Brad Setser

Brad Setser: Follow the Money

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The problem with relying on the dollar to produce a real appreciation in China …

by Brad Setser
July 27, 2009

Is now rather obvious. The dollar goes down as well as up.

Last fall, demand for dollars rose — in part because Americans pulled funds out of the rest of the world faster than foreigners pulled funds out of the US. The dollar soared. As the crisis abated though, demand for US financial assets fell and Americans regained their appetite for the world’s financial assets. Not surprising, over the last few months, the dollar has depreciated.

And since — at least for now — China’s currency is tightly pegged to the dollar, the RMB also has depreciated. Fairly significantly.

The real exchange rate index produced by the BIS suggests that, in real terms, the RMB is back where it was last June. That is when China more or less gave up on its policy of letting the RMB appreciate against the dollar and went back to something that looks like a simple dollar peg.

china-rer-11

Does the RMB’s recent depreciation matter? I think so.

To start, China looks to be leading the world out of the current slump. That normally would result in an appreciating, not a depreciating, currency.

As importantly, there is now plenty of evidence that a weak RMB does have an impact on the pattern of global trade. A big impact.

The boom in China’s exports that characterized this decade came after the dollar’s 2002-2004 depreciation produced a significant real depreciation of China’s RMB — a depreciation that came just as a host of internal reforms pushed China’s own productivity up. The net result: a huge export boom.*

china-rer-3

The average rate of growth in China’s exports in the years that followed the RMB’s depreciation was certainly far higher than the average rate of growth in the years when a a strong (and rising) dollar produced a strong (and rising) RMB.

china-rer-2

Yes, the 1997-2002 period includes a US recession and the 2003-2007 period doesn’t. But the recovery started in 2002, so looking at the 1997-02 period picks up a recovery as well as a recession. And the 2003-2007 period was also influenced by a US slowdown — as for that matter is the 2003-2008** period. The US economy, remember, started to cool at the end of 2006. I don’t think that much stronger average US growth in 03-07 (or 03-08) relative to 97-02 is the best explanation for the difference in the average rate of growth in China’s exports over these two periods.

To be sure, the weak RMB isn’t the only driver of China’s export success. But the host of factors that make China an exporting powerhouse — increasingly skilled labor, a growing network of firms that supply needed components, a lot of accumulated know-how in manufacturing, good infrastructure and the like — normally would push the real exchange rate up. It took the combination of all these ingredients and the RMB’s real depreciation from 2002-2005 to generate the mother of all export booms.

And to me it is surprising that China’s real exchange rate at the end of June 2008 isn’t any higher than it was in late 2001 or early 2002. In every other respect China is a very different place. Lest we forget, in 2001 China’s exports only totaled $270 billion. That total was brought down by the US recession, but in 2002, China’s exports were still only $325 billion. By 2008 they had reached $1425 billion.

They are falling now, but it was still a phenomenal increase — and one that in my view was the product, at least in part, of a slew of Chinese government policies, including the decision to intervene heavily to limit the RMB’s appreciation against the often depreciating dollar, that favored export growth over domestic demand growth. As Simon Johnson observes, China itself made the decision to accumulate a huge pile of dollar and euro reserves, reserves that now clearly far exceed what China needs to guarantee its own financial stability.

Remember, when exports were booming, China was running a tight fiscal policy and limiting domestic lending – -and thus restraining domestic demand growth. As the following graph — from David Boucher of the University of Montreal — shows, the loan to deposit ratio in China’s banks was generally falling during China’s export boom.

china-loans-and-exports

That was especially true from 2004 on, after Chinese policy makers opted to curb domestic inflation — which picked up in 2003 — by restraining lending rather than by letting the RMB appreciate.

China could have opted for a different macroeconomic policy mix back then — one that might have limited the growth in China’s current account surplus. That in turn would have meant that China was less able to supply the US with financing, something that might have helped the US avoid a few of its own financial excesses.

UPDATE:

Don requested data on export and import growth. Here is the data, shown as a y/y change in billions of dollars in a 3m moving average of China’s exports and imports v the real exchange rate. Import growth failed to keep up with export from the end of 2003 to the end of 2007, something that I attribute to the combination of the depreciation in China’s RER from a level of 110 or above on the BIS index to a level consistently below 100 on the BIS index and China’s fateful decision to make a nominal renminbi depreciation consistent with low inflation by restraining lending growth and tightening fiscal policy. The moves in China’s imports since 2007 were strong influenced by gyrations in the price of oil, and then the global collapse of trade.

china-trade-and-rer-41

Not surprisingly, China’s trade surplus was rising during this period. The following charts shows the y/y change in China’s rolling 3m trade surplus, also in dollar billion.

china-trade-and-rer-51

More recently, China’s surplus moved up (in q4 2008) and then fell (in q2 2009), which is presumably one reason why the IMF’s forecasts of China’s trade surplus — as Menzie Chinn recently noted — haven’t been all that stable.

