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China, new financial superpower …

by Brad Setser
August 3, 2009

One of the biggest economic and political stories of this decade has been China’s emergence as the world’s biggest creditor country. At least in a ‘flow” sense. China’s current account surplus is now the world’s largest – and its government easily tops a “reserve and sovereign wealth fund” growth league table. The growth in China’s foreign assets at the peak of the oil boom – back when oil was well above $100 a barrel – topped the growth in the foreign assets of all the oil-exporting governments. Things have tamed down a bit – but China still is adding more to its reserves than anyone else.

Yet China is in a lot of ways an unusual creditor, for three reasons:

One, China is still a very poor country. It isn’t obvious why it makes sense for China to be financing other countries’ development rather than its own. That I suspect is part of the reason why China’s government seems so concerned about the risk of losses on its foreign assets.

Two, almost all outflows from China come from China’s government. Private investors generally have wanted to move money into China at China’s current exchange rate. The large role of the state in managing China’s capital outflows differentiates China from many leading creditor countries, and especially the US and the UK. Of course, the US government organized large loans to help Europe reconstruct in the 1940s and early 1950s, and thus the US government played a key role recycling the United States current account surplus during this period. But later in the 1950s and in the 1960s, the capital outflows that offset the United States current account surplus (and reserve-related inflows) largely came from private US individuals and firms. And back in the nineteenth century, private British investors were the main financiers of places like Argentina, Australia and the United States. We now live in a market-based global financial system where the biggest single actor is a state.

Three, unlike many past creditors, China doesn’t lend to the world in its own currency. It rather lends in the currencies of the “borrowing” countries – whether the US dollar, the euro, the British pound or the Australian dollar. That too is a change from historical norms. Many creditor countries have wanted debtors to borrow in the currency of the creditor country. To be sure, that didn’t always work out: it makes outright default more likely (ask those who lent to Latin American countries back in the twentieth century … ). But it did offer creditors a measure of protection against depreciation of the debtor’s currency.

This system was basically stable for the past few years – though not with out its tensions. Now though there are growing voices calling for change.

China seems to be inching toward the position that those countries borrowing its funds should start to take on some of the risks that China’s government now assumes. The basic idea is simple: China keeps its lending, but gets a better renminbi returns while taking less (currency) risk. That, though, would be a fundamental change in the current international financial system. And it isn’t quite clear how China can change its external profile so long as it wants above all to maintain a peg to the dollar at a level that requires sustained intervention – and a controlled capital account.

Some of China’s borrowers, by contrast, are arguing that maybe China shouldn’t be quite so keen to lend the world quite so much …

Makes for an interesting world.

52 Comments

  • Posted by Cedric Regula

    Dollar Update

    Today seems like a good day to check up on how the greenback is doing.

    This is the first day since last Sept. that the dollar index seems happy staying below 78.

    http://quotes.ino.com/chart/?s=NYBOT_DX

  • Posted by FollowTheMoney

    well put brad. aside internal consumption drivers, the RMB will need to float freely.

    i’m more worried that a flight out of u.s. dollar denominated assets could occur sooner than most expect as the world begins to decouple and emergin players provide stability.

    Unfortunately in my view, it seems dollar devaluation at this point is in the cards. It’s not hard to argue that the Fed has decided to inflate instead of restructure.

  • Posted by FollowTheMoney

    i would also have to argue, that the Fed/Treasury is in a way really testing china’s statements on “dollar stability”.

    So many times China has warned us not to devalue it’s investment, however what can China really do?

    As dollar continues to lose purchasing power China will have to make a decision. I call China “Bluff”. No matter if the dollar lost another 25% vs. Gold would China pull the trigger. They cannot un-peg…..yet.

  • Posted by jonathan

    Do Chinese bankers read your blog?

  • Posted by Yoda

    China doesnt need to unpeg. it will just shrink export to USA, increase export to rest of the world, or increase domestic consumption, as it should be. China will have to stop importing inflation to itself. with declining dollar and higher tax, USA will import less and produce less, high inflation is to stay in USA.

  • Posted by Cedric Regula

    As the CFR commentator on space alien relations, this does remind me a bit of some Vorlon history, and it is somewhat disturbing in the context of Earth relations.

    Before the One World Government was elected to power, the exactly 57 races on Vorlon each had a state government and state militias of equal power, ensuring global military gridlock.

    Just prior to the One World Government proposing that it should be elected to power, the One Economist proposed the single biological currency, the Vorlon Sand Dollar, as the solution to the Gold Standard problem on Vorlon. Vorlonites were so attracted to the idea of a 100% annual return on a annually doubling biological currency, that gold immediately went to zero. Well, not quite zero. It still had some commercial value as costume jewelry, but most Vorlonites don’t wear jewelry.

    Anyway, all Vorlon states immediately went bankrupt and couldn’t pay anyone, including the state militias. (note: some tried to issue “paper” IOUs for a while, but then of course there was no money to pay the IOUs with, so that rapidly failed.)

