Why is China’s government trying so hard to hold down China’s current living standard? And investing so much of China’s savings in depreciating assets?
Dr. DeLong is engaged is a rather spirited debate over at TPMCafe – one that mirrors the debate inside the Democratic party. It is a debate over trade, but it also is a debate over US grand strategy toward China’s rise.
DeLong argues that the United States has a compelling national interest in helping China get rich:
There is nothing more dangerous for America's future national security and nothing more destructive to America's future prosperity than for Chinese schoolchildren to be taught in 2047 and 2071 and 2075 that America tried to keep the Chinese as poor as possible for as long as possible.
DeLong’s position – that the US needs to position itself as a friend of China’s economic development — is an appealing one. But it is also one that I suspect glosses over some big issues.
Both the US and Europe, which has stood by as China actively drove the RMB down v the euro, have done their part to support China’s development over the past few years. US imports from China have increased from $100 b in 2001 to $280b in 2006 (overall US imports from Asia are also rising as a share of US GDP; China isn’t just taking market share from others in Asia). Eurozone imports from China have gone from 62b euros in 2002 to something like 130b euros, maybe a bit more, in 2006. In dollar terms, the increase in European imports from China is far more impressive. Think of a rise from around $50b to over $160b. Both the US and Europe have supplied a lot of demand for Chinese goods over the past few years.
The risk of a protectionist backlash is no doubt rising. But so far, the US hasn’t taken any policy actions that have really crimped the expansion of China’s exports – which is what I think worries DeLong. Nor for that matter has the US government done much – if anything — to help in the US whose living standards have been adversely affected by China’s export success. DeLong and Jeff Faux would both agree that tax cuts for the have-mores whose assets are worth even-more thanks to large financial inflows from China doesn’t count.
The government of China, by contrast, seems determined to keep China poorer than it needs for to be. After all, the government of China, not the government of the US, actively intervenes in the market every day to hold China’s living standards down – or, if not China’s living standard, certainly the external purchasing power of all those paid in RMB.
A few years ago Jeff Frankel looked at the gap between China’s market GDP and its purchasing power parity (PPP) GDP. In general, the market GDP of developing countries is well below their PPP GDP. But China’s market GDP even then was far below what one would expect for a country with its level of development. In 2000, its prices were 23% of US prices, while the model predicts its prices should be closer to 36% of US prices (see p. 14)
I strongly suspect that updated data would show that the gap between China’s PPP GDP and its market GDP remains very, very large. Since 2001, China’s exports have basically quadrupled, Chinese productivity has shot up, the set of products that China produces has expanded dramatically and the external purchasing power of the RMB has fallen. If China’s government stopped intervening and allowed the RMB to rise, the ratio between China’s market GDP and its PPP GDP to rise to a level more typical of other emerging economies with comparable levels of development.
China’s government has had a policy of, in effect, subsidizing the use of Chinese labor for the production of goods for export. It doesn’t just intervene to hold down China’s exchange rate – subsidizing both Chinese and foreign investment in China’s tradable sector. It also offers foreign investors more favorable tax treatment than domestic investors.
The enormous explosion in Chinese exports – and Chinese value-added – hasn’t just impacted the US and Europe. It also had a big impact on many emerging markets. China subsidizes – through its exchange rate intervention – the global consumption of Chinese goods, which leaves producers in other poor countries whose governments don’t offer a comparable subsidy at something of a disadvantage. Chinese exports have increased from about around $265b in 2001 to about $1,000b in 2006 – and are poised to rise to $1,250b in 2007.
Now you can argue that this policy of holding down the external purchasing power of China’s workers has worked. Real living standards in China are growing strongly. Chinese consumers may not be able to afford foreign goods or foreign vacations, but Chinese firms are producing more and Chinese consumers are consuming more. China is a far richer place today than it was a few years ago – even if nearly all analysts think Chinese labor’s share of Chinese GDP is shrinking.
All true. But China’s policy of buying dollars (and to a smaller degree euros) also means that China is sinking a growing share of its national wealth into a set of assets that are almost certain to depreciate over time. There is a lot of talk of the China price – but there also should be talk of the China bid.
China – counting likely flows from Chinese banks as well as flows from the PBoC almost certainly bought about $200b of US debt in 2006. It paid – in RMB terms – a lot for those assets as well: China effectively has a policy of under-pricing its labor and overpaying for its external assets.
The sums involved are not trivial. China is now running a current account surplus of around 10% of its GDP. That implies that about 20% of China’s annual savings (China saves, ballpark, 50% of its GDP) is being invested in assets that are likely to depreciate over time. It is actually a bit bigger, since China also uses funds flowing into China looking for a big payoff to buy low yielding US assets. Barring Chinese policy changes, the amounts will only get bigger. China’s government effectively now has a policy of both holding China’s current living standards down and sinking a fairly large share of China’s savings into assets that are sure to lose value – in RMB terms – over time.
At some point, China will scale back its intervention and the RMB will rise far faster than it has so far. The capital losses could destroy the PBoC’s formal capital: borrowing in RMB, even at an artificially low rate, to buy depreciating dollars isn’t a winning financial strategy. If the PBoC follows the example of Bank Negara Malaysia, and tries “win it back” by betting on various market moves, it might end up losing even more.
That worries me. When the time comes for China to realize the losses that are now accumulating quietly on the PBoC’s balance sheet (and soon on the balance sheet of the state foreign investment company), I doubt China’s leaders will say, “you know, these losses were really incurred years ago, when we decided to sink a lot of Chinese savings into depreciating dollars in order to encourage our export sector and make it attractive for foreign firms to locate investment in China. We shouldn’t blame the US for the fact that China’s investments in the US haven’t done well. We were the ones who over-paid for US assets.”
I suspect China’s leaders will be somewhat less magnanimous. They will argue that the losses didn’t stem from China’s policy over-paying for US assets, but rather from the failure of the US to adopt the policies needed to maintain the value of Chinese investment in the US.
I have seen this before. Who is responsible for the big losses when an investment goes bad, the lender, or the borrower? Think of the debate over Argentina. Is the bond market at fault for lending foolishly to back an unsustainable dollar peg? Or the Argentines, for not adopting economic policies that would have provided their creditors with a bigger real return?
Conversely, I worry that at some point, China will conclude that investing so much of its savings in the non-tradable part of the US economy isn’t the best way of building Chinese wealth, and the flow of funds will stop. If that process is gradual, it will be for the best – but it if it is sudden, well … a lot of US workers now employed in the non-tradables sector will need to shift into tradables production, pronto. DeLong:
In this alternative scenario, the U.S. has to move about ten million workers out of currently-favored sectors–construction, home-equity-credit financed consumer expenditures, and so on–into export and import-competing manufactures. How much structural unemployment does such a sectoral shift require, and how long does the structural unemployment last? Other countries have to shift up to forty million workers out of export manufactures into other industries, and to generate demand for the products of those industries
If that process isn’t smooth, I rather suspect the US won’t say, “You know, we got an awful good deal from China for all these years. Rather than complain about the costs of the transition that followed the end of Chinese financing, we should thank China for selling us so many goods at such generous prices, lending us so much on such generous terms, and for helping keep the profits of US firms up for so long by underpricing its labor.”