* Exports are presented as a rolling 12m sum, in $ billion.
** Technically, I looked at the average y/y growth in a 3month moving average. Adding 2008 to the data doesn’t change much; average export growth from 2003 to 2008 was 28%. Adding 2009 in will bring the average down, but sorting out cause and effect is a bit hard, as the RMB appreciated as the global economy slowed. I would attribute most of the fall in China’s exports to the slowdown, but that no doubt will be debated.

44 Comments

  • Posted by don

    “…but in 2002, China’s exports were still only $325 billion. By 2008 they had reached $1425 billion.”
    Needs to be tempered with data on import growth. for example, a move to more integrated production could produce such a picture with little change in net trade flows.

  • Posted by bsetser

    Don — once china tightened lending (i.e. over the course of 04), import growth fell behind export growth, leading to the emergence of China’s large trade surplus. I didn’t belabor what i thought was well known, namely that China’s trade surplus really soared in 05, 06 and 07 (the rise started in 04 … maybe I’ll add a chart on this)

  • Posted by Twofish

    bsetser: China could have opted for a different macroeconomic policy mix back then — one that might have limited the growth in China’s current account surplus. That in turn would have meant that China was less able to supply the US with financing, something that might have helped the US avoid a few of its own financial excesses.

    I don’t see why. If China hadn’t been pumping in money to the US, then Greenspan would have still been able to keep interest rates low by printing money and triggering massive asset inflation, which was what more or less happened.

    The bubble may have popped a year earlier, but it still would have popped and left a big mess. China wasn’t around in 1980 with the S&L crisis nor was it responsible for the Japanese real estate bubble.

    The problem with all of these numbers is that the sort of assume that economies can be numerically controlled (i.e. the only thing that matters is interest rates and exchange rates), when looking at those charts, there is a lot that numbers don’t explain. I don’t think it is possible to adequately explain what happened without mentioning the obvious fact that China regulated its banks well, and the US did not.

    Also, looking at the chart that you presented, export and real exchange rates doesn’t look to me to be very correlated at all.

  • Posted by Twofish

    And in 2003, George W. Bush invaded Iraq and cut taxes. That’s the basic cause for everything else that happened afterwards. If Bush hadn’t invaded Iraq, that’s a extra $1.5 trillion which you wouldn’t need China to fund.

    Once you have the US government requiring massive amounts of money for a war and being unwilling to raise taxes, then the only thing left is to inflate the currency, which was what happened. The cool thing about asset inflation is that when prices go up on commodities, people feel poorer.

    When prices go up in stocks and houses, people feel richer, even though they are really poorer. So they spend more, which causes more asset inflation, and all this keeps going until everything blows up.

  • Posted by bsetser

    2fish — from 05 to 07 us tax revenues were heading up (thanks to a big boom in receipts from the corp income tax) and the fiscal deficit was going down, so a rising fiscal deficit in the us cannot have driven the expansion of china’s surplus then/ the rise in the current account deficit. your explanation works reasonably well for the 02-04 period (which was just before China’s surplus rose) but not so well for the 05-07 period.

    the fed was also raising rates in 05 so loose money isn’t an obvious explanation for this period.

    as for china regulating its banks well, it kept them from lending — which worked out. but it also required that they fund the pboc and thus the pboc’s purchases of treasuries, which i am not sure will work out all that well when judged in rmb terms. the risk just wasn’t on the books of the state banks!

  • Posted by bsetser

    2 fish — there was a very marked rise in the pace of chinese export growth after the 03-04 real deprecation. look at the kink in the graph of china’s total $ exports in 03. factor in a lag and there is a pretty strong link in my view.

    but there is some volatility as well, some from the the economic cycle in china’s trade parners and some from other sources. but certainly the average pace of chinese export growth was much slower in the 90s when the rmb was appreciating than in the 03-08 period. it also was more volatile, and that often seems to be what comes out of the picture.

  • Posted by Pax Americana

    Hi brad, Enjoy reading reading all your Blogs.

  • Posted by Cedric Regula

    I think from the consumer demand side, HEW is what really kicked in in the 2005-2007 period. In 2005 real estate was just beginning to peak in CA. The rest of the country was still catching up. Greenspan was still denying the housing bubble until Great Plains property headed for OZ. So by that period everyone had equity to access with HEW and the annual numbers were something like $600B. Home remodels with appliances, new furniture, plumbing, and new cars full of Chinese car parts is just the kind of spending to drive Chinese exports.

    But on the supply side I think the whole decade was the retail sector catching on to Wal-Mart’s secret to success. So all of retail beat a path to China’s door.

