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China is starting to sound like a normal creditor country

by Brad Setser
December 4, 2008

Most creditors believe that the debtor needs to take the lead in addressing their own problems. China is, apparently, no different. Geoff Dyer of the Financial Times reports:

Wang Qishan, a vice premier and leader of the Chinese delegation at the two-day talks, called on the US to take swift action to address the crisis and said the two countries needed to work together. “We hope the US side will take the necessary measures to stabilise the economy and financial markets as well as guarantee the safety of China’s assets and investments in the US,” Mr Wang said.

Zhou Xiaochuan, governor of the Chinese central bank, urged the US to rebalance its economy. “Over-consumption and a high reliance on credit is the cause of the US financial crisis,” Mr Zhou said. “As the largest and most important economy in the world, the US should take the initiative to adjust its policies, raise its savings ratio appropriately and reduce its trade and fiscal deficits.”

Jim Fallows’ interview with Gao Xiqing has a similar tone: the US should treat its creditors rather more nicely. Fair enough. China now almost certainly has well over $1 trillion in US Treasury and Agency bonds, and probably close to $1.5 trillion in total dollar exposure (more on that next week). That is a lot by any measure — more than really makes sense.

On the other hand, I hope that Chinese policy makers recognize:

a) They, not the US, decided to intervene heavily and in sustained way to hold their exchange rate down, a policy that necessarily implies financial losses for China. China is effectively overpaying for financial assets (dollar reserves) that it doesn’t need in order to support its export sector. There is no way the US can guarantee China against losses on its holdings of dollars.

b) Investors in highly leveraged financial institutions risk large losses. China’s discomfort with its current losses suggests it never should have bought large stakes in major financial institutions. One of the concerns Larry Summers raised about sovereign wealth fund investments in large financial institutions is such investments would turn the always difficult decision to wipe out the equity of a failed financial institution into a foreign policy decision. That rings true.

c) Given how much the US imports from China, it is hard to see how the US can increase its savings (and reduce its trade deficit) without putting pressure on China’s export sector. Indeed, right now the US consumer seems to be following PBoC governor Zhou’s advice to save more – that is one reason why China’s exports have slowed. And that hardly has made Chinese policy makers happy. Right now a smaller US fiscal deficit would imply even bigger falls in global demand for China’s products.

d) If China wants to maintain its trade surplus — and in the process to maintain a world where China’s exports are growing faster than the world’s imports, meaning that China’s global market share is rising — other countries will necessarily have to run a trade deficit. If oil remains in the 40s, some of that deficit will likely come from the world’s oil exporters. But they can finance their deficit by selling existing US and European assets. They won’t necessary need to take on new debt and borrow China’s surplus. A lot of the offsetting deficit will likely come from the US. By the same token, China can only save more than it invests if someone else invests more than it saves, and thus needs to borrow from the rest of the world — just as the US can only invest more than it saves if someone else (like China’s government) is willing to lend it the funds it needs. There aren’t many places in the world that are likely to absorb China’s projected $400 billion current account surplus.

Chinese complains about loose US policy are a bit at odds with other Chinese policy choices that are aimed at supporting China’s exports.

I would have more sympathy for China’s concerns about its export sector — and the loss of jobs in its export sector — if:

a) China wasn’t running a large current account surplus as a result of policy choices in this decade that had the predictable result of leading to over-investment in China’s export sector, and thus increased China’s vulnerability to a global slowdown (click here for a summary of the article I linked to above that is not behind a firewall).

b) If China wasn’t still widely forecast to grow more rapidly than almost anyone else, which admittedly isn’t saying all that much right now.

c) If China didn’t have the capacity to support employment through a large domestic stimulus. For example, the World Bank is forecasting a smaller swing in China’s fiscal balance in 2009 than seems likely in the US.

d) If China hadn’t pursued a capital intensive development path that has been creating many jobs for a long-time. Effectively China has substituted capital-intensive exports for labor-intensive exports; remember, it is exporting way more in 2008 than in 2007.

e) If Chinese exports weren’t expected to grow faster (or shrink by less) than the world’s imports. Remember China has been gaining global market share for the past several years. And yes, that is something that is, in my view, directly tied to the exchange rate — China’s market share in Europe soared after the RMB fell v the euro. The World Bank forecasts that this will continue in 2009 even with the RMB’s recent broad appreciation … (See figure 2 and the table on p. 9 of the World Bank Quarterly)

The slump in global trade — Korea’s exports were way down in November, and given US auto sales, Japan’s exports likely will be too — is sure to increase trade tensions. And as China starts to realize the costs of its export subsidies — and the fact that avoiding incurring financial losses on its existing investment requires making an ever bigger financial bet on the US and the US dollar — it sure seems that China wants a bit more say over US policy. That too is a potential source of tension.

China effectively choose to loose money lending to the US when it scaled up its purchases of dollars to resist pressure for the RMB to appreciate and in the process subsidize its export sector. But I doubt China sees it that way.

93 Comments

  • Posted by RebelEconomist

    Brad,

    Why doesn’t America simply accept China’s savings and invest more than it saves?

  • Posted by bsetser

    Rebel — isn’t that what the US did from 04-06, just with most of the investment going into residential real estate? It didn’t work out so well …

    Perhaps it might work better if invested in another sector, but long-term, i suspect the conditions that generate China’s surplus (an undervalued exchange rate) also will tend to channel the investment into some of the wrong sectors (notably sectors insulated from Chinese competition).

    If I had confidence that there was an exit strategy and such investments were part of a glide path toward a much smaller Chinese surplus i might view them differently. But right now I have no such confidence.

  • Posted by FRED

    The real tell is that the adminsitration simply doesn;t get it. Bloomberg reporting China is not interested in opening the banking sector to the US despite Paulson repeated pleas (again!). The US has done such a good job managing our own banks you can understand why. Paulson/treasury/US really is the king of gual. Does the US reallys till think that it is going to get a monopoly on the higher margin banking business that was? Perhaps the bigger story is that Paulson and the PTB are still begging for the same old soltuion despite the structural changes ongoing. It provides a glimpse of just how short sided and desperate the policy community is to reconcile its grave failings in policy decisions (and basic math/economics) over the past few decades.

  • Posted by Global Chessboard

    … I doubt it too. China has pursued a strategy of global Yuan hegemony; accumulating excessive US dollar reserves; avoiding needed domestic infrastructure investments; knitting a web of free trade agreements with various African and South American nations; increasing competition for scarce global oil reserves; contributing to a new global arms race through excessive focus on nuclear warhead developments; suppressing the legitimate democratic ambitions of Taiwan and Tibet.
    China’s accumulation of US dollar denominated foreign exchange reserves came from what United States Senator Joe Biden believes is a ‘Gulliver Strategy’. China’s foreign policy is targeted against the spread of our democratic values; and against our defense of global freedom. China has been providing large undisclosed amounts of foreign aid to dictatorial regimes in the African continent. China has been using dollar reserves to secretly aid regimes that we have been opposing in Africa … those same cruel dictatorial regimes that contribute to large scale genocide of defenseless and unarmed civilians in the African continent.
    Honest and hard working Americans have tolerated destructive trade competition from China for quite a long time. China has taken advantage of our openness to cause many of our people to be jobless, and even bankrupt. We cannot allow this to continue.
    We cannot allow China’s evil policy of militarist enforcement of regional hegemony to continue. Injustice anywhere is a threat to justice everywhere. China’s unjust occupation of the free Tibetan population should end. This is not our demand alone. Soon we will demonstrate a consensus on this issue at the United Nations.
    In order to avoid trade sanctions China should work with us to demonstrate peaceful intentions towards neighbors; avoid destructive trade competition; and help us in our efforts to secure a world free of terror for that kid looking up at the helicopter.

  • Posted by Global Chessboard

    :-) @ Twofish, etc … those aren’t my views … it’s just along the lines of what I’m expecting to be said pretty soon. Pacific command soon sails for the East China sea …

  • Posted by Howard Richman

    China keeps counting on an incompetent reaction from the United States, and so far they have meeting their expectations. We suggest an alternative in a commentary published this morning by American Thinker.

  • Posted by Christian

    Frankly, if the US isn’t pleased with their trade deficit with China, they need to stop acting like sissies and do something about it. I am not suggesting a remake of the opium war – mind you after the melamine, lead and other toxic products the Chinese have been providing, i am starting to wonder if they aren’t fairing their own “drug” war with the western world… – but a certain amount of protectionism to counter-balance their currency undervaluation would certainly help. As mentioned in the post, it is fair to say the Chinese are quite pleased with their creditor position and won’t do anything to change things (why should they? I wouldn’t). It is up to the Americans to force changes if they are serious about it.

