China reported an October trade surplus of $27 billion Wednesday. This is a very big number and not one likely to soothe anger directed at China. It will be very hard for China credibly to argue that it is trying to contribute to global growth while pulling in more and more foreign demand. Here is the article in the People’s Daily:
China’s exports rose 22.9 percent in October from a year earlier, while imports increased 25.3 percent, the General Administration of Customs said Wednesday. China’s trade surplus expanded to 27.1 billion U.S. dollars last month, compared with 16.88 billion U.S. dollars in September, making the October figures the second highest this year after July’s 28.73 billion U.S. dollars.
Exports and imports totaled 244.81 billion U.S. dollars last month, a Customs spokesman said. In the first 10 months, the country’s trade surplus totaled 147.77 billion U.S. dollars, down 6.7 percent compared with the same period last year.
Last week I argued that Tim Geithner’s proposal on restricting current account imbalances directly, rather than targeting currencies, was a good idea. October’s trade surplus shows both why it is a good idea and why it will be hard to accept.
The proposal was a good idea because trade responds to a lot more than the level of the currency, and just pushing for currency adjustment might have no impact on the balance. My biggest concern was that if countries like China were forced to raise the value of their currencies faster than they liked, or if tariffs were imposed on their products, there would be a huge temptation to intervene in other areas, especially by lowering real interest rates.
This would not only prevent the tariffs or currency appreciation from having much impact on the trade imbalance (indeed the imbalances might actually get worse), but it could seriously increase domestic distortions. As undervalued as the renminbi might be, I am convinced that the most serious domestic distortion in the Chinese economy, and the biggest cause of the trade surplus, is excessively low interest rates.
Low interest rates (along with their cousin, socialized credit risk) are the main causes of capital misallocation and excess capacity in China, and are probably also the main forces pushing down household income and household consumption as a share of GDP. In that case the rebalancing benefits of an increase in the value of the currency could easily be swamped by the damage caused by reducing real interest rates.
It’s the interest rate, stupid
This by the way is what happened, in my opinion, in Japan after the Plaza Accord. Not only did Tokyo wait way too long to begin the rebalancing process, but when the rest of the world (i.e. the US) refused to absorb its huge and expanding trade surplus and forced up the value of the yen, Tokyo made things worse – it counteracted the impact of the rising yen by expanding investment, expanding credit, and lowering interest rates. This accelerated Japan’s structural imbalances, set off a further frenzied rise in asset prices and capacity, and worsened the eventual adjustment. This also seems to have happened after China began revaluing the RMB after July 2005.
That is why I think a current account target would have been a more effective way of forcing a rebalancing, although of course if you are eager to postpone the adjustment as long as possible, restricting very easy-to-monitor current account balances create a real problem. So when the initial reactions from China seemed favorable to Geithner’s idea, I though this was good news.
But when Yi Gang, a deputy central bank governor, said last week, seemingly in response to Geithner’s proposal, that China aimed to reduce its surplus to 4 per cent of GDP in the medium-term, I was nonetheless surprised that China seemed so eager to go along. After all, as early 2009 amply demonstrated, China is very dependent for its growth on widening trade surplus, and if the surplus was cut by a third in the next year or two, which is what it would take to bring it to under 4% of GDP, it would cause a several percentage point slowdown in Chinese growth, which could only be reversed by another surge in bank-driven investment.
But events and policy speeches in China seem to suggest that the leadership is finally starting to see how risky continued expansion in investment has become. There is a growing sense, I think, that capital is not being wisely invested. Monday’s People’s Daily had what I thought was an interesting article:
China will continue to steadily push forward reforms in its interest rate mechanism, the Shanghai Securities News reported Friday, citing Guo Qingping, assistant governor of the People’s Bank of China (PBOC), the central bank.
…He explained that in order to achieve that goal, China’s central bank will further strengthen and improve macro-control of its financial system and steadily promote the market-oriented interest rate reform. It will also promote reforms of larger commercial banks to establish a modern enterprise system, he added.
It seems to me that perhaps those in China who have wanted to improve the capital allocation process by liberalizing interest rates are trying to speed up the process a little (a cynic might say: by trying finally to start the process).
But it is not going to be easy. Repressed interest rates may indeed be the biggest source of China’s domestic imbalance, but they are also the biggest cause of rapid Chinese growth in the short term. Give up one and you must give up the other.
Irreconcilable differences
If Beijing really is starting to worry about the negative long-term impact of increased and increasingly misallocated investment, then how could it support the idea of a significant contraction in the current account surplus? If it were to happen, Beijing would be forced to choose either a sharp slowdown in growth or a rapid increase in investment, and the rumors are (and mind you, these are only rumors) that Beijing is hoping to reduce credit expansion next year to RMB 6 trillion – it was RMB 9.6 trillion last year and expected to be RMB 7.5 trillion this year
How much of a slowdown? Li Ruogu, chairman of the Import-Export Bank of China, had what I thought was a rather novel way of expressing China’s dependence on trade and why the rest of the world should accommodate China. According to an article in Wednesday’s South China Morning Post:
In a possible preview of Beijing’s position in Seoul, the head of a government bank on Wednesday rejected suggestions the yuan is undervalued. He said a rapid rise in the yuan would cause massive job losses and Western nations would have to be ready to accept millions of Chinese immigrants.
“If you are not ready, then please don’t pressure China to appreciate its currency, because it cannot solve the issues faced by the West,” said Li Ruogu, chairman of the Import-Export Bank of China, speaking at a conference in Beijing.
Mr. Li, is right, I think. A rapid revaluation would be very difficult for China, as I have argued many times because it cannot afford to bring down the trade surplus rapidly, but on the other hand a failure to address the trade imbalance is likely to be very difficult for deficit countries.
Perhaps not surprisingly Beijing, it turns out, was not that eager to support Geithner’s proposal. Here is what an article in Friday’s South China Morning Post had to say:
China pushed back strongly against US policies yesterday ahead of the G20 summit, saying Washington’s plan to impose current account targets resembled a “planned economy”.
The remarks by Cui Tiankai , a deputy foreign minister (pictured), was the first high-level official stance from Beijing on the issues. “We believe a discussion about a current account target misses the whole point,” he said. The United States proposed at the G20 finance ministers’ meeting last month that countries should cap current account surpluses or deficits at 4 per cent of gross domestic product as part of efforts to rebalance the global economy. “Of course, we hope to see more balanced current accounts,” Cui said.
“But we believe it would not be a good approach to single out this issue and focus all attention on it. The artificial setting of a numerical target cannot but remind us of the days of planned economies.”
Enough people have chuckled at the irony of Beijing’s disparaging of planned economies for me not to comment, but it is worth pointing out that China is very worried about the double impact of a contraction in the trade surplus and the impact of the Fed’s quantitative easing. If the former occurs, it will be almost impossible for Beijing to reduce the impact of the latter without causing a sharp slowdown in growth
Beijing claims that QE2 makes it impossible for other countries to protect themselves from massive capital inflows that will destabilize local asset markets. Actually, Beijing is wrong. There is a way for countries to protect themselves against QE2, but it would require that they give up intervening in their currency. In other words the only reason QE2 will create excessive monetary expansion in China is because the PBoC will insist on purchasing all dollar inflows at the exchange rate set by the PBoC and monetizing them. So QE2 is fairly explicitly the US countermove in the great global game of beggar-thy-neighbor.
QE2 and the currency war
Meanwhile there has been a real flurry of attacks on QE2 in China. Tuesday’s People’s Daily has an article (“China vows to collar US over monetary policies”) that starts:
China yesterday urged the United States to “act responsibly” in its monetary policies, and said that concerns will be raised at the upcoming G20 summit in Seoul, South Korea. Vice Minister of Finance Zhu Guangyao made the remarks at a press briefing on President Hu Jintao’s attendance to the meeting.
The US Federal Reserve last week announced plans to purchase US$600 billion worth of government bonds in a bid to revive the sluggish economy. The near-zero US interest rate and a weak dollar are expected to push liquidity into Asian countries, potentially destabilizing emerging economies.
Zhu urged the United States to “realize its responsibility and obligation as a major currency issuing country, and take responsible macroeconomic policies. “We will have candid discussions with the US side. We hope its macroeconomic policy can be conducive to the development of the world economy, not the contrary,” Zhu said.
What an impasse. China and other countries are right to claim that QE2 is likely to lead to asset bubbles outside the US, but only, as the US points out, in countries that intervene to prevent dollar depreciation, something the US is anyway eager to discourage. If Beijing is correct however in claiming, as it has for many years, that Chinese currency policies should be aimed at China’s needs, not those of the US, it is hard for them to dispute the Fed’s argument that Fed monetary policies should be aimed at satisfying the needs of the US economy, not the needs of China.
That doesn’t mean Beijing won’t try. Last Thursday Xinhua had a piece arguing that “global reserve currencies come with responsibilities”:
The U.S. Federal Reserve announced Wednesday it would buy 600 billion dollars of Treasury bonds, effectively printing money to jumpstart the flagging American economy. The move is a boost to the U.S. economy but risks creating new capital bubbles for other countries.
The U.S. dollar is the most widely held reserve currency in the world today. The devaluation of the U.S. dollar plus an overly loose currency policy that leads to a sharp increase in capital flow will drive large amounts of hot money to newly emerging economies in search of profits.
The International Monetary Fund (IMF) has recently warned that Asia and other emerging markets are facing the double risks of a huge influx of foreign capital and an accumulation of inflation pressure.
Chinese Commerce Minister Chen Deming has also pointed out that “out-of-control” U.S. currency issuance and big international commodity price hikes would probably saddle China with imported inflation.
Ironically, one of the factors driving big international commodity prices up is the depreciation of the U.S. dollar, the main global reserve currency. In the past few months, a vicious cycle of currency flow became obvious. The Fed launched a round of quantitative easing, causing an overflow of capital (hot money pooled in other countries). This led to imported inflation jeopardizing the economies of other countries, which were then forced to intervene in the foreign exchange market.
The last line is a little funny, since not all countries only began intervening in response to dollar weakness, but the key point is that it is mainly the combination of QE2 and intervention that causes monetary expansion outside the US. And if the US is determined to get the dollar to depreciate, something that other countries including China have no trouble accomplishing with their own currencies, it is hard to see why putting pressure on interveners would not be in the US interest.
Hot money
There will also be attempts by Beijing to manage hot money inflows: Tuesday’s Bloomberg had this article, on a topic we were all pretty much expecting:
China will force banks to hold more foreign exchange and strengthen auditing of overseas fund raising as part of efforts to crack down on hot-money inflows. The State Administration of Foreign Exchange will tighten management of banks’ foreign-debt quotas and introduce new rules on their currency provisioning, the regulator said in a statement on its website. The government will also regulate Chinese special-purpose vehicles overseas and tighten controls on equity investments by foreign companies in China, it said.