  • Posted by FollowTheMoney

    My view is this. Say Twofish sells Bread. Twofish’s only neighbor in the subdivision is Brad. Twofish loans Brad money so Brad can buy bread from Twofish. Brad goes to bed stuffed as he consumes more and more bread week after week. This relationship continues meanwhile the debt and interest charged to Brad increases, but twofish doesn’t worry because Brad has always had a great reputation of paying back his loans, and afterall word around town is don’t mess with Brad, he’s big and if you mess with him he’ll fix you up…

    Well, as years progress there’s a few acres next door, they’re sold, new construction is under way in the subdivision and soon Twofish will have neighbors. A year later the neighbors arrive hear Twofish makes Bread. Soon enough the neighbors start buying bread from Twofish, they start buying in small quantities but month after month they increase purchases of bread. The nieghbors don’t send IOU’s but instead pay with direct compensation.

    Well, as time progresses, more and more familes move into the subdivision and Twofish takes a look at IOU’s from Brad. He’s shocked, he gives Brad a notice. Twofish becomes informed that Brad lost his job so he continues to give Brad bread on IOU’s. Meanwhile the neighbors continue to order bread and the internal assets of Twofish outweigh the IOU’s from Brad.

    Finally one morning Twofish, swamped with orders from new neighbors simply says to Brad, i like you, i helped you, but you took me forgranted. Twofish shuts the door on Brad. Brad is unemployed and has turned obese from overcomsumption of bread the previous years. Swallowed in debt and left without Bread, Brad breaks down. Meanwhile Brad is deterioration mode Twofish is prospering. Twofish has saved, established new trade relationships, and impressive internal orders from his expanding family and friends.

    Moral of the story? Well, pay attention….What could happen within?

    -120days, 12 months, or latest 2012:)

  • Posted by RodgerRafter

    Another great post, Brad.

    “the host of factors that make China an exporting powerhouse — increasingly skilled labor, a growing network of firms that supply needed components, a lot of accumulated know-how in manufacturing, good infrastructure and the like”

    This has been the big benefit from China’s weakened currency. These advantages are steadily increasing through China’s focused stimulus efforts, while the West lets the free market meltdown ravage its industries.

    The RMB was pegged at about 8.27/$ from September 1998 to July 2005.
    From July 2005 to July 2008, it steadily declined. Meanwhile, the Euro soared, and I suspect China was busy accumulating more euro assets.

    With the RMB stabilizing over the last year around 6.83/$,
    the big thing I’m waiting for is when China will begin the next period of orderly decline.

    As you note, the dollar has been falling lately, even with China’s support, as it did from 2002 to 2004. When that support erodes, the dollar could fall even harder, as it did from 2005 to 2008.

    The more independent China becomes, with rising domestic demand and an economic recovery in the rest of the world, the less reason there will be for China to support the dollar.

  • Posted by cindy6

    Obesity is caused by McDonald’s. Alcoholics are victims of bars. Typical Americans.

    One has to ask why is a floating rate system necessarily the right thing? Why should the uncompetitive ones be given an easy way out by depreciating rather than reducing their costs organically?

    If you want the RMB to appreciate, easy, have a STRONG dollar. Not able to depreciate at will is the cost of being the reserve currency. There’s no free lunch in this world…the 1st thing my econ professor taught me.

  • Posted by Rien Huizer

    Great post, Brad. Despite lingering doubts about causality suggestions in yr argument.

    And it is timely. China should talk not onlywith the US right now, but with all its trade partners. I am absolutely sure that the exchange rate is not the only problem, or even that a more realistic exchange rate will fix it, but it is historically irresponsible for China (that should ring a bell among the older generation who still went to Party school) to keep running these large surpluses if it knows that an FX adjustment would at least do something to shift the trade balance.

    And of course it should not forget to attack the roots of this problem. Looking at the PIN, Beijing does not disagree that there is work to be done. But perhaps Beijing needs a little help from the outside world. And maybe, the crude tool of FX adjustment may be that kind of help, for a while at least, and until the current crisis is past its critical point.

  • Posted by Rien Huizer

    Cindy6:

    “One has to ask why is a floating rate system necessarily the right thing? Why should the uncompetitive ones be given an easy way out by depreciating rather than reducing their costs organically?”

    Good question. The answer is that it is easier to increase the cost of living (imports get more expensive) than overtly reducing wage incomes (in international competition terms the alternative to devaluation). The lrd story of the frog in cold or boiling water. Economics has little to do with this.

  • Posted by Rien Huizer

    Twofish,

    I sympathize with the defense’s problems but the case is intrinsically weak..

  • Posted by bsetser

    Cindy6 — I second Rien’ response.

    Adjustment through deflation historically has been very very painful. I would note though adjustment can happen in the context of a peg through inflation in one country or deflation in another, so a higher rate of inflation would be one potential mechanism of adjustment. That was the de facto the method of adjustment adopted by many Gulf countries.

    I also would note that China cannot peg to the dollar without also fixing the United States exchange rate, and the US never opted for a peg rather than for floating –

  • Posted by Cedric Regula

    Post 70s I used to read a bunch of goldbug stuff, and one of their favorite arguments was that governments always choose inflation over deflation as the cure for whatever ails us. Reasons are Keynes “sticky wages” phenom, but the common sense explanations are easy to understand. No one likes wage cuts, and worse yet, they can push consumers into insolvency, which could trigger debt deflation.