    So Vorlon historians think the new currency and global collapse of the old racial state governments sort of greased the path to electing the One World Government to power. Seems that way to me too, of course, and the first thing the OWG did was to offer to pay the state militias in Sand Dollars(they had the forsight to have a large stock already). The armies of the world were quickly consolodated under the OWG.

    So this bit of Vorlon history makes me worry a little bit that China may decide to let the RMB appreciate and just start paying our military directly and cut out the middle man!

    Not real sure if that’s a good thing or a bad thing, but it would be something very different to wonder about.

  • Posted by student

    Can the US Gov default selectively on the bonds held by the Chinese only? This will imediately strengthen the USD and it will be justise done for all the currency manipulation done by the chineese pegging their currency to USD and de facto subsidising their exports at the expense of the american workers. We never asked the chinese to buy our bonds anyway. I am sure US goverment does not give a damn about what the chinese are saying and it is good. Default on all bonds held by the chinese, this is the solution.

  • Posted by Blissex

    «One, China is still a very poor country. It isn’t obvious why it makes sense for China to be financing other countries’ development rather than its own. »

    To me it makes perfect sense in several ways, and Japan and other “producer” countries have done the same, and China has special reasons too.

    First of all an important detail: China may be poor, but it is highly developed. Being poor/rich and developed/undeveloped are very different things: Arabia is rich but undeveloped, China is poor but developed.

    Chine is very different from the poor and undeveloped countries like say Laos or Uganda.

    It is just missing productive capital.

    Producer countries want to maximize market share, because they want to maximize the influx of productive capital and the *number* of jobs, at the cost of the level of wages.

    By providing subsidies China have managed in less than 10 years to create an immense base of productive capital, a lot of it paid for by foreigners being “bribed” with cheap finance and an advantageous exchange rate. That immense base of productive capital is worth a lot more than a couple trillion dollars.

    Thinking that (virtual) pieces of paper with “USA Treasury” on them is wealth is 21st century mercantilism. What matters is the amount of capital capable of producing and creating value added, and as to that China’s ruling class have been entirely focused.

    Also, China’s rulers know pretty well that the one-child-urban0-couple policy has created a natality bust, and they clearly see relatively capital intensive industry as the way forward.

    Arabia have spent their own riches on foreign-marble palaces — China have got factories and research labs from USA at USA’s own expense, just by tweaking some variables that are used in the spreadsheet of USA’s ruling MBAs. Great power to them.

  • Posted by Blissex

    «One, China is still a very poor country. It isn’t obvious why it makes sense for China to be financing other countries’ development rather than its own. »

    Continuing…

    The value of China’s foreign reserve is not a big deal in the great scheme of things: if they were canceled tomorrow, all those factories, all those labs, etc. would remain. That is what makes a country prosperous: China has had a stupendous boom in productive jobs and capital, the USA in toxic mortgages, and there are imbeciles in the USA that think that well off Chinese will/should restart the housing bubble yby buying up USA houses in exchange for visas. So far have the mighty fallen.

    To China the foreign reserves are just in effect a gambit, a bribe for devil foreigners.

    Sure, the Chinese government is keen on the subject of the value of those foreign reserves, as it is a matter of face (very important to the continuation of their power, but less to the future of the country), as Chinese people don’t forget the depredations and exploitation of foreign colonialists.

    And this is just a clear example of this attitude:

    «We never asked the chinese to buy our bonds anyway. I am sure US goverment does not give a damn about what the chinese are saying and it is good. Default on all bonds held by the chinese, this is the solution.»

  • Posted by Cedric Regula

    student

    I guess we could freeze all Chinese assets, and use human rights and global warming violations as the excuse. But that would severely test every one’s belief that MAD works as a deterrent to nuclear war.

    So I think the way it really goes will be the typical political mish mash of smoke and mirrors which will result in all parties taking a “haircut”. That means fall in the dollar for the Chinese along with domestic inflation. That results in investor losses on all fixed income. We’ll get more taxes for the rich and way more taxes for everyone else. Probably a carbon import tariff and a host of other regressive taxes on US citizens like cap and trade, maybe a federal sales tax or higher income taxes.

    Discretionary income will drop and the consumer still needs to leverage and boost personal savings rate. This will reduce state sales tax revenue, so states will increase property tax.

    Imports from China will drop during this process, and they will find themselves “decoupled”.

  • Posted by Twofish

    student: Can the US Gov default selectively on the bonds held by the Chinese only?

    No.

  • Posted by yoda

    USA gov can default on all bonds, but then USA will find herself “decoupled”. at any rate, look for dollar $USD to retest $70, break that to $50 much more fairly priced.

  • Posted by bsetser

    agree with 2fish.

    blissex. other asian countries haven’t actually followed the same trajectory as china. Japan’s current account was generally in balance when it was growing most rapidly. Korea often ran deficits. No one consistently ran 10% of GDP surpluses while as poor as China still is.