The measures underscore concern around the world that the Federal Reserve’s decision last week to buy its own debt to keep borrowing costs near zero will cause investors to seek higher yields in emerging markets. Chinese and European leaders have said they plan to discuss the impact of quantitative easing at the Group of 20 summit this week in Seoul as well as the dangers of competitive currency devaluations.
Meanwhile the South China Morning Post had this to say, on a related topic:
China signalled its intention on Tuesday to crack down on excess cash sloshing around its financial system, by unexpectedly raising the yield on bills at a central bank auction and vowing to stem hot money inflows.
The moves suggest increasing concern from Beijing about a surge in liquidity in its financial markets after the US Federal Reserve’s decided on another round of quantitative easing, heralding for some analysts further monetary tightening steps sooner than had been expected.
The expectations were fuelled by comments from two central bank deputy governors that the Fed’s easing could lead to asset bubbles and inflation and that Chinese authorities were keeping a close eye on the situation. “China still has a strong momentum of rapid credit expansion,” said Du Jinfu, one of the deputy governors, in summing up the challenges facing the central bank.
I don’t think any of these measures will make much difference. China already is experiencing a liquidity-driven investment boom, and would have already raised interest rates if it weren’t so difficult to do so (many borrowers can barely service debt even at such low interest rates), instead of letting them decline in real terms, as they have all year. And even if SAFE can prevent some hot money inflow, it will not be enough to keep matters from getting worse, especially since most hot money inflow is likely to be generated by small and medium family businesses in China with international links. These are hard to monitor and control.
On Wednesday there were also reports that the PBoC raised minimum reserves again, in order to soak up liquidity. According to an article in the South China Morning Post:
China has increased required reserves for its biggest banks to mop up some of the cash that is streaming into the country and posing a growing inflationary threat. Although Chinese officials have directed their ire at US monetary easing as a cause of unwanted speculative inflows, data on Wednesday provided a reminder that a whopping trade surplus is the main source of Beijing’s liquidity headache.
The central bank lifted the reserve requirement ratio for Bank of China and Bank of Communications (SEHK: 3328) by 50 basis points, three industry sources told Reuters. Chinese media said the increase also targeted the country’s other main state-owned lenders. The move means the biggest banks are setting aside a record 18 per cent in reserves, BNP Paribas said in a note to clients.
You can’t sit out a trade war
I feel bad for countries like Brazil and Thailand that are being caught up in this monetary tug-of-war between the US on one side and China and countries that intervene on the other. So apparently does Martin Wolf. In a very testy piece in Wednesday’s Financial Times (“anyone with half a brain should realise that the US can no longer combine a large trade deficit with a manageable fiscal position”) he expressed his frustration with the inability of some analysts to see why the US has little choice but to attack the global imbalances. If it doesn’t, the desperate need of the rest of the world to grow its share of global demand will swamp the US economy.
Against Wolf I saw another very interesting piece in the Financial Times by Yao Yang, director of Peking University’s CCER, that among other things said:
The real question is whether China has the power, long enjoyed by the US, to stand steadfast against outside pressures. Put another way, China will only undertake a fast revaluation if other countries can credibly threaten punishment. The long-standing view in China is that the US and its allies lack the will to punish, even if they may have the means.
China’s leaders believe that, when the political dust of the midterm elections falls to earth, Americans will see they benefit from the cheap goods a weak renminbi provides. They also gain little from an upward valuation. Research suggests that even a 20 per cent appreciation will have minimal impact on the US economy. China, on the other hand, will see employment and GDP drop by over 3 per cent.
No wonder there is a firm belief among China’s elites that rational American policymakers are not serious about appreciation, because it makes no sense for a rational actor to inflict costs on others without gains.
Wow, if this true, we have a real problem. Beijing believes that there is no real desire on the part of Washington to address the deficit, while Wolf argues that if Washington doesn’t act soon it will face a rising trade deficit, more unemployment, and a worsening fiscal deficit. I think they are both right – Washington is worried about the deficit and Beijing believes Washington doesn’t care. This is a great setting for some pretty foolish brinkmanship. Yang even adds that in the argument between the two “it is conveniently forgotten that China is also contributing to the world, by providing cheap goods and credit.”
Wow again! You hear this a great deal in China, and even by a lot of American economists – that somehow China’s great gift to the world is that it provides subsidized consumption to foreigners while taxing foreign consumption at home. But if the world has an overconsumption problem along with an unemployment problem, why would the world consider this to be a gift? And if it really is a gift, shouldn’t Beijing be delighted when the US offers back to China the same gift? After all by forcing up the renminbi Washington wants to lower the cost to Chinese households of foreign consumption and pay for it by raising the cost to Americans of Chinese consumption.
Expect nothing from G20
Maybe not. Perhaps my mother was right, and it really is much more fun to give a gift than to receive one.
Each major country (and many minor) is pursuing monetary policies that attempt to create domestic growth at the expense of their neighbors. One of the terrible consequences of trade and currency war is that every country eventually gets caught up in the process and must play the same brutal game or suffer the consequences. No one paid much attention to beggar-thy-neighbor polices when the world was growing quickly, but it should have come as a surprise to no one that once global demand growth slowed, it was going to create a huge problem for international trade.
I hate to sound like a broken record, but since China and the US have seemingly valid and actually quite similar reasons for insisting on policies that are mutually contradictory, and neither can force the other except by accelerating their incompatible currency policies, there is almost no possibility of a happy solution to the trade disputes. In fact before the G20 meetings have even started, bad tempers and frayed nerves seem to provide some ominous signs. Here is what an article in Wednesday’s South China Morning Post said:
An all-day G20 planning session grew so intense that officials had to leave the door open to keep the room from overheating, underscoring deep tensions over global economic rebalancing one day before the start of a summit.
Deputies drafting a final statement to be released after the Group of 20 summit concludes on Friday remained far apart on pivotal issues, including currency exchange rates, G20 spokesman Kim Yoon Kyung said on Wednesday. “We had to open the door because the debate was so animated and the room was getting hot,” he said.
I think there is a very good chance that in retrospect QE2 will be seen as the equivalent of the Plaza Accord. If the US continues to pursue quantitative easing, it could spell the last stage of China’s great growth spurt followed by the beginning of the big adjustment. And like the Plaza Accord it will sow many years of suspicion and conspiracy theories.
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On a separate note, last week CIC chairman Lou Jiwei said that we should expect China’s long-term GDP growth rate to drop to 6%. According to a Bloomberg report, he said:
“If we consider the population factors and the movement to a higher stage of development, it implies that China’s potential economic growth rate will experience quite a big drop in the next three to four years.”
Although “population factors” matter, they matter in the long term, and not in three to four years, so when he says that growth will drop sharply in the next three to four years, I suspect Lou means that the main reason will be a “movement to a higher stage of development.” Of course the phrase “a higher stage of development” sounds to me like a euphemism for “major restructuring of the growth model,” and that, I suspect, will be the main cause of a sharp slowdown in growth. To my thinking, raising household income automatically means removing the household subsidies that generated rapid growth, and this will cause growth to slow sharply.
Meanwhile last week another policy advisor said something quite similar. According to an article in Thursday’s Xinhua:
Chinese economic growth may slow to about 7 percent per annum in the next three to five years from the current 10 percent level, Liu Shijin, deputy director of the Development Research Center of the State Council, a government think tank, told a forum Saturday.
Liu said along with the slowing in growth, rising costs and price hikes will be the three major challenges China faces in the future. He warned of price hikes caused by excessive liquidity, especially after the U.S. adopted its “quantitative easing” monetary policy.
He said the U.S. policy will add to inflationary pressures in emerging economies including China. China will face great imported inflationary pressures, he said. He also said the weakening of the U.S. dollar is “inevitable” in the long run, which may prompt a “currency war.”
The Chinese economy will encounter severe challenges in the coming few years and undergo its “most significant” transformation over the next 5 to 10 years, he added. He urged more efforts to restructure and reform the economy.
About one and a half years ago I published an article in the Financial Times with the title “Get ready for lower Chinese growth.” In it I argued that
Over the next five years or more Chinese economic growth will necessarily be lower than growth in Chinese consumption. The massive but unsustainable investment in infrastructure and new production facilities that characterises the Chinese fiscal stimulus package will not be able to change this fact. From its dizzying heights during the past two decades, the world needs to prepare itself for a decade during which, if all goes well, China grows at a still respectable but much lower rate of 5-7 per cent. If the current fiscal stimulus package retards China’s adjustment process, as many analysts argue that it does, growth rates may be much lower.
The article caused a lot of comment, and some very vituperative disagreement, because at the time it seemed totally incredible for anyone seriously to argue that Chinese annual growth would shift down to 5-7% in just a few years.
In fact I wasn’t really arguing that growth would slow on average over the next decade to 5-7%. I said if all goes well it will slow to that level. To me the logic of the growth model, and all historical precedent, suggests that the necessary adjustment will be quite difficult.
It looks like slowly the consensus is moving to the 5-7% growth number. I suspect that within a year it will be all but impossible to find anyone who admits he hadn’t assumed this number all along. I apologize if I sound like I am trying to score points. I am not. I just want to remind people that the consensus is shifting (as it usually does) very slowly but very steadily. I still think average growth rates over the next decade are likely to be lower than 5-7%, heavily front-loaded of course, but of course I will wait until everyone gets to 6% before I say that.
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After such a long post I guess I guess I should provide a touch of relief. China’s recently founded sovereign credit rating agency, Dadong, is often dismissed as a sort of rating-agency clown, more eager to get publicity than to build credibility. They recently downgraded the US from AA to A+.
According to an article in Wednesday’s People’s Daily:
A leading Chinese credit rating agency yesterday downgraded the sovereign credit rating of the United States from AA to A+, claiming that the U.S. government’s solvency is “on the brink of collapse”.
Some analysts have argued that Dadong confuses nationalism with credit ratings, and that its purpose is to gain attention by regularly downgrading the US. Actually I think the critics are wrong. If the US Government’s solvency “is on the brink of collapse”, as they say, I think it is an extraordinarily generous gesture nonetheless to rank US Government debt A+. Greece should be so lucky.
It seems an appropriate time to repost an updated version of my dream speach by Obama; to the persistent surplus countries.