  • Posted by Bob_in_MA

    Clearly you are right, but the opportunity to address imbalances in a logical and prudent manner seems to have slipped away.

    Frankly, I’m not sure I believe anything done in China (increase social welfare spending, build schools, etc.) or the U.S. (lower mortgage rates to 4.5%, spend like drunken sailors, etc.) is going to have much of an effect.

    The beast has been loosed.

    There is way too much debt in the world that funded way too much production. I’m not sure the fact that they occur in different places really matters. Does it matter whether the excess capacity to build TVs is in the Far East rather than the Midwest?

    I think the people, like Krugman, for whom the correct path seems so obvious are deluded as to their own abilities.

    And the famous quip from Bernanke to Martin Feldstein and Anna Schwartz that the Fed was wrong in the 1930s but wouldn’t let it happen again may well be so much bravado.

    They may just be wrong in new ways.

    Anyone with confidence in policy makers (including Obama’s crew) to steer us through this is a supreme optimist, which I have never been.

  • Posted by bsetser

    I do not really understand why the treasury is continuing to push to open up China for (under-capitalized) US and European banks right now. I always thought Paulson over-emphasized financial sector liberalization and right now it is an obvious non-starter. It also benefits a rather narrow cohort of Americans — and a very different cohort than would benefit from a more appreciated RMB.

  • Posted by FG

    A lot of the talk focus on China, but are global dollar reserves rising or decreasing at this point? (with oil below $50)

    For its part China seems bent on buying more dollars, but will lower prices create more demand from US consumers? There may be a diminishing return for them.

    When the Fed is massively manipulating mortgages rates, why worry about Chinese purchases of treasuries? The effect on the US economy is probably less now, isn’t it?

  • Posted by Global Chessboard

    @Brad:
    … to understand that you need to know the lie of the global chessboard and the rules of the game.

    Read up what’s happening with Landsbanki Bank’s UK assets; Trade Bank of Iraq’s funding sources; ConocoPhillips losses in Venezuela due to nationalization of all oil fields; Venezuela’s nationalization of the Bank of Venezuela; private banking in Iran; ownership of private banks in Hungary; EU bailout loan to Hungary; EU and IMF’s limited assistance to Iceland; Russia’s loan to Iceland; Russia’s bombing around the Baku-tiblisi-ceyhan pipeline in Georgia; the massacre of civilians in Sri Lanka; the protests in Thailand; the terror attacks on Mumbai; the level of poppy production in Afghanistan; the fall in China’s imports of hard wood logs; IMF’s plans for fast track assistance to Latvia; …
    I was like you till three weeks back, honestly. But I’ve been finding out. Sometime during the last few days, I learnt what’s really going on.
    If you really understand the answer to this one the answer will change your life; for ever.

  • Posted by Brian Shriver

    RebelEconomist (et al):

    It is a travesty to assume that savings equals investment. Savings is a zero-sum game. Primary flows may or may not flow. And, most relevant, borrowings can be used for a variety of reasons, including (a) business investment, (b) deficit spending (including housing), and (c) financial market speculation.

    Unfortunately, in the US there has been far more (b) and (c) than (a). How much can you invest in US industry when the US is at a strong competitive disadvantage against those countries with intelligent forex policies?

  • Posted by DJC

    From Asia Times,
    http://www.atimes.com/

    This US-induced global financial disaster that now threatens to keep the world in deep economic depression for another decade and more is essentially the product of US ideologically-based policy and practices. While substantial damage has already been irreversibly done to the world economy by the collapse of economic bubbles caused by a liquidity flood, particularly to confidence in the market system, the US rescue strategy has been to keep the debt bubble from bursting with indiscriminate injection of liquidity. Until the US monetary policymakers realize that excess liquidity denominated in fiat dollars cannot create wealth, but rather it destroys wealth, the debt-infested US economy will not begin to recover.

    Further damage to the global economy cannot be averted without a fundamental change in US policy that has been exploiting its predatory monetary hegemony. This dollar hegemony grows out of a fiat dollar that has allowed the US to finance its decades-long current account deficit with a compulsory compensatory capital account surplus, sucking wealth from the exporting emerging economies to the US to keep it as the world’s richest economy that consistently consumes more than it produces with the help of debt denominated in fiat dollars that the US could print at will.

    Notwithstanding President Bush’s attempt to blame the victims for the crime, the easy credit was not caused by massive inflow of foreign capital. It was the other way around. The massive inflow of foreign-owned capital denominated in dollars was caused by easy credit which grew out of monetary indulgence on the part of the US central bank which alone can issue dollars. This monetary indulgence enabled the US to sustain a current account deficit with a capital account surplus of recycled dollars. The US has been consuming more that it produces through recurring trade and fiscal deficits made possible by dollar hegemony, sucking up wealth from its trade partners who are not in any position to increase domestic consumption because real wealth has been exported to the US in return for fiat dollars that cannot be used in the domestic economy without causing inflation.

  • Posted by bsetser

    DJC — please explain why the US trade deficit didn’t fall when the fed raised rates and the treasury reduced the fiscal deficit? US policy cannot exactly explain why long-term rates didn’t rise with short-term rates/ fell below short-term rates? And if China thought US policy was too loose, why did it keep pegging to the dollar/ keep so many reserves in dollars.

    I shouldn’t rise to the bait but ….

  • Posted by Global Chessboard

    @Brad:
    Focus on answering your question. If China’s doesn’t open up the banking sector then either the US dollar will collapse, or there will be severe import controls; ultimately it’s either open up the banking sector or face a future war for China.
    I hope they will go the India way. They can open up their sectors over a period of time. Social goals through state owned banks; business goals through foreign investment; and they can make a lot of money in the privatization process.
    Let’s see what happens, it has to pan out either now; or soon after Obama takes official charge.

  • Posted by MakeMeTreasurySecretary

    Brad,

    You pretty much said it all and said it very eloquently indeed. So, what to do/

    At the end, we are all slaves to our ideology and mythology, so we can be easily manipulated. China essentially says, You wanted free markets, I will show you free markets. The US, on the other hand is frozen in indecision.

    But there are solution to the problem, which Zhou Xiaochuan very accurately described: “Over-consumption and a high reliance on credit is the cause of the US financial crisis”. For example, we can discourage investment in real estate through regulation and tax policy. We can force the dollar down by buying reserves (yes, even Italian bonds!) We can put a tariff on everything imported. Oops, I forgot. All these cut against the grain of our ideology and mythology. So we are back to square 1.

  • Posted by cam

    The U.S. might as well call China’s bluff and say, “If you don’t like our economic policies sell your treasury/agency bonds.”

    China won’t, obviously, since their economy is dependant on keeping their currency undervalued against the dollar and the only way they can continue that policy is by buying those treasury/agency bonds.

  • Posted by Global Chessboard

    Brad:
    I do not really understand why the treasury is continuing to push to open up China for (under-capitalized) US and European banks right now.

    If anybody knows the answer to that one I would prefer to discuss as a personal view over Email rather than on this forum.

    I’ve already answered it, though not directly.

    … it’s globalchessboard2008@gmail.com

  • Posted by anonymous monetarist

    Thursday, December 4, 2008
    Yuan Watch : Let’s make a deal!

    Reading between the lines of the articles below, it would appear that the Chinese are threatening to depreciate the yuan in order to protect their investments (treasuries and agencies) in the face of the Federales monetization program.

    No other explanation makes sense.

    The Chinese can’t depreciate the currency enough to have a dramatic effect on exports, as acknowledged by the Chinese Central Bank governor.

    What can Zirpmeister Ben and Timmy G do to assuage their Chinese counterpart to continue yuan appreciation so as not to set off additional asian devaluations and demand destruction?

    What guarantees will be given in order to protect Chinese investments?

    According to the World Bank the Chinese will still have dollar reserves that they need to dispose of in 2009 due to decrasing terms of trade (cheaper inputs i.e.,half-off sale on all commodities.)

    Continued yuan appreciation with guarantees to the Chinese that offset currency risk of our sovereign debt would seem to be the desired outcome.

    A currency swap with appreciating reserves tied to the depreciating value of the greenback? Maybe Goldie can share some of the Treasury CDS.

    Don’t laugh … imagine how silly any of today’s headlines would have been a year ago.

    Connect the dots as you see fit with the articles below.

    Thu Dec 4, 2008 2:17am EST
    BEIJING, Dec 4 (Reuters) – Zhou Xiaochuan, governor of the People’s Bank of China, flew to the United States on Thursday for an unscheduled meeting, a central bank official said.