  • Posted by DOR

    Let me ask this, in all seriousness.

    If you were planning China’s monetary policy for the next decade, and you were a bit concerned that the global financial architecture was on the verge of the greatest change in decades, would you rush to float your currency or make it fully convertible?

    And, if you were looking at the shakey (-3.6% in teh first half) US economy, would you be taking advice from the same people who cheered as the bubble expanded? The same ones who championed living so far beyond their means that the inevitable implosion has shaken markets as far as Estonia and Mumbai?

    Or, would you look at China’s own track record of careful, cautious, exploratory steps taken with great care and studied in depth before being accepted as good decisions?

  • Posted by Qingdao

    Let me ask this in all seriousness: What assumptions do readers of this blog make about the gov’t (central and local) in China? I ask this because when i read an excellent paper by Prasad I find that where I disagree, he has made a very different assumption about the nature of this govt.

  • Posted by Rien Huizer

    Brad:

    “China seems to be inching toward the position that those countries borrowing its funds should start to take on some of the risks that China’s government now assumes. The basic idea is simple: China keeps its lending, but gets a better renminbi returns while taking less (currency) risk.”

    How?

  • Posted by Rien Huizer

    Cedric,

    “So this bit of Vorlon history makes me worry a little bit that China may decide to let the RMB appreciate and just start paying our military directly and cut out the middle man!”

    A little gem.

  • Posted by Rien Huizer

    Brad,

    “blissex. other asian countries haven’t actually followed the same trajectory as china. Japan’s current account was generally in balance when it was growing most rapidly. Korea often ran deficits. No one consistently ran 10% of GDP surpluses while as poor as China still is.”

    I do not agree completely. While Japan and Korea had an industrialization model relying on foreign savings, and for nationalist reasons those savings were not in equity form, leading to lot of foreign debt in certain stages, Taiwan and especially Singapore were quite similar to the Chinese SEZs. They typically had domestic policies that virtually guaranteed low private consumption and high public savings (and Singapore still encourages FDI returns to be reinvested) combined with exchange rate policies that would keep local industrial investment internationally competitive.

    Singapore’s CA surpluses are often in excess of 10% of GDP. For Taiwan things are now much harder to observe because no one knows (or is prepared to share) how large the Taiwanese economy is when you include its Mainland portion. Taiwan itself generates fairly large surpluses, but I am sure Greater Taiwan does much better. With a bit of luck Greater Taiwan could now be bigger than, say Korea as an industrial power.

    How large a portion of China’s total surplus would be the surpluses attributed to Greater Taiwan, Greater Singapore, and of course the very different Greater Japan and Korea?.

    No other once poor East Asian country has/had that situation, at least not on this scale. Beijing needs to balance the requirements of foreign investors (forgot, for UK in the FDI statistics read: Overseas Chinese through BVI companies), the demands of its socio-political model and the demands of trade partners. Guess who comes last? And the more China grows (which it will until it has run out of employables) the bigger the problem will get.

  • Posted by Paul Denlinger

    The Chinese ruling party is divided about how far to take its reforms. For now, it is easier for it to help its own state-owned enterprises to buy and hoard global resources than it is to liberalize its own domestic financial industry.

    If it were to liberalize its own financial industry, the party would no longer control how capital is allocated within China. This would provide the capital-starved private sector with the fuel it needs to take a larger chunk of the Chinese economy, but the power and influence of the ruling party and state-owned enterprises would rapidly diminish.

    By buying and hoarding commodities overseas with its foreign exchange, it can extend its influence overseas, while continuing to keep China’s private sector weak and prolonging its own rule in China.

  • Posted by Rahul

    Fantastic post

    agree with points 2 and 3 though still unclear about point 1.

    Regarding point 1: Wasn’t US poorer than Europe around 1910 (essentially before expenses of WW-I)? So parallel with China still holds – I think.

    Regarding point 2: I think we are in a phase where Chinese govt will sponsor reconstruction loans to the developed world. As developed economies gather traction, you will see private Chinese start investing in western economies.

    I would hide in RMB (waiting for currency appreciation in terms of purchasing power) and thereafter chase growth, innovation and entrepreneurship in US/EU where returns could be higher. Because of deferring exchange rates in these two times – I would still end up with major investments in China.

    Regarding point 3: This is biggest quirk of our times. And herein lies the biggest risk. The trade above would have been a no-brainer but for this.

  • Posted by Rien Huizer

    Qingdao:

    Let me ask this in all seriousness: What assumptions do readers of this blog make about the gov’t (central and local) in China? I ask this because when i read an excellent paper by Prasad I find that where I disagree, he has made a very different assumption about the nature of this govt.

    What article do you mean? He should be very familiar with the way in which China is governed at the central and gvt level..An ideologal bias perhaps clouding pure scientific thought?