_______________________________
Greetings folks. I am here to talk to you on behalf of the trade deficit countries about a serious economic problem that demands your attention. Since the end of WW-II the world has had an unprecedented period of prosperity. Average living standards in most countries (including yours) have increased substantially. This is due in part to expansion of global trade. But a serious problem has developed that threatens the whole system of international trade, and with it many of the gains we have achieved. We (the trade deficit countries) have accumulated a large amount of external debt that is owed to you (the surplus countries), and the debt accumulation continues at a substantial pace. This debt has grown to the point that it threatens future stability of the world economy. Frankly, we simply do not want any more debt. In fact, under current conditions many of our countries clearly have no way to pay back our current levels of debt.
We would like your help in solving this problem. But before I get specific about the help I am requesting I want to make a few points. First I want to congratulate you on your achievements. You have worked hard and diligently, you have saved and invested and have built efficient industries that produce quality goods. I also want to make clear that I am not asking you to stop working hard or to stop efficiently making the products that you do so well. I am not asking you to cause widespread unemployment or other economic distress in your countries. I am not asking you to spend beyond your means and put yourselves in debt to us or to each other.
So, what is it that I am asking? You have developed industries that export goods sold all over the world. This results in a large flow of money coming in. In many cases you have built factories and made other investments in other countries that also result in money flowing into your countries. So here is my request: When money flows in from your export sales and external investments I am simply asking you to SPEND THE MONEY! Why is this so important? Because if we buy something and send you the money, and you do not spend it, it does not come back to us. Then, the next time we want to buy something we cannot pay for it. So if we go ahead and keep buying anyway we have to buy on credit, i.e. borrow the money from you. As I mentioned, we already have enough debt and really do not want more. Many of us cannot afford to repay the debt we already have. By the way, I want to clarify that when I say “spend the money” I do not mean spend it on putting us in debt (buying our bonds or making more loans), this is not what I mean by “spend the money.” I also do not mean spend the money to buy up our existing assets, our countries are not for sale. If you want to spend the money on building new factories or other productive assets in our countries that’s OK. With the exceptions noted, you can pretty much spend the money on whatever you choose. If you spend it, it will find its way back to us.
Now some may say “we do not know how to spend the money,” or maybe “what could we possibly spend the money on,” or maybe “our people and our businesses simply refuse to spend the money so it piles up in our banks and the banks cannot just sit on it, they must lend it out and if no one in our country wants to borrow it we must loan it to other countries, our hands are tied, we are helpless to stop this.” Well guys, this is really not rocket science. You have a lot of smart people in your countries. I think that you can figure out how to spend the money. In fact, I am convinced that if you put your minds to it you can find plenty of things to spend the money on that actually benefit your people and your countries. But if you cannot figure it out, I can give you lots of suggestions. We have a lot of people in our countries that our very good at finding ways to spend money, and if need be I will arrange to loan you some of those folks to help you find productive and beneficial ways to spend the money.
I also want to clear up the common misconception that your countries rely on your trade surpluses to maintain your economic growth and create employment. The reality is that if you spend your excess export earnings internally it will increase your economic growth and employment, while at the same time reducing your trade surplus. Piling up cash (or our debt) from excess export earnings does not grow your economies. On the other hand we (the deficit countries) could reduce what we buy from you in order to reduce our trade deficits. That would also reduce your surpluses, but in a way that reducea your economic growth and employment. The objectives of my request are to allow your economies to continue to grow, while allowing the trade deficit countries to stop going further in debt, and also get our economies growing again. These objectives are essential and we will pursue them aggressively.
My request to you is simply a request, because in fact we have no way to force you to spend your money. However, an option we do control is to reduce the amount of money we send you until it equals what you are willing to spend. This would require us to reduce what we are buying from you. I know that this would be painful for you, and in the sort term at least it would be painful for us. However, it is clear that the current path is unsustainable and I prefer this pain to that we will have to bear if we let the current situation continue until the whole system collapses in a major crisis. Or, you can reduce the pain for both of us by spending the money. Spending your excess export earnings internally in ways that benefits your countries seems like a small price to pay to maintain world economic growth and prosperity. However, the choice is yours.
Overestimation of its relative economic power, reliance upon mercantilism for growth, and intransigence in taking the steps necessary to reduce outsized commandeering of world demand has prompted the U.S., the dominant economic power, to use overwhelming force to bring China into line. Germany and its enablers will be collateral damage, as will other exporters. Negotiations, supplication, and toothless threats by bit players in Congress have been ineffective.
The U.S. issues the world reserve currency for a reason – it has been and remains the source of what has been, on balance, a benevolent economic hegemony since WWII. The benevolence comes from recognition of the rights of man – all men – as enshrined in the Constitution. The hegemony springs from –mostly – enlightened economic and political thought and practice permitted if not actually encouraged by the Constitution, and the messy freedoms that ensue.
But there are limits to American benevolence. One can only presume that the patience of policy makers has been exhausted, and that QE2 is the leading edge of a surge that will build up over time until the needed rebalancing begins to occur in earnest. Either China implements much of what Mr. Pettis and others have already identified as necessary, or the pressures of the dollar wave will force changes upon China’s heretofore command economy in a much more unpredictable manner. Likely much to the detriment of its extant power structure that exercises its power absent the legitimacy of elections.
Everyone suffers losses in war – and an economic war this is – but the U.S. is much more resilient and in a better position to sustain necessary losses than its mercantilist foes. In the event, the U.S. will regain at least a portion of the jobs that it has ceded to those who unfairly skew the terms of trade. Unfortunately, it will be a less-than-zero-sum exchange, but the U.S. has at long last been pushed into this trade by the gutting of its manufacturing base and the attendant loss of jobs.
Rather than the brickbats that have been hurled in recent days by the likes of China, Germany, and Brazil, the leaders of those countries had best be pragmatic and decide how they will deal with the new reality of a U.S. defending its interests. Those who have accumulated large dollar reserves have done so by building or rebuilding their economies; that benefit is enough, the issuer does not owe them indentured servitude. Their own errors of allowing short-sighted internal misallocations are, frankly, their problem. The incremental nature of the surge offers them a chance to get their respective houses in order before being engulfed by the flood.
Appropriate actions – not words – could encourage Mr. Bernanke et al to reciprocate and help us step back from the brink. However, I share Mr. Pettis’ pessimism in this regard, but am perhaps less sanguine that China has time to adjust. The 5-7% growth “consensus” may seem wishful thinking in another 18 months, absent those actions. It is time to begin shorting the Chinese economy.
(BTW, Gottschalke is a pseudonym, and should not be construed as indicative of my heritage. Conspiracy theorists take note. I am a political and economic observer with a graduate economics education, a buy-side equity analyst of a very specific industrial sector, and personal investor. I am greatly concerned for my children.)
Prof Pettis
You have said in a previous post that you expect Chinese asset markets to perform well while at the same time you expect economists to lower their estimates for Chinese growth. Is this not a problem?
My other question involves the plaza accord analogy. One could argue that “it is different this time”. The Yen held relatively stable against the dollar between 1985-1989 it wasn’t until 1991 or later that the Yen Adjusted much higher. If the yuan was to make a similar kind of adjustment would that not hurt real estate prices or at that very least prick the bubble?
I understand your argument about government spending and investment fueling the growth but Chinese asset markets are the final destination. Could the speculation suddenly end if the returns were to simply decrease?
Nice to be able such detailed posts from you over time.
Low interest rates (along with their cousin, socialized credit risk) are the main causes of capital misallocation and excess capacity in China
You are getting Austrian by the day. Meant to be a compliment:)
Hope you can convert Geithner and Bernanke by the way to pay attention the meaning of this word “mis-allocation” and their felllows in China. I have some doubt though.
QE2 will be seen as the equivalent of the Plaza Accord.
I have to say I disagree with both the wording and the meaning. This Plaza “devaluation was planned, done in an orderly, pre-announced manner and did not lead to financial panic in the world markets.”
We are getting onto very different waters here and I basically agree with the conclusion and the title. The US authorities will – at some stage – get more than what they are looking for. Both in terms of devaluation and inflation.
No judgment on side at this stage, I understand that the Federal government is trapped and may have no alternative. But the way things happen here – no agreement, little to no improvement in financial regulations, no serious litigations on harm done et greedy banksters exposed all over the place, a VERY serious disruption – historical level – in international money markets is certainly not to be discarded.
Regards
Wow. Great post. The letter Obama released and Geithner’s co-op-ed with Australia and Singapore show me that the administration is going into the G-20 with about as strong a game plan as one could hope. The India trip also served as a nice prelude, endorsing India’s drive for a permanent UN seat. Unfortunately, I don’t think it will make a too much difference, there isn’t anyway to square the circle.
China needs to cut investment and has a fairly limited capacity to increase consumption in the short term. The US is out of fiscal bullets, at least politically. There will almost certainly be a QE3 and QE4 (the Fed will try to adopt a less visible nomenclature as this becomes the new normal).
One thing Chinese officials should bank on is that the US won’t tolerate deflation, so they can revalue or accept inflation.
Michael,
As you say, a very long post, and a confusing one. The present situation does not offer the China/US partnership a win-win outcome for any available strategy as far as I can see. Maybe the US first move will give it an advantage. However, there is no way to establish what National Interest means in the new political situation in Washington and this QE2 is far too small to have an effect on the output gap (anyway, it should not work in an advanced economy like the US as every undergraduate is taught) but it may, as you suggest, cause some harm overseas. But there is no sign that the harm is well calibrated and focussed. Likewise, we have no way to know what, if at all, will change in China as a consequence of several things: political learning (the Party must be finding that society is evolving), growing GDP, the growing travesty of letting the SOE barons get rich while risking a trade war that may devastate the Chinese economy. So, a long and not necessarily clear piece with many “dog whistles” is very appropriate!
And full marks to the Chinese who announce an embarrassing result (that they easily could have massaged downwards) when the script requires them to be accommodating. Much better than Premier League..
If the US were to fight war1,war2,war3…war-n increasingly, and incurred 1thrillions, 2t,…n thriliions. Assuming 50% of these war expenditures represent outflows and become defits for US and thus surplus for ROW and assuminng the limit for deficits/surplus is breached for US and many other countries. Whose job it is to fix this breach? The US or the ROW?
For the well being of China it should widely spread its wealth. Instead of loaning money that will never be repaid its government needs to find a way of giving money to people who will buy real goods with it and use those goods productively. A real negative interest rate.
This is harder to do successfully than is generally recognized.
Michael, I would agree with your recent posts that, in a sensible world, the brains trust would sit down and bash out a co-ordinated agreement that would spread the necessary adjustment over many years but, most unfortunately, we live in a world where sense is a rare commodity. It will be depressing to see it unfold but I would expect stupidity to rise ever more prominently to the fore. I can’t think that will be too good for those trading copper, oil etc. We might be near the high watermark for some of those. Could be the last chance to dance and sell the hell out of them.
