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Thursday, January 24, 2008

The Why of Now

posted by on January 24 at 17:20 PM

Stimulus, stimulus, and stimulus—all financed with more debt. Zero wage growth for the working class in the recent economic expansion. A collapsing dollar—against everything but the Yuan. Massive losses to the American manufacturing base. Huge public and private indebtedness.

How did we get into this mess?

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 go 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.

Check out the fantastically lucid account by James Fallows of how this obscene and unsustainable mis-balance was created, sustained and will likely unravel.

If you find the machinations of global capital as unbearably sexy as I do, here’s a tidbit explaining how the Chinese government forces this situation:

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. And there are numerous less obvious reasons. The very act of managing a currency’s value may be a more important distorting factor than the exact rate at which it is set. As for the rate—the subject of much U.S. lecturing—given the huge difference in living standards between China and the United States, even a big rise in the RMB’s value would leave China with a price advantage over manufacturers elsewhere. (If the RMB doubled against the dollar, a factory worker might go from earning $160 per month to $320—not enough to send many jobs back to America, though enough to hurt China’s export economy.) Once a government decides to thwart the market-driven exchange rate of its currency, it must control countless other aspects of its financial system, through instruments like surrender requirements and the equally ominous-sounding “sterilization bonds” (a way of keeping foreign-currency swaps from creating inflation, as they otherwise could).

These and similar tools are the way China’s government imposes an unbelievably high savings rate on its people. 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 (see “Mr. Zhang Builds His Dream Town,” March 2007). 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.

Swoon! Worth a read…

RSS icon Comments


Yay! I believe this explains why Chinese officials have expressed grave concern for the survival of their industrial production base if US consumer spending drops much at all. They have no domestic mechanism to make up any of the difference.

Posted by tomasyalba | January 24, 2008 5:38 PM

I swooned over the same article, Jonathan. It made me glad I started up my subscription again.

On the plus side, China is now in the position of having to prop up our economy to protect their own investment in us. They can't bail on the dollar, no matter how tempting a move that might be, without kissing most of their wealth goodbye. But oh, if they ever do....

Posted by Fnarf | January 24, 2008 5:43 PM

@fnarf, this is exactly what i have, and others have been saying for years.

Posted by Bellevue Ave | January 24, 2008 5:50 PM

Yes, BA, I know, and so have I. But the article brings a number of things into much closer focus.

My favorite part was when he mentioned that the top China econ guy, Lou Juwei, arguably the most important economic figure in the world, has never bought a share of stock in his life, never bought a car, never bought a house. That is wild.

Posted by Fnarf | January 24, 2008 5:55 PM

Check out the fourth page for how James thinks it might all unravel in a bad way--into irrational mutual destruction due to a misunderstanding or hurt feelings.

Personally, I worry far more about social unrest in China causing another Great Leap Forward-esq (otherwise known as the largest man made famine in human history) or Cultural Revolution-esq (otherwise known as the children run the cities of the world most populous country for a decade) internal shift in power from the Dengist developmentalists to the Maoists.

China is overdue for such a minirevolution, and the social, environmental and economic problems are severe enough to trigger such a rebellion. Did anyone else read the NYT article on training around the anticipated Beijing pollution during the 2008 Olympics? And this is a showcase city at a showcase moment for the country. Not even the PLA can hold such forces in forever. If and when that snap happens, we're going down the drain right with our Dengist partners.

Posted by Jonathan Golob | January 24, 2008 6:02 PM

The Chinese intend to invade the US and take it over once this setup proves insolvent.

Posted by Gomez | January 24, 2008 6:08 PM

The rate on those bonds is between 3 and 4 percent. As long as the combination of economic growth and inflation eclipses that we are coming out ahead. In fact since we buy a shitload from China, both win.

Posted by Giffy | January 24, 2008 6:20 PM

@6, last I checked it was the Russian who were going to invade... by hiding in container ships arriving at Harbor Island.

Posted by Giffy | January 24, 2008 6:28 PM

"Stimulus" is just econo-speak for the latest fix to feed our addiction to materialist consumerism and living an environmentally, economically unsustainable "lifestyle."

Posted by Andy Niable | January 24, 2008 6:38 PM

Jonathan thanks for your nerd posts. This situation is pretty crazy and something that is just waiting to be busted open. After living in China for a month with my gf's family I see MAJOR change coming their way.