There is one big difference between the UK and the US back when the US was the rising power and the US and China today. Back when the UK was wealthier than the US, it was the creditor, lending to support the United States development. Right now, China is the creditor, lending to support the United States ….well, I guess you could say the United States development.
But it is development of a very specific kind. The development of new kinds of financial engineering. The development of a lot of suburban real estate, to be sure. The development of new means of leveraging up any asset that is insulated from Chinese competition and delivers a steady cash flow: Think urban office towers filled with bankers repackaging residential mortgages into safe tranches that can be sold to the People’s bank and not-so-safe tranches that, well, are no longer so easy to sell. China certainly hasn’t been financing investment in the US tradables sector – yet eventually, the US will need to produce something other than IOUs (and a few planes) that it can sell to pay back its Chinese creditors.
DeLong has in the past argued that the US should aim to try to replicate its post-war success at creating a liberal international economic order. The new liberal international economic order though would extend beyond the US, Europe and a few islands in East Asia. It would in effect, draw in the big population centers of the Asian land mass as well.
That is a very appealing vision – one that I think is very widely shared. By the party of Davos. But not just by the party of Davos.
I worry, though, that the conditions that allowed the US to construct a liberal international order after World War 2 no longer exist. In the 1940s and 50s, the US ran a current account surplus, so it was financing the rest of the world (Europe, most notably). US imports and exports were small as a share of its GDP, so there was a lot of room for both to rise as a share of GDP.
Right now, though, the US is a net debtor. So far, it has been able to finance large deficits primarily by borrowing against the rising value of the external assets that it accumulated in the past. So its net debt hasn’t increased. But that won’t last forever. European markets won’t consistently outperform US markets. And China now wants to buy the United States external assets, not just lend to the US against their rising value.
Moreover, the US now imports something like 17% of its GDP and exports about 11% of its GDP. The scope for US imports to continue to grow faster than US exports and for the gap between imports and exports as a share of GDP to widen seems limited.
In 20 years, both imports and exports may be 25% of US GDP, bring the US trade deficit down to zero and stabilizing the US external debt – that implies far faster growth than US exports than imports, and a big change from the post war order.
In a sense right now, rather than having a Marshall plan, where the US – at the time the US public sector – financed the reconstruction of Europe on very generous terms while opening its markets to European goods (creating the conditions that allowed Europe to repay the US loan), we have something that looks like a Marshall plan in reverse. Or maybe half the Marshall plan — China doesn't seem to have given much thought to how the US will pay it back.
China’s public sector is, as a matter of policy, providing subsidized financing to the US. The reverse comes because China, still a very poor country, is financing the still very rich US. Bretton Woods 2 is very, very different from Bretton Woods 1.
I am convinced the post-war analogy doesn’t quite fit. But I also don’t have a better one to suggest.
UPDATE: DeLong responds (sort of). I would be interested in his response to my argument that the current system looks set to lead to future tension between the US and China, with the Chinese arguing that the large losses they are likely to eventually take on their dollar holdings are the fault of the United States. The Chinese argument won't be totally false either — the US is unlikely to run its domestic macroeconomic policy to try to maintain the dollar's external value. But then again, the US has never hinted that it would.
To be clear, I don't want Chinese exports to fall — that would imply some kind of disorderly adjustment. But I do believe that China should allow the RMB to appreciate to slow the pace of Chinese export growth — and that China should no longer rely on net exports for a fraction of its growth. Indeed, it would be nice if China supported global demand growth for a while, and Chinese imports grew faster than its exports.
Josh Bivens (or is it Max?) also has some interesting thoughts — I completey agree with the argument that China's peg has become a growing constraint on the policy choices of other emerging economies.
Agreed. China is keeping its own population poor. That has been China’s 4000 year history. It’s vast population has been, and still is, fodder for great enterprises. At some point, China has to take responsibility for its own history–and its own foolishness.
There are no words to describe the idiocy of DeLong’s position, other than it is an apology for foreign corporate interests.
The argument that we should worry about what Chinese kids think in 2070 boggles the mind. Has DeLong even an inkling about global warming or environmental destruction? Does he even have a clue about what the conservative IPCC report says? Is he aware that more shoes on GW will be dropped in April of this year?
China will never make it. Just think: Between now and 2012 China plans to build 512 coal burning plants, more than any other nation in that time frame.
By any measure, China’s industrial direction is absolute insanity.
This kind of insane argument makes despair that economists live on this planet.
Towards the end of the Victorian era I believe, England, then at the presumed “height” of its Imperial power, began to run extraordinary budget and/or external deficits while at the same time turning from a manufacturing power to the center of the financial world. I may have the details a bit off but the parallels would seem to be there.
i would need to double check, but i think Victorian england had such a large invisibles (services/ investment income) surplus that it never really ran a large current account deficit — it paid for its imports out of the profits on british investment abroad.
it’s all part of their diabolical plan to take over the world! they appear weaker than they really are, those meek little savers, punching interminably below their weight class; no one pays them any mind as a threat (except rumsfeld occasionally, when it suits him) as they quietly plug away at building and/or acquiring the instruments of our destruction, which we give them — happily providing them the technology and resources… it’s all so very plain to see and therefore all the more nefarious, really
Guest — that is a bit too dark for me. i am more inclined to see a political system incapable of making policy adjustments as quickly as needed as the world changed — the Chinese weren’t expecting the $ to fall v the euro in a big way, didn’t realize how big an impact it would have and never really planned on adding to much to their reserves (or subsidizing foreigners using China as an export base to the extent that they have). but once they embarked on this course, it was hard to change — especially b/c there are a lot of interests in China that are “winning”.
Remember, the costs of holding to many reserves are backloaded — while the benefits of using the central bank to support export growth are frontloaded …
http://www.businessweek.com/magazine/content/07_10/b4024037.htm - How Long Can The U.S. Count On Foreign Funding?
It is absurd to state that the Chinese government is holding down living standard. Over the past two decades, the Chinese government has reduced more poverty in absolute numbers than any other nation in world history. Per capita income has grown at double digit rates over the same period. A solid middle class population of over 200 million has developed in the industrial urban centers of China, and a record number of Chinese students are graduating from universities. By any measure, the Chinese poverty reduction program has been more successful than any of the Neo-liberal restructuring policies implemented by the US Treasury controlled IMF in Latin America or Africa. Despite the pullback correction on the Shanghai stock exchange, the Chinese economy is fundamentally sound with rapidly rising industrial productivity and production.
j/k! i was just echoing neocon futility
conspiracy is just so much more engaging than the subtle edge of occam’s razor — everybody’s stupid 
cheers!
Brad- on the (in)capacity of the Chinese to change (or possibly the suffer the fate of Japan in the 1980s), any views on the contributions of Eichengreen and Graham to the latest FT economists’ forum (http://blogs.ft.com/wolfforum/2007/02/history_holds_l.html#comments)?
…Eichengreen draws attention to the relatively successful Korean experience, one he attributes to democratization while Graham points to the nature of Japan’s heavily protected domestic markets, one which resonates with the continuing dominance of (only partly privatized) SOEs in the Chinese market (as opposed to the more dynamic export-oriented, foreign-invested sector), a feature that is compounded in China’s case by the cellularization of its market along regional lines.
There is one big difference between the UK and the US back when the US was the rising power and the US and China today. Back when the UK was wealthier than the US, it was the creditor, lending to support the United States development. Right now, China is the creditor, lending to support the United States ….well, I guess you could say the United States development.