Beautifully written and argued as always. But I still don’t quite see the importance of distinguishing unwise investment (building empty cities) and private expenditure (like the yachts the rich never have time to use). The fact is that total world demand can’t be expanded much at the moment because that would increase oil use, and since there is no spare capacity there would be a price spike that would crash the world economy again. So everyone needs to follow China’s combination: Invest in cheap electricity; invest in electrification of everything; keep private demand down. How about we in the developed world spread the pain of keeping private demand down by forcing everyone to take part of their wages as “Energy Crisis Bonds” that will be turned back into money as we get past the current crisis?
Another truly great post! You really do well highlighting the views from both sides of the Pacific, as well as the contradictions and misunderstandings.
As always, a nice roundup of some of the various views out there in relation to China’s macroeconomic policy.
Just wanted to point out that there are some voices in China that have recognized that China can reduce or counter the inflationary effect that QE2, by pushing ahead with reforms to exchange rate flexibility – you can find an argument for more exchange rate flexibility in the front-page editorial of this week’s issue of The Economic Observer – Independent Monetary Policy is Vital for China http://www.eeo.com.cn/ens/Observer/editorial/2010/11/09/185318.shtml
Prof. Pettis, I write just to say that I enjoy reading your site and check it regularly for new posts. I’ve been reading here for over a year now and look forward to each post.
Although I consider myself fairly intelligent (who would admit otherwise?), I’m almost completely in the dark when it comes to economic issues. Thank you for writing in such a clear manner. It doesn’t quite feel like I’m drinking from a fire hose anymore.
I have more of a request rather than a question. What reading material would you recommend to compliment your own work for someone who is quite new to the world of economics? Do you have a reading list prepared for someone not ready for graduate level material?
Thank you.
I think that this comment from Martin Wolfe sums up the issue……….
“Not only did no one ask China, the foremost example, to add the huge sum of $2,400bn to its reserves, but many strongly asked it not to do so.”
I would add that if any nation is worried about the value of their USD holdings, then they should stop being long on the USD.
I have to wonder if the Japan comparison is once again appropriate. Despite their high debt the seem unwilling to offload their USD holdings. Is this the future for China as well?
I am very grateful for your terrific work and your exhaustive analysis. So I hesitate to ask for more.
But I wonder whether a back of a napkin sketch of the magnitudes required to move this Titantic would actually show that QE2 is enough. What if it just doesn’t change things that much?
thank you for another lucid explanation of what is happening in/with china.
do you think QE2 is an intentional shot by the FED, primarily aimed at yuan manipulation?
Let us remember the absurdity that a major world power is accumulating the currency of another country on a massive scale. A super-power like China has no need for a currency reserve, it is beyond all logic. Therefore, also currency intervention is beyond all logic.
In previous trade wars, there were no multinationals. It is hard to image how a trade war will break out under globalization.
Believe it or not, both infrastructure and the service industries are woefully lacking in China, except in some areas of first tier cities. Urbanization, accelerated development of service industries, especially education and health care, and farther build-up and improvement in infrastructures will guarantee high growth rate in China for many years to come.
Note in China, the unemployment rate among college graduates underscores the extend of under development in service industry more than anything else. In fact, if the inadequacy in health care professions is sufficiently addressed, health care professions alone will absorb ALL the unemployed college graduates each year in China. People should realize that China is neither Soviet Union nor Japan.
Love the Chinese statement about accepting their refugees if we don’t allow them to continue extracting our wealth. So are they saying that they’ll give our jobless blokes asylum in Nanjing if we allow their present policies to persist in impoverishing us?
Is Mr. Li prepared to accept the immigration of unemployed residents of the PIIGS and US resulting from, in part, Chinese policy? The logic is completely parallel. Unfortunately, not too many Spaniards or Americans probably want to work for a Chinese wage and forced expatriation won’t stand up to Western human rights standards. This presumeably is his fallback position.
As for Yao’s article, one can only hope this is merely a part of the Chinese bluff.
I was incredulous when I read it as I found it incompatible with what I have viewed as an increasing awareness by China’s leaders that they need to reorder their economy. If not, I believe you are correct in sensing a VERY bad outcome.
If I could impose a wish upon you Prof. Pettis, it would be to unravel the next strata. For example, if investment needs to be pared back, does growth really need to decline? If a microeconomic shift occurs whereby the ‘private’ sector is favored rather than SOEs or LGFVs in terms of loans, could not the more efficient allocation of capital actually spur growth? There have to be ways out of this that national income accounting cannot explain because it operates at too ‘macro’ a level.
Michael
I still have doubt on the overall impact of QEII. If the too low interest rate in China is the problem of capital misallocation and over-investment, the same ultra low interest rate in US seems not to bring back investment. US is in a period of restructuring ( China is still continuing its pre-crisis model) . And US businesses have difficulties to make long term investment decision due to macroeconomic and policy uncertainty.
In order to foster internal demand China should develop the information technology systems to modify the central banking system so that the central bank deals directly with the public. In this arrangement each adult citizen could have an account with the central bank for the purpose of conducting monetary policy. New demand would be created by expanding the money supply evenly into citizens accounts in adequate increments and new funds would not be debt just money transfers.
This would foster higher demand and people will be less likely to default on existing debts. At the same time the nation could appreciate its exchange rate and wane its dependance on foreign demand.
Michael,
I have a question on the relationship of currency revaluation and inflation. Say there were just two countries and we somehow knew empirically that country A’s currency was overvalued by 20% to that of country B’s.
If country B’s currency rose 10% over a five year period and over that period its price level rose 10% more than country A’s, would that be equivalent to a 20% rise in value?
Also, there was a paper published in May on VoxEU that tries to explain why some deleveraging economies seem to recover fine even as the deleveraging continues. This is the gist of their conclusion:
“If the private sector is de-leveraging, then a slowdown in the pace of de-leveraging is sufficient to boost domestic demand growth. A credit-led rebound in domestic demand can occur even while credit growth is negative ”
http://www.voxeu.org/index.php?q=node/5038
But if an economy can gain an apparent boost from a slowdown in the pace of de-leveraging, it would stand to reason that a country with very high loan growth could suffer a negative impact if the rate of loan growth were decelerating. Obviously I’m referring to China here, where the Y7.5T in new loans this year would dwarf all previous years, except for last year.
Is it just the magnitude of new lending that matters, or does the rate of change matter as well?
Thanks!
Michael:
As a side comment, I don’t think perverse investment decision making in china is due to low debt rates. Actually, by world standards, nominal Chinese borrowing rates are not that low. In my mind, it is the cost of equity that is low. My associates and I joked when discussing WACC, that the cost of equity in China was cheaper than the cost of debt! Cost of equity and Chinese lenders tolerance for highly levered borrowers create the problem. As long as the investment is projected to pay back the debt incurred, SOEs don’t seem to be too worried about sweating the rest.
In the Chinese approach to business, increased production volume accomplishes 2 benefits: cost efficiency and market power. Thus, adding more machines will make a company more efficient (cost competitive) and, through volume, garner more market share. Therefore, the company will have marekt power and at sometime in somebody’s lifetime, be able to reap the benefits of market power through a higher price for a decent ROE. Western claims of dumping or predatory pricing are another way of looking at this.
Economist has a very good discussion:
http://www.economist.com/economics/by-invitation
There is a good point by Beatrice Weder,Harold James, that we should analyze the underlining causes of the imbalance. Deficit and surplus is a normal issue between trading partners. Wether deficit is sustainable is not dependent on its size but rather on the structure.
Deficit countries have in turn capital account surplus, which means inward capital flow. If those capital is for investment purpose and means production for the future, deficit is sustainable. Otherwise if capital is to finance consumption, deficit is not sustainable.
Improving the US investment ratio should be the policy focus. Back to my last post, a weaker dollar could improve the business investment in US? Maybe, I am not sure.
A couple quick thoughts on Chinese rebalancing, borrowing some from other economic disciplines that rely more on expectations.
China has already publicly declared that it foresees a revaluation of the yuan of 3-5 percent annually as a reasonable rate of appreciation. If the currency is currently 20-30 percent undervalued (assuming this does the accounting based on trade deficits rather than the nominal exchange rate), the combination of persistently high (and although underreported hopefully still fundamentally stable) inflation coupled with a steady rise in the value of the yuan seems to suggest that real exchange rates would be “corrected” within 3-4 years. But the Chinese Central Bank has also indicated the desire to continue hiking rates over the next couple of years.
Making the reasonable assumption that Chinese firms will recognize and attempt to account for these additional costs, don’t we have the potential for a reasonable and healthy (if somewhat painful) adjustment process over the medium term? If businesses expect factor prices to tighten and product costs to rise as a consequence, can’t they begin preparing now for a potentially severe path of adjustment? It seems to me like this might be a bright spot in the otherwise bleak medium term outlook.
Also, in terms of banking system solvency, it seems reasonable to me that the Chinese government would want to do something akin to continuing to raise reserve requirements while also hiking both the deposit and lending rates. This would soak up liquidity, allow banks to continue to accrue a large(r) capital cushion, and essentially force them to prepare for the inevitable losses on NPLs that must result from any reform to the interest rate regime.
I don’t have the capacity to crunch the numbers on the ability of Chinese firms to weather any of these adjustments, but it seems to me like through setting a clear commitment to a certain path of economic reform, China can actually defray some of the damage we would expect to see from any rapid changes. The danger to this method is of course that trading partners loose their patience and force China to take drastic action, derailing expectations and causing massive economic losses. But, if allowed to run its course, such a plan seems to present a clear means of correcting global imbalances and beginning to address some of the distortions domestically.
Re ‘a leading Chinese credit ratings agency’: Is it not Dagong (you have ‘Dadong’)? In any case I look forward to their analysis of the Finnish industrial giant Bonk Business Inc.
What I don’t understand is: how rapidly are wages and income increasing in China? If the Chinese enjoyed a greater fruit of their labor, wouldn’t that increase their domestic consumption and (hopefully) their purchase of foreign imports to China as well? It seems as though the state is raking too much off the top. Don’t our global imbalances derive at root from global wage disparities?
In the case of Japan, it seemed as though they got drunk off their commercial success, leading at some point to a real estate hysteria whereby they convinced themselves that the real estate in Tokyo was equal in value to all the rest of the world’s real estate put together! Needless to say, loans made on those kinds of bloated valuations are going to lead underwater, and they have now spent the last 15 years quietly recovering from insolvency rather than enduring the embarrassment of writing losses down. Such are the wages of self-deception. [But I wonder if what is happening in China is at all comparable.]