    By Li Yanping and Dune Lawrence
    Dec. 4 (Bloomberg)
    The comments in Beijing today by Vice Premier Wang Qishan and central bank Governor Zhou Xiaochuan came as U.S. Treasury Secretary Henry Paulson praised China’s “responsible role” in combating the crisis.
    “We hope that the U.S. can take all necessary measures to stabilize its financial markets and economy as soon as possible and ensure the safety of China’s assets and investments in the U.S.,” Wang said. “To work together to tackle the financial crisis is the most pressing task that we are facing.”

    by Joe McDonald
    Dec 4th -AP

    “The Chinese continued to reinforce to us that they were committed to continued reform, and by that I mean continued appreciation (of the yuan) over time,” said an American official who briefed reporters on condition he not be identified further.
    The American officials said they did not know details of what Wang meant by protecting Chinese investments.

    thestandard.com.hk
    (12-04 17:19)
    China needs to be prepared for the worst case scenario amid a deepening global economic crisis, central bank governor Zhou Xiaochuan said.
    Zhou also urged the US government to take more measures if needed to help stabilize the global economy and financial markets, Jin Qi, head of the international department of the Peoples Bank of China said in Beijing after a meeting of the China-US Strategic Economic Dialogue.
    China’s government should take timely, effective and pre-emptive measures, analyze the progress, evolution and outlook of the crisis and be especially prepared for a worst- case scenario, Jin quoted the central bank governor as telling the meeting .

    By Wang Bo (China Daily)
    Updated: 2008-12-02 16:00
    The governor of the People’s Bank of China, Zhou Xiaochuan said earlier that he wouldn’t rule out the possibility of the renminbi depreciating.
    “The moderate depreciation of the Chinese currency is conducive to the domestic economy,” said Guo Tianyong, director of the Research Center of the Chinese Banking Industry, Central University of Finance and Economics.
    But he also pointed out that as overseas demand has declined substantially, renminbi depreciation is not “quite an effective tool” to spur export growth.

  • Posted by DJC

    Brad Setser : please explain why the US trade deficit didn’t fall when the fed raised rates and the treasury reduced the fiscal deficit?

    DJC: Writes Economist William Greider, the only guaranteed mechanism to reduce the trade deficit is a US recession. The Federal Reserve’s monetary policy of flooding the economy with excess “credit bubble” liquidity at the slightest economic decline has repeatedly inhibited market forces from imposing a correction of US economic imbalances. As Twofish also argued, the US trade deficit in the couple hundred billion dollar ranges pails in comparison to the 7-8 trillion dollar bailout of Wall Street banks by American taxpayers.

    Brad Setser: And if China thought US policy was too loose, why did it keep pegging to the dollar/ keep so many reserves in dollars.

    DJC: Over the past decade, the China PBoC monetary policy in relation to the US Dollar was left basically on autopilot. It was never their intention to accumulate a $2 pile of US Treasury bonds. The China PBoC also finds itself entrapped by the US Dollar hegemony regime.

    “China must use the opportunity offered by the current global financial crisis to restructure and reorient its economy toward domestic development financed by sovereign credit denominated in Rmb, away from excessive dependence on export for fiat dollars to feed profit to foreign investment. This shift requires a period of strict capital and currency control until China is free from the effects of dollar hegemony which inhibit the application of sovereign credit for domestic development. In this uncertain climate of international financial turmoil, China should refrain from further measures to move its currency towards free and full convertibility in the global currency markets. Appreciating the exchange value of the Rmb will only strengthen dollar hegemony while doing little to solve China’s problem of export dependency.

    The amount of sovereign credit needed to develop the Chinese domestic economy will be enormous and much larger than China’s current $2 trillion foreign reserve. Any further move toward free and full convertibility of the Rmb will restrict China’s ability to finance its much needed domestic development with massive sovereign credit. Until foreign trade is reduced to around 35% of GDP, China will find it counterproductive to let the Rmb appreciate against other currencies. The domestic sector must accelerate its growth to reduce the current level of foreign trade from its 70% of GDP to around 30% of GDP, and to increase consumer spending to 70%. This means the domestic sector must grow at a rate double that of the export sector.” – Asia Times

  • Posted by Global Chessboard

    Let’s get the basics right. When a country faces falling exports, it sells the forex reserves and defends the local currency. And that involves ‘appreciating’ the RMB against the USD. What China was doing till as of a hours ago was it was ‘devaluing’ the RMB. If they’re going to devalue the RMB and let the USD reserves flow out then it means a global USD collapse.

    @Brad: Can you please clarify on this?

  • Posted by observer

    bsetser: I do not really understand why the treasury is continuing to push to open up China for (under-capitalized) US and European banks right now.

    Is it really that hard to understand? Paulson spent his career at Goldman Sachs and made a fortune. Of course he subscribes to the self-serving belief that investment banks are doing the Lord’s work and financial sector liberalization is the key to world-wide prosperity.

    He clearly lack the intellectual integrity to adjust his views to the finance-created catastrophe that is unfolding right now.

  • Posted by RebelEconomist

    You make a good point Brad; unlike the UK, at least the US had a surge of new housing to show for its current account deficit (although the surge in private residential construction only accounts for a minor part the current account deficit). No doubt a worthwhile target for any fiscal package is to spend money to ensure that this housing is not wasted in the subsequent bust.

  • Posted by Global Chessboard

    @ observer
    LOL :-) What would be your estimate of Paulson’s IQ?

  • Posted by observer

    Global Chessboard: Let’s get the basics right. When a country faces falling exports, it sells the forex reserves and defends the local currency. And that involves ‘appreciating’ the RMB against the USD. What China was doing till as of a hours ago was it was ‘devaluing’ the RMB. If they’re going to devalue the RMB and let the USD reserves flow out then it means a global USD collapse.

    What China is doing with its exchange rate policy is old-fashioned mercantilist dumping of products at artificially low prices to force competitors out of business. It is illegal for a company to do that and it should be illegal for a country to do it as well.

  • Posted by Charles

    Christian, many more Chinese than western kids have suffered from the criminal manufacturing practices of Chinese businesses. And the US has its own execrable commercial practices, like exporting banned pesticides to Latin America. Plus, the only reason that the leaded toys and melamine containing food got in is because the regulatory powers of the FTC/CPSC and the FDA have been gutted. Thirty years ago, there would have been proactive inspections.

  • Posted by Howard Richman

    @anonymous monetarist wrote: “Reading between the lines of the articles below, it would appear that the Chinese are threatening to depreciate the yuan in order to protect their investments (treasuries and agencies) in the face of the Federales monetization program. No other explanation makes sense.”

    There is another explanation that makes sense from the standpoint of psychology. You are making the assumption that policy makers are responding rationally. I used to co-author theoretical psychology papers with Herb Simon, who won his economics Nobel Prize for pointing out that business administrators do not act rationally. Policy makers are not rational. They make their decisions based upon rules-of-thumb (i.e., “heuristics”).

    Chinese policy makers have adopted the rule-of-thumb that weakening their currency increases demand for their products. This rule has worked in the past. They just haven’t realized that the situation has changed because they’ve bankrupted their customers. (Mercantilism has the flaw that it destroys the markets for its products.)

    American policy makers have adopted the rule-of-thumb that you fight recessions by increasing government budget deficits. It’s worked in the past. They just haven’t realized that they are in a world-wide depression caused by mercantilism in which fiscal stimuli increase trade deficits so much that they are ineffective.

    By the way, your pseudonym suggests that you are a monetarist. I consider myself to be one also. My father and I have proposed a new balanced-trade rule-of-thumb for monetarists in a commentary that was published today by American Thinker.

  • Posted by observer

    Global Chessboard: What would be your estimate of Paulson’s IQ?

    I have no doubt he has a very high IQ. IQ tests focus on important things like solving logical puzzles and do not measure irrelevant things like intellectual integrity.

  • Posted by Ying

    Strong dollar policy has been officially adopted since Robert Rubin became Treasury Secretary. From Rubin to John Snow, and Henry Paulson, all of them repeatedly claim that strong dollar is national interest. Can someone explain what it really means?

    Does it mean that maintaining strong dollar will continue to make Japanese, Chinese and other developing countries to purchase US bond and Securities?

    For me, it is not a coincidence that China artificially keep its exchange rate low without the consent of the US administration. Both sides have vested interest in keep it low.

    From business perspective, multinational companies are interested to keep dollar strong if they raise funds in dollars and spend the funds in RMB by foreign direct investment. Their labor cost will be denominated in RMB and their products will be sold in $ with high value. Because of the size of these firms, they often operate at monopolistic market and get big concession or benefits in establishing their firms in China. It is common for CEO of big firms from the West to meet Chinese leaders on TV.

    For small business owners in China which market is US and Europe, most of them don’t have any knowledge of exchange rate and they don’t care about which direction the exchange rate will go or try to predict it. Their main job to push cost down to beat local competitors. They also don’t have the political influences to decide the exchange rate.