    It just amazes me how long it takes until we are faced with choosing between the red pill or the blue pill.

    70s goldbugs always assumed we need to inflate out of government debt. But now I think it is the entire credit bubble.

    And that is just the debt part. Then there is the part about being world competitive, which can come about thru technology edge, infrastructure, management edge, productivity increases, and/or world competitive wages.

    So that sounds like a big inflation pill to take, since we already have decided deflation is not the choice.

    Even so, we are having difficulty shoving inflation down everyone’s throat. Weak demand is a problem, and we also need the Chinese and Oil people to help so we can generate commodity and import inflation.

    Seems we can’t inflate until we have their permission.

    But we are getting good news on the China front. They were able to get M2 growth since they have a unique way of getting banks to lend whenever the Party says to. Then they also have their “dollar surrender law” which requires all trade dollars coming into China to be exchanged for RMB at the rate the Party specifies. So that is the peg and also China’s lever for controlling import inflation in the US.

    Now China just announced they are worried about Chinese inflation re-igniting soon. But it doesn’t sound like it is caused by import inflation in China, or lots of export dollars flowing in that they match by printing RMB. Domestic reasons like property inflation are cited.

    Not real sure where I’m going with this, but it almost sounds like a sort of de-coupling going on. Not the truly happy kind where GDP levels grow at coupled rates, but a forced one that happens at a lower level of growth.

    But that would make the peg less neccesary, and dependance on China funding more tenuous.

    So it seems to me we may get a situation where funding becomes more scarce, or expensive, even before we get a chance to inflate out of old debt. It’s already happened at consumer and corporate level, and the USG would be next.

  • Posted by cindy6

    Rien, bsetser,

    The question was rhetorical.

    Depreciation is inherently cheating on the savers, foreign AND domestic. Just because sth is easier doesn’t make it the right thing to do. Besides, deflation is what the IMF prescribe for everyone else. S. Korea and Hong Kong adjusted by deflation in ’98. Singapore and Taiwan have both seen pay cuts among public employees this time around. Just because some nations are too rigid and too pampered, IMHO, really is no one else’ concern.

    And the US did CHOOSE a fixed exchange rate, by being the sole reserve currency in the world. You can’t enjoy the ride w/o paying the fare. I would have more sympathy for your position the day I see serious US efforts in establishing a substitute reserve currency.

  • Posted by Rien Huizer

    Cindy,

    “Singapore and Taiwan have both seen pay cuts among public employees this time around.”

    As MM Lee KY would say, Singapore (and now also Taiwan) have good government..This comment is not rhetorical, it is obligatory. Incidentally, what does the US’s fixed exchange rate entail? What currency is fixed against the USD? HKD, SAR and e few others, but that is not US policy. Or do you mean a US commitment to keep the (external) value of the USD stable. I do not believe that that is either US policy or even legitimate.

  • Posted by FollowTheMoney

    cindy-

    deflationary collapse, followed by very rapid inflation.

    history will show that both the deflationary and hyperinflationary nuts will turn out to be correct. However one before the other:)

  • Posted by Twofish

    FollowTheMoney: My view is this. Say Twofish sells Bread. Twofish’s only neighbor in the subdivision is Brad.

    Ummm no. One problem with economics is that people tend to want to talk in terms of analogies, when that often just will not work. I can’t print money, change laws, I’m not subject to political restraints, risk profiles are different, etc. etc.

    You can use an analogy to illustrate an argument, but it’s unwise to use one to form policy. One example of this is that what a national economy needs to do in a recession is totally opposite from what you or I need to do.

    bsetser: which i am not sure will work out all that well when judged in rmb terms. the risk just wasn’t on the books of the state banks!

    I think it’s going to work quite well. The problem is that commercial banks can’t absorb huge losses without causing a banking crisis, whereas central banks can. If you have a commercial bank get hit by currency losses, then they stop lending at which point you risk pushing the economy into a deflationary spiral. Whereas the central bank can just print money to make up for any losses.

  • Posted by DMA

    Brad,
    Good analysis.
    One important point you seemed to have missed when you analyzed China’s export boom from 2002/3 to 2007 was that China joined the WTO end of 2001. This provided, to a great extent, a more stable and predictable external environment for its export growth, alongside the exchange rate policies.

  • Posted by Twofish

    cindy6: Depreciation is inherently cheating on the savers, foreign AND domestic. Just because sth is easier doesn’t make it the right thing to do.

    If you start talking about right and wrong here, you run the risk of coming up with political and economic programs that are totally out of touch with reality.

    Maybe it is the *wrong* thing to do, but none of this matters if you can’t get elected.

    cindy6: Besides, deflation is what the IMF prescribe for everyone else.