And speaking of self-deception, that brings us to the U.S.A. For how much longer can it be said: what’s good for America, is good for the world? Surely, Americans face their own long hard slog of recovering from bloated over-estimations of value. But. Can America rebuild her capacity for advanced manufacturing? Can America educate her younger generation to excel in cultural competition? Can America overcome her addiction to military spending? These aren’t foregone conclusions, given the current state of America’s politics.
Two points about point of view:
1. We all tend to see China’s economic policies as inflexible, and therefore deterministic: “if this happens, then that MUST happen”. But US policies are far more rigid than Chinese, for political reasons. The Chinese government can, will, and does change policies quite fluidly for a large country. Our 30 years of doom-prediction and their 30 years of continued success are proof of this.
2. We tend to see China through a telescope of our own design, in which we loom very large. OUR markets, OUR access, etc. But China has been diversifying both its input sources and its markets for years. A drop in trade with the US certainly would cause problems for China, but as a percentage of their growth mix, we have been falling steadily (by design, one suspects) for years, and that trend will continue next year. Domestic markets are China’s OVERWHELMING source of prosperity, and they are growing quite nicely.
The implication is that China and the U.S. have reached a psychological impasse which politically neither can back down from. The Lex Talionis phase [began nearly one year ago] will only escalate further.
Michael, do you think that Premiere Wen Jiabao and President Obama can reach an understanding that will fend off further escalation? Or are we on the path of woe?…,
“If country B’s currency rose 10% over a five year period and over that period its price level rose 10% more than country A’s, would that be equivalent to a 20% rise in value?”
No one addresses this and it confuses me. China by pegging simply ‘exchanged’ an exchange rate change with inflation. The currency value is still floating and I have no idea why it would be expected for the RMB to appreciate.
I think no one asks US to spend more than a thrillion on 2 wars, 800b annual military budgets, have a thousand military bases around the globe, 12 aircraft carrier fleets,…and forces resultant surpluses from such expenditures on ROW and then turns around to blame others for unfair trade. One defence official testified in Congress earlier this year that 2/3 of war budgets go to foreign security contractors. Wake up USA and please stop the deceits. These type of trade surplus/deficit problems have unlimited bounds and could only be fixed at the source. If US is serious about imbalances, it could fix these military and war expenditures as soon as it wants the imbalances to go away rather than indulge in incessant rants and harassments against surplus countries.
HuaQiao
I disagree with your predatory dumping theory. I haven’t seen any empirical evidence that company plays predatory pricing(hence price is below the production cost) can increase its price to recover the cost once achieving big market share. This strategy can not work as far as the entry barrier is low.
I will argue that one major benefit of a company of growing big is to enhance its political power in rent seeking practice. This is even more true in country like China where rule of law is missing. Government will privilege those big firms over ordinary people in cutting red tape which will reduce company’s operational cost. Big firms will get easier access to credit.
I think most audience here have very well understood the argument of Michael. For a balanced opinion, here is a good piece from Donald J. Boudreaux:
http://www.thefreemanonline.org/columns/thoughts-on-freedom/on-trade-and-currency-manipulation/#
RE: What an impasse.
Indeed. The reason for the impasse is not economics nor politics. Its about classic negotiation or in this case lack of it.
- US has an overconsumption problem. e.g. Apple will continue to purchase iphones from China while they cost $4 per. Walmart will continue etc etc
- China will resist pressure to alter currency values because wage inflation and social stresses threaten the existence of the country.
So .. why can’t the leaders, and the likes of Martin Wolf the oft quoted economic writer see that the opportunity must lie not in ignoring the realities of global labour disruption but in laying out a framework of international inter government payment of some type. Only they can design a soft(er) landing.
For example if the G20 or the Doha rounds looked at a negotiated sequencing of import /export taxes designed over a long period to recognise the inevitability of GDP per person alignment over time.
Any other solution will be classic tit for tat economic warfare.
Litz, thanks for the comment. You may be right. I can only relay what my Chinese associates say is the reason for adding capacity…first is efficiency and second is for market power. I think the first reason is dubious and the second reason is specious for the very issues that you highlight (barriers to entry).
But if you look at the huge leveraged position of SOEs and their march for more and more capacity in a world where there is already too much capacity, it begs a rational explanation. I do think you are right to say that the real reason is political power. Perhaps the two are the same in China…market power and political power.
But if it is not dumping, which by definition is a temporary situation, then it must be that the low cost of equity (from the state shareholder) and the tolerance by Chinese banks for leverage create a long term cost advantage for Chinese manufacturers (in addition to currency exchange).
I think there is a very simple solution to all this. The US can just increase average customs tariffs for everyone by 5 to 8%. That should do it.
This will promote readjustment. Also, protect US industry to create some jobs there. The dollar will gain a bit of strength.
Only US consumption might suffer a bit. Here too, I suspect “good consumption” read as consumption by rich would remain un-impacted- and “bad consumption” on useless “stuff” that Americans are prone to would get hit.
It would also very quickly achieve the FEDs inflation target.
Give me one good argument against this solution!
As Andy Xie indicated in one of his article, it is very plausible that renminbi is overvalued. Judging from the many investments and asset bubbles, and amount of renminbi pumped into the market not just because of trade surpluses, but from around an estimated thrillion of FDI, in flows from Chinese diaspora(a lot of this ends up in properties in Chinese cities). The main upward pressures on renminbi comes from hot money. Once the factors for these hot money in flow abates, there would be downward pressures on renminbi. Further, I could not understand that China manages only 2-5% margin for most of it’s manufactured products if the renminbi is greatly undervalued.
@bob_in_ma
I read that VoxEU article you refer to with great interest as well. The fact that the flow of debt is the important factor (and not the stock) can be aprehended in a straightforward way. Indeed, debt money is lent into existence and usually immediately spent (when given to industry or individuals). So demand is linearly impacted by new debt.
However de-leverage deals with the stock of debt. The stock of debt is an entry in book-keeping and an interest payment. Deleverage can happen on the books (with all the bad consequences to banks balance sheets) without affecting new emmission provided reserves and demand are adequate.
In other words, the impact in time of “adding debt” or “removing debt” are not the same. Adding debt impacts GDP at the time it is added, removing debt doesn’t. This is why you have over-all debt removal but increase in GDP through new debt that is less than what is taken off the books. I thought the article was a bit obscure in explaining this point.
Michael,
I am always puzzled at a simple level when people accuse others of mercantilism. Very simply put, why does china dump products? because it can, and it will do so as long as it serves it well. The flip side of this is that it does it with a “slave” labor force.
Chinese workers are slaves, Western workers are un-employed. Ironically, the west is pushing for a re-valuation of the yuan which would enrich the CN citizens.
However there is a fixed cost to building factories and training workers. And even if the price of manpower is the same, there is a cost to moving. In other words, the jobs that are gone are not likely to come back, since it would mean that chinese wages need to be above western ones for it to make sense to bring the jobs and factories back. And today, it is slave labor vs fat wages. Germany held onto its production and is reaping the benefits.
In a way, this all wouldn’t be a problem if the act of creative destruction had led to higher paying and more creative jobs in the western world. However maybe we are reached the limit of training and knowledge of the masses. A large swath of the population is only fit for these low level jobs that are gone.
All of this points to the fact that when growth slows bad things happen. However in this case the west is still consuming cheap goods from CN and we are far from seeing the soup lines of the 30′s depression. We may in fact be entering the post-scarcity world dreamt by the ideologues of communism. Irony is that it is slave labor, kept as such, that is making this dream reality.
And then there is a much darker, paranoid interpretation. That bond amassing is just the way to get the US under servitude. The US is not far from a debt trap with respect to china. And maybe it knows it. The basic problem there is that when growth is absent then bond structures create capital accumulation loops. Another way of stating that is that equity is in fact more fair in that it participates in both the upside and the downside. In that light, QE is simply an attack on the holdings of CN. Both directly on the bonds (call them) and their interest as well as the reserve holding by depreciation of the dollar. In that optic, QE2 and its brother are just targeted like a microwave weapon onto the iceberg in front of the titanic. Melt it away. At the end of the day, CN will have raised its population out of poverty. if there had been *real* growth then the west would have been happy and no imbalance would develop. But, absent growth of creative destruction, you are just left with the stealing of jobs.
marc fleury,
Yes, I see what you mean. I agree the article seemed to be making things more complicated than was necessary.
I guess one question is, when they say there was Y550B (or whatever) of new loans issued in September, what exactly do they mean? Do they mean the total stock rose that much? Because if that’s the case, you’d need to know how many old loans matured without needing to be replaced, or were written off, etc., to know what the new lending “pulse” was.
If they mean that’s how many loans were written that month, you would need to know how many were merely replacing maturing loans.
One question, outside small marginal benefits, even if measured in tens of billions of USD annually, how is the USD beneficial to the American people or the US economy.If, the US gains a benefit of let’s say 100 Billion USD from having the USD as the international reserve currency, remember, that sum is less than 1% of its GDP. If countries have a policy of devaluing their currency, certainly they devalue it by more than that percentage, China alone devalued its currency by 60% in one year, 1994, perhaps that kickstarted another 16 years of growth. Something to ponder.
The issue is that this system needs to work for all. Something, the conspiracy prone, might want to consider more carefully in their postulations which might be derived from watching and reading too much fiction, which is exhibited by much writing in the comment sections of newspaper articles generally, and globally, due to the limited time with which people review the issues, and their lessor abilities to truly analyze, extrapolate from a host of view points, across a range of themes, or simply to question the frames and memes that have been handed to them by media, often written by individuals, not specialized in the areas they comment on, or who simply, regurgitate popular themes carried elsewhere as if their own. The indisputable, as has been shown time and again, is more often not simply disputable, but short-sighted, incorrect, and detrimental to the goals that people believe they are espousing.
Even if all China’s reserves were in USD, and they are not, then, that would be approximately 16% of US GDP in Dollar Terms. So, if 2/3, are in USD debt, or assets to the purchaser, then than is about 10-11% of US GDP.
To those who talk of the US military, and no way supportive of many of the endeavors undertaken by it, but, consider the following:
Trade and Sea Lanes (Mallaca and Hormuz Straits): imagine piracy more broadly rather than the logistical support provided by the US Navy in Multi-Lateral cooperation with countries globally on this issue. Asia and Europe get 2/3 of their oil from the ME, to say nothing of trade in other commodities or manufactured goods (perhaps there should be a surcharge on trade provided to any who provides the service of protecting sea lanes, of course this could be opened up to competitive bidding, were there to be any takers, other than who provides it presently, I doubt it, although Hyundai would probably put in a bid, and international shipping companies could get affordable labor more cost effectively than is had at present, but for the quality, capabilities and training of those who provide it at present)
Anyway, a bit tongue in cheek, but really, something to consider…..