Brad, you need to rework your history courses.
In 1929 the USA were the creditors and overlending to the UK. That s the same thing than china and USA now.
Your point of view only makes sense if you believe the situation is closer to 1910 than 1929 but a look at debt levels would tell you it is not.
Compared to the postwar era the main difference are :
- the lost power of labor, wages lag productivity hence only debt can fuel growth as there is not enough demand for products without this rise in debt
- the deregulation of finance that has allowed the growth in debt
- the opening of all borders which has deprived states of their regulatory power
If the RMB was to appreciate, wouldnt it lead to a drop in agricultural prices that are keyed to world markets, hitting already dirt poor farmers and placing more pressure on migration to the cities?
Despite the pullback correction on the Shanghai stock exchange, the Chinese economy is fundamentally sound with rapidly rising industrial productivity and production.
lol dave you are completely out of reach with reality.
No doubt china has done lots to reduce poverty and I don t buy either Brad s one shot exchange rate argument. THe chinese have bet that by staying constantly poorer than they should be (having a depreciated currency) they would grow richer and richer at a very fast rate. The italians or argentinians in the past have chosen the other path, seem rich, even though it depresses their growth.
However it is cleat to all that china s policy is headed for the biggest wreckage in world history.
Given the present overinvestment level and dependance on foreign market it would be logical to guess that the chinese crisis will be harder than 1932 in the USA. But remember chinese population is 1 billion, 200 millions in the major cities you said. Well figure 30 `% unemployment in cities … 60 millions people. quite a lot, quite a recipy for civil disorder. No ?
A tremendous post. Perhaps the best elegy for BWII I have read yet.
One point that this otherwise magisterial discussion does not cover, though, is that Chinese savers are not sheep. Their actions - as yesterday showed - are a variable in the equation.
When anyone, Chinese or otherwise, exchanges other goods for RMB or claims to RMB, he or she is buying an instrument whose value can only be defined by the PBOC’s balance sheet. Which consists largely of long-term liabilities of entities with a notable propensity to pay off old debts by issuing new ones. (At some point, we may have to start thinking of the US government as just another SOC.)
The RMB is certainly undervalued with respect to the dollar. But this relationship tells us nothing about the RMB’s relationship to other assets.
As China modernizes and as frictional effects decrease, the fact that yuan and yuan savings instruments are not an effective store of wealth - at least not compared to any asset whose price can keep pace with the growth of the Chinese money supply - creates demand for alternative stores of wealth.
In other words, assets like Shanghai A shares and real estate are, in a very literal sense, competing with the Chinese monetary system.
No human economy has ever existed which did not include at least one asset whose valuation relative to other goods cannot be explained by direct supply and demand. I always laugh, for example, when goldbugs claim that gold is the only workable currency because of its “intrinsic value.” Dollars have intrinsic value too - you can snort coke with them. If anyone ever manages to float a fiat currency whose supply is fixed, gold will trade for $20 an ounce and people will be using it for doorstops.
(The fact that no one will sell you gold for $20 an ounce today is not caused by the fact that today’s currencies have negligible intrinsic value. It is caused by the fact that they are financially unstable, their supply is expanding rapidly, and traders do not, at present, believe that any sustained contraction is a politically credible possibility. See, for instance, this story from Malaysia.)
In any case, if there is any force that seems most likely to rein in the PBOC, it is the humble Chinese saver. (Is there a Chinese equivalent of “Mrs Watanabe”?)
History records many attempts to turn stock markets, and real estate, into monetary systems - to overvalue them in the same way that paper currency is overvalued now, or that gold was overvalued under the classical gold standard (and is still, to a lesser degree, overvalued now). All of these efforts failed, for a very simple reason - an asset which is not intrinsically scarce cannot absorb monetary valuation.
When stock markets are overvalued relative to the cost of borrowing money, for example, the result is textbook Austrian malinvestment. Factories cannot sustain a price higher than the cost of building a new factory. Nor can skyscrapers, although there are some real estate markets (like the one I’m lucky enough to live in) which exhibit real scarcity.
No - the Chinese state needs to offer its citizens a genuinely scarce monetary asset, whose price actually increases and whose supply does not, when more of them buy more of it. The RMB at present does not fit this description. Nor do Shanghai shares.
I know very little about China and its government, and I have no way to predict when this issue will become acute, or how the PRC will respond to it. But it strikes me as a very good candidate for the eventual proximate cause of the end of BWII.
would anyone like to join me in considering the possibility that the policies of china, and america, do not represent far sighted calculation - but mere political tight rope walking between competing short term interests and their lobbyists.
so often in history things occur which nobody wants - like the first world war - but everybody gets. power seems to be some kind of pyramid, with less room for manoeuvre the closer you get to the top.
china and america are linked (look at the stock markets!). why do the chinese sweat to earn dollars that are ‘bound to depreciate’? why do the americans ? the dollar may suffer a fall - but among the unfashionable possibilities is that a falling chinese currency may cause it.
what would a radioactive middle east do to chinese prosperity ?
This description of China today sounds an awful lot like descriptions of Japan in 1989 when Japan’s economic boom was at its peak. If one substitutes “Japan” for “China” in your statement “China’s government has had a policy of, in effect, subsidizing the use of Chinese labor for the production of goods for export” you would have a fair description of Japanese domestic labor policy. At that time, Japan’s export sector was being subsidized at the expense of Japanese consumers, who in spite of the massive increase in GDP that had taken place since the 1970’s who had a lower average standard of living than US consumers. As an example, one could purchase Japanese-made cameras more cheaply in the US than in the markets at Akihabara in Tokyo. Japanese people lived in tiny apartments or homes (and still do) compared to their US counterparts. Japanese companies paid huge amounts for US assets, particularly real estate, that turned out to have been gross overpayments (think of the Pebble Beach golf course).
I think that the core issue for the PBoC is that if the RMB is allowed to go to its market price, then China’s export sector will suffer severely. Given that the export sector has been the primary source of per capita income improvement, the PBoC is reluctant to kill this golden goose, even though it knows that RMB appreciation is needed in the long run.
Also, if China allows wages to increase, that would funnel through to increased prices for Chinese goods on the world market leading to some amount of negative export growth. The key is to balance the increase in domestic consumption that would result from higher wages with the decrease in exports. I don’t think that it is humanly possible to manage that balance without dislocations. When the dislocations come, Chinese leaders can point fingers at the US all day long, but the talk won’t mean anything. Especially when Chinese policy has been to systematically torpedo US investment in tradables production capacity.