    Trade Surplus is a headache for Chinese government. Low labor cost stimulated export industry. Private sectors exchanged US dollars immediately into RMB which in terms to recycle more money into fixed investment. Overproduction capacity and waste is a enormous problem in China. Despite the central government’s efforts to cool down the economy between 2002 to 2006, there is very limited success. Wages has been pushed lower and lower in a relative sense facing the increased competition among producers. Income inequality, environmental deterioration and long working hours make average workers especially migrant workers no happier than Mao’s time. No money can purchase clean air, clean water and your health.

    From US side, they mislocated resources to unproductive or even destructive purposes. I won’t say too much about it.

    Crisis is an opportunity to fix old problems unless we can’t learn the lesson from it. It is more than necessary to need cooperation between both sides at this time. I believe the area of cooperation should be:

    -Environmental sustainable consumption and production. US consumers shouldn’t be allowed to consume products that is not environmental sustainable. China producers shouldn’t be allowed to pollute for profit.

    -Joint efforts in research in new energy efficiency programs

    -Joint efforts in improving education in both countries.

    -Joint efforts to provide social safety net for low income families and promote social stability instead of recruiting more police to watch people.

    -Population control ( Nobody likes it. But for a sustainable earth, all people have to do it)

    I think if politicians in both countries focused on the needs of majority people in both countries, they will be able to find consensus on many issues above.

  • Posted by gillies

    helicopter zhou ?

  • Posted by Global Chessboard

    Brad:
    why did it keep pegging to the dollar/ keep so many reserves in dollars.

    It’s an old martial arts approach. Your opponent strength works against your opponent. they accumulated dollars and used them to increase their influence.

    Now they will collapse the dollar and their influence can continue without dollars.

    It’s hard to know if the above headlines are showing a deal or a mess. If they continue to devalue the yuan it means a USd collapse pretty soon, it should tie in with further CDS increases on treasuries.

    If they keep the yuan strong against USd it means they’re going to hang on to the USD reserves. And that’s a banking sector opening up deal.

    It’s precarious to see them announcing agreement on energy, etc … you don’t know if that’s the good enws that comes before the bad news, or if it’s just good news overall.

  • Posted by observer

    DJC: Any further move toward free and full convertibility of the Rmb will restrict China’s ability to finance its much needed domestic development with massive sovereign credit.

    Normally I try to ignore DJC’s ultranationalistic trolling. But this is reaching a new level of absurdity. China needs huge foreign exchange reserves to finance domestic development???? That is a matter for fiscal policy: what had it got to do with accumulating dollars.

    DJC: Until foreign trade is reduced to around 35% of GDP, China will find it counterproductive to let the Rmb appreciate against other currencies. The domestic sector must accelerate its growth to reduce the current level of foreign trade from its 70% of GDP to around 30% of GDP, and to increase consumer spending to 70%.

    Is this a joke? China has been growing at more than 10% for years now. You want to keep exports growing as they are and simultaneously grow the domestic spending? What is that going to require? 40% GDP growth rates?

  • Posted by Global Chessboard

    … and I saw the People’s Daily photographs of the Admiral Chabanenko firing a salvo in the Caribbean Sea … joint exercise with Venezuela …

  • Posted by RebelEconomist

    “…please explain why the US trade deficit didn’t fall when the fed raised rates and the treasury reduced the fiscal deficit? US policy cannot exactly explain why long-term rates didn’t rise with short-term rates/ fell below short-term rates? And if China thought US policy was too loose, why did it keep pegging to the dollar/ keep so many reserves in dollars.”

    Easy. The US was in a credit boom as financial innovation (especially CDOs) made borrowing easier than ever. Given China’s fixed exchange rate policy (maintained since 1994), this led to an increased trade deficit with China. The boom prompted the Fed to tighten and automatically reduced the US fiscal deficit. When a country pegs its currency to another for monetary stability, they will not give up the peg lightly, and anyway, their key concern is the inflation rate of the peg currency, which did not reach an unacceptable level.

  • Posted by Global Chessboard

    @Dr. Richman
    I hope the Chinese will agree to opening up their banking sector for foreign investment.
    It might also be a case of cognitive error at this forum rather than thumb rules in the PBoC. We think they need our dollars, but they don’t. Any day they want to they can collapse the dollar. That will make us bankrupt.

  • Posted by Global Chessboard

    You have to see that China, Russia, Venezuela, Iran … all have to be dealt with. We’re through with Iraq and Iceland; I haven’t checked the Norway story yet.
    It’s too many challengers and only folks like the UK and the Indians really supporting.

  • Posted by Twofish

    observer: Is it really that hard to understand? Paulson spent his career at Goldman Sachs and made a fortune. Of course he subscribes to the self-serving belief that investment banks are doing the Lord’s work and financial sector liberalization is the key to world-wide prosperity.

    Ummmmmmm…… No.

    Most people I know that work in investment banks want more regulation, because people there have seen the sausage factory first hand. That’s why much of Wall Street voted for Obama, because Bush and the Republicans tend to be clueless about such things.

    Also financial crises are *NOT* the interests of people in investment banks, as you can see by the layoffs and firings that are going on right now.

    The nice thing about capitalism is that money can sometimes cut through the bull crap. If you want to convince someone on Wall Street that people should have more regulation, tell them to look at this years bonus.

  • Posted by Twofish

    Chessboard: why did it keep pegging to the dollar/ keep so many reserves in dollars. It’s an old martial arts approach. Your opponent strength works against your opponent. they accumulated dollars and used them to increase their influence.

    Hardly. China has huge dollar reserves because they say how a currency crisis could destroy a government like it did in Indonesia and Mexico.

  • Posted by Howard Richman

    @Global Chessboard “We think they need our dollars, but they don’t. Any day they want to they can collapse the dollar. That will make us bankrupt.”

    You are essentially correct. They will eventually pull the plug out from the dollar and send the United States into a high-inflation, currency collapse. But your timing is wrong. They could not do it now and they would not do it now:

    1. They couldn’t cause a dollar to collapse right now with the world going into depression because there is way too much private capital out there looking for a home. If US Treasury interest rates started to go up, there would be a tremendous inflow of private foreign capital looking for positive return.

    2. They don’t want to do it now. They have too much market share that they still want to steal from us: automobiles, commercial aircraft, high tech, GE appliance, construction machinery, etc.

    My guesstimate is that they’ll pull the plug out from under the dollar in about 3 or 4 years, sooner if hard-line communists take power (after all Marxists think socialism is the cure for depressions) and send the present-leadership to reeducation camps.

    This is the perfect time for the United States to enact Import Certificates.

    Howard

  • Posted by Twofish

    Chessboard: … I doubt it too. China has pursued a strategy of global Yuan hegemony;

    No it hasn’t. China’s primary concern is keep the government in power and making China rich and powerful. Imperial overstretch will make your country weak and bankrupt, and China learn that from Russia.

    People assume that China will do certain things because that’s what they would do if they were running China. Fortunately China isn’t run by anyone like American neo-conservatives. China’s main interest is domestic economic prosperity.

    Chessboard: China’s foreign policy is targeted against the spread of our democratic values; and against our defense of global freedom.

    This is nonsense. The Chinese government is extremely non-ideological, and it doesn’t care what governments are like.

    Also, who is “we”?

    Chessboard: Honest and hard working Americans have tolerated destructive trade competition from China for quite a long time.

    Most Americans make money from Chinese trade than lose by it. You have been so blinded by a false conspiracy than by the *real* conspiracy.

    China seeks to control US policy by making lots of Americans get extremely rich if China rises.

  • Posted by Global Chessboard

    Those weren’t my views, Twofish … didn’t you see the post below … I was just guessing at the kind of excuses they usually have for sanctions and wars and such like …

  • Posted by ReformerRay

    Long ago DJC said “The US has been consuming more that it produces through recurring trade and fiscal deficits made possible by dollar hegemony”.

    The trade deficits have many causes. One of the strongest is the large amount of Net Wealth owned by U.S. households and non-profit organizations – 58 TRILLION at the end of 2007.

    China, Japan, Germany, Canada, Mexico and residents of other nations would like to own those assets. So they send more goods to the U.S. than they buy from us.

    That motivation would remain, so long as the Net Wealth remained – regardless of which currency is used to pay for imports and exports.

    The dollar continues to be used out of inertia. But it is an inertia shared by everyone who trades and is not enforced by anyone – certainly not by the U.S.

  • Posted by observer

    Twofish: Most people I know that work in investment banks want more regulation, because people there have seen the sausage factory first hand. That’s why much of Wall Street voted for Obama, because Bush and the Republicans tend to be clueless about such things.