So this is more complex than it is considered to be, and again, once and for all, just so we get it correct, the USD as the International Reserve Currency does not benefit the US PEOPLE or the US ECONOMY, but is highly useful for other structures, in addition to other things, for Global Trade and, quite, possibly, necessary for Global Development. The level of understanding around these issues need get considerably more mature, or occurrences anti-thetical to historical movements, especially over the last century or so, could see a reversion to previous positioning, and perspectives.
So if you find yourself, the Freest of Free Traders, or supposed Economic Justice Seekers cum Environmentalists, or those who are found of reading shallow Alternative Histories (conspiracy theories as to the nature, and genesis of things) or those who lack the vision to see well beyond, and before, your lifetime in these matters, much more depth and breadth to the discussion need to start to enter your perspectives, as Economics is but one frame to view these issues through, although all frames, and people need be considered. It is nice, how well Michael outlines, some of these issues.
Anyway long term:
Resources (Water, Land, Metals, etc…)
People (Global Development, Progress in as many nations as is possible, concurrently)
Money (Its worth, value, uses, utility, necessity to any system, and uses toward progress)
Policies (the value of strong legal foundations for equitable broad-based growth, SMEs, need for Services and Ideas to comprise a greater percentage of Global GDP, forever, into the future, how lack of such inhibits growth within countries, of domestic industries and how the use of Infant Industry principles on a universal scale inhibits the creativity of domestic entrepreneurs to solve domestic problems in the attempt to create global champions)
Technology (how advances will alter the face of everything, even the nature of production, but a 100 years ago planes and autombiles, marginally before that trains, and not much further beyond that the Cotton Gin, so…..immutable economic laws are fungible, but the grander impacts upon the development of the global peoples need be primary in this discussion, while fostering an interest, some knowledge of responsibility toward, limiting the sizes of populations in some areas of the world….in is truly heart wrenching the manner in which some live in the world, the responsibility for addressing this is global and begins at the local level, as does all development, which points back to strengthening institutions where ideology fails to prevent alterations but for maintenance of the status quo, within nations globally)
To the guy who mentioned commodities, most likely, were China shifting lower, which would be beneficial in many ways, then sell Peru and similar, anyway, small, isolated, low per capita GDP countries, despite some success in growth which doesn’t bleed through to the general populace in meaningful ways, couldn’t alter the structure of the global economy, if it has imbalanced it.
So, much work to do my friends, and much longer time frames need be considered, with material steps along the way.
There have been a lot of discussions about how China can rebalance its economy, thus helping the world balance global trades, but a lot fewer discussions on what the US can do reduce its trade and budget deficits. This is particularly true in the US media. To the US, it seems that what needs to be done is for other countries, particularly China, to allow their currencies to appreciate so that the US can export more. That’s it. But this won’t be easy. Let’s look at the other side of the equation, which is imnport. As most people seem to agree, the current problem resulted mainly from the US overconsumption over the past decades. Isn’t it fair to say it is time now for the US consumers to do more to pay back to those deficits? Why can’t the US government impose a VAT like Europe and Canada on purphases? Why can’t they increase taxes on gasoline to align the price with that in other countries? These additional taxes would almost certainly reduce consumption and thus imports, and the government will have additional revenue to balance the bugdet. I know this would delay recovery of the economy, but it is a painful process
the US must live with, much like what is going in the Europe (e.g. UK and France).
It is true that many manufacturers in China only manage 2-5% margin,but I do not think it is because RMB is not unvalued.
I note that China has taken a completely different industralisation strategy from Japan and Korea,which took great efforts to develop their own domestic brands in international market,hence the emergence of Sony,Panasonic,Toyota,Hyundai,Samsung,etc
On the other hand,countries like Singapore took the easy way out,work for MNCs and earn wages fr MNCs,or import substitution.
Taiwan Hong Hai is a typical example,grew very fast but only 1-2% return.
I got a clue for you. If our dollar goes down and china’s out put goes down as estimated the good owl USA won’t have a pot to piss in? Because we don’t make anything to sell? we won’t have any money to buy things with or anything to buy? Be carefull what you wish for? Before you start trying to steal another countries wealth you better make sure you have the clout? DO WE? NO!
If USA does not make anything to sell,I wonder what actually compose of USA’s manufacturing output in the statistics?
Thank you.
http://www.cato-at-liberty.org/the-rumors-of-manufacturings-death-have-been-greatly-exaggerated/ -
Daniel J. Ikenson has an interesting reoport on USA manufacturing industry.
http://www.cato.org/pubs/tbp/tbp-029.pdf
Larry 2010
VAT, taxes on energy, increased efficiency in the fleet, these are all things, even Healthcare reform, where the US can gain efificiencies, and movements that are decidedly beenficial to the US economy. Increasing efficiencies and productivity, returns, and similar, coupled these to movements in technology, although this does create further issues, and one can see why predictions relative to the US economy, even concerns over debt, are misleading. Although as relates to debt, and lessening amounts of debt, relative to GDP, and what this, the lessening amounts, portends for global growth is a concern. Most notably for those who have relied on it for development, increases in their own money supply and savings, and for maintanence of stability raltive to the expectations of large swathes of workers.
Really why more maturity and flexibility, need enter into this occasion, especially where increases in GDP per capita, in small populous, commodity producers, due to rises in commodity prices, as domestic manufacturing industries universally are battered by structural mechanism elsewhere, really trends the global development trajectory lower, and couldn’t replace the demand and debt engines that have fueled global growth. So things will alter slowly, if a stern face need be maintained to support the memes promulgated within associated societies. A new model isn’t in the offing, that is clear. Although as is desired, the return of historically important nations to the world stage, and the associated responsibilities that entails for global growth, need be supported, applauded and encouraged.
It is interesting, if one harkens back to 2000, with projected surpluses, there was great worry that US Fed debt would trend under 4 trillion, risking bond markets, and shelter for capital to move into when things didn’t fare well. Then the ensuing occurrences, a massive uptake in global growth, serious capital accumulation in some areas, great growth in commodity sales, if domestic manufacturing industries haven’t fared so well, and before this, during this, and even unto now, the same dialogues. So look at GDP, not in PPP, not on any terms but simply nominal GDP in USD terms globally, in the major economies discussed, and accross those that have performed well. People talk of a shift in economic power, as if a new occurrence, but it is a trend that goes back to 1950′s, only increasing in number of beneficiaries along the way. What we find now, is that the system has evolved into containing so many new aspirants. Not that a model, a desire, or any participant, or group of participants are changing the way things can be done. Simply building on what has come before. If minds globally were not so susceptible, to frames and belief constructs that were carefully constructed during a previous era of conflict, where even synergies existed during that period, which belied certain levels of cooperation between opposing parties which may still go unrealized today. Yet among any, who has positioned oneself within one of the camps, who find some definition of they are as human beings in one of the frames, who have spent life’s reading materials and viewpoints which support those frames, who have spent lives among people who share similar frames, the level of discourse which spews from their mouths does nothing but seek extension of those frames.
If aspirants are to realize their desires to have an advanced material existence, it must occur under far more resource efficient modalities, where their is a greater preponderance upon individual rights to reach their human potentials, as nations work to mitigate the serious inequalities that exist across the system (over a very long-term) while understanding that there exist mutual goals to be had in development. Further, as people and nations search to make sense of what is occurring, due to limited time, even developed ability, people are susceptible to be led astray by commonly misconceived descriptions of what is occurring. That unless these things are addressed, they will lead to insurmountable objectives to national, regional, and global stability. That much more needs to be done toward facilitating entrepreneurship at the grassroots level, and that such is a requirement toward fulfilling the psycho-spiritual needs of the inhabitants of a shrinking earth, to make them more able to reach some level of fulfilling potential against the backdrop of a broader world, either unable to make sense themselves, or desirous to confuse for parochial gains. That these needs will be fulfilled somehow, and even where some naivete may rule the day at present, it won’t in the future. Enabling an environment for decidedly stupid, short-sighted, and often counter-productive belief sets often contradictory to espoused goals. That while this is occurring, it won’t for long, and where someone holds a set of unswerving perspectives as to what is true and right, they limit themselves, as they hope to delimit the range of discussable options. Where greater flexibility to lives and lifestyles has been the by-product of an advancing state of technology since the state of nature, more flexibility has been required in making use of such, and even more will be required into the future. As such, lingering memes from previous eras need be seriously rethought, as does notions of beneficiaries and motivations or the world may find itself seriously lacking in both for what can be the betterment of our world.
Prof. Pettis,
Here’s a link to a video I came across, I thought you may enjoy.
Michael,
You said that if the Rmb appreciated, Chinese policy officials could offset the loss in international competitiveness with domestic credit expansion. Is the obverse also true? If China tightens domestically, can they devalue the Rmb to maintain their exports?
Chinese officials are worried about inflation. They also have serious asset bubbles they are trying to unwind. Maybe they think they can win a currency war against the U.S. There is also plenty of junk to buy for maximum devaluation: California, Irish, Greek, and Spanish bonds all come to mind.
Do you think they can win a currency war?
Do you think a currency war would become a trade war? How quickly? With what consequences?
Michael:
Dis you see this by former Trade negotiator, Clyde Prestowicz:
“A much better approach [for Obama] is to go to the Chinese and say, “I understand, Prime Minister Wen, President Hu. We understand that you guys are doing what you think is best for the Chinese economy. I know you’ve got to create jobs and clean up the environment, and I know you’re doing what you think is best for the Chinese economy and God bless you, I hope you succeed. If I can help you in some reasonable way, I will. But I want you to understand that I need to create jobs, too. In fact, if you just look at the election results of [November 2], you will understand I really need to create jobs or I might not be here in a couple of years. I need to take the steps necessary to create jobs in the U.S. I’m always willing to talk if there are issues, or you have concerns about what we’re doing. I’m always willing to negotiate. But I am going to take the measures necessary to revitalize the U.S. economy.”
So this is really what is in the offing…some options to counter….
China’s export-led growth model is a variant of the Japanese model…..The model is to suppress domestic consumption to focus on achieving high savings, channeling the savings into export industries, achieving economies of scale by focusing on exports and even subsidizing exports…holding huge dollar reserves.
On the one hand, you could say, “Wow, that’s a real threat. If they sold their dollars, the U.S. would be sunk.” The problem is that they don’t have any real place to sell their dollars. The U.S. actually has a lot of good options.
President Obama himself, without going to Congress or the G20 [group of 20 major developed and developing nations], can engineer a revaluation of the currency…… We could impose a tax on foreign [purchases] of U.S. Treasuries. That would effectively change the currency rates.