To get back to my analogy with Japan, I would say that China can now look forward to a similar long period of stagnation in sectors that have been experiencing bubble-like growth and difficulty in getting GDP growth from the domestic sector
Gillies — I would second your point about policies more often than not being driven by short-term political calculations, domestic interests and a fear of changing what seems to be working (Even as the world changes) than far sighted calculations of self interest. If any one had written the State council a memo in 2001 saying “you should embark on a policy of using the central bank’s balance sheet to lend $300-400b a year to Europe and the US by 2007, and rapidly increase your reserves so that they go from $200b to 2 trillion by the end of 2008, and not worry about any associated risks — capital losses in the central bank, domestic monetary expansion, etc — ” I cannot imagine that it would have been given a serious hearing.
df — I consider WW1 the inflection point. Before the way, the US tended to borrow from europe. afterwards, it was a lender. WW1 was the great tragedy that ended European dominance of the international state system — and the int. financial system (it also laid the ground for ww2 and all its horrors; i sort of buy the one long war thesis”
guest — of all the arguments against RMB appreciation, concern about the impact on grain prices and rural china is the one i find most compelling. the basic problem is that setting the exchange rate to protect uncompetitive chinese rice farmers creates an exchange rate that leaves china’s coastal manufacturing zones way too competitive in global markets — basically, China is two economies, and right now its exchange rate is set for its least competitive part (contrast to germany after reunification, which set its exchange rate for its most competititive part). Any policy that allows a serious appreciation in the RMB needs to be accompanied by steps to offset its impact on rural china. I am not dogmatic here — a more appreciated RMB (much more appreciated) that is balanced by a bit of Japanese or Korean style protection of the rice market (which effectively changes the rural to urban terms of trade) or a on-budget subsidy of Chinese rice farmers (a la many countries) doesn’t bother me too much. The global trading regime isn’t (yet) free trade in agriculture.
All this talk of what keeps or does not keep “China poor” is really not very useful for anyone who has spent any time studying forex markets. After all, there are always both winners and losers from any forex change in any society. People working in export industries in China (or possibly so), and the owners of the companies, gain from the low value of the yuan/rmb. Consumers (or potential ones) of imports are losers of the undervalued y/rmb. Over the longer term there becomes the question of how all this fits into growth, and so forth. To the extent the undervalued y/rmb helps long term growth, then DeLong’s concern is misplaced, but it is not obvious whether it does or not.
Brad:
Isn’t the fundamental problem for BWII the low US savings rate? The Chinese save too much so they finance our non-tradeable sectors and encourage our prolific spending. But if BWII goes away, doesn’t US still need continued financing to shift resources into tradeable sectors? Isn’t one of the downsides of BWII that US tradeable sector assets are now exceedingly cheap? With $1T in reserves, China could get Chrysler, Ford and GM and still have change left over for Cisco or Intel. Could BWIII be a reverse of BWII, with cheap US goods going over to China? I just don’t see anyone else financing world for the foreseeable future so I am still skeptical that BWII will unravel anytime soon.
I find it curious to note how Americans always want to solve the “China” problem by forcing China to do this or that (all in its own interest, of course, which it is too short sighted to see). I would think it would be easier for the US to solve things by making changes in the USA where we can pretty much do what we please. But hey, if we actually did something here at home it might hurt. Better keep bashing the Chinese, however pointlessly, since that doesn’t hurt us much at all.
The United States is so fortunate to have so many economists who can explain how people in the United States are going to remain prosperous without having to, you know, make things and stuff. All the U.S. has to do is keep selling more and more financial assets abroad, which can continue indefinitely of course.
China is running a full-employment policy. This is seen as necessary because it is trying to close State-Owned Enterprises or transform them to privately run businesses. Without abundant export jobs, the unemployment problem (which is quite bad anyway) would be even worse than it is.
Therefore the policy decision is made to reduce the benefits to those employed, by making the RMB they earn worth less, so as to allow others to have jobs too. This is typical Socialist / Communist planning. It’s not really fair of Brad Setser (if he understands and agrees with my description) to leave out the benefit to the otherwise unemployed, just complaining about the effect on those fortunate enough to have money already.
Note that this strategy has been in effect for a number of years already, but now the leader is the super-populist Hu Jintao who is determined to take care of those left behind by the boom on China’s east coast.
“China is now running a current account surplus of around 10% of its GDP.”
Brad,
The explanation is quite simple; historically basically every country to rise to develop after the UK has done so under a quasi-mercantilist policy of encouraging exports, industrial development, running large balance of trade surpluses, and suppressing imports.
The Chinese government is simply pursuing *the* effective development strategy (see Western Europe, Japan, South Korea, etc. vs. everyone else).
http://www.ustreas.gov/press/releases/hp95.htm - it’s funny if you google paulson+speech+china it’s titled “the sanest speech on china from a us [government official in a long time]“
also ’stealing’ intellectual ‘property‘, viz. http://www.10zenmonkeys.com/2007/02/08/cory-doctorow-overclocked-ru-sirius-interview/ - “America became an industrial power by being a pirate nation. After the American revolution, America didn’t honor the copyrights or patents of anyone except Americans. If you were a European or British inventor, your stuff could be widely pirated in America. That’s how they got rich. Only after America became a net exporter of copyrighted goods did it start to enter into treaties with other countries whereby American inventors and authors would be protected abroad in exchange for those foreign authors being protected in America. But now you have these countries in Africa, in Asia, and in Eastern Europe, who are signing on to trade agreements with the U.S. where they basically promise to just take huge chunks of their GDP and export it to the U.S. It’s a kind of information feudalism, you know? Info-serfs.”
LC — Martin Wolf, among others, has convinced me that the current low US savings rate is at least partially a function of policies that have pushed up savings in china and the oil exporters. it isn’t autonomously determined, at least not entirely — without cheap chinese financing we in the us would have saved more/ invested less and no doubt invested more in tradables and a bit less in housing (China impacts the composition of investment and output). the has cut its fiscal deficit, but, given the availability of so much financing from abroad, private savings has fallen so the current account deficit (Savings-inv gap) has still trended up.
relying on national savings — i.e. not borrowing from abroad/ not running big current account deficits — has been a big part of the east asian model. but during their high investment catch up phase, both japan and korea ran roughly balanced current accounts. a 10% surplus during the high investment catch up phase (or for that matter, at other times for a major industrial economy) is something quite new. it isn’t a continuation of east asia’s save a lot and invest a lot at home model. that model didn’t include save so muchj that you can invest a lot AND lend a lot to your consumers until very recently.
something has changed.
The explanation is quite simple; historically basically every country to rise to develop after the UK has done so under a quasi-mercantilist policy of encouraging exports, industrial development, running large balance of trade surpluses, and suppressing imports.
You obviously aren’t familiar with economic literature, since you don’t seem to realize that mercantilism doesn’t work.
What China needs to do is import some American economists who can explain to them how the world really works. Then their economy can shine brightly like 90s Russia, postwar Iraq, Latin America, etc. have done with the help of U.S. economists.
Brad:
Thanks for the explanation. But my point was even if BWII unraveled and US started to invest more in tradeable sectors, it would still need capital. All these plants that are now being mothballed need more investment to get back on line and even more investment to become more efficient. In that case, wouldn’t US still need Chinese financing? (although it would be financing via higher value Yuan and the Chinese domestic market?)
More generally, I think you’re right policy choice has pushed down US savings rates, but it’s policy on both sides. We (the US) chose to adopt a more protetcionist stance towards foreign (read non-Western) ownership in our tradeable sectors and the natural resources sector, but sold all the debts to finance the public sector and our professional (mecenary) armed forces sector. The Chinese decided to join because they benefited from the US security export. So for this to unravel, we either cut back on our Pentagon expenditure (no more treasury bills to Chinese) or ramp up our tradeable sector again. However, for either case, there needs to be capital to finance the transition. Besides the Chinese, can anyone else take up the task? Is a net result of this more foreign ownership (Japanese, Korean, Chinese) of our tradeable sector assets?