    Which is why I don’t think highly of the IMF.

  • Posted by rj

    I can’t figure out what China’s end game is. Maybe this is me just being conspiracy-minded, but they’re saving the money for something. I don’t think they’re sitting it there so that when recession occurs they can give it away willy nilly. Yes, they are doing that as far as gaining influence in parts of the world, but I don’t think that’s the primary reason.

  • Posted by DMA

    I could give you a little bit of explanation on this as a Chinese.
    Reason one. Culturally, Chinese and many Asian people want to save enough money for unforeseeable things that might happen in the future. On this account, no matter how hard the Chinese or the US governments try to persuade them to spend, they won’t do that necessarily. They will spend, but won’t be like people do in the US.
    Second, it is a self-insurance, a result from observing what has happened in Asian financial crisis in 1990s. More fundamentally, China thinks that it is still viewed by many, if most, western governments as an alien, being a communist country (though it is not really one in strict sense) and considered an authoritarian regime, so it does not trust that much what people say. I would rate this as a fair reason as well.
    Third, it is that they want to accumulate this hugh amount of money, but that policies in the past have contributed to this and it is very difficult to do the right things at a relatively quick speed. They would have to weigh different options against different scenarios, and contextualize some of the options.
    Hope this helps.

  • Posted by FollowTheMoney

    @ DMA-

    it’s all about marketing and consumer behavior. western corporations and think tanks need to close the doors and develop strategy to target chinese consumer.

    they need to create an image, but do so in an intellectual approach. you can’t just take a country that’s been accustomed to ‘poor’ standard of living and start promoting orange county lifestyle. you need do so carefully and selectively. it starts with the youth, brand builders, social media and channeling an image that asians find necessary to adapt.

    unfortunatley i dont have millions nor speak mandarin to jump start such an operation, however those that have the right relationships and understand social media 2010+forward will make a fortune in China. it will take time, but those who tap the internal consumption market in china with strategic marketing/image/brand building will do extremely well.

  • Posted by seatrus

    DMA: “…China joined the WTO end of 2001. This provided, to a great extent, a more stable and predictable external environment for its export growth, …”

    Some economists were actually predicting the collapse of Chinese economy when China joined WTO back then.

  • Posted by DMA

    To seatrus,
    The problem with economists predicting (no offense to economists friend) is that it is not possible to quantify how and when government in China regulates and/or introduces so-called macroregulatory measures…
    They might have also underestimated the flexibility exercised by some part of the economy that was not well captured (not the illicit one, but those sectors for which an adequate account is simply too difficult to do in a short period of time, particularly in the service sector)

  • Posted by Cedric Regula

    The other thing that happened with China at the beginning of the decade was we gave them “most favored trading partner” status. That removed a something like 50% import duty and replaced it with the something like 5% tariff that our developed country + Mexico(under NAFTA) trading partners pay.

    That would make a big difference.

    Also, China has recently stated their game plan. They want to use excess reserves to support Chinese companies become multinationals. They also want to buy natural resources.

    Also, also…I read an informal poll in Japan where Japanese were asked why they save so much and is it a gene defect? They said it is because they think the Japanese government is going broke and they will never see whatever they call social security.

    So deflation fighting hast begat deflation psychology. Go figure.

  • Posted by greg

    Cedric Regula: The other thing that happened with China at the beginning of the decade was we gave them “most favored trading partner” status. That removed a something like 50% import duty and replaced it with the something like 5% tariff that our developed country + Mexico(under NAFTA) trading partners pay.

    That is not correct. China has always had the “most favored trading nation” with the US. But the MFN status was subject to annual review before China’s WTO entry.

    The annual revire of MFN status was a big headache for the USG in the ’90s, with Congress threatening to revoke China’s MFN status to push for human rights cause in China and the USG can’t really pull the trigger. The name “most favored trading nation” is a misnomer since it’s really just normal trading relationship. Only a few countries in the world do not have the MFN status with US. In the end, USG changed the “most favored trading nation” to “normal trading status.”

  • Posted by bsetser

    I did leave out the WTO, which i guess reflects my own view of its relative importance: WTO accession ratified the status quo, as China already recieved MFN access to the US and I think Europaen market. Maybe locking that it made China a somewhat more attractive base for exports, but my own guess is that the rmb’s big depreciation against say the euro had a bigger impact. But it could certainly be added to the list of factors that normally would push China’s real exchange rate up, especially if WTO accession for some reason was a stronger shock to China’s exports than its imports.

    Cindy — the US in 73 famously delinked the dollar from gold, and more or less indicated to all those holding dollar reserves that the US would not direct its monetary or fiscal policy toward maintaining the dollar’s external value. Those holding dollars as their reserves should know this — and those who added to their dollar holdings at an increasing rate as the dollar’s value in euros fell certainly should know this. China opted to hold dollars not b/c the US was committed to maintaining the dollar’s external value, but to support its exports. I am with Simon Johnson on this.