Brazil, Thailand, Switzerland and a couple of other countries are already imposing limited capital controls. We could make similar moves….. The U.S. President could take action against imports being subsidized by currency manipulation to countervail those subsidies. That again would rebalance the currency.
A really important issue that is rarely discussed is investment incentives. A country like Singapore, Ireland, France or China will approach a global company and say, “Why don’t you move your production to my country? If you do, I’ll give you free land and infrastructure and you’ll only pay half price for utilities. And by the way, you won’t pay any taxes for 20 years. If you need a capital grant of US$1 billion or US$2 billion, we could arrange that.”……At the federal level, we don’t match the investment incentives. As a result, if you look at the way the global economy works, virtually all incentives — whether taxes, investment incentives or currency valuations — encourage the movement of production of tradable goods and services out of the U.S.
Knowledge@Wharton: Why doesn’t the U.S. match the incentives?
Prestowitz: The argument has been made by our leading economists and has been accepted by our policy makers that that’s picking winners and losers and anti-free trade, free market, Adam Smith and David Ricardo. In fact, many of our economists argue that the incentives offered abroad are just gifts to American consumers and we should be happy about that.
…..The result of [the Republican gains in Congress] will not really be better business, even though the Tea Party and the Republicans are presented as the party of business. In fact, they’re not. Or, put a different way, they hate regulation. Of course, they want tax cuts. So that is helpful in some ways to business. But what the mainstream of American business really needs is a global currency regime that doesn’t put American exports at a disadvantage.
So anyway, these are some of the reasons, we really have to get these things right. Or they will be righted one way or another, sooner or later, and while short term gains might seem beneficial, considering longer term requirements, demographic, societal, and economic issues on the greater path to development, there is necessarily, some levels of cooperation to be had, or certainly there will be a plethora of development opportunities to consider.
Consider what has happened over the last thirty years, rather 60 or 70, and weigh in whether or not these things should continue, whether that path, even if it has led to a pile of trinkets and similar in some corners, if it hasn’t been beneficial. What is required is that beneficiaries more fully ensure that benefits reach all strata in society. To that end, really, greater emphasis on the value of ideas, and institutional strength need be considered. There are tenors, deeply ingrained, that will see, and eventuate in a reversion if such things are not considered and well understood, this surely will not be beneficial for the forward development of man. So, more need be more honest, in exactly what it is their having at, where even the thinly veiled misunderstandings of a Tea Party movement belie, movements more broadly, that could easily swing in directions of less utility to global development. Where zero-sum games, and gains are made the criteria with which to review trade interactions, a zero-sum gain may eventually eventuate. Remember, that despite how some may view the benefits that accrue from some perceived position, and how this is trumpeted or decried globally, there are deeper undercurrents which could easily see a reversion to historical themes which might actually displace the very system which so many have benefited from it seems that some have benefited disproportionately. I can guarantee that many, who are perceived to have benfited would argue differently, and that there are many more choices than are currnetly even considered feasible. In fact, not simply feasible, but likely, which is lost on many observers, as some observers may believe they have benefited, and others truly believe that it has been a benefit, where more universally it is thought that options don’t exist, where of course they do, coupled to the right mix of incentives, as has been shown. So they question is really who has been laying the golden egg, and I suggest we might want to more fully consider that, and that considerations might be significantly different than are supposed as has been shown these last several decades. Of course this could change, what the impacts of such a movement are, are not terribly difficult to predict. To refer, to a popular colloquialism, ” Do you really want to go there?”
Michael:
A question, if QE2 is an attempt to devalue the dollar, and if the Global Economy grew by leaps and bounds during the 2000-2008 period when treasuries were purchased by those abroad exploded as nations intervened in FX markets, rather than traded more broadly and recycled those dollars in more productive ways, and if the QE2 is the purchase of Treasuries, which is the same as the acquisition of reserves by those Nations who purchased treasuries, and if this purchase of treasuries, QE2, is a reversion to Command, or Planned economy, then what is the gathering of treasuries, the purchase of such, the intervention into currency markets, the provision of incentives, the provision of rebates, the attempted creation of industries using infant industry theory on a mass scale, and is that not planned especially where all these things combine and lead to growth in money supply, lending, savings, asset creation and similar. Further, if current purchases are an attempt to devalue the USD, then what were the gathering of treasuries during the mass intervention and growth phase in the previous era?
Is it simply who is doing the purchasing, and really would that matter to the dynamics of the issue? And if the US is using this as a policy for current growth, what is the relation between QE and growth, and the nature it played in growth, is there a relationship to the owner of treasuries and growth?
Further, is this illustrative of the possibility or fact that the US didn’t NEED foreign financing, and that such really enabled growth more widely?
If the US could QE, in the present era, then why would they NEED foreign financing, or is this just systemic and support your hypothesis as to such things needing to balance….which supports mine that the USD, as a reserve currency, is neither good for the US economy nor people, but is good for international trade, and why these things need be seriously considered, or there will be serious belt-tightening globally, despite the poorly inspired, developed and understood rhetoric from all sides on this issue.
I think what people fail to realize is that there are many benefits to be had under all occurrences, even those which, due to our mind-frames, perspectives, and built-in environmental and experiential belief sets are seen as detrimental. In fact, such instances, may portend more benefits than most people realize.
It’s interesting, but not hard to analyze, the double-speak of most on these issues.
Prof Pettis
At the risk of being labelled a ” jingoistic China supporter” (not that that wasn’t levelled previously), have to say I do agree that having hot money inflows into Asia, China in particular isn’t the smartest move, intended or otherwise as an effect of QE2. Both China and the US have valid arguments for their policies but the US is missing a point, whatever the comparisons with Japan and the Plaza Accord days, China is not the origin/source of American financial or economic problems, that theory belongs to the conspiracy theories that are bound to flourish in the near future.
Pushing China won’t cause the see saw to swing back up, not when the EU is on the farther side of the same end as the US and looking ever more likely to break that end of the see saw. If China, for reasons of its own, tips into a hard slowdown and “social chaos”(think unemployment, massive dissatisfaction and political grab for power), The load will fully shift to the end where everyone else is, with China in trouble, don’t expect the rest of Asia to be any better. That can only mean a world in misery with little or help getting out of the mess amy time soon.
Funny you should mention Brazil and Thailand, countries who have intervened whilst mouthing platitudes. Not sure if you see the Asian perspective of things, after all the talk about currency manipulation, the US pulls the gear labelled unilateral depreciation to the speed of 600b, to Asian eyes, the moral high horse has not just ground to a halt and thrown its rider off, the rider is eating dirt and proclaiming it’s manna not manure.
Frankly, this is 2007/2008 redux, and am more amused than agitated
and frankly this drama beats all the reel drama produced these days, so let’s just sit back and watch who cracks first.
Thought this might be of interest, though it sounds like previous articles posted on Yves Smith’s site half a year ago. Makes you wonder if people took a sleeping pill and went to sleep over the issue. And now comes the awakening
http://www.nytimes.com/2010/11/16/business/global/16euro.html?pagewanted=2&_r=1&ref=world
Judy,
@ yr 60, indeed watching this from a safe distance is not too bad. And it is real as well. As to the outcome: I wonder whether the announcements about tightening budget constraints (in the PRC mainly by reducing new large credit approvals by SOE banks) will have much of an effect, apart from making it harder for borrowers without useful connections. It depends, as usual on how much real power-to-govern the Party?State structure has. Probably the Party macro interests (survival of the institution and its main beneficiaries will come to the forefront and it that respect the internal dynamics of the succession provide an interesting degree of complexity. For PRC afficionados, great watching with plot and subplot constantly changing until all is revealed and nothing solved.
However, apart from contributing for some loss of face of the US administration, seconded only by the hosts and Australia, China’s policy appears to ne not very responsive to the QE2 (and QE2 is not likely to have much of an effect too). The main game is going to be whether the new US political configuration will be able to impose more austerity (despite high unemployment, but cannot be cured by the policy instruments available to the present or the former configuration. China (as a symbol, not necessarily as the sole enemy) provides a useful distraction, playing on the traditional mix of xenophobia, ignorance and perceived unjustice from abroad that tend to work well everywhere, but is unpopular with the business elite. Which makes it difficult to use. Taking into account that the US system does not directly rely on vote-buying, but on rather complex channels for the business elite to wield electoral influence, only a government that gambles for survival would use it. And that appears to be the position the Obama gvt is in. But it would be very hard to turn rhetoric into action (despite the Tea Party’s more or less similar noise) because the Republican controlled House will not cooperate in action that will have an effect on the ability of US firms to source manufactures overseas. Any laws passed by them would have serious flaws (despite a patriotic rhetoric). Only the currency is safe ground and that is an internationally complex issue, where the US appears to have no teeth (and the main beneficiaries would be competitors of China like Korea..).
I expect more tangible activity on the part of Europe if/when the Euro weakness resulting from speculation in EUR gvt paper passes.
That brings me to this Smith article (yr 61). He assists in sowing the fear that drives a particular type of speculative opportunity. It is a great way of making money (it reminds me of the conversion trades of the 1990s where you knew that the EU (or Canada that had a similar opportunity around elections) would simply survive and that imbalances would disappear (i.e. the opposite of a tipping point situation like the Baht and the Swedish Crown, with attractive contagion plays attached). Different opportunities demanding different styles, but both inherently profitable because of the free options provided by politicians. Unfortunately, the EU is unlike the US an area with severe microeconomic inefficiencies (labor immobility for once, a redidue of class based politics, each country with its own laws and business elites, etc) so the speculators have more to work with and the citizens more to endure…
Re previous comment: “conversion trades” should of course be “convergence trades”.
Judy:
Really who is the USD weak against. It has moved against the Swissy, the Canadian, The Euro, the AUD, the NZD, marginally against the SGD, somewhat against the Eastern European currencies (against the EU, perhaps, in this case). Further since the great weakening of the SEA currencies in 96-97-98, they have gained some ground, not even back to their previous places, in many cases not even back to historical trends. The real issue is if those currencies move without the Yuan moving, it just further makes those countries less competitive and likely drives Supply Chains further up into clusters more closely to assemblers. Hence why they feel the pinch, as the longer the Yuan waits, the more pressure those currencies feel, and the artificial constructs that exist siphoning off output, then demand and similar within those economies. But as to QE2, and if 600 is a big number, then what is the previous years of reserve acquisition. How does the name of the purchaser, alter the impact that extend from the purchases?
Although arguably the world economy did nearly double during that period. Again, why the USD is possibly good, even necessary for world trade, but perhaps, not, as currently designed, good for the US people or economy.
I appreciate the toils of the economix blogger, having to write the same article over and over and over again while trying each time to make it ‘new’. Kind of like working in Adam Smith’s pin factory.