Finally, your point about UK or US financing the world in the past is a good one. However, is there anything inherently wrong with a poorer nation like China financing the world? The Chinese get a very stable security envrionment to grow while US gets to spend more money than it has. Yes, the Chinese are poor compared to the West, but when UK and US financed the world, the world was much poorer and the average citizen in UK or US probably didn’t fare much better than the average Chinese citizen today. Sure, US has had spectacular growth since WWII and a lot of the credit goes to BWI, but if BWII unravels, will the system that replaces it be anything like BWI and anywhere near as stable? That’s the unknown.
No Asian country is ever going to import a manufactured product (in a meaningful quantity) from the U.S. that it can make for itself. The only manufactured products the U.S. sends to Asia now are aircraft (and their parts) and the most highly advanced high tech products. As Asia moves up the technology pyramid the U.S. won’t even be able to export those products anymore.
Basically China has given the US infinite credit to buy its products. A credit card with no maximum, as it were. And the US has greedily accepted. A lot easier to buy on credit than having to actually pay.
why do you expend so much effort in trying to predict the future ? all you have to do is to tune in to the BBC - who - (video on the internet this week) - reported the collapse of WTC 7 (9/11) twenty minutes before the collapse happened, so inexplicably and unexpectedly.
if the cat is really out of the bag this time - there will be more volatility. that’s my own little prediction.
Again, very intelligent diagnosis of the symptoms and possible outcomes, but the focus on the exchange rate smells more like the proverbial “with a hammer in hand everything starts looking like a nail.”
As you said it is rather strange that China has a large impoverished population yet runs a large trade surplus. I agree something is very wrong with this picture. The problem is how is RMB appreciation going to fix that? RMB appreciation will make it easier for those who are already well off to buy more foreign goods or travel abroad. How does it help those migrant workers seeking $100/month work in a factory?
I also disagree with the fear of large capital loss on the foreign reserve. That loss will only be there if PBoC attempts to defend RMB at a higher exchange rate in the future, otherwise the loss is almost fictitious. The real loss is tied to the purchase power of dollar in terms of what China wants to import, which as far as can be reasonably foretold, is only weakly dependent on the USD/CNY exchange rate. BTW, US has a large gold reserve (anyone knows how big it was in percentage of the GDP at the time when it was accumulated?). That was an equally, if not more, inefficient use of capital (let’s see: what has the metal done for us over all these years other than taking up security personnels guarding it?).
brad you parade nearly your whole circus here
except why you think
the polit bureau isn’t listening
beyond this inbertia theory
“once they embarked on this course, it was hard to change ”
with this enigmatic
camel’s nose poking under the tent
” especially b/c there are a lot of interests in China that are “winning”
once you’ve id ed the two groups
tell me how you know
today’s chinese winners
win less
then the discounted value
of what tomorrows chinese losers will lose
The point of comparisom between the UK and US in 1929 and China and the US today made by df is invalid in that it took WW1 to reverse the lending and investment flows across the atlantic between 1910 and 1929. The US government and Economic performance has managed this since 1980 without facing any sort of challenge. Given the ending of the Cold War the opposite scenario has been the case, an unprecedented relative economic decline.
brad i sense a really deep reluctance to
identify the source of the imbalance
in us mnc policy consensus
towit
“f the us trade deficit …we’re forking it in ”
i suggest we all
stop laying this rapidly growing monster
(not china but the us trade imbalance)
at the door of the polit bureau
and start laying where it not only belongs but can actually be fought out
at the door of the fed and the treasury
and first and most importantly the congress
this goes back a long way
and among others includes with your ex boss
bobby bonds rubin
and his benign neglect of the trade deficit dollar
of the late 70’s
though the real horror came with the newbes
that fought the gap by a dollar drop against europe
which would be all well and good
if stuff like
the airbus v boeing taffy pull
were all there was to the gap
The explanation is quite simple; historically basically every country to rise to develop after the UK has done so under a quasi-mercantilist policy of encouraging exports, industrial development, running large balance of trade surpluses, and suppressing imports.
This true statement goes against the current economic orthodoxy. You must repent.
The Chinese leadership wants their nation to make things and stuff because that will give them more say in the world of the future. They are willing to let the Chinese masses live more frugally than the masses need to right now for two reasons. One, the future wide spread prosperity in China is dependent on and will make up for the current austerity. Two, the leadership themselves, unlike the masses, can 100% live it up today.
For those who ignore history and will be forced to read about it:
During the Clinton administration the budget deficit declined every year (and eventually became a surplus), while the trade deficit increased every year.
So maybe we can come up with some way that will actually solve the trade deficit instead of blaming it on the budgeteers.
Brad - brilliant post. Tell your boss you deserve a big raise.
DeLong says: “There is nothing more dangerous for America’s future national security and nothing more destructive to America’s future prosperity than for Chinese schoolchildren to be taught in 2047 and 2071 and 2075 that America tried to keep the Chinese as poor as possible for as long as possible. ”
Does any country feel “gratitude” to another for buying their stuff? Are Japanese and South Korean schoolchildren taught that the USA provided them with export markets? I kind of doubt it.
Brad–I think you are right in saying that Victorian England had a large current account surplus, thanks to invisible surplus, which overcompensated trade deficit. Actually, it had increasingly large current account surpluses, before they reaching nearly 10% of GDP just before the WW1. So, the current situation in the US is completely defferent from that of Vitorian England.
Again, I totally agree with you, as far as appropriate policies for China are concerned. As for the US, I think it needs significant policy shift to increase saving and redirect investment in coming years; for instance, 1) abolition of the tax deduction for housing loan interest payments, 2) privatization of Fannie Mae and Feddie Mac, 3) substantial increase in gasoline tax burden, and 4) introduction of a VAT at the Federal level.
The most convincing argument for yuan appreciation, from a grizzled Reagan Treasury appointee.
It’s amazing how durable missionary diplomacy has proven to be. ‘We know what’s best for you’ was the basic American attitude toward China throughout the Nineteenth Century. From the discussion, it still is.
If ‘China’ refuses to recognize the 2nd (or more?) citizenships of its own population abroad (how many?), if there may be reasons to create incentives for Chinese citizens to emigrate.
re: “‘We know what’s best for you’ was the basic American attitude toward China throughout the Nineteenth Century”
one difference now being that more of those Americans are Chinese.
“…China’s bank stocks are expensive and will fall 5 percent to 18 percent further this year, CLSA said in a report yesterday… A measure of the Shanghai and Shenzhen 300’s 10-day volatility is at 67 percent, the highest ever in its two-year history…” http://www.bloomberg.com/apps/news?pid=20601013&sid=axgdzlVNQFnY&refer=emergingmarkets
Will not these (all nations) take up a taunt song against him, even mockery and insinuations against him, and say woe to him who increases what is not his- for how long- and makes himself rich with loans? Will not your creditors rise up suddenly, and those who collect from you awaken? Indeed you will become plunder for them, because you have looted many nations all the remainder of the peoples will loot you.
from the bible. Habakkuk 2:6-8
I agree that this is a well-informed, constructive discussion, taking into account the incidental effects of intervention, and how it could eventually prove costly for China. This is evident from the number of comments. I am not sure about a raise though…..getting paid for engaging in such interesting discussions seems like to a pretty good deal to me already!