  • Posted by Qingdao

    Rien Huizer: “Is the Chinese growth miracle built to last?” go to his web site or China Economic Review. I don’t think he has an ideological bias, but anyone who thinks about China has to make a host of assumptions about the nature of the regime; i.e. Yasheng Huang and Meixin Pei make very different assumptions than many on this blog; this (I think) is where most of the confusion comes from.

  • Posted by Rien Huizer

    Qingdao,

    Yes I’ve found an read it. I guess (but not more than that) that he has abstracted from political reality. That could be called a political bias. The kind of future that he schetches for a reforming China seems to be at odds with the the way the CCP governs. Not a bad article though. Just irrelevant.

  • Posted by RebelEconomist

    Twofish,

    Why can’t the US selectively default on bonds held by China?

    I am not saying that the US should do this (in fact I think it would be monumentally stupid), but I think it can. Treasuries are registered securities, and China’s holding is far too large to launder its receipts of interest and principal to any significant extent.

  • Posted by RebelEconomist

    Brad,

    I do not see why China could not continue to peg to the dollar (or, strictly, its currency basket apparently dominated by the dollar) while lending in renminbi. At the moment, China’s lending largely recycles the dollars obtained from its trade surplus. If China lent in renminbi instead, its exporters could invoice in renminbi, while the Chinese authorities could maintain the peg with a smaller amount of intervention at the margin.

  • Posted by bsetser

    Rebel — in theory it could. but as long as it pegs to the dollar, it will in the first instance accumulate dollars in the fx market. it then needs to find someone who wants to sell rmb denominated bonds to get us dollars. and as long as china is sitting on a pool of usd, i suspect most borrowers will conclude that they could borrow usd from china as easily. moreover, most borrowers are unlikley to want to borrow in rmb if they cannot hold rmb reserves. and it is hard to hold rmb resreves so long as china has capital controls — and it is hard for china to lift those controls so long as the rmb is perceived as a one way bet. so in practice, there are obstacles … my view at least.

    rien — i am pretty sure that taiwan didn’t run 10% of GDP surpluses during its rapid growth phase. the surpluses are more recent (and have been sustained in part by lots of reserve accumulation). i don’t know enough about singapore to have an informed view; the issue though is not whether singapore now has a large external surplus but whether it had such a large surplus during the high investment/ high growth phase of its development. Moroever, a city state is clearly different from a country of china’s size.

  • Posted by bsetser

    DOR —

    I am not sure that all Chinese policy can e characterized as “careful, cautious, exploratory ” and so on. The scale of the current lending boom/ monetary expansion isn’t modest, to take one example — though you can argue an extraordinary shock requires an extraordinary response. And i personally don’t think accumulating $2 trillion dollars in reserves is cautious or careful; I would use words like unprecendented and extraordinary and even potentially risky.

  • Posted by Rien Huizer

    Brad,

    Taiwan’s and Singapore’s high growth phases were way back. There was a time when they did not have large surpluses, but during the time they were as industrialized as China is now, (forget about the poverty, that is irrelevant, except as a source of cheap labor -as I said, China has a local pool and Spore and Taiwan do not anymore so they have to import workers or export jobs), basically an industrialixed country. China’s in-house poor are more of a curse than a blessing (sorry, no association with Deut 30 intended), but, so far, pretty well controlled.

    I think the point is not that an unpleasant, poor country’s gvt is having these great surpluses, to the detriment of the local population (it is up to that population to do something about their lot and if they understand history they wait until their state has killed all manufacturing outside China), but that an industrial country with a huge reserve army of cheap labor is undercutting Europeans, Japanese and Americans (not to mention Thais and Indonesians), in cahoots with Western vendor of the output. The Chinese poor should not be our concern, but the future European and American poor should.

  • Posted by juglars_conscience

    Dear Brad,

    I looked at the Chinese net international investment position a few weeks ago and I believe the figure is something like + 10% of GDP. The net holdings of China’s US dollar assets must be pretty small. You hinted at this in the first part of the post but don’t pursue it. Comments?

  • Posted by Rien Huizer

    Brad,

    Or not?

  • Posted by Judy Yeo

    Just wondering, if one really wanted to diversify away from US$ assets by lending in Aus $ or euros and expecting payment in those currencies won’t it constitute a more unobtrusive way of diversification? Of course that depends on demand for credit and sometimes that isn’t quite stable or forthcoming as brad pointed out.

    Brad and huizer, 2 responses to earlier comments on earlier posts are on my blog – had trouble posting on ur site over the weekend – apologies and thanks due to your webmaster . (didn’t manage to save other comments but hey, less to respond to huh?!

  • Posted by Rien Huizer

    Judy,

    Less to respond to, lah?..

  • Posted by Twofish

    RebelEconomist responds: Why can’t the US selectively default on bonds held by China?

