monetary policy in the US. Here we have the converse: The exceedingly low cost of money in the US supported in part by Asian financing is helping to enable continued high oil prices by reducing the threat to oil-exporters of a global demand contraction. This seems counter to even very short term strategic interests of the United States, even positing (optimistically and hopefully) that the US and large Asian economies are natural allies who will eventually find a constructive way to work through the current imbalances.

  • Posted by steve kyle

    I have been trying to think about the “natural allies” notion. It made perfect sense when we were both enemies of the USSR, but that is no longer the case. Now, it is easier to see us as competing for the same resources (oil mostly) and eventually coming to some sort of conflict if our overt grabs for control of oil by, e.g. trying to turn the Persian Gulf into a US lake looks like it is working. Sort of reminds me of the history before WW II when the Japanese felt we were shutting them out of raw materials they thought they legitimately ought to have access to.

    On the other side, the more trade we have with each other the more we are on the same side. So I am all for full speed ahead economic intertangling with the Chinese – But what makes me nervous is the obvious ability of some in the Republican Party (I wont put it on the Dems because even if they deserve it they arent in power) to completely ignore economic reality and go for short run political gain.

    So it would make sense for us to do whatever possible to make the Chinese feel secure in their supply lines and in the creditworthiness of those who are borrowing from them (us). It isnt clear to me that we are doing either one.

  • Posted by anne


    The response to my comments was convincing and necessarily discouraging. The problem is severe and having written out my argument it strikes me as foolish. Using dollars to set off debt in renminbi, when renminbi is the undervalued currency and renminbi debt problems are likely to grow quickly when real property prices stop rising, is not an effective solution to shoring up bank assets. There is a problem.

  • Posted by brad

    Steve — good point. the combination of low (tho rising) US policy rates and low long-term rates has let US consumers continue to spend (in part by borrowing) even in the face of higher oil, higher oil prices have not triggered a fall in demand. And Asian oil importers (the third point you truncated), particularly CHINA, are using policy/ administrative controls (i.e. guidance to the state oil company) to limit the domestic price increase associated with higher global oil, limiting the feedback on demand from Asia (hmm — Chinese manufactures get an oil price subsidy in addition to an exchange rate subsidy — that is sure to make US manufacturers happy … ).

    In the short-run, all this helps support the global economy; in the long-run, it seems to me to increase a range of risks.

  • Posted by brad

    steve kyle — thanks for thinking about the “natural allies” point; i wanted to start a discussion on grand strategy, not just economics!

    one question — suppose China keeps the peg for three more years, and adds say $200b a year in dollar assets, bringing its total dollar reserves up to $1050 b, and its total reserves to say $1450 b (the exact forecast can be debated, but if the peg is kept at close to its current levels, it seems to be that the incentive to bet on chinese revaluation goes up over time, so reserve accumulation goes up). Does that degree of financial interdependence strengthen ties between the US and China? The PBOC has a huge stake in America at that stage. Or does it introduce a potential source of leverage ($1000 b in dollar asset is a huge number; think of the impact of selling some)/ a potential source of tension? It would certainly be unprecedented. Japan holds an enormous sum of treasuries, but it is tied to the US through a security alliance …

  • Posted by anne

    Immediately, though possibly foolishly, I would respond that China and America are growing continually more economically dependent on each other in a way that is benign. China is not ideologically driven, and while competitive for reasources and trade, there is no sense the leadership wishes to be threatening. A mutual cultural appreciation in the countries is especially evidenced in the arts.

  • Posted by Jim

    i like the point about the broken feedback loop of higher prices to reduced demand for oil, this market manipulation can definitely lead to tension…

    i’ve been wondering about an analogy between the great depression in the u.s. and current china. both have severe monetary craziness (1928 gold = 2005 $). much of the consumption is built on foolish debt. new technologies are building up serious deflationary pressures.

    except now it’s much more of a global thing. and the supply-side and demand-side fools are on different sides of the pacific, generally speaking.

  • Posted by still working it out

    I do not think that China and the US will become strong overt strategic competitors in the near future. China’s seems to be quite sensibly concentrating on economic growth. As long as the US does not prevent them growing to their economic potential it is pointless to try and compete with America until China has surpassed the US economically. As Sun Tzu says

    “Therefore a victorious army first wins and then seeks battle;”

    In a world in which the US had its financial house in good order it would be natural for the US to try to contain China. The US is committed to a uni-polar world and China, with its huge population, is a natural threat to that.