Think about how our youth are influenced by the constant sea of information, culture, and networked lifestyle... Well in China similar things are happening and the young kids aren't taking it for granted.

I really think that the olympics are going to be a spark or two for some powder kegs that are sitting around. There will be too many eyes on china for old china to squash new china's message.

Posted by drew | January 24, 2008 6:44 PM

@5 & @10:

As someone who's spent a lot of time in China, I agree (I think) with Drew. If you've been to China, you'll realize the Maoists aren't going to take over again any time soon, if there are any Maoists left at all. The managing of the Chinese economy is actually remarkably unpoliticized, and will remain so for the long term. The political realm-- the part of it divorced from economic policy-- remains "Communist," but it's agenda is only to preserve social order. In the poor Western provinces it pays to be "Communist" and trot out the tired Maoist nationalism to preserve social order. But in the rich East you'll find much less or none of that. Deng-style dynamism and reform is the policy, and modern business-capitalist is the zeitgeist. If any minirevolution happens, I think it'll be moving further away from the Maoist past.

Posted by Mr Me | January 24, 2008 7:50 PM

@10, thats why I no more fear China then the UK fears us. There is something incredibly appealing about the idea the secular free societies that is rather contagious.

The sooner China joins us and begins to fully contribute to the great expansion of knowledge and technology the better.

Posted by Giffy | January 24, 2008 7:52 PM

I started reading this post and started thinking, "Jonathan ought to check out that James Fallows piece in the new Atlantic." Little did I know that's where Jonathan was going…

I just subscribed to The Atlantic after reading the Obama cover story in the previous issue. Fallows's China piece alone was worth this month's price of admission.

Against this specter of America as debtor nation, I've had the same reaction Jonathan has had to this rush toward an economic stimulus. It's as if an athlete is starting to show the harmful effects of taking steroids. And the trainer's response? "Let's pump him with even more steroids."

Posted by cressona | January 24, 2008 8:00 PM

Great Article Jonathan.

One of the best posts on the Stranger in a long time.

Posted by Obvious Guy | January 24, 2008 8:03 PM

Golob doesnt post that much but he makes up for it with quality. chaz and ecb could take a lesson.

Posted by Bellevue Ave | January 24, 2008 8:20 PM

Ditto @15...

I was prepared to role my eyes when I saw the word "stimulus" and "China" within a few lines of each other.

Alas, thank you Jonathan for a thoughful post. As always.

Posted by oneway | January 24, 2008 8:39 PM

@10 and 11. See, this is why I love slog! People with actual experience in contemporary China commenting! So much of how I think of the country is colored by whatever education I had in the post-revolution history of the country. Thanks for filling in the detail I cannot.

@14 and 15. Thank you. For what it's worth, Charles, ECB, Annie, Eli, and Josh--who each receive some of the nastiest comments on Slog--are among the smartest and most articulate people I know. And I know many smart people.

Posted by Jonathan Golob | January 24, 2008 8:39 PM

smart, or GRE smart?

Posted by Bellevue Ave | January 24, 2008 8:53 PM

This is awesome Jonathan, thanks.

Posted by Donolectic | January 24, 2008 9:56 PM

Just because you disagree with them BA, doesn't mean they're not smart. Smarter than even you, oh ye of the oversized ego.

And, kudos to Mr. Golob.

Posted by gnossos | January 24, 2008 11:43 PM

they seem to have larger egos than me if they think we will accept their propositions on their supposed intellect alone. and I just said the quality of their posts sucked.

Posted by Bellevue Ave | January 25, 2008 7:57 AM

Mr. Golob's posts are always delightful in tone, interesting in content and informative. They leave me with absolutely nothing nasty to say.

I therefore have no use for them.

Posted by NapoleonXIV | January 25, 2008 9:19 AM

And since I'm saying nice things this morning, Dan's Bill Maher piece is very, very good.

Posted by NapoleonXIV | January 25, 2008 9:29 AM

It sounds like an international finance version of the old saw, "If I owe the bank $20,000, that's my problem. If I owe the bank $1,400,000,000,000, it's the bank's problem".

Posted by COMTE | January 25, 2008 9:55 AM

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