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02/14/2008
China's Dollars
James Fallows has a piece in the January/February 2008 issue of
The Atlantic concerning America’s debt to China “The $1.4
Trillion Question.” Following are a few excerpts.
“Through the quarter-century in which China has been opening
to world trade, Chinese leaders have deliberately held down
living standards for their own people and propped them up in the
United States. This is the real meaning of the vast trade surplus –
$1.4 trillion and counting, going up by about $1 billion per day –
that the Chinese government has mostly parked in U.S. Treasury
notes. In effect, every person in the (rich) United States has over
the past 10 years or so borrowed about $4,000 from someone in
the (poor) People’s Republic of China. Like so many imbalances
in economics, this one can’t on indefinitely, and therefore won’t.
But the way it ends – suddenly versus gradually, for predictable
reasons versus during a panic – will make an enormous
difference to the U.S. and Chinese economies over the next few
years, to say nothing of bystanders in Europe and elsewhere.
---
Last November, Chinese Premier Wen Jiabao said, “We are
worried about how to preserve the value” of China’s dollar
holdings. Fallows has a good, simple explanation for the dollar
and pricing.
“When the dollar is strong, the following (good) things happen:
the price of food, fuel, imports, manufactured goods, and just
about everything else (vacations in Europe!) goes down. The
value of the stock market, real estate, and just about all other
American assets goes up. Interest rates go down – for mortgage
loans, credit-card debt, and commercial borrowing. Tax rates
can be lower, since foreign lenders hold down the cost of
financing the national debt. The only problem is that American-
made goods become more expensive for foreigners, so the
country’s exports are hurt.
“When the dollar is weak, the following (bad) things happen: the
price of food, fuel, imports, and so on (no more vacations in
Europe) goes up. The value of the stock market, real estate, and
just about all other American assets goes down. Interest rates are
higher. Tax rates can be higher, to cover the increased cost of
financing the national debt. The only benefit is that American-
made goods become cheaper for foreigners, which helps create
new jobs and can raise the value of export-oriented American
firms (winemakers in California, producers of medical devices in
New England).”
---
“So why is China shipping its money to America? An economist
would describe the oddity by saying that China has by far the
highest national savings in the world. This sounds admirable,
but when taken to an extreme – as in China – it indicates an
economy out of sync with the rest of the world, and one that is
deliberately keeping its own people’s living standards lower than
they could be. For comparison, India’s savings rate is about 25
percent, which in effect means that India’s people consume 75
percent of what they collectively produce. [Reminder from Econ
101: The savings rate is the net share of national output either
exported or saved and invested for consumption in the future.
Effectively, it’s what your own people produce but don’t use.]
For Korea and Japan, the savings rate is typically from the high
20s to the mid-30s. Recently, America’s has at times been below
zero, which means that it consumes, via imports, more than it
makes.
“China’s savings rate is a staggering 50 percent, which is
probably unprecedented in any country in peacetime. This
doesn’t mean that the average family is saving half of its
earnings – though the personal savings rate in China is also very
high. Much of China’s national income is ‘saved’ almost
invisibly and kept in the form of foreign assets. Until now, most
Chinese have willingly put up with this, because the economy
has been growing so fast that even a suppressed level of
consumption makes most people richer year by year.
“But saying that China has a high savings rate describes the
situation without explaining it. Why should the Communist
Party of China countenance a policy that takes so much wealth
from the world’s poor, in their own country, and gives it to the
United States? To add to the mystery, why should China be
content to put so many of its holdings into dollars, knowing that
the dollar is virtually guaranteed to keep losing value against the
RMB [remnimbi/yuan]? And how long can its people tolerate
being denied so much of their earnings, when they and their
country need so much?....
“At no point did an ordinary Chinese person decide to send so
much money to America. In fact, at no point was most of this
money at his or her disposal at all. These are in effect enforced
savings, which are the result of the two huge and fundamental
choices made by the central government.
“One is to dictate the RMB’s value relative to other currencies,
rather than allow it to be set by forces of supply and demand, as
are the values of the dollar, euro, pound, etc. The obvious reason
for doing this is to keep Chinese-made products cheap, so
Chinese factories will stay busy. This is what Americans have in
mind when they complain that the Chinese government is rigging
the world currency markets .
“The result, while very complicated, is to keep the buying power
earned through China’s exports out of the hands of Chinese
consumers as a whole. Individual Chinese people have certainly
gotten their hands on a lot of buying power, notably the
billionaire entrepreneurs who have attracted the world’s
attention. But when it comes to amassing international reserves,
what matters is that China as a whole spends so little of what it
earns, even as some Chinese people spend a lot.
“The other major decision is not to use more money to address
China’s needs directly – by building schools and agricultural
research labs, cleaning up toxic waste, what have you. Both
decisions stem from the central government’s vision of what is
necessary to keep China on its unprecedented path of growth.