  • Posted by Cedric Regula

    Greg

    Thanks for the clarification. I must have read about passing an annual review to qualify, and interpreted that in my mind as a first time change in status.

    I was pretty busy with work back then, and didn’t have much spare time or energy to follow what the rest of the world was doing.

  • Posted by Twofish

    DMA: Reason one. Culturally, Chinese and many Asian people want to save enough money for unforeseeable things that might happen in the future.

    I don’t think that this provides much of an explanation of anything, because it doesn’t explain why Chinese savings increased dramatically after 2000. Most of the increase in Chinese savings after 2000 involves corporate savings, which don’t seem to me to be amenable to cultural explanations. Also it doesn’t explain why consumer spending has increased the last few months.

    Also, if you are worrying about unforeseen things, what about hyperinflation or bank failures? The fact that Chinese people save in banks assumes that they don’t think that either is a major possibility, which brings up the whole questions of institutions.

    DMA: On this account, no matter how hard the Chinese or the US governments try to persuade them to spend, they won’t do that necessarily. They will spend, but won’t be like people do in the US.

    In the last several months, people in China are spending more, people in the US are spending much less.

    I hate cultural explanations because they are meaningless. Chinese people save because they are Chinese explains nothing. Chinese people save because they worry about unforeseen events, is a bit better, but you then have to worry about why Chinese people are worried about hospital bills and not bank failures.

  • Posted by Twofish

    FollowTheMoney: western corporations and think tanks need to close the doors and develop strategy to target chinese consumer.

    There is no Chinese consumer and no Chinese market. There are about fifty different markets and hundreds of different consumers. The bad news is that there isn’t one market. The good news is that China is big enough so that if you hit one market, that’s several tens of millions of people.

    FollowTheMoney: You can’t just take a country that’s been accustomed to ‘poor’ standard of living and start promoting orange county lifestyle.

    Yes you can, if you target the right people.

    FollowTheMoney: unfortunatley i dont have millions nor speak mandarin to jump start such an operation.

    If you want to market to certain groups of people in China and you are speaking Mandarin, you already are at a huge disadvantage. Sometimes you need to speak dialect. Sometimes you need to speak English and *not* go local. For lots of things (cars, fruit, and education), US means quality, and the logical thing for an American company to do in China is to wave the US flag.

    The problem is that it’s possible for an American company to build an American car in China.

    rj: I can’t figure out what China’s end game is.

    The grand strategic goal which has been a consistent aim for China for the last 130 years has been to become a great power. Assuming current rates of growth, it will take China another 50 years or so to get there, and China is intent on maintaining current rates of growth.

    bsetser: the US in 73 famously delinked the dollar from gold, and more or less indicated to all those holding dollar reserves that the US would not direct its monetary or fiscal policy toward maintaining the dollar’s external value

    And in the 1990′s the conventional wisdom was that emerging markets should peg their currencies to the US dollar. The belief was that the 1970′s was irrelevant history, and that the US economy was strong enough so that you’d never have a situation in which the US dollar would drop in value. If you want, I can pull lots of papers and op-ed pieces from the early 1990′s that make this point.

    The idea that the US dollar would drop in value was something that was similar unforeseen by anyone in the early/mid-1990′s. This poses a problem since you similar can’t change currency policy quickly without causing a crisis.

  • Posted by Twofish

    Whether other nations should have relied on the US to maintain stable currency values is sort of a moot point, since the economy theories of the 1990′s assumed that the US dollar could and would be used as a standard reserve currency and maintain stable value.

    If we want a world in which the US dollar doesn’t have a stable currency value, then it’s going to look very different than what people had in mind in the mid-1990′s. It’s not clear what that world is going to look like.

    Part of the problem is that any set of institutions has to be politically workable. If you have a system which absolutely requires China to appreciate its currency, then having a system in which the only thing that you can do if it doesn’t is to “ask nicely” just will not work.

    And that probably means a very limited role for international organizations like the IMF. The IMF can force Zambia to do something, but against a major power, the IMF and the World Bank are pretty powerless. The US and China tell the IMF what to do, and not the other way around.

  • Posted by bsetser

    I agree with 2fish’s argument on culture; it is hard to see how chinese culture explains the rise in China’s savings rate in this decade, as Chinese culture didn’t change. Moreover, the rise in national savings wasn’t due to a rise in the household savings rate.

    2fish — i think the argument in the 90s was that the dollar (or euro) was more stable than most EM currencies, and thus pegging to the dollar or the euro was a reasonable way of ending inflation/ hyper-inflation in some EMs. Monetary anchors and all. The dollar certainly wasn’t stable v the yen or the euro over the course of the 90s, hitting low lows in 95 and high highs in 00. the dollar did rise v most ems, but that was b/c of em crises — as EMs recovered, it was reasonable to think their currencies would tend to rise in value v the usd. remember that japan’s currency went from 300 v the usd to 100 v the usd as japan developed.