Having said this and having read the article (again) it is interesting to note the absence of any discussion of American/OECD mis-appreciation of our malaise as a liquidity rather than a solvency problem. The outcome of this has been excess liquidity: ZIRPs, carry trades and hot money flows then bubbles that make problems increasingly intractable. China and the US mirror each other’s domestic funding situations (with China’s being similar to the US’s in the 1920′s — hard currency surplus, trade surplus and excess manufacturing capacity) while both carry massive, bubble- related credit excesses on their balance sheets.
This contradiction will not be solved by minuscule adjustments to F/X or even by tariffs. Both must decide to grow up and restructure. Both need to escape the consumption trap and waste- based economy which is at the bottom of system- wide insolvency. China needs to allow more foreign investment in areas outside currency speculation, it needs to be more like safety- net Europe. Europe needs to be more like the US (wants to appear to be) with more free markets and more open employment marketplaces. The US needs to become more thrifty like China (which seems to be what is taking place, already). These are all structural reforms, not easy ‘policy’ adjustments that have no staying power.
China needs a safety net that is less costly than Europe’s. Europe needs the entrepreneurs that America produced before finance poisoned the well. America needs to get rid of the Ponzi schemes that pass for ‘investment’ and savings — as are the case in both America and China right now. Both countries need a dose of ‘rule of law’. All three areas need to start conserving energy.
The US can start the ball rolling by adding a (stiff) gasoline tax and pushing up short term rates. Doing ends the dollar carry, wipes out the F/X speculators and kills the Saudi Arabia tax on the US economy. Taxing energy also cuts US consumption and provides incentives for savings/capital formation. This makes labor cheaper relative to more expensive machine production and ‘output’ which is pricing itself into bankruptcy due to increasing relative energy input costs.
“”"Yao Yang even adds that in the argument between the two “it is conveniently forgotten that China is also contributing to the world, by providing cheap goods and credit.””"
He’s half right. China bailed out US manufacturers by taking all their unwanted high- wage jobs allowing the shell that remained to profit. Don’t agree? Look @ municipalities and state governments choking on high- wage, high- benefit workers which cannot be shuffled off to Guangzhou: firefighters, teachers and librarians. The rising costs — related to the rising demand for the ‘moderne’ and all that goes with this terrible and self- destructive fad — are going to win out in the end.
If this isn’t inducement enough to reform it is hard to see what else can accomplish the job.
good point on dadong. downgrading US credit seemed like a pretty reasonable move, in and of itself. but there was some language that i saw quoted in news coverage that got pretty close to using the US debt as a means of condemning market economics as a model. that part seemed overtly political to me. also, excellent points on Yao Yang’s FT piece. i had the same reaction when i read it initially. i’ve seen the “chinese generosity” argument popping up all over the place since this whole nonsense got into full swing last year, and it’s always driven me crazy. thanks for taking the time write this blog, by the way. more and more, i find that it’s one of the few places to find honest and educated analysis of the chinese economy.
QE2 feels like smoke and mirrors to me. I doubt there will be little impact felt against China. America’s largest corporations have gutted US factories for the terrific access to mercantilism in China. What is their game plan in the midst of overcapacity and swelling trade deficits? Answer: QE2 (keep the game alive on life support). All the talk about balancing the US trade deficit by increasing domestic capacity in China is rhetoric bullshit, let’s face it, it’s too little too late. I doubt we will see any massive privatization efforts by China’s state assets any more than Microsoft and Exxon is willing to split up its market share. Don’t look to the policy makers to fix things, it will be an unpredictable grassroots driven change and I have no idea what the outcome will be 20+ years from now!
Thanks for the responses, csteven and huizer.
Did not quite understand the thrust of csteven’s comment but gathered it’s re the US$ (either that or my brain really is on long vacation and hence the lack of focus.) and the whole currency issue/spat. Not debating the accuations and counteraccusations or even the fact that the yuan is “not quite the value it’s supposed to be” (euphemistically put) and the effects of that on various countries. The fact remains that QE2 simply puts all the moral lectures the US and other countries have been delivering re devaluation and currency manipulation into the trashbin because the very least QE2 is going to be viewed as is the real life maneuver known as “can’t beat them, join them”.
Huizer
Agree on the implied stalemate situation in your comment. Just a little mroe interesting than staring at a chess board because you have all that rhetoric and stage management (the tea party incidentally reminds me of some characters in Carroll’s Alice and I do believe that they might not have much impact politically other than assuaging the populist anger) which just makes this a lot more raucous than the standard telly fare these days
China serves as a convenient enemy figure the way Russia was a great cold war enemy persona, that has been part of my theory that American politics (at least post WW2) have been built round a kind of Star Wars mentality but that’s another long story which I won’t bore you with. Frankly, just meant that whilst China does pose as a source of some trouble, it should not be seen as the only source of problems and that people are fooling themselves if they think that solve the China problem and everything will be hunky dory which is as much a myth as Camelot was.
The furore over the impending need for rescue (Ireland and Portugal) is not likely to end any time soon and the role of speculators is pretty evident. Moral misgivings aside, it’s a one way bet that’s pretty much reinforcing, the further the speculators press, the bigger the spreads, the more unease and fear it creates, the more the fear takes hold, the more the markets will reflect that and really, it becomes a self fulfilling vicious cycle. What is interesting is when contagion takes hold and how fast it spreads from Ireland to Portugal (and don’t hold your breath) Spain and beyond. Nasty business and my guess is what Asia saw in the Asian financial crisis will be nothing compared to what we may see real soon.
Of course, the real disaster is when China reaches tipping point/ lands harder than expected, that would be when we all truly live in interesting times and when some anti-China factions understand what it is to beware what you wish for (incidentally both are allegedly part of an ancient Chinese proverb/curse.)
Judy (Yoda?) Great minds think alike. I guess what you meant to show was that as an investor one should not always take the political situation as prepared for public consumption, as the basis for your own assessment. Not that your friendly securities analyst is much better though. The “chessboard” as seen by the relevant players is invisible for most of us and the players themselves have only limited information. On top of that, they are not infallible and handicapped by “values” of their own choosing, or ones that they and their advisors have integrated into their public persona. In a very diverse society like the US, personal values may be shaped by PR advisors, sponsors and party people, but when the values have too little electoral appeal, political organisers and funders can always find more useful ones and attache them to fresh faces, and that is what makes democracy workable and different from anarchy.
My problem with China is that it has a legacy of rather uniform values-driven exposure of individuals and party to the public. So far, the public had little more of a divergent repertoire of responses to unpleasant policy than the Yellow Turban approach which, despite myths created by Mao ZD, is not really a constructive approach to changing government for the better, more a welcome sort of amorphous venting of frustration (and in the great Chinese tradition, venting took place with a lot of violence and occasionally useful dynastic change). Any leadership operating in Zhonghua has probably some capacity for fearing Yellow Turbans, but modern forms of dissatisfaction management using media effectively could work wonders. However, it would be much better to shift to a US-style politics, where lots of values and preferences are given airtime, but the result is a very undifferentiated type of policymaking, at least as it relates to the important areas of defense, economic management and foreign policy. The problem is not what to do, but how reposition the party without losing control. And loss of control in China would be in no one’s interest. Loss of control in the US would simply mean a new government, maybe no better than the one just thrown out. In China it would mean anarchy.
As you see from the US example , it is possible to have continuity (the worthy Asian ideal of policymaking) without sacrificing the myth of pluralist democracy that keeps people quiet. I hope some day some bright spark will understand that it is important for China to have a politics with a variety of narratives, some unpredictability, a little more of the US reality show element and no “big hooks” for prospective Yellow Turbans. But it takes a bit of courage and maybe disowning a few less telegenic friends. And, proper government. Not this opaque amalgam of Party and State. Buy the barons out and let the government govern…Take a leaf of LKY’s book and learn to act like JFK. And teach your people relativity.
That is what this contest is all about, not a lot. Lots of PRC worthies love being in the US and lots of US politicians would not mind the attractions of senior positions in the CPC. It is just that it is too easy for internal competitors in both countries to appeal to some domestic audience that may be about to lose lose something if China and the US work together (rather than follow complementary policies).
Judy:
Really quite simple, Asia model is entirely export dependent, 45% at last count, with rises in intra Asian trade, mostly in intermediate goods. This, although making great strides in some measures of human quality indexes, needs to more fully bleed through to populaces there, and is not sustainable, and lessens potential for growth elsewhere. The currency issues, are that the USD is not weak against many currencies, neither historically or at present, but there are pressures on certain currencies, due to a limited range of options for capital to flow to. Many of these trade nations, the other Asian nations, would love for their currencies to rise, and they are unable to do this, because one, for the Yuans weakness (a 60% devaluation in 1994) and because of the other structural mechanisms. Were these nations to rise prior to the Yuan, these nations would only lesson their competitiveness relative to the China in the industries where they might maintain an advantage, for one reason or another at present. With such structural mechanisms as exist in China, movements to purchase bonds on a scale as currently envisioned, while shifting from dollar assets, will place similar constraints on affected economies.
This from a person who believes that the USD as a reserve currency is neither good for the American people, nor the American economy.
So, people can argue this or that, at the end of the day, such structures, as exist in China, and as exist in others impacted who have been forced to acquire more reserves than are necessary for a healthy amount of trade cover, will force a rebalancing.
China can help reduce the problems greatly — by finding and funding, with debt and equity, new companies in America! Then the excess reserves of the US come back to the US, and only the mid- & long term future profits go to the Chinese owners.
When was the future date of that cool Chinese video? 2030? A few hundred billion invested every year might do the trick. How much of GM did the Chinese buy?
Huizer [obi wan kenobi? frankly, not enamoured of the star wars franchise and therefore think maybe michael pettis would prefer the yoda term!
]
have my reservations regarding the US system, let’s just see how the bloodbath between the GOP and the democrats turn out. Let’s just remember the earliest attempts at democracy turned out really ugly for its practitioners. there’s that ever thin line between rule of the majority and rule of the mob and it’s likely to be a mob manipulated by a minority with intentions that are less than noble.
Csteven
you do realise that the US has in effect, though maybe not in speech, capitulated to the idea of exporting its way out of the current crisis? and let’s just be frank, from a trade/export perspective, no one would want to lose their “competitive” advantage. There is imbalance and no doubt there will be people who suggest rebalancing it in different ways, but let’s just remember that that is nothing new, whilst the US was flourishing, there were already imbalances just in different directions (and one suspects that as long as it affect someone else, it was likely to be ok with the ‘superpower’ that be), what’s making these imbalances the focus of attention is not so much the economic effects they have but the effect on politics particularly populist politics .