Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

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Andy Xie gives no quarter

by Brad Setser
July 26, 2005

Xie to the market (and to the US): Take your 2% and stop telling China to revalue!

Here is the difference between Xie and me, put simply.

Xie thinks the US is trying to get China to "artificially" push up Chinese wages.

The vast US trade deficit … cannot be solved by artificially raising Chinese wages.

I think a country that is spending $260-300 b (14-16% of its GDP) to keep its currency from appreciating is artificially holding down Chinese wages and Chinese purchasing power.

In the process, China — not just the Fed, as Xie argues — artifically holds down US interest rates.  That helps the US in some ways.  Certainly in the short-run.  But doing so has long run costs, on both sides of the Pacific.  The US is storing up a big adjustment, as resources will have to flow out of interest-sensitive sectors at some point.  And resources will likely also have to flow out of China's export sector, or at least Chinese factories will have to regear to serve China's internal market.  To those adjustment cost, add the massive bill China's taxpayers will get when China realizes the costs of the massive "subsidies" its central bank is now providing to China's offshore customers.   Buying high (i.e. buying dollars at 8.28 RMB, or 8.11) and selling low (selling dollars for RMB at 7, 6 even 5 RMB to the dollar) is a pretty sure fire way to lose money.

And it is not obvious that China is better served subsidizing American consumption rather than putting its money to work at home.  Joe Stiglitz has long defended  China's peg.   But he — like Roubini — worries that China might be better able to adapt to the loss of the US export market than the US to the loss of Chinese financing.  Stiglitz's warning to the US needs to be taken seriously:

China could easily make up for the loss of exports to America – and the wellbeing of its citizens could even be improved – if some of the money it lends to the US was diverted to its own development. China has huge investment needs. If its government is going to lend money, why not finance its own development? Why not fund increased consumption at home, rather than that of the richest country in the world, to pay for a tax cut for the richest people in the richest country, or to fight a war which most view as anathema?

The CIA calculates that China's 2004 PPP GDP is around $7300 billion – a bit over $5,500 per person (link from PGL of the Angry Bear).   At market rates, China's (2005) GDP is only $1850b, or a bit under $1500 per person.  The large gap between China PPP GDP and its GDP at market value – even taking into account the fact that poor countries usually have a market GDP well below their PPP GDP – is what leads Jeff Frankel to conclude that China's currency is undervalued.

That matches my own subjective economic development smell test.   Beijing looks like the capital of a country that is wealthier than say Turkey, not the capital of a country that is just starting to develop.  And I don't think that is just because Beijing is the capital of a very large country.

Be forewarned – I'll probably be focused almost exclusively on China for the remainder of this week.  I want to return to CNOOC (in the interim, read this from Brainard and O'Hanlon), to comment on the Wall Street Journal's excellent article on US/ Chinese dollar diplomacy – and China's internal currency politics, and to talk a bit (more) about China's reserves.


  • Posted by DOR

    Steve M,

    Thanks for your comments.

    China achieved unprecedented improvements in raising standards of living for 1/5th of the world’s population through deregulation and decentralization. The business aspect was a sideshow compared to the rise in caloric intake, literacy and longevity.

    The first step, back in the 1970s, was to let farmers sell surplus, from their personal gardens, in the cities. The increase in incomes was so startling that people actually left the cities to go work on the farms. That set the foundations in place for the urban takeoff in the following decade.

    By “pumping billions of dollars into research”, are you referring to foreign investment? I think that must be the case, since there really wasn’t much of a boom in SOE investment in the 1980s and 1990s.

    As for state planning, that died out long ago (at least in China). The March 1998 reorganization saw the elimination of the electric power, coal, metallurgical industry, machine-building industry, electronics, and chemical ministries. The State Planning Commission was renamed (twice) and is now the State Development Planning and Reform Commission, and it has a whole new agenda.

    In short, China over the last 25 years did everything the West asked it to do to change its economic policies.

  • Posted by Movie Guy


    As you know, the CIA still calls China a communist state.

    I have read your blog. So, I have some appreciation for your views and observations. Many of which I agree with and others that I appreciate.