  • Posted by DMA

    To Twofish: Cultural factors are difficult to quantify and explain, but they do play a role. I am a Chinese and I talk to a whole lot of my folks on issues like these, the general impression is that people will spend and probably more and more, but won’t be deeply indebted. Only a small fraction of people will spend whatever they earn, and even fewer people would go into debt to support the level of living that they can not afford.
    I agree that much of the savings from 2000 was from the corporate sector and there got to be better ways to channels the earnings into social spending (by taxing them for example), but similarly, many Chinese companies are run by people who think that holding cashes or savings in the banks would provide them with a lot of comfort than investing them (which actually brings up another point, over investment, which leads to excessive capacity). As mentioned earlier, Chinese people will spend and probably more and more, particularly responding to some stimulative measures taken by the government. The rise in consumption in the first half of this year was, to a great extent, flamed by some of such measures, such as subsidizing electronics purchases made by farmers, subsidizing purchase of vehicles, etc. However, the consumption only picks up modestly, not to the level that many economists would have liked it to be. I actually believe that even if China builds up a fairly adequate social safety net (which may take a few decades to do), the saving level would not go down very much, probably hovering around 20 to 30%.
    On the point of bank failure, here comes the Chinese characteristics, because people know and believe that the banking system is state owned, and effectively, there will be a blanket guarantee for bank deposits (I mean mainly big four commercial banks). So people are not that worried. Plus, banks are becoming more healthy, compared to a few years ago, though that might only appear on the books. But people feel more comfortable now.
    Maybe in addition to building a good social safety net, and taking measures to boost consumption, capital market should also be developed to allow for more and diversified investment choices. This, I think, would help reduce the excessive savings. Here again, people would caution that it may not be a good idea, given the “innovative and hard-to-understand products developed by financial practitioners” and their devastating impacts as manifested in the financial crisis.
    I am not using cultural factor to explain everything on China’s high saving rate, but feel that it plays a role, and sometimes important roles. A better understanding of this would help explain what happened, and what might happen in the future.

  • Posted by bsetser

    DMA — thanks for your comment, and for your balanced insight into the role of culture v institutions (like a social safety net, or the lack there of). One question: why would building a social safety net take decades? China built a global exporting powerhouse in around 10 years, so decades (as opposed to a decade) feels a bit slow …

  • Posted by Rien Huizer

    Brad:

    ” One question: why would building a social safety net take decades? China built a global exporting powerhouse in around 10 years, so decades (as opposed to a decade) feels a bit slow …”

    Is that a rhetorical question?

    China (unless the Mao era managed to fool me completely) had a lot of basic things not so long ago, and together they constituted a sort of safety net (though the more capricious episodes of the Mao (what is his Temple name by the way?) tended to overwhelm it). Mao’s successors (1) demolished most of this and (2) started to export cheap, embodied labor as a CCP version of Asian export oriented developmentalism. And that strategy worked extremely well and resulted in (1) plenty of money to finance imports (2) remigration of industrial and managerial skills that had moved out during/before the Mao era (HK, Taiwan) and which seeded what we are seeing now in the 1990s, attracted by cheap, socialized, trainable labor and an environment that was hungry for industrial modernization (no greenies etc) (3) healthy growth of infrastructure (4) and opportunity to develop an indigenous consumer base, but one with un-western characteristics.

    The leadership may feel that a modest set of institutions (like Singapore, excellent health care, education and a mandatory old age scheme, but little for the unemployed and the careless) would actually be useful (and popular as well) but That would mean dealing with the enormous collective action problems embedded in this non-model. Essentially, the citizens lack any capacity to organize themselves towards this. The barons do not like it and are well organized for obstruction. An alliance between the Centre and the citizens is difficult to imagine. The problem is that China is neither a dictatorship (a benevolent dictator would be able to hire a few consultants and implement one in a very short time) nor a democracy (at least one with substance) where a political movement might promote it (and the design and implementation would be problematic, but ultimately there would be something) and either legitimately establish one or legitimately fail to do so.

    In China there will be something when the warlords find it in their interest, and it may well be local, rather than national.

    That could be accelerated if the foreigners became more demanding of the conditions under which their exports are made. And as China’s CA surpluses become more and more problematic internationally (unemployed workers are the most powerful agents of protectionism, especially in democracies), probably the pressure to reform (i e raise Chinese production costs) may well increase. The PIN includes many suggestions to that effect. In fact, currency appreciation (and not only against USD) may, in the short term, be easier to handle than reform. But if reform could be structured to give the centre more control, that might be more attractive.

  • Posted by bsetser

    Rien — if China’s currency appreciates/ its surplus goes down/ china’s trade is more balanced, there would be a stronger case that china’s social safety net is China’s business, not the world’s. If china wants an adjustment path that doesn’t involve currency appreciation, then it may need to make domestic institutional changes on a somewhat faster pace than perhaps it finds comfortable.