    Legal and practical issues. Obama just can’t get on the phone and say “don’t pay Chinese bonds.” He doesn’t have this power. Chinese government officials could go to court and in five minutes get an injunction to pay Treasuries, at which point if Treasury refuses to pay, you have a coup d’etat.

    Under US law the only way you can do this legally is to have Congress pass a law, and to have Congress pass a law would take weeks to months, and five seconds after someone even thinks of a selective default, the world financial system would collapse.

    Also, if the US decides to default on US Treasuries, China can get the Treasuries to an investment bank, and get a depository receipt. US pays investment bank. Investment bank pays China. Now you can try to make that illegal, but you have the problem that the investment bank is in London or in Hong Kong, and not subject to US regulation.

    In fact, much of the reason that London and Hong Kong are financial centers in the first place was so that the Soviet Union and Red China could hold US securities and assets in the depths of the Cold War without risking them being seized by the US government.

  • Posted by Twofish

    It is possible to “selectively default” but that basically involves groups that everyone in the world is mad it. A lot of the reason the reason that there hasn’t been any major terrorist attack, is that the US and the rest of the world have shredded al-Qaeda’s financial networks. Deciding to launch a holy war against international finance and the Saudi royal family was a seriously bad idea.

    Similarly, one thing that keeps North Korea under control is that if it gets enough people seriously annoyed and scared, it’s bank accounts in Macao go poof…..

  • Posted by Twofish

    Huizer: What assumptions do readers of this blog make about the gov’t (central and local) in China?

    I assume that Chinese government officials (like most people in all political and economic institutions) are motivated by the desire for money and power. I also assume that they aren’t particularly stupid in figuring out how to get it.

    RebelEconomist: I do not see why China could not continue to peg to the dollar (or, strictly, its currency basket apparently dominated by the dollar) while lending in renminbi.

    I don’t see how this is stable. Once you have large amounts of Renminbi outside of China and not under the control of the Chinese government, you no longer have total control of your currency policy. If you have a peg, currency traders will make super easy profits doing things that will destablize the peg. See the US dollar 1971-1973 or the Pound crisis in 1991.

    To put it crudely, right now the Chinese government can send in a detachment of police into a trading floor of a Shanghai bank, point guns at the traders and say *stop doing what you are doing*. It can’t send that detachment of police to New York or London, and it even practically can’t sent it into Hong Kong, which is why HK has a different currency.

  • Posted by Twofish

    Huizer: The Chinese poor should not be our concern, but the future European and American poor should.

    Who is we? Since I’m Chinese, I’m pretty damn concerned about the Chinese poor.

    Also why should Americans be particularly concerned over European poor as opposed to the poor in China, India, or Latin America?

    One good thing about globalization is that it’s not clear who “we” and “they” are.

  • Posted by Twofish

    Twofish: China’s in-house poor are more of a curse than a blessing (sorry, no association with Deut 30 intended), but, so far, pretty well controlled.

    Whether something is a curse or a blessing depends on how you look at it. One thing that I like about capitalism is that it gives people incentives to find creative ways of turning curses into blessings. The fact that you have several hundred million people willing and able to work, is something that you can make a great deal of money out of.

  • Posted by Twofish

    Huizer: The kind of future that he sketches for a reforming China seems to be at odds with the the way the CCP governs.

    I think that people vastly underestimate the ability for the CCP to undertake some very fundamental changes. The CCP is after money and power, if you can convince the CCP that multi-party parliamentary elections would lead to the party officials being more rich and powerful than before, you’ll have multi-party parliamentary elections very quickly. Now it seems pretty obvious to me, and it’s probably seems pretty obvious to them that doing that would have the very strong change of the CCP losing power.

    But with things like strengthening the judicial system, SOE and banking reform, death penalty reform. A lot got done in those areas because people were able to do the reforms in ways that didn’t threaten the Party’s grip on power, and in fact increased it.

  • Posted by Jian Feng

    I find Paul Denlinger’s comments very revealing. The most important thing for the CCP is to stay in power, as long as possible, if not forever, just like the First Emperor once imagined. Thus, the foreign reserve can be view as China’s financial nuclear weapons. There is no chance that CCP will lesson the hold on it. CCP will accumulate more if it does nothing.

    There has never been a financial superpower that is not a superpower in military, science, technology, propaganda/media control, etc. Once upon a time, China’s share in the global GDP peaked around 30% in 1820. We all knew how fragile a “financial superpower” without a few paper tigers can be. The Royal Navy took no time to deliver the message.

    Thus, the only way that the CCP is going to spend China’s foreign reserve is in ways that it perceives will strengthen its power, both in China and globally, since there is nowhere to duck your head in the sand like what China did circa 1800s. There is limited amount of commodities that China can buy. China needs more military spending to keep these commodities accessible and available. China also needs to spend much more on science and technology to invent new gigs to let 1.3 billion people live a better, less polluted life. In terms of spending, military, science and technology can be black holes. A few trillion dollars would fit in nicely. It would be more efficient if United States was willing to barter. It’s terrible waste to reinvent the wheel. But, United States is no Switzerland; it does not sell mercenaries. The deal has to wait, but the Uncle Sam’s bargaining power is diminishing but cutting F-22s, etc. Aside from financial innovations, military is the single most valuable asset Uncle Sam has. Science and technology can be viewed as part of the military.