    However China’s financial leverage over America creates a political dynamic in the US where it is not practical for US leaders to demonise China. At first glance this seems strange as China wielding a one trillion dollar club should be quite threatening. But in practice, the bigger that club grows the more nervous Wall St will be about any tensions between Washington and Beijing. If every time a senior US leader chastises China it is followed by a tumble on Wall St then it hardly makes political sense to try and compete with China. And a as a last resort China can threaten to deliberately induce a recession by dumping securities. Bush Snr won the war but lost re-election due to recession. Reagan’s “evil empire” rhetoric against the Soviet Union would surely have been a lot meeker if the USSR had China’s financial leverage over the US.

    It is for this geo-political reason that I think China will be happy to continue acquiring US financial securities well past the point where it makes economic sense and will even be happy to endure substantial losses on those securities. They are using the financial leverage to postpone any conflict with the US until after they have surpassed the US economically.

  • Posted by test

    i apologize…testing.

  • Posted by sanj

    Why is the republican party — the party of big business — so intent on drowning the country in
    debt ? Why arent business leaders — whom have a leash on the pary — being more vocal
    about the iminent looming disaster ?

    Its obscene that educated people could even
    consider privatizing social security at a time like this, given all the additional debt involved.

    Is this really just blind ideology ?
    It never occurred to me that even ideology
    could trump the longer term economic interests
    of the ruling class. I just don’t get it.

  • Posted by anne

    When you ask the question with such passion, I am reminded that I simply do not know. Was there ever sincerity? Surely, I do not find it now.

  • Posted by steve kyle

    as the cliche goes, if I owe you a million dollars, I’m in trouble. If I owe you a trillion dollars, YOU are in trouble.

    But it is a good question about economic entanglement in the capital account vs. the current account. In other cases I sort of automatically think of the issue as one where if you trade more with each other then you are more on the “same side”. But if it is too lopsided in the K account then maybe its different. Certainly the politics are different – when we are talking about goods and services there is always somebody’s job involved – someone the newsies can go and interview and put on national news. Its harder to do that with the capital account.

    But that bears some more thought – What kind of interdependence is good? or is it all good?

  • Posted by anne

    All good, Steve. I am gladened with every exhibit of Chinese art I see. The more we are tied economically and culturally the better 🙂

  • Posted by camille roy

    “Why is the republican party — the party of big business — so intent on drowning the country in
    debt ? ”

    This is a question that addresses not the rational calculation of self-interest but a confluence of historical and ideological forces. The best book on this subject that I’ve read is:

    Made in Texas
    George W. Bush and the Southern Takeover of American Politics
    by Michael Lind.

    Lind is a 5th generation Texan and casts invaluable light on the forces driving today’s ideological alignments. One way to think of it is that this is a Southern party more than a Republican party. It has more in common with the oligarchies of South America than with the Republicans of yesteryear, those pragmatic businessmen and statesmen of the Northeast.

  • Posted by Alex

    Agree with Brad’s posts for a while now about U.S. econ., current accounts, and trade situation.

    Sorry, but disagree with most of you (Movie Guy exception) are naive or not really interested in American citizens interests.

    Am very concerned about China, China’s plans, and what N.Y. based funny money boys and paper professionals have done in China; also what they have all sold elsewhere to grow huge U.S. account deficits, sell U.S. treasuries & our govt. agency paper and to whom, and sell off U.S. assets, etc. Am very concerned what the N.Y. based and other funny money boys did to fund Amer. corporations massive new plants in China then sending those products as imports to be consumed here after having spent the last decade gutting this country’s productive segments.

    I am seriously concerned. Have agreed with Brad’s
    take on things for a while.

    Anne, seem more than a bit naive regarding all. If it was only art and culture……

  • Posted by brad

    Alex — appreciate the endorsement of some of my arguments, but be careful: I am, in most respects, a NY based funny money type. There is a certainly a range of opinion in the NY financial world on the sustainability of the current situation, and a certain amount of unease.

  • Posted by anne

    There is no reason I can find to believe that China should be more than an economic competitor for India and Japan or Europe and America. We have gained many consumer benefits from trade with China, and they are building a better life for 1.3 billion people. Also the various and continually growing cultural exchanges with China are drawing us closer. A few days in New York or San Francisco will show how deep cultural exchange with China has become. Similarly there is a profound American presence in China’s costal cities.

  • Posted by anne

    BBC is reporting that Korea has announced they will diversify currency reserves. We will find how that effects the Euro and dollar, and the bond market.

  • Posted by steve kyle


    Dont forget – The funny money boys dont get to pick who they sell the debt to. Auctions dont work that way and besides that there is a secondary market. We get to pick the quantity of debt we sell. The market gets to pick who ends up with it.

    We can and should worry about who gets it – it does matter – but the only thing we can do about it is fix our fiscal train wreck.


  • Posted by rt

    China’s losses for maintaing the peg are being over-stated, from Chinese perspective.