  • Posted by Twofish

    bsetser: One question: why would building a social safety net take decades? China built a global exporting powerhouse in around 10 years, so decades (as opposed to a decade) feels a bit slow

    Because building infrastructure is easy. You say build this highway. A lot of officials make money when the highway gets built, and it’s done. Any money that gets siphoned off in the form of corruption and bribery is a one time event, and it doesn’t matter as long as the road or port gets built. The other thing is that it’s pretty easy to engineer a road. People basically know what a road looks like, whereas it’s really tough to figure out how to design a good health care system.

    With health and education the payments are ongoing and it’s a tremendous challenge to get payments to the right people and away from the wrong people. Also if you do it wrong, then it is tremendously hard to undo.

    Also, given the fact that the United States has be trying and failing to have universal health care for the last fifty years, I don’t think that it’s wise to think that there is something wrong with China that has to cover five times as many people with five times less resources, but still has managed to put something together in fifteen.

  • Posted by Twofish

    Huizer: Essentially, the citizens lack any capacity to organize themselves towards this. The barons do not like it and are well organized for obstruction.

    There really is no one in China opposed to universal health care, the trouble is that it’s just a massively difficult thing to do. If you read the World Bank’s reports on NCMS you get an idea of how messy it is. What do you set the deductibles at. Who do you call if you have a billing issue?

    And even if it is place, Chinese are not going to trust it for another decade.

    Huizer: In China there will be something when the warlords find it in their interest, and it may well be local, rather than national.

    I think the term warlords is misleading because it mischaracterizes how much power local officials and or don’t have. Warlords have their own military forces, and that is something that is under very tight control by the central government.

    The other issue is that warlords have their independent sources of finance whereas most local governments in China are dead broke because they are barely keeping up with education spending.

  • Posted by Twofish

    The other thing about Chinese politics is that you shouldn’t oversimplify. If you look at Chinese health care, there aren’t three interest groups, I can easily come up with about thirty different interest groups, each waiting something different. Provincial officials, county officials, township officials each have different interests. Rural officials and residents have different interests than urban officials and residents. Rich people have different interests than poor people. You have private hospitals, public hospitals, private employers, state employers, about ten different ministries, each with different interests.

    (And that’s just health care, you also have pensions and education, each with about fifty different interest groups.)

    So putting together a health care system is vastly more complex than becoming an export powerhouse.

    Also China became an export powerhouse by accident. There was as far as I know, absolutely no master plan in the mid-1990′s to dramatically increase Chinese exports. It’s just that there were about five different things that just happened between 1993 and 1999 that did this. For that matter, pretty much no one in 1978 ever really intended China would end up as “capitalist” as it did.

    Health care is the same way. Most of the last decade has been spent on pilot projects in which they set something up in some sample county somewhere and see how it works or doesn’t work.

  • Posted by Pax Americana

    Chinese culture, and racial memories from the Mao era, must permeate in the Chinese consciouness, as regards their propensity for saving money, high regard for education the “iron ricebowl ” mentality is not totally put to rest, and will not be till universal healthcare and Pensions are avaliable to large sectors of the rural population.

  • Posted by dma

    Brad: on China built a global exporting powerhouse in around 10 years, so decades (as opposed to a decade) feels a bit slow …
    I meant to say that it takes decades to build a (fairly) good/adequate social safety net. In urban China, it already exsits, though on the verge of broke. It is non-existent in rural China. And it takes a lot of political capital to do it right, particularly given the positions of different interests groups both within and outside the Party. A bit similar to what is happening here on the health care reform.
    Another difficult issue is that social safety net has been weaven together with a household register system, which essentially means that if you are officially registered in Shanghai, you are entitled to the social safety net provided in Shanghai, but not anywhere else. If you a farmer and move to Shanghai and work there, but do not have household register, you will not be able to enjoy the benefit of social safety net provided by the municipal government to its residents. Nor a resident in Beijing can enjoy the Shanghai benefits. You can not take your social safety net with you, essentially. It is not an easy thing to get a household register in big cities, even in medium sized cities. A lot of fresh graduate students will go all out to find ways to get a household register in cities like Beijing and Shanghai as most, if not all, hiring companies would require that you have a household register before they can hire you. Much has been said about reforming the household register system, which essentially bounds Chinese to where they are originally from (unless you find out ways to get away from it, say by working a government agency, state owned companies, universities, etc) and acts as a severe hinderance to the free movement of labor across the country, in the past 10 years, little was done. This constitutes another big barrier, as far as I perceive.
    To sum up:
    1. It takes long to build a FAIRLY ADEQUATE social safety net;
    2. Interest group resistence and political bargaining (including who should do what between central and local governments0;
    3. household register system tying provision of social safety net to your officially registered residence.
    There might be other factors, but these three are the main ones as I see that makes the building of an adequate social safety net a long and painful process.

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