    I call BS. That’s either a completely ignorant statement or a lie, sorry to say. Where were these regulation-loving investment bankers when their lobbyists were hard at work opposing any government oversight of derivatives etc. For e.g. see:
    http://www.bloomberg.com/apps/news?pid=20601087&sid=aYJZOB_gZi0I

    That financiers gave money to Democrats means nothing. See what they got as a reward: Rubin and Summers – the same people who killed the Glass-Steagall Act among other things – are back in power. The Democrats are just as corrupt as Republicans.

  • Posted by DJC

    Global Chessboard: China has pursued a strategy of global Yuan hegemony

    DJC: The China PBoC promotes global diversification with a multi-currency monetary regime. The Chinese have specifically called for called for currency diversification in the international monetary system. Every financial crisis since the 1971 collapse of the Bretton Woods fixed exchange rate regime has been caused by exchange rate instability. Exchange rate policies cannot be substitutes for structural economic adjustments necessary for mutually beneficial trade between two economies. Nor can exchange rate policies be substitutes for sound domestic monetary or economic policy. Above all, the international monetary regime must be free from US Dollar hegemony. The Chinese yuan will emerge as a regional reserve currency among numerous Asian currencies including the Hong Kong dollar.

  • Posted by DJC

    Imperial US Geo-political overstretch
    http://www.globalresearch.ca/index.php?context=va&aid=11291

    For decades Washington has prevailed because the US dollar is the reserve currency. It is the world’s money. This advantage allows Washington to purchase almost every other government. There are governments all over the world, from Europe to Egypt, from Ukraine to South Korea to Japan, that are owned by Washington. When Washington speaks of spreading freedom and democracy, Washington means it has purchased more governments to do its will.

    These purchased governments do not represent their people. They represent American hegemony.

    Now that the Great Hegemon is bankrupt and its economy is collapsing, thanks to unbridled greed, American influence is waning. The US dollar cannot survive the massive red ink that the US generates.

    When the dollar collapses, the image of a strutting Washington as “the world’s only superpower” will evaporate. The evil that is the American government will find itself at war with its own people and those of the rest of the world.

  • Posted by el presidente

    It seems as if China is really over a barrel; if the United States wants, it can print money and China will virtually have to buy it to support the Dollar against the RMB (not to mention maintain the paper value of its dollar holdings).

    A little money printing would go a long way toward solving the United States’ problems; China could dump the dollar, but only at the cost of destroying its domestic economy.

  • Posted by gw

    Paulson has to ask for something tough and take a stance of principle to avoid to be seen as beggar or worse. He also has to ask for something that can be easily denied w/o loosing face. Asking for opening of the Chinese banking industry at the time the own industry has more urgent things to do – perfect.

    This is a smoke and mirrors move and is intended to give the media a soundbite that is positive for him – otherwise media may start thinking for themselves. Now this would be disaster but unlikely yet.

  • Posted by Twofish

    observer: Where were these regulation-loving investment bankers when their lobbyists were hard at work opposing any government oversight of derivatives etc.

    Your typical mega-bank has about 250,000 employees most of whom really don’t have that much say over what the PAC does.

    There is this idea that a bank consists of 20 cigar smoking millionaires in a board room and that’s not the way that it works.

    Also you do learn stuff. In 2003, lots of people plausibly and honestly believed that you could end up making more money with less regulation. It’s 2008, and it turns out that you can’t.

  • Posted by el presidente

    DJC:

    Every financial crisis going back 50 years has been caused by the inability of countries to maintain forced exchange rate stability; not by instability itself. If countries let their currencies “float”, then speculators have no targets to attack, and imbalances in trade are not magnified by monetary phenomena.

    So saying that instability causes crisis is true, but tautological. The true cause of the crisis was the policy of maintaining exchange rate stability in the face of changing underlying trade flows and economic circumstances. Without the buildup of forces against the “current order” (that is, the curent exchange rate levels protected by governments) there would be no crisis.

    U.S. Dollar hegemony, moreover, is neither a good or bad thing for any individual country other than the United States. It benefits the United States to the extent that the government can finance extraordinary deficits cheaply. Assuming the expected future exchange rates are the same as the present rates (that is, assuming there is no currency market intervention by governments), Dollar hegemony is equivalent to basket hegemony.

    Of course, given the massive effective currency interventions going on on behalf of China and the Gulf, that isn’t true. Dollar hegemony is critical to their future wealth, because they own so many dollar assets that would be devalued in a basket backed world.

  • Posted by paine

    the tone of your scold brad
    seems too labored
    just as the vice minister’s
    is too pat
    put on your soft shoes

    relax
    the struggle is only just begun

    sino-yank lines are drawing themselves here
    they hardly need spin

    the two hulks trade and forex policy
    like dueling player pianos
    is running on paper rolls long ago punched

    history displays naked facts
    that force nasty conclusions

    tensions become contradictions

    best turn around

    uncle keep the buyer of last resort hat on

    run huge fiscal deficits
    hyper employ the joe six packs

    uncle has only a printable buck or two
    to lose
    and a world recovery to win

  • Posted by MakeMeTreasurySecretary

    ReformerRay has made what I consider a very important point “The trade deficits have many causes. One of the strongest is the large amount of Net Wealth owned by U.S. households and non-profit organizations – 58 TRILLION at the end of 2007.”

    I would translate that as “The U.S. households and nonprofits feel rich and spend accordingly.”

    Then, the fact that now they feel less rich (the 58 trillion that Reformer mentions should be about 40 trillion by now) should mean that they should spend less. And, lo and behold, they do. Thus, in the aggregate and disregarding for a moment the pain some people feel, the “financial crisis” is not a crisis but the loud resolution of a silent crisis that went on for a long time. It is the “back to reality after a long vacation” moment.

  • Posted by credulous_prole

    American banks continue to merge amongst themselves and increase their holdings of Chinese banks.

    Twofish has it right: the Chinese are using T’ai Chi: using the greedy and unpatriotic American private sector to undermine America’s fundamental strength.

    However, China’s castle is built on ponzi finance. They just flew over a honcho from the PBoC to meet with Paulson etc, and so clearly they’re starting to break.

    I think America wins this round of chicken.

  • Posted by el presidente

    It isn’t a matter of “more or less” regulation. The U.S. financial system has too much regulation not too little. It’s about “smart vs. dumb”.

    Sarbanes-Oxley and 10b-5 don’t contribute to stable, efficient markets and impose absurd costs. Leverage caps and own-account trading restrictions for financial intermediaries would protect the system.

    You know… be sure you choose the right one.

  • Posted by Twofish

    credulous_prole: Twofish has it right: the Chinese are using T’ai Chi: using the greedy and unpatriotic American private sector to undermine America’s fundamental strength.

    If you end up in a situation in which most Americans end up benefiting from Chinese trade and China’s rise to power, it becomes very difficult to argue that promoting Chinese trade or China’s rise to power is unpatriotic or that it really weakens the United States.

    Also turnabout is fair play. If you have a situation in which most Chinese find that they benefit from America being a rich and powerful country, I don’t think anyone in China will object.

    It’s not really zero sum.

  • Posted by Twofish

    ReformerRay: The trade deficits have many causes. One of the strongest is the large amount of Net Wealth owned by U.S. households and non-profit organizations – 58 TRILLION at the end of 2007.

    ReformerRay: China, Japan, Germany, Canada, Mexico and residents of other nations would like to own those assets. So they send more goods to the U.S. than they buy from us.

    Suppose a US company pays China $150 to get a laptop manufactured, and then takes that laptop and then resells it for $500 dollars. The deficit is marked as $150, but you’ve just increased the total wealth of the United States by $500.

    I’m arguing that this is the economics of trade, and that as people realize that this is what is going on, they stop objecting to that $150 that is going to China since without that $150, people aren’t going to get that $350 out of it.

    If you manufacture it in the US, the labor costs are going to be ten times as high, the production cost for the laptop in $1500, and that laptop doesn’t get built and people end up with nothing.

  • Posted by credulous_prole

    Twofish:

    Your example is specious: it’s importing deflation from China and exporting inflation to China. It drives down wages for labor in the US and, if perfected, will annihilate the middle class fantasy.

    Pretty crappy model, imho.

  • Posted by Judy Yeo

    The present crisis has certainly provided the opportunity to examine if old constructs work. For instance, people are seen to be more focussed on politics and patriotism when there is nothing else that’s more positive to occupy their attention.

    When you’re a debtor you’re at the mercy of the creditor; this has been sorely tested and proven not quite true particularly when you’re a debtor the size of the USA. As Brad’s analysis shows, the creditor has a lot more to consider when he is overcommitted in a deal.

    As for zero sum, look, when the equation has only 2 sides to it, it almost certainly necessitates zero sum for the 2 sides to balance. It’s more an effect of the equation than the parts of the equation, at least that’s my humble opinion. Causal relationships are sometimes harder to establish than they are to assume.