  • Posted by bsetser

    juglars –

    I have focused on the asset rather than the liabilities side of China’s NIIP. Most liabilities come from FDI, and most FDI in China actually comes from places like Taiwan and HK (and some FDI from HK may be mainland money that did a roundtrip to exploit the privileges foreign investors used to get) not the US and Europe. Most of China’s assets by contrast are claims on the US.

    consequently, China likely has a net liability position vis a vis HK and Taiwan and some other Asian economies with lots of FDI in China, and has a large net asset position with the US and possible Europe.

    a lot depends on the valuation of FDI in china though, as most foreign claims on china are equities and most chinese claims on the world are debt.

  • Posted by RebelEconomist

    Twofish,

    If the Chinese invoiced the US in renminbi, and lent the Americans the renminbi to pay, there would not be large amounts of renminbi outside China. The only difference from the present situation would be that the Chinese would hold renminbi-denominated US debt and the Americans would be on the hook for the currency risk. Of course having to pay in renminbi might make Chinese exports less attractive to Americans. The peg would then be maintained by intervention that is independent of trade and trade finance.

    You are right that selective default to China would raise all sorts of problems for the US – I said they would be monumentally stupid to do so – but also right to say that there are examples that show that restrictions can be quickly imposed if the political will exists. I hope it never gets to that.

  • Posted by Twofish

    RebelEconomist: If the Chinese invoiced the US in renminbi, and lent the Americans the renminbi to pay, there would not be large amounts of renminbi outside China.

    But that would involve far more control over the Chinese economy than the Chinese government has.

    RebelEconomist: but also right to say that there are examples that show that restrictions can be quickly imposed if the political will exists.

    I don’t think I showed any such thing. It took about three to five years of negotiations to destroy al-Qaeda’s funding network. North Korea took a few years.

    If the political will exists, then Parliament can name me the Queen of England and Ruler of France. I think that’s far more likely then having the political will to default on US Treasuries.

  • Posted by Greg in Asheville,NC

    It seems we have gotten so familiar with one other massive change in the US’ relationship with China that we no longer comment on it.
    We do accept that there once was a time when American Jingoists and subscribers to the views of Cold War ‘hawks’ and neocons saw China as Prime Candidate #1 to “Replace the Soviet Union as our Military Nemesis and as our Raison d’être, and ‘To Be Contained’”.
    But we rarely reflect on how as recently as April 1, 2001, so few Americans were surprised when after being in office a mere 70+ days, the trigger-itchy neocons inhabiting the Bush Administration used naval surveillance overflights to finagle themselves into the Hainan Island incident, a military stand-off resulting in 1 dead People’s Liberation Army J-8 interceptor naval fighter pilot, and a crippled Navy EP-3E surveillance aircraft stranded on Chinese sovereign soil with its crew scrambling to erase sensitive data before surrendering the ARIES II craft to Chinese Authorities for crating & shipping. It would be 11 days before the crew were handed over to the US; 92 days before crates of the disassembled hi-tech aircraft were delivered, by a Russian firm no less, back to the US.

    Fast-forward past $2 billion in purchases of US debt and the bursting of global asset bubbles, and few today can even fathom the point of a US-China testing of military brinkmanship.

    And yet I’d argue that that is not the only massive change in our perception of our relationship. I believe that when we debate Brad’s point that “I never quite accepted that a world where the governments of poor countries finance some of the world’s wealthiest consumers really made all that much sense” (from another post of his), we have to ask whether a populist representative democracy in China would continue the communist party’s economic priorities of investing in foreign debt relative over direct domestic investments.

    We should allow that debate to advance itself’, in time it leads to the bigger revelation: whatever domestic political force could displace the present Chinese government would most likely be a powerful populist movement…and I highly doubt an installed populist government would continue buying so much of America’s debt at the expense of advancing domestic social needs. Ergo, the massive change we speak little of is how much the US needs ‘No Change’ in a Chinese government that financially enables America’s current economic formula where debt-enabled consumer spending drives 70% of GDP. We rarely continue the discussion to its logical conclusion which is how big of a vested interest the US has in the current Communist system, and how economically threatening a populist, worker-installed, representative democracy in China would likely be to US economic interests.

    Back in April 2001, who could’ve dreamt such a dramatic, though never spoken, turn in geo-political desires of the US, let alone back in 1989 during the Tiananmen Square protests when Neocons also fanned the flames of imposing a representative democracy in China?
    What a difference a decade or two, and $2.5 billion in foreign reserves purchases, can make.

