Monday, November 16, 2009

China And Trade Imbalances

This morning, I saw that Paul Krugman has a column up today about the deleterious effects of China's policy of pegging its currency to the dollar. I also watched an interview on BCC World News with an Oxford professor who says that China views itself as the emerging power and the United States as declining. A sentiment echoed by numerous China watchers in several interviews I've seen recently.

In particular, the Chinese feel that their more heavy-handed approach to managing their economy has been vindicated and will be happy to stop hearing lectures on the need to reform their banking sector from their American counterparts. The American banking systems has problems, but this narrative, while it makes the Chinese happy, isn't exactly accurate.

The Chinese banking system has massive, structural problems. There are so many that it's difficult to know where to begin, but primarily the problem is that they are government controlled. Yes, many of our banks are as well, but this is (hopefully) a temporary and drastic measure taken to avert crisis, not a long-standing policy of government control. This state control in China has led the banks into subsidizing other government companies with loans that will never be paid off. And since reporting and statistics in China are so poor I'm not even sure the Chinese know how bad they are in the shit. As I believe I've written before, this lack of a proper banking sector, along with almost all the Chinese economic policies, contributed to our banking crisis.

The Chinese government, its ideological basis having been discredited, has decided to base its legitimacy on its ability to deliver order and economic growth. It has decided to do this in the same way many of its neighbors have done -- export driven growth. It exports goods and gets foreign currency in return. For our purposes, we'll call the foreign currency dollars.

If it had a normal banking system and given its economic growth rate, these dollars would be sold and the proceeds injected into the domestic banking system. This would raise the value of the Chinese currency in relation to the dollar, and encourage and facilitate domestic investment and consumption. This would mitigate the trade imbalance and help China develop faster.

Instead, the Chinese encourage exports, but then require the dollars be surrender to the government. The government exchanges those for Renminbi, which it then has to turn around and sterilize. The dollars flood back into the US, in the form of Treasury bonds and other investments, and the US banking system is, in effect, acting as the de facto banking system for the Chinese as well.

At first glance, this doesn't sound like much of a problem for the US. London made a ton of money doing the Eurodollar banking for the Eastern Bloc during the Cold War. But it seems as if there was too much money chasing too few opportunities here in the US. Logically speaking, the investment should be the other way around. Americans should be investing in rapidly growing economies like China's.

This isn't to say that the US was some innocent victim of the Chinese economic policies. Our bankers were happy to use the money. Our citizens were happy to buy houses and cars with the money at low interest rates. Our government was happy to spend without paying for it.

What I am saying is:
First, the Chinese still have huge problems with their banking system and economic policies. Problems that are, as Krugman explains at the currency level, responsible for exacerbating global imbalances.

Second, government involvement in the economy can paper over a lot of things. What seems like a controlled, predictable economic growth can unravel very quickly. I think of it much like a dam. It can control the flow of water day-to-day, but pressure builds up. When it breaks it breaks big-time.

Third, the gloating of Chinese leaders, even if it's subdued, augurs poorly for the China. If China has often had one thing going for it, besides its population, its the idea that China has leaders who were long run thinkers. Think Mao saying it was too early to tell the impact of the French Revolution. The idea that we've reached some inflection or intersection point where China is surpassing the United States is presumptuous in the extreme. The current turmoil in the American economic system, and by extension in the political system as well, is temporary. It seems to me the Chinese are reading too much into this and making questionable assumptions about the future based on current conditions.

This is a consequence, I would argue, of their complete lack of ideological foundations. With communism dead, they are left with pursuing legitimacy based upon technocratic ability to deliver material progress, which is a largely an empirical, technical pursuit. Ordering their ends toward empirical, technical pursuits necessarily shortens their time horizons to what they can measure and reasonably predict. This switch from long-term to short-term will be the reason for their inevitable downfall.

Some of you are probably saying that American leaders are often short-sighted. Ah, but there is a massive difference. The American political and economic systems are inherently flexible and practical. It often doesn't seem like it, but when push comes to shove it works. China has no such inherent flexibility. Perhaps there's a capable or strong leader in charge when a crisis comes and they get through that one. But eventually there will be a crisis when the leadership screws up. Once it screws up its legitimacy is done. The United States legitimizes its leadership every few years. We might try everything else first, but we wind up doing the right thing.

1 comment:

Anonymous said...

You might enjoy this:

"...The theory of the inevitable rise of China is similar to the recent theory of the inevitable end of the U. S. as a mainly Caucasian country: It is based on the extrapolation of current statistics that will not continue, and that in the case of the Chinese economy, are a fiction anyway.

"China has a centrally directed economy, and calculates growth rates as a function of production, not spending; and production is deemed to occur when it is commissioned by the state. Thus, all Chinese predictions of economic growth are self-fulfilling: The central economic leadership orders production of toasters or submarines and announces construction of roads and sports stadiums, and the anticipated costs are added to the GDP at once. (In western countries, by contrast, GDP is the sum of consumption, investment, government spending and exports.)

"The government monitors the progress of state construction and inventory levels, but doesn't release these numbers. It regularly claims 15% annual retail sales increases, but that reflects shipments to retail outlets, not sales, and even less, sales revenue. Such a system preserves some aspects of the catastrophic Soviet-style command economy. There are reports of consumer goods being virtually given away at point of sale, i. e., at below their cost of production.

"All outsiders can do to judge the progress of demand is to see what the central bank does with credit and the money supply. The country has had a 21% decline in exports this year, so to achieve its 8% economic growth for 2009, there will have to be a 15% to 17% increase in domestic economic activity. There has been a strenuous effort to increase domestic demand, and the much-ballyhooed US$586-billion Chinese stimulus plan was really an excuse for the relaxation of credit and the redesignation of categories of already approved expenses.

"The money-supply increase for this year is a very audacious 34.5%, to stimulate domestic demand. The two Shanghai stock exchanges almost doubled (before a recent 20% downturn) and major city residential prices are up around 13% so far this year. So bubbles are clearly developing. The country's claimed savings rate of 50% is not real, because it includes provision for all health care, retirement benefits and other social spending that is provided by the state in most western countries.

"China claims to be expanding health care and other social services, but has not allocated realistic amounts to accomplish this. The country also has no credible legal system, and is rife with corruption (as evidenced by the shoddily built schools -- used as shelters during the recent earthquakes -- which were built on the cheap with no structural steel, and then collapsed, killing thousands of people). It has one billion peasants who largely live as they did 3,000 years ago. Almost every great urban development attracts swarms of expropriated people throwing rocks at bulldozer drivers, and the Chinese navy regularly steals the catches of commercial fishermen. The one-child-per-couple policy is creating an ageing and male-unbalanced population. It is a rough country, oscillating between near chaos and Tiananmen-like exertions of authority.

"The rise of China is impressive and an objectively good thing, and the United states is labouring. But the U. S. has a functioning, if conspicuously imperfect, political and legal system, formidable resources, an incomparably productive work force, nearly four times China's GDP, and a popular culture that dominates the world. It must put its house in order, which will be painful, but a trifle compared to the challenges facing China. The United States has seen off greater challenges than this."

- Conrad Black

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Mrs. P

 
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