  • Posted by Judy Yeo

    As for the treasuries investment, have to admit, when they came out with the suggestion to buy treauries to support the bailout efforts, almost spilled the drink , was trying to imagine Brad’s online response. Seems the PRC has toed the line unwittingly? Sigh, when the world converges, strange things happen.

  • Posted by ReformerRay

    Twofish uses the example of manufacturing a laptop because that is the largest component of imports into the U.S. But laptops are not the only item in the world. If we look at the exports from the U.S., we see that flow dominated by semiconductors.

    I have never advocated manufacturing everything in the U.S. Far from it. I believe in the virtues of trade. I am just trying to change the system of trade so that the U.S. can continue as a participant. The longer we tolerate a large trade deficit, the more U.S. industries will be destroy and the harder it will be to find things we can export. We must export or die, given the global economy.

    While I emphasize the losses due to the trade deficit, at the last time I looked at the data, the U.S. had the second largest total value of exports in the world, after Germany.

    This country is not preparing to participate in a sustained way in the global economy. But we are not dead yet.

  • Posted by ReformerRay

    I have no idea what products the U.S. should make and sell overseas. I just know our future depends upon our ability to find something. I hope we are not limited to military supplies.

    Competition is the best way to discover what the U.S. can export.

    Any system for restricting imports must include strong competition among U.S. products for sales, both domestically and overseas.

    Comptetition can be maintained by limiting the restrictions on imports to 5 countries – China, Japan, Germany, Canada and Mexico. Those are the 5 countries that produced 60% of the U.S. trade deficit in 2005. With a gradually increasing tariff on everything made in any of those countries and sold in the U.S., some of the goods produced in those countries will continue to be sold in the U.S. regardless of the tariff. In addition, all other nations can sell imports into the U.S. BUT, all those other nations will live with the knowledge that if the numeric trade surplus with the U.S. becomes excessive, in the eyes of the Congress and the President, their country can be added to the list of proscribed nations.

  • Posted by ReformerRay

    Perhaps I should add to the above detail, the following.

    First, the goal of trade for the U.S. must be changed from free trade to equal trade.
    Second, that goal must be articulated firmly and repeatedly by all officials and especially by anyone sent to negotiate trade.
    Third, membership in WTO and all current trade treaties must be discarded, rejected, made void.

    A though reversal of trade policy must precede any program from reducing the U.S. trade deficit.

    Somewhere in this process, the assumptions widely used by most international trade economists must be examined and those that contradict the goal of equal trade must be shown to be irrational. Otherwise, any such proposal as outlined above is dead on arrival.

  • Posted by credulous_prole

    Folks, the yuan is going to get devalued.

  • Posted by ReformerRay

    Equal trade is the solution for all the ills Brad has identified.

    Equal trade benefits both nations because expanded exports is required in each nation. More exports produces more GDP.

    Equal trade also requires expanded imports in both nations. Additional imports usually implies greater consumption. And imports chosen over domestic products by definition provide a marginal gain over domestic production, when the consumer is free to choose. The quality of life is improved by imports equal to exports (most likely).

    Countries benefit from trade only under the condition that exports are as large or larger than imports. I know Adam Smith tried to argue against that proposition in Book IV but his arguments are unpersuasive. I have read all the arguments I can find against the above proposition. None are persuasive. Please cite a source where I can see any empirical or theoretical or logical reason for rejecting that proposition.

  • Posted by observer

    Twofish: Your typical mega-bank has about 250,000 employees most of whom really don’t have that much say over what the PAC does.

    Yes and about a 1% of them take 90% of all the compensation, make all the strategic decisions etc. It is understood that when we talk about greed on Wall St, we are talking about that 1% not the secretaries and janitors.

    Twofish: Also you do learn stuff. In 2003, lots of people plausibly and honestly believed that you could end up making more money with less regulation. It’s 2008, and it turns out that you can’t.

    It is 2008 and it turned out that yes, you could make a ton of money, but only for a short while. So the bankers paid themselves as much in bonuses as they could get away with while the going was good.

    Now the banks are broke, but the banker’s past bonuses will keep them comfortably warm while tha taxpayer replenishes the capital they once looted.

    If any of these bankers had an ounce of honor, they would return their bonuses. But of course they won’t return them because they have no shame.

  • Posted by Howard Richman

    One of the problems I give my students at this time of the year is to calculate the US government’s debt as a percentage of GDP. Last year at this time it was 66%. Today it is 75%. (The national debt is $10.7 trillion and GDP is $14.4 trillion.)

    Howard Richman
    http://www.tradeandtaxes.blogspot.com

  • Posted by cam

    Economists are always extolling the benefits of free trade. Then when free trade leads to the situation where the U.S. “needs to be nice” to countries financing that deficit, those same economists response to this situation is defeaning silence.

    They need to speak up and tell America how wonderful it is to be indebted to China for $2 trillion.

  • Posted by Twofish

    observer: Yes and about a 1% of them take 90% of all the compensation, make all the strategic decisions etc.

    Things are skewed, but not that skewed. Also upper management makes strategic decisions, but people down the chain make tactical decisions and feed information up to upper management for them to make strategic decisions.

    observer: It is understood that when we talk about greed on Wall St, we are talking about that 1% not the secretaries and janitors.

    99% of the people that work in investment banks aren’t janitors and secretaries (who by the way also get bonuses and can be extrmely highly paid at the senior levels.)

    An investment banker really isn’t a senior executive position. The type of people that you do find in investment banks are traders, quants, structurers, stock analysts, computer programmers. A *lot* of computer programmers. Your typical investment bank has several thousand computer programmers, more than Microsoft.

    observer: Now the banks are broke, but the banker’s past bonuses will keep them comfortably warm while the taxpayer replenishes the capital they once looted.

    Actually no. You can make a gazillion dollars if you are CEO, or if you happen to win the lottery and be in an area that turns out to be extremely hot one year.

    Otherwise, you make a decent living, but it’s a house in Queens or New Jersey lifestyle rather than a penthouse in Manhattan.

    People still have these weird stereotypes that don’t accurately reflect current the work force. I’ve been trying to get some stats, but the numbers I find are that that the UAW has an active membership of 183,000 while there are about 200,000 people working in securities firms in NYC, and about 800,000 nationwide.

    Part of the reason that Congress is more willing to bailout financial firms than auto workers is that there are more people working in banks than are working in car factories.

  • Posted by cam

    “As the largest and most important economy in the world, the US should take the initiative to adjust its policies, raise its savings ratio appropriately and reduce its trade and fiscal deficits.”

    I am eargerly waiting to hear the Chinese plan about how the U.S. can reduce its trade deficit with China.

    Does it include China not sending more goods to the U.S.?

  • Posted by Global Chessboard

    Does anyone have the latest on the SED in China? Dd they have a final agreement on the exchnage rate? Did they announce anything about opening up sectors?
    Twofish?

  • Posted by Twofish

    ReformerRay responds: Twofish uses the example of manufacturing a laptop because that is the largest component of imports into the U.S.

    I don’t think you got my point. Let’s assume for a moment that the US exported *nothing* (zero, zip, nada), my argument is that you can (and in my mind do) end up with a situation where the US benefits from trade.

    You create a $500 laptop with cheap Chinese labor where the alternative is creating nothing at all.

    The thing that you need to explain is if a trade deficit is such a horrible thing, then why are not more people against it?

    My answer is that people are angry when they are *losing* their job to trade, but once they have *lost* their job, they end up doing something else and don’t care anymore.

    Right now the Teamsters are recruiting truck drivers from laid off autoworkers, and so next year anyone that would have been upset that their job went to China, will be working at Walmart selling Chinese goods or working in docks unloading ships from China or driving trucks moving goods from China to Walmart them there or in banks managing Chinese money, and everyone will fight like hell to keep those goods moving.

    ReformerRay responds: Somewhere in this process, the assumptions widely used by most international trade economists must be examined and those that contradict the goal of equal trade must be shown to be irrational.

    That’s not your problem. You have to get in front of some group of people and make a speech that says, stopping imports from China will either save your job or get you a better one. I’ve asked you repeatedly to make that speech, and I haven’t heard it.

    It doesn’t matter what academic economists say, what matters is if you can get up and make a speech saying vote for me and I’ll put a chicken in your pot and cash in your pocket, and no one in the last ten years who is anti-trade has made that speech.

    Meanwhile, all of the factories that get hurt by trade have closed and all the jobs that can go to China are there already.

  • Posted by Twofish

    Chessboard: Does anyone have the latest on the SED in China?

    It’s just a photo op session. If Paulson really wants to have a deep discussion with the head of the PBC, he can pick up the telephone, and any real discussions happen between their staff when the cameras aren’t looking.