    Ok, the remnibi would be priced higher. By how much? 20%? Big deal. This means they end up buying slightly fewer Boeing airplanes, pay more than ‘market value’ for US assets etc. Well, this is small price to pay for stability, get technology and excellent export-driven growth.

    Meanwhile, the US govt. is heavily dependent on Chinese to finance their deficits. The shock to US economy from any inevitable future readjustments is going to be far greater than to China.

    Well, they heard about Pentagon war plans for war against China in 2010 in the heady days of early 2001. So from a Chinese perspective it makes good strategic sense to have the US be even more dependent on them.

    The ‘losses’ are a small price to pay for what they are getting.

  • Posted by anne

    Japan’s Ties to China: Strong Trade, Shaky Politics

    TOKYO – Just as China’s state news agency was berating Japan for its “wild behavior” in joining the United States to express their “common strategic objectives” in Taiwan, the news came Monday that Japanese trade with China jumped 27 percent last year, hitting a record high of $168 billion.

    It was only the latest example of a troubling dynamic in the countries’ relations: white hot economics and deep freeze politics.

    The joint United States-Japan declaration on Taiwan, buried last week in a long, seemingly bland statement of cooperative security objectives, left many Chinese analysts outraged. “Japan colonized Taiwan for half a century,” one Chinese expert based here said Monday, hardly containing his anger. “When Japan talks about Taiwan, we think they have no right to talk.” He asked to remain unidentified because he did not want to criticize Japan publicly.

    But others say Japan’s mention of Taiwan in its list of goals for a safer Asia was part of a larger effort to stand up to China’s expanding power.

    Japan’s growing economic dependence on China would seem to point toward a greater deference from Tokyo. But political and military affairs have risen in importance in the region, and for Japan’s government they may now be edging out economic concerns. As a result, many here say, it makes sense for Tokyo to bolster Taiwan, a convenient buffer state that absorbs the military hostility and expansive energy of its rival.

    To the east of Taiwan, Japanese islands already feel Chinese pressure: Chinese drilling last fall for gas in an area claimed by Japan, a Chinese submarine caught in November trying to slip through Japanese territorial waters, and a continuing effort by China to have a Japanese island declared a rock, a legal strategy that would deprive Japan of thousands of square miles of economic rights….

  • Posted by anne

    China Reins in Producer Prices

    China’s producer prices rose 5.8 percent in January, the slowest pace in nine months, as lending restrictions helped rein in an investment boom.

  • Posted by sanj

    George Soros seems more concerned about
    Opec countries dumping their dollars for euros
    than any Asian central banks doing the same thing.

    Seeing that oil prices can only go higher from
    here on (meaning more dollars sold), and that Opec’s dependence on America as a buyer (and guardian) will only lessen over time — doesnt this pose the risk of an equally scary outcome ?

    Given the increasingly shaky political foundations that these Opec governments are sitting on, theres
    good reason to worry.

  • Posted by Steve McQueen

    When one looks at Chinese imports, I think it’s important to break things out a little more – there’s the commodities dimension, and then there’s the services dimension. Re: commodities, I think oil can be ‘the new gold’, and as consumption from China rises, I think it will be interesting to watch the impact in the US even with a fixed currency exchange rate. The services dimension is a bit different – my vague impression is that the Chinese are not too keen on importing services, because they have the capacity to develop this internally without being dependent on anyone else. As case in point, I believe there have been many statements emanating from China about “we need the world’s advice on financial markets”… but where are the results?

    Regarding influence, I think we’ve already crossed the bridge. #1 issue is Taiwan – basically the US will no longer support Taiwan in a military way… for China this is a huge win in a very economic sense. #2 issue, consider Iraq and what trouble the US has had… because they didn’t build a coalition, they are footing a huge bill. Affordability of US wars is an obvious problem and I think we could see further influence from China here. Suppose it was the Chinese rather than the Russians supporting the Iranian nuclear effort – I think this would be a much scarier story. Economically it looks like China has the weak hand, but if they need political influence for their access to commodities in order to manage internal economic growth (i.e. so huge commodity prices don’t cause problematic inflation), they are very well-positioned.

  • Posted by IJ

    The return to greatness of the Middle Kingdom (China) is a feature in the current edition of ‘Foreign Policy’.

    Excerpts from the seven essays include:

    “My theory of international politics says that the mightiest states attempt to establish hegemony in their own region while making sure that no rival great power dominates another region. The ultimate goal of every great power is to maximize its share of world power and eventually dominate the system. . . Beijing began by making nice in its own neighborhood. It has sought to develop friendly relations with the major states on its periphery-Russia, Japan, India, and the Central and Southeast Asian states-that are potential balancing partners in any future U.S.-led, anti-Chinese coalition. . .The best outcome that a state can hope for is to dominate its own backyard.”