Can you really say that China’s exchange rate policy is holding down their current living standards though, Brad? The intervention is reportedly sterilised, so it is not clear that it represents an inter-temporal shift of consumption. It may not do so if the duration of the domestic debt issued for sterilisation purposes matches that of the reserves assets. In other words, its key effect is to switch domestic savings into overseas markets. Given that Chinese domestic interest rates are extremely low and that obvious domestic investment opportunities seem to be being readily taken up already, maybe the intervention operation represents a prudent policy to channel some of China’s savings into more productive investments than the people might otherwise be inclined to make. Even if China does ultimately make losses on its overseas investments, these might be less than would have been made by allowing a wasteful build-up of excess capital at home.
Whether the present policy is unwise or not depends on what would happen if China’s markets were liberalised. How much arm-twisting is done to sell sterilisation bonds, and would there be an outflow or an inflow of savings if the capital account were liberalised? This touches on your (Brad’s) thought-provoking comment overnight on the FT Economists’ Forum discussion about the order of liberalisation. How an emerging economy should proceed with liberalisation is clearly a fascinating question.
I think that the US is on firmer ground raising these structural issues with China rather than whining about what China buys from the US given its offered market prices for goods, services and assets.
Hi everyone. Just want to share an article with you. Looks like
the AP is finally putting some bite into its reports. Below is an article
about recent comments by Alan Greenspan. What I like the most is the very last paragraph.
After quoting a comment by greenspan that China should let its currency rise
in value, the reporter adds a paragraph saying “That, however, would do
little to improve U.S. trade balance because a decrease in Chinese imports
would likely be replaced by those from other developing nations.”
I totally agree. As many of us here have been saying , changing the currency exchange
rates will do little to solve US problems, as a decrease in US imports from
China would simply be filled in by other low-cost producers. The only answer
to our economic problems is clear, coherent strategy, and concerted effort
and investment in our long-term economic strength. Good for the AP for
calling attention to some basic economic facts.
http://news.yahoo.com/s/ap/20070301/ap_on_bi_ge/japan_us_greenspan;_ylt=AqrfofOgaVmxzSr5PoLlMRdv24cA
When I checked the quote from Habakkuk a couple posts above, it said DEBTORS and it never said creditors, so the meaning is a bit different in the translation below:
http://www.ebible.org/web/Habakkuk.htm
2:6 Won’t all these take up a parable against him, and a taunting proverb against him, and say, ‘Woe to him who increases that which is not his, and who enriches himself by extortion! How long?’
2:7 Won’t your debtors rise up suddenly, and wake up those who make you tremble, and you will be their victim?
2:8 Because you have plundered many nations, all the remnant of the peoples will plunder you, because of men’s blood, and for the violence done to the land, to the city and to all who dwell in it.
re: “because a decrease in Chinese imports would likely be replaced by those from other developing nations.”
as if their exchange rates would not also adjust accordingly…
A Communist interpretation, if at all possible, may be more appropriate in this context.
“…Mr Xu, 61, is not the only Chinese Christian to suffer for his faith. Both Catholics and Protestants have long complained of persecution by the Communist authorities, and human rights groups claim the problem is getting worse…” http://news.bbc.co.uk/2/hi/asia-pacific/3993857.stm
Mmmm , why is Japan more advanced and developed doing the same thing (and has been for years)? Why have the worlds economies been screwing their savers for several years. Why does the financial industry appear to have a politically and regulatory privileged position where it has become economically and politically influential. Why does the the sky fall in every time the stock market falls a few percent? Why are banks making record profits and doling out to the same workers who made record losses while the depositor and saver is paid a return below inflation? Why does the sky fall in every time asset prices drop. Why does has the Western mentality become increasingly short term, why dos the Westerner increasingly shirk responsibility for their actions, etc etc. Should be increasingly obvious
this discussion has touched on more points that i can respond to –
I agree with “guest” who hinted that a shift in production to other emerging economies likely would lead their exchange rates to apprecite. i just don’t buy the “if not China, then someone else argument” — for one, there isn’t the capacity to produce $1,200b of goods outside of China, and that capacity won’t arise over night, for two, the capital inflows needed to generate that kind of capacity would push up the real exchange rate, for three, the successful trade flows from that shift would push up the real exchange rate — unless the rest of the world is a mirror image of China, which i rather doubt. Right now, in any case, it is very clear that China’s unwillingness to let its exchange rate appreciate is a constraint on others’ willingness to appreciate. the Thai’s aren’t worried about competition from the US.
As for gcs’s argument that i cannot be sure that
” today’s chinese winners win less then the discounted value of what tomorrows chinese losers will lose.” that is true. i cannot be sure. what i am pretty sure of is that China future losers — those who will bear the cost of today’s massive subsidy of Chinese exports via the central bank, as well as those who will pay the bill for cleaning up the banks if the banks have financed over-investment in the export sector (not obvious) or, more likely, if the very loose monetary policies adopted to support the peg (combined with tight administrative controls) end up leading to stock and property bubbles and large losses. My concern is that in China, the winners are very visible, while the losers aren’t — indeed, the losses are now hidden and won’t be realized until far off.
i didn’t see any one respond to my argument that when those loses are realized, China will likely blame the US for not paying more attention to the concerns of its creditors in its decision making. debtors and creditors don’t always see eye to eye. to me, that is an important point — i would be interested in additional reactions.
on the same front, i don’t see much evidence here in the US that the winners from globalization are willing to do much to compensate the losers — look at all the opeds in the WSJ/ wapo defending hedge fund compensation (worth every penny) and arguing that the rise of private equity shows that the CEOS of public companies are really underpaid. independent of the merits of that position, it doesn’t exactly show a lot concern for the plight of those who haven’t seen big gains — i don’t think it is a total shock in that context that the US median worker isn’t as keen on continued globalization. if it just leads to bigger payoffs for those at the top, well — the median worker (read voter) may not object to throwing up some roadblocks.
as for neo-missionary-dom, two points. One is that a lot of my critique of BW2 is echoed by Chinese critics of the current system. i won’t name names, but they exist — and they make many of the same points, namely that it isn’t in China’s interest to offer as big a subsidiy to foreign investors/ put so much of China’s wealth in depreciating foreign assets.
as for would RMB appreciation make China wealthier — absolutely, in dollar terms! the hard question is would it slow China’s rate of growth. and there i would refer back to an earlier discussion, one keyed off Larry Summers FT comment. Right now, China is taking steps to curb domestic demand. so if exports contributed less to growth, China could lift the brakes and get more domestic growth — in other words, keeping the economy from overheating given how much external stimulus comes from the export side requires policy steps to slow the rest of the economy. that gives me hope.
Finally, sterilization. that is a topic all its own. China’s sterilization is clearly partial. money growth has been pretty strong. China also artificially keeps the cost of sterilization down by, in effect, forcing the banks to lend to the government (administrative controls keep the banks from lending out all their growing deposits). Moreover, one of the costs of the current policy is the very low interest rate on Chinese bank deposits — an interest rate that has been set primarily to discourage capital inflows — so one of the costs of the current policy is that all Chinese savings in the banking system (and there is a lot of it) gets a very low return .. far lower than what likely would emerge in a competitive market. All this makes assessing the costs of sterilization difficult.