    Chessboard: Dd they have a final agreement on the exchnage rate? Did they announce anything about opening up sectors?

    No. Anything that you have signed at these meetings are things that were carefully negoitated long ago. The only real thing that gets done at these meeting is to have the lower level staff people meeting and introduce themselves to each other, and come up with a list of agenda items for the next six months.

    It’s unlikely that you will have any major changes in opening markets since all of that was negotiated with WTO.

  • Posted by df

    stupid question !!! Tuh !!!
    Any way things happen just as forecasted.
    Too bad humans learn little from past crises.

  • Posted by Rien Huizer

    Brad,

    Usually I can follow your argument, although not always with agreement about the assumptions. I simply do not believe in standard prescriptive international economics, because it is far too simplistic and ignores friction and national preferences which may be offensive for other people but if they lead to policies that enjoy the people’s consent (stupid/ignorant as they ay be) than tha’ts it. You can try to convince the leaders of that country to change their ways, or even to educate their people towards different preferences, but that’s it. Af course you can also apply pressure or, if you are sue you will win cheaply, go to war. Trade war that is.

    The Chinese remarks about US consumers having to live more within their means and regulators doing a better job would of course make part of China’s market smaller. But it is quite possible that Chinese firms (leave the gvt out of the equation for a while), including US-owned ones or foreign owned in general would still manage to grab a growing slice of a shrinking pie, at the expense of Asian neighbours and NAFTA-based producers mainly. There is no reason why China could not export a lot to the US even if the US had trade equilibrium.

    I do not know in what context these remarks were made. They may simply be a slight to a messenger without an ongoing mandate (who might as well have excused himself), or a threat to someone who may be genuinely concerned about the trade prospects of a few other Asian countries that would be at a huge disadvantage to China in a trade war between Asian countries about a shrinking US market.
    Lots of possibilities.

    But the Chinese are not alone to urge the US to adopt more orthodox macroeconomics and regulatory practices. Most people I know would have nodded their heads in agreement. So this is not a matter of a creditor telling a debtor what to do (let’s face it the debtor has been telling quite a lot to the creditor in the past), just a rare moment of candor, a slight or a signal about future policy.

    We will find out soon, probably. Who knows, the new adminsitration may have other things to discuss with its trading partners and creditors.

  • Posted by a

    DJC said:
    “It was never their [Chinese] intention to accumulate a $2 pile of US Treasury bonds.”

    That’s a pretty big unintentional error. So the Americans are supposed to feel guilty because the Chinese didn’t know what they were doing? If it was never their intention, then maybe they should stop accumulating more? No? Pretty please?

    2Fish says: “Part of the reason that Congress is more willing to bailout financial firms than auto workers is that there are more people working in banks than are working in car factories.”

    I don’t think so. The largest reason was that no one knew what would happen if the financial system freezed up, so everything was done to prevent it. A lesser reason was that financial firms donate a lot more money to politicians, and are much more likely to provide well-paid jobs to retired politicians. And a lesser reason still is probably the idea that banking is a “high-valued” business, which the U.S. would like to keep going on its shores. But more workers? That’s a new one – and IMHO not correct.

  • Posted by ReformerRay

    TWofish says :”It doesn’t matter what academic economists say, what matters is if you can get up and make a speech saying vote for me and I’ll put a chicken in your pot and cash in your pocket, and no one in the last ten years who is anti-trade has made that speech”.

    That is an interesting challenge but I never thought of the problem in that fashion. Convincing “the crowd” is a problem to be solved by a politician. I am not a politician. I am a retired academic. The only audience I want to convince is people who have read Adam Smith and who continue to defend his ideas and who begin international trade textbooks with a discussion of comparative advantaage. Paul Krugman is my target audience – or since he will not read this blog, people who agree with his textbook written in 1994.

    The people whose jobs I am interested in have not yet been born. The next 5 years are going to see tremendous adjustments in the U.S. economy. I would like to see the country emerge from this process on track to protect the earning power of future generations.

  • Posted by ReformerRay

    ReformerRay responds: Twofish uses the example of manufacturing a laptop because that is the largest component of imports into the U.S.
    I don’t think you got my point. Let’s assume for a moment that the US exported *nothing* (zero, zip, nada), my argument is that you can (and in my mind do) end up with a situation where the US benefits from trade.
    You create a $500 laptop with cheap Chinese labor where the alternative is creating nothing at all.

    I get your point, twofish. It is possible to set up a scenario where the alternative is creating nothing at all if you limit the U.S. response to building a laptop.

    I did not respond immediately because you can see yourself that the real world does not limit the U.S. to building laptops. We build computer chips and airplanes and earth moving equiptment, all of which sell overseas.

    The U.S. should continue to get laptops from China. We must, however, find enough things we can export to CHINA that will equal to goods we want to accept from China. Any other option requires the U.S. to send to China each day some of the financial assets belonging to U.S. firms and citizens.

  • Posted by ReformerRay

    “There is no reason why China could not export a lot to the US even if the US had trade equilibrium”

    I just like to quote good points. Would include the recent post by “a” but it all is good. Read it above.

  • Posted by ReformerRay

    You may ask, “Why don’t you publish your ideas in academic journals, where they would reach an academic audience”. I have tried. I have not yet formulated by ideas in a way that is persuasive to the editors.

    If you can find a copy of the Spring 2008 issue of The Long Term View published by the Massachusetts School of Law at Andover you will find an article by me titled “An Anti-Free Trade Position”. Unfortunately, the last part had to be cut by the editor. That article does not include my reasons for rejecting Adam Smith’s argument against equal trade.

  • Posted by Twofish

    a: But more workers? That’s a new one – and IMHO not correct.

    This is a factual issue that we can resolve by looking at the numbers.

    Citigroup employs 350,000 people while GM employs about 280,000 people. Chrysler has about 70,000, where has Morgan-Stanley has about 50,000. Goldman-Sachs has about 20,000 employees.

    The fact that people think of banking as something twenty people do in smoked filled rooms do rather than as a high-tech industry that employs hundreds of thousands of people (and not a few physics Ph.D.’s) is part of my point that the rhetoric of trade and some of the political assumptions that people make are invalidated by facts on the ground.

    ReformerRay: That is an interesting challenge but I never thought of the problem in that fashion. Convincing “the crowd” is a problem to be solved by a politician.

    But the thing about trying to convince a group of people is that it is a two way street. If you try to convince an auto worker or an investment banker of something, you learn something about the auto and/or banking industries.

    The problem with not doing this is that one runs the risk of being detached from the real world. How do you know of Adam Smith or Karl Marx is right? You maintain contact with what oil drillers call “ground truth”.

    ReformerRay: Any other option requires the U.S. to send to China each day some of the financial assets belonging to U.S. firms and citizens.

    And my point is that this is not necessarily a bad thing. Here is a thought experiment.

    Imagine a computer programmer that is locked in his house and telecommutes to work, and gets everything delivered to him. He runs a huge trade deficit with the rest of the world. He has food and manufactured goods delivered his house and he exports nothing. All he does is pay other people for food and goods. He manufactures and exports nothing in his house. Everything he owns is delivered that house, and all he does is to write checks that come from his work as a programmer.

    You’d think that he is spending himself into the poor house. Because if you look at what happens at the front door, all the programmer is doing is writing checks and accepting deliveries of plasma TV’s. But he is not.

  • Posted by ReformerRay

    Twofish – OK, I will follow your thought experiment. The last sentence is crucial. He is doing more than writing checks and accepting delivery. He is sending something outside his house that is valuable enough to the recipient to send him checks in return. No cash payments to him, no cash payments from him.

    In this simplified thought experiment, the limitation remains. He cannot pay for what he wants unless someone else pays him for what they want. Without a store of wealth in his house, he cannot run a deficit. If he has 50 trillion stored in his house, he could continue to write checks for what he wants for years, without receiving any money from outside.

    In the real world, the U.S. does have a stash of money stored in its house and it has been using it to pay for goods consumed in excess of goods produced and sold to outsiders.

    I want to stop what we are doing and return to a situation where the store of wealth is ignored, remains untouched, and the current generation is forces to consume an amount equal to what it can produce domestically.

  • Posted by ReformerRay

    Twofish – I focus on manufacturing because manufacturing goods are the main way the U.S. gets return payment for domestic production. If we get enough payments from outside from doing computer programming, and this flow can be documented, I would be happy to expand my definition of trade to include the flow produced by computer programming. You do know that some money flows from the U.S. to outside to pay for computer programing.

  • Posted by ReformerRay

    TWofish – You also know that services are poorly measured but are included in the trade statistics for goods and services – which produced a deficit of 700 billion in 2007 (819 billion for goods only).