    Moreover China runs a trade deficit with the developing world, and is investing wherever it can find willing sellers. It looks as though the nation will do very well out of globalisation, buying what influence is necessary.

  • Posted by dave

    China and the US both see themselves as the natural rulers of the world. Of course there is tremendous potential for conflict, even warfare. Anyone who denies it is whistling past the graveyard. US popularity in China is very low. I have not seen poll numbers for the US, but I suspect the reverse is true too. The latent dislike of eachother is not merely driven by economics, but by negative cultural sterotypes and racism (on both sides).

    It is folly for the US to indebt itself to a foreign power with aspirations of eventual global dominance in our stead. Explanations along the lines of “China’s refusal to continue to float us would hurt them more than us because it would stund their export-led growth” are completely unconvincing to me. They A) actually produce things; and B) will at some point if not already have a populance ready to consume.

    I postulate a scenario where China pulls the plug on itself and the US, but they are much more able to pick up the pieces than we are, because our entire system is premised on unbroken capitalism, where in the PRC capitalism is a very recent overlay on top of a 2,000 year tradition of authoritarian central control and planning.

    I dont hate China, but I am not a fan of their culture’s traditional style of government; I think our government is negligent in its assesment of China’s threat in terms of their ability to cause social unrest by collapsing our economy.

  • Posted by gilies

    brad says –
    ‘The US borrows in its own currency. It won’t default, at least not in the conventional sense.’

    brad, i accept the points you make in response to the ‘project for the new american century’ quote – but this sentence interests me. is there a sense in which default is possible ?

    russia has supplied anti aircraft missiles to syria – careful to supply those that fire from heavy vehicles, not those which are hand held and thus can leak out to terrorists, because this would have a dramatic effect upon the balance of power in the region.
    suppose there was a pre emptive attack upon iran, and china supplied shoulder launched anti aircraft missiles to iran – could the u s sequestrate her assets in america? even then – would the u s want to ?

    my reason for going to the p n a c site was to try and see if the neo conservatives’ manifesto had any economic policies.

  • Posted by steve kyle

    could the us freeze assets in America? sure. we have done such things before. should we? another question entirely.

  • Posted by brad

    Interesting scenario. The US froze iranian assets, i think, after the Iranians took the US embassy.

    Freezing China’s reserves would be a draconian step, though; China might retaliate in some way. Afterall, even if they only have say (made up number) $160 b in reserves at the NY fed, that is 10% of their GDP. And other countries might think twice about holding their reserves in dollars. The overall effect = guaranteed hostility for generations between US and China, and probably the end of the dollar’s global status as a reserve currency. Our close allies might hold their reserves in dollars, but others would not …

    Incidentally, could concerns about the US freezing its assets be one of many reasons why China seems relatively keen on buying dollar assets through intermediaries (with the other reasons including “not wanting the entire market to know what you are doing” when the US data is released). Pure speculation on my part, I have no clue whether this even cross the minds of China’s reserve managers.

  • Posted by still working it out


    ‘The US borrows in its own currency. It won’t default, at least not in the conventional sense.’

    I think what Brad is talking about is printing dollars.

    All US debt is denominated in US dollars. Because the US government controls the mint it can always print extra dollars to pay the debts. This is not without costs of course.

    The big cost, to EVERYONE, would be inflation and lots of it. The reason that this would in practice still be a default is that the inflation would erode the value on any debts held in US dollars. If you’re getting 5% on a bond and inflation is running at 10% then you’re losing 5% a year. So you’re still screwed even though you’re still getting paid.

    Printing dollars is not an option available to most countries as their debts are usually denominated in foriegn currencies (usually US dollars).

  • Posted by steve kyle

    dear still working it out

    that only works the first time you start inflation going – after that people will only buy short paper – and the interest rates on that will reflect the inflation – it isnt as straightforward as it might seem at first to inflate the debt away. It depends on the term structure of the debt – we used to float a whole lot more long bonds than we do now. Now we do more ten years and shorter. There is somewhat of an incentive to shorten the debt since that minimizes interest costs – but then you cant inflate it away as easily.

  • Posted by still working it out

    steve kyle,

    I never thought of that. I guess that means that printing money would exacerbate a rollover crisis quite badly if the US ever faced one. Interesting considering that the Treasury is continuing to shorten it debt.

  • Posted by Comacocktail

    Brad and all,

    What are the Chinese saying? What do they feel is working or will work to ease China into their inevitably larger global role? Not their government leaders, just their people. Would it be possible to “invite” someone born and raised in China, educated in China, employed in China, supporting a Chinese family in China, to read and respond to this blog? You know, keeping with Barnett’s idea of connectivity, the Chinese perspective might help those of us who are “still working it out”.