1) the PBoC limits its current capital losses by adding to its future capital losses and building up its $ balance
2) the gov helps limit the PBoC’s losses in other ways as well, notably by forcing the banks to hold $ from their IPOs offshore, creating the state investment co and the like — fx risk is being dispersed.
3) some of the costs of sterilization are shifted to the banks, as the gov. uses administrative controls to force the banks to lend to the government at a low rate.
4) some of the costs of the system are shifted to depositors, who are given very low RMB returns (which they accept in part b/c of the possibility of capital gains — low interest on RMB is better than low interest rates and a capital loss on $/ euro) and so on.
Doing a full accounting would be very, very hard.
Incidentally, the term structure of the sterilization bills is very short — way shorter than the term structure of the bonds China holds as reserves. and as the stock of bills grows, the amount that needs to be rolled over is getting very very large — this is definately something the PBoC worries about. Read some of the writings of Yu Yongding.
Brad:
Glad you touched on CEO and Hedge Fund Manager pays. However, suppose RMB appreciates rapidly, won’t the CEO and Hedge Fund benefit just as easily by requesting pay in Yuan? Also, an appreciation in Yuan may not do much to discourage export industries since it’s already big ($1200B by EOY 2007), but it could very well increase China’s pace of industrialization by enticing more Chinese firms to target the domestic market. Will that show any visible benefit for the average American worker?
Regarding your point on potential Chinese blame on US, I see us (the US) in a no-win situation. If we acted more in interest of the creditor and changed our policy, then there might be a mass exodus from dollars and the global trading system might collapse. Does China wish for that? At least with the current system, China is growing and when it incurrs the additional loss in future, it will be richer and better able to handle it. It’s the “Hey, I am only watching my own interest” cop-out, but unfortunately that’s the way the world is.
I just don’t see any good alternative being proposed right now that would a.) help the impoverished American worker b.) help the impoverished Chinese worker c.) cause an orderly transfer of assets from the winners to losers.
well I disagree with all of you. I think the US economy is a powerhouse which drives the world economy. I think it is a sign of US success and strength when foreign banks want to put their excess savings here by buying US bonds. I think it is only right that their savings should finance our deficits, since we are their best market. I think they should thank us for running up these enormous deficits, and giving them a place to put their excess funds. I think they should thank us for the privilege of buying US bonds to finance our deficits and profligate spending. I also think it is only right that they should do so. The world savings are meant to finance the US economy. Our SUVs are the rightful recipients of the world’s energy resources. Entire continents must be despoiled so that we can have the latest cell phones. Whole forests miust be provided so that we can print grocery coupons. I think is just the way it oughta be. it’s only fair.
Isn’t it?
re: “China will likely blame the US for not paying more attention to the concerns of its creditors in its decision making”
this could very well be, but it isn’t as if the U.S. hasn’t been forthcoming about the risks - or that China has not had a part in creating that risk (?)
re: ‘winners from globalization compensating the losers’
The glib response may be ‘let them make art’ (the dollar amounts - are exchange rates a driver in this market? - relatively insignificant, but certainly growing)
“…worldwide sales of Contemporary Asian Art.. 391% above sales in the prior year…” http://news.moneycentral.msn.com/provider/providerarticle.aspx?feed=PR&Date=20070301&ID=6555320
‘In China’s New Revolution, Art Greets Capitalism’ http://www.nytimes.com/2007/01/04/arts/design/04arti.html?ex=1325566800&en=ba1a6b8418c78d5a&ei=5088&partner=rssnyt&emc=rss
or start catering.
“…as of September 2006, the 60 richest Americans had an estimated $630 billion of wealth, up more than $62 billion (about 10 percent) from the year.. Mr. Ellison would have to spend that $30 million a week — $183,000 an hour — on things that can’t be resold, like parties or meals, just to avoid increasing his wealth…” http://www.nytimes.com/2007/03/01/business/01scene.html?dlbk
one question being where and how these savings are held.
” when those loses are realized, China will likely blame the US for not paying more attention to the concerns of its creditors in its decision making.”
=================
Isn’t that what the US is doing right now?
brad writes:
“.. when … loses are realized,
( their official dollar assets tank in rmb value)
China will likely blame the US
for not paying more attention
to the concerns of its creditors
in its decision making”
err ..i’m mister prc lover
and i see this as only meaningful
if its true
would a us dollar deval now hurt china more
then a future deval as delong shot suggests
at least by implication
with his laissez f policy
default on the installment plan it will be either way and also no surprise to the politbureau
if they’re still in the saddle in 40 years
they want this set up
and surely they don’t want a fast dollar dive agin their currency
————————–
but if all this is about
simply
” don’t give a potential enemy nation
any more ready ammo then you can about prior acts of hostility ”
its nonsense
for any future sino american logo machia
there’s always going to be more factoidal horrors
produceable
than any one needs to deploy anyway
in the agit prop fabrication department
supply is endless and nearly instantaneous
ask russ limbaugh
i didn’t see any one respond to my argument that when those loses are realized, China will likely blame the US for not paying more attention to the concerns of its creditors in its decision making. debtors and creditors don’t always see eye to eye. to me, that is an important point — i would be interested in additional reactions.
China’s Central Bank has two options that would stop the accumulation of foreign reserves (dollars). The CCB could let the yuan float more freely or it could monetize the dollars coming in (resulting in inflation and devaluing the yuan). Instead the CCB decided to embark on the unstainable path of sterilization.
The dollars that are backed by actual yuans are not a problem because like all money today, the yuan is a fiat currency so China can’t lose money on something created out of thin air. With the sterilization bonds there will be a loss eventually of course, but it would be ludicrous for the CCB to believe that it is buying U.S. debt with the expectation that the dollar/yuan relationship is going to remain stable. Already the CCB is letting the yuan appreciate at about 4% a year, so presumably the CCB realizes that if the yuan is free it would be appreciating even more.
Somehow I have a problem picturing the Chinese being shocked and outraged when all their U.S. debt becomes devalued (at least with a straight face).
Somehow I have a problem picturing the Chinese being shocked and outraged when all their U.S. debt becomes devalued (at least with a straight face).
I don’t…have a problem, that is. The essence of their strategy is to NOT let US debt be devalued. Even if they know it is, in reality, they don’;t wanbt it devalued on paper. that’s why they’re buying bonds. If they really didn’t care if it got devalued, they wouldn’t care about buying bonds to prop up our finances in the first place.
While not directly addressing the topic of this blog entry, I find that conversations about China’s economy to be completely bifurcated. One one hand is the the discussion of the fast growing economy and the government’s responsibility in the context of the global economy. Other discussions revolve around the tremendous difficulties still faced, and the large number of poor, uneducated, etc that live within China’s borders. The large size of China’s population (as well as India’s) is obviously why this disconnect exists. When you have even a small percentage of their economy capable of being called “middle class” then people can discuss that ad nauseum and rarely account for the living standards of the rest of the country.
1) China needs a huge store of wealth in order to pay for the people who are going to be retiring in 2020
2) China does not have the internal mechanisms to efficiently allocate this wealth. The last thing you want to do to a broken system is to throw money at it.
3) The currency losses that China faces by investing in the United States are less than the losses it faces investing in China with a bad financial system.
4) China gets stuff for its losses. The surplus that China is exporting is about $200 billion/year and given a 30% revaluation that’s a $60 billion/year. For that $60 billion, China gets the US Navy guarding lines of communications with the Middle East, and influence over US foreign and defense policy especially with respect to Taiwan.