  • Posted by Rien Huizer

    Twofish,

    “Also why should Americans be particularly concerned over European poor as opposed to the poor in China, India, or Latin America?”

    That is a good question with an easy answer. Globalization (rather improvements in logistics control and communications) has made certain types of labor uncompetitive in their local markets. The worst affected by this phenomenon are the Europeans and Americans. I did not suggest that Americans should care for Europeans or vive versa, but that their governments face the same challendge. Of course in their consumer role, residents of these countries have benefited from lower cost goods, and new jobs have been created in transporting, retailing etc that would not have existed otherwise. Given the fact that the people affected are citizens and have political rights (and in Europe they are organized as well, on a class basis via unions and labor parties) there is a risk that this will lead to trade political friction. If we had a world economy closer to arrow-debreu assumptions, markets would simply take care of the problem (and I guess there would be political risks then as well!) but the real world has lots od distortions, asymmeties and protectionisms. That facilitates the formation of reservoirs of (a) unemployable people in the rich countries and (b) the persistance of inexpensive (I mean also taking into account non wage costs and environmental limitations) labor that can be more or less mined. Both are potential issues for populist and ethical audiences respecively.

    But pse do not think that my concern is about the lot of the poor, because then I might as well be concerned with the lot of roughly half the world’s population. But most of these people do not count, democratically. My remark aimed at the self interest of Western politicians, following more or less your own principle of motion in politics, and my preference for stability and order over elusive concepts like justice or market perfection.

  • Posted by Rien Huizer

    Twofish,

    “But with things like strengthening the judicial system, SOE and banking reform, death penalty reform. A lot got done in those areas because people were able to do the reforms in ways that didn’t threaten the Party’s grip on power, and in fact increased it.”

    Completely agree here.Control is the name of the game. That is why it would be so interesting to see what the Centre makes of the kinds of things in the PIN that have nothing to do with the exchange rate. Those reform ideas could strengthen the Centre (as bank reform did) but there are always unintended consequences. I think that SOE reform has stalled below the level where the Centre likes it to se (look at the spectacle around the steel industry). The judicial etc reforms take a lot of time because of the changes in culture. Just copying the Buergerliches Gesetzbuch and training lots of youg legal professionals does not get you good practice.

  • Posted by Twofish

    Greg: Back in April 2001, who could’ve dreamt such a dramatic, though never spoken, turn in geo-political desires of the US, let alone back in 1989 during the Tiananmen Square protests when Neocons also fanned the flames of imposing a representative democracy in China?

    I did.

  • Posted by Twofish

    Jian Feng: The most important thing for the CCP is to stay in power, as long as possible, if not forever, just like the First Emperor once imagined

    I don’t think that is true. Most Party bureaucrats that I’ve met see Party membership as a job. I don’t think many of them would really care if the CCP exists a hundred years from now. They care if *China* exists a hundred years from now, but that’s different. Lot’s of people I know are willing to die for China. I don’t know a single person that is willing to die for the Communist Party, and no one in China that is willing to die for communism.

    You can see this sort of in what happened in the Soviet Union. Once it became obvious that the Communist Party was an obstacle to people keeping their personal money and power, people left it.

    Jian Feng: Thus, the foreign reserve can be view as China’s financial nuclear weapons.

    Which did nothing to help the Soviet Union survive. Nuclear weapons mostly useless. Any weapon that ends up destroying you if you use it is pretty awful.

    Huizer: Completely agree here.Control is the name of the game.

    It’s not control. Merely supervision. Control doesn’t work. You end up with Stasi like files on everyone, and miss the fact that your economy doesn’t work.

    The Communist Party of China doesn’t care what you do as long as it doesn’t think that you have any chance of overthrowing it. By not caring about things that aren’t a threat to its power, it can stomp down more heavily on people and things which it thinks are.

  • Posted by Tourdelance

    What’s China worried about anyway? The US Dollar is ready to rally soon. The trade is overloaded on the short side. Virtually no bulls in the market. The rally should commence in the next month or two. Deflation dictates such.

  • Posted by Timer

    Can’t remember where I read this so I can’t give credit.

    Amassing 5% to 6% of gobal currency reserves occured in the 1920′s US pre depression era. In Japan just before the lost decade. In China as they are having serious problems with of all things, inflated real estate prices.

    The world needs balance and it looks like 6% of global currency reserves is a tipping point.