    China, though, is not a democracy. Its leaders are not elected freely by the general population. Its citizens do not determine the laws under which they live by method of voting for officials, free of “party” or gang restrictions.

    It’s not a socialist democracy. Again, no elections of its national leaders by the general population. And so on.

    Many different forms of national government, including dictatorships and communism, can achieve economic success under a well balanced plan. And any national government can employ capitalism as an economic tool.

    If China is not a communist state, then it most certainly is a nation of 1.3 plus billion people ruled by a dictatorship or fascist party of citizens. Ruled by a gang if you will. Their way or no way.

    The controlling party/government is opposed to free speech as evidenced by its mining/blocking of information following across the internet in China.

    Yes, China is improving. But the same master party runs the nation.

    I’ll cheer loudly for China when its people are completely free to vote for their elected officials at all levels of government, and have the legal right to vote them out of office a few years later.

    Meanwhile, mainland China has a growing number of missiles pointed at Taiwan. The very people that the ruling party in China doesnt’ want to have free voice in determining their own future.

    I say remove the missiles.

    Taiwan is no threat to China. Unless China is afraid of its model as a nation and society.

    Huge China afraid of Taiwan… That doesn’t make sense unless it is afraid of its ideology.

    What ideology could China be worried about at the national party/government level?

    Freedom? Democracy? Things like that?

    If there is no fear of democracy, then China’s national government needs to embrace freedom and democracy. Let power transfer to the voting booth in small but reassuring increments. Or step out of the way now, and let the 1.3 billion plus people vote their hearts and minds.

  • Posted by sunbin

    Movie Guy,

    Thanks for your comment. I am also flattered that my blog was read :).

    I do not think we disagree in terms of substance. I do not dispute the fact that China is not democratic. I call it authoritative, but the difference from dictatorship is not too big. So we agree there.
    (Although i wouldn’t use the word fascist — which is reserved for the italy and japan in 1930-1945)

    The difference between China and Marcos’ Phillipines, Most of South America, Mahatir’s Malaysis or Park’s S Korea is a lot less than what China differ from USSR, Cuba or N Korea.

    I don’t care what CIA’s definition is. I don’t even know if they have a proper definition for ‘communism’. e.g., Oppenheimer, who headed the Mahattan Project, was labeled as a communist.

    All I want to clarify is that dictatorship and communism are very different concepts. Some people in US equate communism with evil, but among the intellectual communism is also viewed as an ideal Utopia. I think associating either concept with China is very misleading.

    As for Taiwan, I don’t want to go into the debate of that. I deeply believe the Taiwanese people should have their own choice and their independence does not harm people in either side of the strait. However, I should note that mainland China has a point in comparing with American Civil War in 1865. The Conferate pose no threat to and had absolutely no intention to invade the Union.

  • Posted by Steven M

    Hi folks. Thanks for your comments. I agree with the viewpoint which says that China is a communist dictatorship. That doesn’t mean they haven’t had major reforms, or major concessions of freedom. The point is whether the underlying power is vested in communist forms of power and policy-making.

    For me, the crucial question in identifying communism is, is there an unconditional right to private property, and do individuals have power versus the state.

    Yes, you cou could make a case that those are issues in the US too. But all I am saying is that those are the areas to look for the key evidence, in order to identify a state’s underlying ideology and intrinsic differences. Otherwise, you could simply blur all distinctions; but these are still valid and important distinctions.

    Sunbin, that is true, Japan, Singapore, etc, have used central planning. I didn’t mean to imply that no democracies have used central planning. I only meant that if you do want to find aspects of communist methods in China, they are there, whether in more benign form or more malicious one.

    As far as pumping billions into industries, I simply meant that many industries are state-subsidized. I’m not saying that is so bad; as I’ve said, I think we need a little more national/public investment in key US industries here.

    Dor, you make some good points. As far as China’s economic reforms, not only did it do what the West asked it do, those reforms are enabling it to outpace the West. Good plan of ours, to demand reforms so that our competitors can outrace us. Oh well.