It’s a bargain.
Brad:
You have given very good reasons why the Chinese RMB should rise in value. However, I haven’t seen much material (from anyone) on the reverse side of this adjustment. What must US do in the face of RMB’s rise to reduce the deficit. Like you, I originally believed exchange rate was the solution and it was (pretty much) the only thing that mattered. However, recent events amid Yuan’s (slight) move upwards has me rethinking that position.
First off, I agree with you that increase in RMB appreciation will reduce Chinese exports. However, I am not convinced the converse side of that argument, that a weaker dollar will increase US exports is true. I base my doubts for the following reason: a weaker dollar means more expensive inputs for US production. Not only will cost of capital go up, but cost of (foreign) equipment, resources and marketing will go up. Take for example the semiconductor industry. The weaker dollar means the silicon die is cheap, but the final assembled chip (coming from China) will be more expensive. Supply and demand dictate that China will assemble fewer chips, which means less US production of silicon die. Now consider a worse scenario, one in which Chinese packaged chip is expensive in US, but is cheaper in Yuan denominated China. So demand shots up in China. However, that doesn’t necessary translate into a increase in US production capability because cost of expansion in US dollar is high. Cost of expansion in China, however, is relatively cheaper (because of stronger Yuan) so the new fab gets built in China. What’s alarming to me is that I have seen trends like this happening since the higher value of Yuan has been factored into corporate decision making.
Second, I think you polarize the situation a bit by making the CEOs and Hedge Fund managers as winners and auto workers (as well as textile workers) losers. There are many (small) winners in between these extremes. People who perform necessary corporate functions such as accounting, sales and marketing have (to various degree) benefited from a cheap RMB. It makes travel costs cheaper (to China) and corporations can pay for US overhead to mentor Chinese counter parts. With a stronger Yuan, corporations may no longer be able to afford these overheads and as most of sales and revenue growth occur in China, will be forced to cut back in US. (Most people blame that as outsourcing.) Also, auto workers who are displaced get $100,000 buy outs. Poor Chinese farmers get subsidized by Chinese government. What do these people have?
Third, I think your point of China blaming US is a bit disingenuous. China has blamed US before and will no doubt find many reasons in the future to blame US again. What I find more interestig is why aren’t we Americans blaming our government? Where is our policy that would encourage expansion of production in US while capital is cheap rather than waste it on real estate?
Finally, I’d like to see more thoughts on what US should do in face of rising RMB to expand our production assets before we blindly force Chinese to revalue. If we don’t, the cost associated with a disorderly exit from BWII will be very high.
Whew, go away for a few days and it can be impossible to catch up.
Brad,
I think the basic disagreement - which we either have to live with, or disprove one way or the other - is that East Asian economies easily substitute for each other in supplying goods to the US. There is the capacity to produce $1.2 terabucks worth of goods outside China (and, at a price tag likely to be 10-30% higher); it just isn’t being utilized to make stuff for the US. There won’t be an automatic, easy and swift shift from Made in China to Made in (Non)China, but there’s nothing to say it is impossible.
Profitably making things for US consumers in the US, to the tune of $1.2 terabucks (more like double the price) has not been proven. Hence, “if not China, then someone else.”
.
Mr Setser,
Niall Ferguson gave some numbers for UK exports, imports, and overseas earnings before WWI, in his book Empire. Yes, the UK ran a vast trade deficit financed by profits from investments. I think the numbers were exports (7%), imports (12%), and earnings (7%). The 2% current account surplus flowed back out into new investments. I read the book a few years ago (and no longer have it), so these numbers could well be somewhat off.
I once purchased an economic history of the UK to find some hard data. No such luck. However, the big picture is clear. The UK declined as a manufacturing power (in part) because overseas earnings paid for imports instead. That is (was) saner than what the US is doing. We are liquidating our manufacturing sector and replacing it with debt accumulation.
Let’s continue discussions in Brad’s absence…..there has certainly been plenty going on in the markets to discuss!
Regarding Peter Schaeffer’s comment: as I say from time to time, the prudent US response to the official inflows from Asia and the oil producers would have been to add to America’s own foreign exchange reserves (even now, the opportunity to do so may not be entirely lost). But they take the Leona-Helmsley-like view that reserves are for little people. I would urge the EMU countries to avoid repeating America’s mistake and build up the ECB reserves as the use of the euro as a reserve currency grows, especially when complaining that other reserve currencies are unreasonably weak. The same advice probably applies to the UK (my country) too.
Brad asks how China might respond to losses sustained on its dollar reserves. It depends on how they arise. If dollar depreciation is driven by some “unconventional” monetary policy operation engineered by Bernanke to forestall deflation, and if China’s attempts to diversify into real assets have been blocked by CFIUS, then they would have a right to feel aggrieved. One economic sanction that the Chinese might consider in such circumstances is to disregard US intellectual property rights for some period.
It is often said that, if you owe the bank a lot of money, it is more their problem than yours. This is only true if you have a viable plan to avoid depending on the bank in future.
RebelEconomist,
I like your idea. However, how would the US pay for its foreign exchange reserves? Print dollars? Sell bonds? Presumably the latter. However, the annual bond sales required to offset official inflows would run to hundreds of billions per year. More than the budget deficit right now. Presumably the bond sales would cause interest rates to rise and the dollar to fall.
Yes Guest, the net impact of my policy proposal would be increased government bond sales and a larger holding of foreign currency reserves assets, but I would argue that this is as it should be. It is the present policy which is abnormal. And yes, this would be expected to lead to higher long term dollar interest rates, which might have restrained the equity market back in the 1990s and the housing market in this decade, and a lower dollar, which might have reduced the current account deficit. It would not require an increase in base money supply though, other than perhaps temporarily, as the dollars spent on the reserves would be raised by selling treasuries.
How is the present policy abnormal? Firstly, under any measure of reserves adequacy that I know, the present level of US reserves is far too low - more anomalously low than China’s reserves are anomalously large. And that is now - at China’s rate of growth, it will not take long for its existing stock of reserves to look no larger than reasonable. It is not that America has reduced the nominal value of its reserves; rather that it has not maintained their adequacy in the face of rising economic activity, financial flows and trade flows. Secondly, despite the large government deficits in recent years, the US government debt to GDP ratio is not high by international standards. It is not that the treasury market would have been unable to absorb the additional sales without an excessive rise in long term rates. Effectively, the US has funded part of its budget deficit from its foreign exchange reserves.
The present policy seems to have arisen as the least line of resistance, rather than deliberate choice in the light of rigorous analysis. There does not seem to be any US foreign exchange reserves policy. The US authorities seem to think that reserves are not necessary for them, but the reserves have not been actively reduced, and as far as I know, neither the Fed nor the US Treasury has done, let alone published, any analysis of what the appropriate size of the US foreign exchange reserves should be. It is, I would say, a case of complacent neglect.
Of course, to restore the adequacy of the US reserves to the level of, say, twenty years ago would require large bond and dollar sales, which would be inopportune now that the US housing market and the dollar have weakened. But from time to time there are chances to at least make some progress, such as last month when the yen was weak.
we worked it all out the other day! basically picture an end game were we’re importing vast sums of chinese skilled (heck, even unskilled) labor to the US and placing them in rececently relinquished homes