  • Posted by Pete Murphy

    Our enormous trade deficit is rightly of growing concern to Americans. Since leading the global drive toward trade liberalization by signing the Global Agreement on Tariffs and Trade in 1947, America has been transformed from the weathiest nation on earth – its preeminent industrial power – into a skid row bum, literally begging the rest of the world for cash to keep us afloat. It’s a disgusting spectacle. Our cumulative trade deficit since 1976, financed by a sell-off of American assets, is now approaching $9 trillion. What will happen when those assets are depleted? Today’s recession may be just a preview of what’s to come.

    Why? The American work force is the most productive on earth. Our product quality, though it may have fallen short at one time, is now on a par with the Japanese. Our workers have labored tirelessly to improve our competitiveness. Yet our deficit continues to grow. Our median wages and net worth have declined for decades. Our debt has soared.

    Clearly, there is something amiss with “free trade.” The concept of free trade is rooted in Ricardo’s principle of comparative advantage. In 1817 Ricardo hypothesized that every nation benefits when it trades what it makes best for products made best by other nations. On the surface, it seems to make sense. But is it possible that this theory is flawed in some way? Is there something that Ricardo didn’t consider?

    At this point, I should introduce myself. I am author of a book titled “Five Short Blasts: A New Economic Theory Exposes The Fatal Flaw in Globalization and Its Consequences for America.” My theory is that, as population density rises beyond some optimum level, per capita consumption begins to decline. This occurs because, as people are forced to crowd together and conserve space, it becomes ever more impractical to own many products. Falling per capita consumption, in the face of rising productivity (per capita output, which always rises), inevitably yields rising unemployment and poverty.

    This theory has huge ramifications for U.S. policy toward population management (especially immigration policy) and trade. The implications for population policy may be obvious, but why trade? It’s because these effects of an excessive population density – rising unemployment and poverty – are actually imported when we attempt to engage in free trade in manufactured goods with a nation that is much more densely populated. Our economies combine. The work of manufacturing is spread evenly across the combined labor force. But, while the more densely populated nation gets free access to a healthy market, all we get in return is access to a market emaciated by over-crowding and low per capita consumption. The result is an automatic, irreversible trade deficit and loss of jobs, tantamount to economic suicide.

    One need look no further than the U.S.’s trade data for proof of this effect. Using 2006 data, an in-depth analysis reveals that, of our top twenty per capita trade deficits in manufactured goods (the trade deficit divided by the population of the country in question), eighteen are with nations much more densely populated than our own. Even more revealing, if the nations of the world are divided equally around the median population density, the U.S. had a trade surplus in manufactured goods of $17 billion with the half of nations below the median population density. With the half above the median, we had a $480 billion deficit!

    Our trade deficit with China is getting all of the attention these days. But, when expressed in per capita terms, our deficit with China in manufactured goods is rather unremarkable – nineteenth on the list. Our per capita deficit with other nations such as Japan, Germany, Mexico, Korea and others (all much more densely populated than the U.S.) is worse. My point is not that our deficit with China isn’t a problem, but rather that it’s exactly what we should have expected when we suddenly applied a trade policy that was a proven failure around the world to a country with one fifth of the world’s population.

    Ricardo’s principle of comparative advantage is overly simplistic and flawed because it does not take into consideration this population density effect and what happens when two nations grossly disparate in population density attempt to trade freely in manufactured goods. While free trade in natural resources and free trade in manufactured goods between nations of roughly equal population density is indeed beneficial, just as Ricardo predicts, it’s a sure-fire loser when attempting to trade freely in manufactured goods with a nation with an excessive population density.

    If you‘re interested in learning more about this important new economic theory, then I invite you to visit my web site at OpenWindowPublishingCo.com where you can read the preface, join in the blog discussion and, of course, buy the book if you like. (It’s also available at Amazon.com.)

    Please forgive me for the somewhat spammish nature of the previous paragraph, but I don’t know how else to inject this new theory into the debate about trade without drawing attention to the book that explains the theory.

    Pete Murphy
    Author, “Five Short Blasts”

  • Posted by ReformerRay

    When your book explains why Japan and Germany have not suffered the same fate as the U.S., your theory will have more force.

    Japan and Germany did not buy into the Free Trade theory. Population density had nothing to do with that decision.

    They were defeated nations but before WW II they had been powerful and growing more powerful. They renewed the competition to prove their value if not superiority to the U.S. and England by taking advantage of our stupid support for free trade.

    My fate is intimately tied up with that of the U.S. but I take my hat off to Japan, Germany and now China. They were willing to do what was necessary to recover what they see as their rightful place in the world.

    Population density has nothing to do with this struggle.

  • Posted by ReformerRay

    Mr. Murphy – I agree that the theory of Comparative Advantage must be used in a limited setting but if used properly, it is a valid assumption. The proper setting is when trade between two nations are equal or in a more simple form, is a simple exchange of goods for goods. When that happens, Comparative Advantage is valid.

    Where Comparative Advantage is not valid is when trade is unequal – not a swap or its equivalent. In that case, domestic production is not increased in both countries. It is the increase in domestic production in both countries that is crucial to insure that both countries benefit.

    The foundation of my argument is Adam Smith’s fundamental contention that the wealth of a nation depends upon the ability of the domestic economy to produce goods and services.

  • Posted by Man of Steel

    I think Mr. Setser should become a lawyer, since he is so very good at murkying what is white to grey, and blame the innocent instead of the guilty.

    Last time I checked no one held a gun to US consumers or US gov’t to take on debt and spend like there is no tomorrow.

    I get credit card offerings, HELOCs, loans all the time but I don’t use them because I live within my means. I have no need to project an image of Master of the Universe to my friends or neighbors just to make myself feel better while belittling them at the same time. I save my money from my job from what I have produced with my faculty.

    The US don’t have to be the world’s policeman, don’t have to fight 2 wars, and certainly don’t have to spend all the money on sophisticated weaponry.

    Last time I checked if you want to tell the world that you’re the richest, most sophisticated country then behave like a leader when things are tough, don’t turn around and balme what is really still a Third World country for all the woes that you have created in the first place.

  • Posted by a

    2Fish: ” This is a factual issue that we can resolve by looking at the numbers.”

    I’m not disputing that the banking industry employs more people than the auto industry. I’m disputing the causal relationship you asserted: *because* they employ more, they were bailed out.

  • Posted by Pete Murphy

    ReformerRay, you’re absolutely right that Japan and Germany (and lots of others) don’t believe in free trade. But they’re the first to criticize the U.S. for not believing in it if we even express concern about our trade deficit.

    And I agree with your comment about comparative advantage – that it works between two equal nations. But population density is a major factor in that equation. Free trade between two nations of grossly disparate population density will result in a trade deficit for the less densely populated nation almost every time.

  • Posted by ReformerRay

    Imports and exports must be equal for comparative advantage to describe reality.

  • Posted by ReformerRay

    Mr. Murphy – My point was not clearly enough stated. You believe that popul;ation density is the cause of variaation in trade balance between the U.S. and its trading partners. If that is so, population density should also control the variation between trade balance in other countries. I invite you to further defend your assertion by showing a correlation or association between population density and the trade balance in Germany and Japan – or any other country.

  • Posted by mike

    Is China really hurting itself?

    China’s growth is disproportionately exports and manufacturing, for which there are increasing returns to scale and a lot of learning-by-doing. Keeping their currency artificially cheap helps China develop a long-run comparative advantage and thereby helps long-run growth.

    This is the kind of stuff Krugman just won the Nobel for. It makes a lot of sense.

    So, China may be doing the right thing, not just for China, but for the whole world.

  • Posted by ReformerRay

    Is China really hurting itself?
    China’s growth is disproportionately exports and manufacturing, for which there are increasing returns to scale and a lot of learning-by-doing. Keeping their currency artificially cheap helps China develop a long-run comparative advantage and thereby helps long-run growth.
    This is the kind of stuff Krugman just won the Nobel for. It makes a lot of sense.
    So, China may be doing the right thing, not just for China, but for the whole world.

    China is definitely doing the right thing for China. For the whole world, I doubt it.

    The total amount of manufacturing goods sold on the international market is a finite amount – not a constant amount, but a finite amount. Competition for that total, whatever it is, is a zero-sum game, in that whatever % of the total is won by country A means that country B cannot have that %.

    It is true that the total grows each year and the competition among nations provides better opportunities for consumers throughout the world.

    It is also true, that growth of the share that goes to China results in some country, probably the U.S. since we have by far the larges trade deficit, losing share.

    The U.S. is made worse off when a share of world exports is reduced in the U.S. and increased in China.

  • Posted by myrtle beach

    chinas economy also seems to be slowing down. It will be intresting to see what happens in the next year.

    in the next 12 months we will see the option arms peak, which with all of the other financial problems the US is facing, it will be intresting to see how a democratic president reacts.

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