  • Posted by Rider I

    We now live in a market-based global financial system where the biggest single actor is a state. I would like to further your statement of the market based global financial system. Glad to see you are moving up in the world. Good to go. These words will probable fall on shallow ears as you have left this site. However, still though, this needs to be said.
    The thought that we live in a market based global financial system intrigues me. I have come to find that we truly have allowed the Communist Style Economics that we so defended against during the Cold War to take a huge hold. It has become inherent that your exact statement is true. However, I would have to differ with the world market financing. Currently, it is the Communist Party financing that keeps us dependent on the one single party state and not a properly regulated global market. This state is the Communist party. As such these statements will be made in a vacuum un-present the norms of the power of the free markets that are still left.
    The Communist Party has been allowed to get away with huge International Economic cartel abuses. This includes everything from vertical resources acquisition, to the shipping lanes, back to the production, packaging and even the distribution, then leading right into the financing department. They have also been able to pad their economy by using their SOE cartels to look after those who best serve the Political Party. They have inherently been able to sneak around and cloak their ever expanding State Owned Enterprises; which, in the cold war would have been unheard of without proper regulations. But, today we allow them to compete unfairly and we just keep borrowing money to keep paying them our jobs, debts, and allowing them to gain Political and Military advantages through the use of their SOE’s acquiring free market shares and infrastructures like ports and resources.
    The idea that it is a world market is starting to be lost. As the American board that was supposed to specifically watch over the Communist Economic Cartels has been lost and spread out to a security review board that has too few workers and not enough funding. We have seen a huge loss in the ability to defend against the Communist Cartel Economics. This has also been seen recently as the WTO Working commission on Interacting and Competition of International Anti-Trust laws in specific Cartel activities has become inactive. At a time when the last part of the Cartel Strategy is becoming more than prevalent on why we do not like Cartel activities. The allowance of the cartel activities really has turned it into a Communist bizar. Allowing Communist Cartels to purchase the very business they crashed because of their unfair competition. Also places like Brazil through huge parties that Capitalism caused the world crash, the Leader of Venezuela just stole 11 American oil rigs even though they had to the money to pay them under the Chinese Communist watchful eye, and the Chinese Communist went around behind Americas back saying it was their fault. Yet, no one had the where with all to say no China no it was your cartel activities that caused this and you need to stop, tell Venezuela to pay our people and stop trying to buy business with your SOE Communist Economic Cartel Political and Military national interests
    It was the Communist Economic SOE cartels fault for creating the biggest unfair competition since the threat of the Soviet Union. We have seen countries so dependent on the Communist Cartels for resources and manufacturing that it has become ridiculous to hear politicians keep saying we allow the loss of jobs to the Communist so we can create and keep high technology jobs. But, however, we also are losing the high technological manufacturing jobs too. As a matter of fact our very Secretary of Energy spent about 50% more on financing foreign SOE’s in China to further their technological advancement of green tech manufacturing than he did on his own countries job market. It has become so blatantly abusive that there is no one to report it to, the US and other free world countries did not even stand up to the Communist. Nor do I really think anyone even knows that they are abusing their SOE Cartels.
    As such, I write to create an interest I do not see, as we have lost the world free market and gained a Communist Cartel Market. Look at the world, find the countries with the biggest Communist Cartels and you find the state’s that are doing the best. So your comment is true yet at the same time not true; Global market no, state financers yes. Therefore, Globally underdeveloped countries, countries with individuals and corporations avoid of government national interest cannot compete with SOE cartel abuses. Leaving a single country dominance and not a world fair and peaceful marketplace. We have allowed the Communist Cartels to try and overtake the American freedom dollar and place in a selfish government that uses its SOE’s at such a mass level as to destroy foreign markets. They do this so (it, their cartels) can then go and acquire the markets it has destroyed for political and military purposes, whether they know it or not. I would think if this was a global market someone would have Stopped them and regulated them before they were allowed to get this far. The Communist Cartel has 3 out of the top ten world business competing with companies with no government interest. It is my prediction that within the next 10-20 years all the top business will be country owned business causing wars for resource and market shares if we don’t properly regulate the Abusers of SOE cartels and bring back the world market of peace and harmony of business to business instead of country v country as inherently SOE Cartels lead to.
    That is why the Communist party has been able to get away with what they have been able to get away with. The Communist party has been using a centralized national and military political interest to compete against countries with individuals and corporations avoid of government ownership. Inherently we have seen millions of jobs lost and not replaced 100,000 of employers had to shut down and could not re-open and yet, we still are allowing the Communist Cartels to be abusive and blame us for their abuse.

    Please see my website, if you ever read this. It is a currently under construction to become the best Anti-Economic Warfare blog ever and the bright light for the biggest Communist Cartel Abuses since the Soviet Union.
    http://rideriantieconomicwarfare.blogspot.com/
    Think you can ride with the Rider I?

  • Posted by Rider I

    Cite for the Secretary of Energy spending 50% more on Foreign creation of High tech green jobs than he did for his own counties interest of creation of jobs and technology here at home. Makes me sad when things cannot be mitigaged. I am the Rider and you are in my scope. I want justice, legally and properly.

    http://investigativereportingworkshop.org/investigations/wind-energy-funds-going-overseas/story/renewable-energy-money-still-going-abroad/

  • Posted by bubbles

    i would also have to argue, that the Fed/Treasury is in a way really testing china’s statements on “dollar stability”.

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