The government doesn’t want to let the market set the value of
the RMB, because it thinks that would disrupt the constant
growth and the course it has carefully and expensively set for the
factory-export economy. In the short run, it worries that the
RMB’s value against the dollar and the euro would soar, pricing
some factories in ‘expensive’ places such as Shanghai out of
business. In the long run, it views an unstable currency as a
nuisance in itself, since currency fluctuation makes everything
about business with the outside world more complicated.
Companies have a harder time predicting overseas revenues,
negotiating contracts, luring foreign investors, or predicting the
costs of fuel, component parts, and other imported goods.
“And the government doesn’t want to increase domestic
spending dramatically, because it fears that improving average
living conditions could paradoxically intensify the rich-poor
tensions that are China’s major social problem. The country is
already covered with bulldozers, wrecking balls, and
construction cranes, all to keep the manufacturing machine
steaming ahead. Trying to build anything more at the moment –
sewage-treatment plants, for a start, which would mean a better
life for its own people, or smokestack scrubbers and related
‘clean’ technology, which would start to address the world
pollution for which China is increasingly held responsible –
would likely just drive prices up, intensifying inflation and thus
reducing the already minimal purchasing power of most workers.
Food prices have been rising so fast that they have led to riots .
“This is the bargain China has made – rather, the one its leaders
have imposed on its people. They’ll keep creating new factory
jobs, and thus reduce China’s own social tensions and create
opportunities for its rural poor. The Chinese will live better year
by year, though not as well as they could. And they’ll be
protected from the risk of potentially catastrophic hyperinflation,
which might undo what the nation’s decades of growth have
built. In exchange, the government will hold much of the
nation’s wealth in paper assets in the United States, thereby
preventing a run on the dollar, shoring up relations between
China and America, and sluicing enough cash back into
Americans’ hands to let the spending go on.
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On U.S. fears of a rich, strong China
“The U.S. and Chinese governments are always disagreeing –
about trade, foreign policy, the environment. Someday the
disagreement could be severe. Taiwan, Tibet, North Korea, Iran
– the possibilities are many, though Taiwan always heads the list.
Perhaps a crackdown within China. Perhaps another accident,
like the U.S. bombing of China’s embassy in Belgrade nine years
ago, which everyone in China still believes was intentional and
which no prudent American ever mentions here.
“Whatever the provocation, China would consider its levers and
weapons and find one stronger than all the rest – one no other
country in the world can wield. Without China’s billion dollars a
day, the United States could not keep its economy stable or spare
the dollar from collapse.
“Would the Chinese use that weapon? The reasonable answer is
no, because they would wound themselves grievously, too. Their
years of national savings are held in the same dollars that would
be ruined; in a panic, they’d get only a small share out before the
value fell. Besides, their factories depend on customers with
dollars to spend.
“But that ‘reassuring’ answer is actually frightening. Lawrence
Summers calls today’s arrangement ‘the balance of financial
terror,’ and says that it is flawed in the same way that the
‘mutually assured destruction’ of the Cold War era was. That
doctrine held that neither the United States nor the Soviet Union
would dare use its nuclear weapons against the other, since it
would be destroyed in return. With allowances for hyperbole,
something similar applies to the dollar standoff. China can’t
afford to stop feeding dollars to Americans, because China’s own
dollar holdings would be devastated if it did. As long as that
logic holds, the system works. As soon as it doesn’t, we have a
big problem.
“What might poke a giant hole in that logic? Not necessarily a
titanic struggle over the future of Taiwan. A simple mistake, for
one thing. (A speech) – perhaps in response to a provocation by
Lou Dobbs. A rumor that the oil economies are moving out of
dollars for good, setting their prices in euros. Leaked suggestions
that the Chinese government is hoping to buy Intel, leading to
angry denunciations on the Capitol floor, leading to news that the
Chinese will sit out the next Treasury auction. As many world
tragedies have been caused by miscalculation as by malice .
“So, the shock comes. Does it inevitably cause a cataclysm? No
one can know until it’s too late. The important question to ask
about the U.S.-China relationship, the economist Eswar Prasad,
of Cornell, recently wrote in a paper about financial imbalances,
is whether it has ‘enough flexibility to withstand and recover
from large shocks, either internal or external.’ He suggested that
the contained tensions were so great that the answer could be no.
“Today’s American system values upheaval; it’s been a while
since we’ve seen too much of it. But Americans who lived
through the Depression knew the pain real disruption can bring.
Today’s Chinese, looking back on their country’s last century,
know, too. With a lack of tragic imagination, Americans have
drifted into an arrangement that is comfortable while it lasts, and
could last for a while more. But not much longer.”
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Fallows has written some of the best material on China in recent
years. My only thought on the above is that where I used to
think China could use the nuclear option, regarding the dollar,
I’m now of the opinion that it is easier for them to play the
nationalism card, when necessary to placate a restive public, by
going after Taiwan because, first, the United States will do
nothing to defend its ally, and, second, after a very brief period
of international condemnation, it will be back to business as
usual.
Hot Spots returns Feb. 21.
Brian Trumbore
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