The China Syndrome: what the current talks with China tell us about America's situation

by: Ian Welsh

Tue Jul 28, 2009 at 11:00

The US/China talks are actually, in many respects more important than the healthcare debate. What China is willing to pay for may well be what the US can do, and what is being negotiated right now is what they'll pay for.

Let's take a look at the issues.

The exchange rate and Treasury purchases

First we have this:

At stake is continued demand by China, the largest foreign investor in U.S. Treasuries, for the unprecedented issuance of American government debt.

 Sounds good.  But then we have this:

The value of China’s currency, the yuan, is also on the agenda. The U.S. regards China’s currency policy as a distortion and wants China to let the value of the yuan appreciate. 

Here's the problem. Those two things are in opposition.  The more treasuries China buys the more downward pressure there is on the Yuan and the more upward pressure on the dollar.  Buying treasuries (or any other dollar denominated assets) does not lead to the Yuan appreciating, unless China buys less of them.  But if China buys less of them, well, the US won't have enough purchasers (actually the US already won't have enough purchasers and the Fed will have buy treasuries, but how much is in question.)

US Savings Rates, the Death of the American Consumer and the everlasting great recession

Ian Welsh :: The China Syndrome: what the current talks with China tell us about America's situation

What's interesting about all this is how honest Geithner is being about the US economic situation with the Chinese.  Take for example, this:

In the talks today and tomorrow in Washington, U.S. officials said they plan to tell the Chinese the American rebound from a recession won’t be led as much by consumers as past recoveries.

Why is this?  Because employment is not going to recover before the next recession, and because the savings rate for the US has to stay relatively high so that Americans can de-leverage, as has also been admitted:

“We are committed to taking measures to maintaining greater personal saving and to reducing the federal deficit to a sustainable level by 2013,

 What this means is that the consumer spending is not going to lead the recovery this time around.  Consumers are not going to dig the US out of this, because China is not willing to lend US consumers that much money anymore.

But the statement is contradictory on its face.  If deficits have to be brought under control, and savings rates have to be kept relatively high, who's going to create the demand required by the economy to get out of the great recession?  Not government, because of the deficit issue.  Not consumers, because they are going to have a higher savings rate and their assets (read houses) aren't going to look good to be borrowed from.

Which leads us to another point.  Both America and China did a stimulus.  China's stimulus is already working.  It had 7.1% GDP growth.  The US is still mired in recession.

Why?  Two main reasons.  

  • China did its stimulus right.  It wasn't 40% bullshit tax cuts with almost no stimulative effect.
  • China, as a creditor rather than debtor nation with huge savings, can credibly be expected to continue its stimulus, while the US can't.  When businesses make decisions about spending they need to know the money will be there next year, they don't know that with the US.
Americans also want the Chinese to move to greater domestic demand,, to open up the Chinese market to US investment (because American companies desperately want to be able to invest in a country with real growth prospects, rather than the US) and to start buying more US goods.  This requires letting the Chinese currency appreciate against the US dollars and is needed long run for American health.  But in the shorter term it leads to a fiscal crisis.  If America doesn't want to increase taxes to pay for its own spending, how can China buy less treasuries and US assets and thus allow the Yuan to appreciate?  And why should they, when right now in exchange for money the Chinese can afford to lose and crappy consumer goods, the US is exporting its industrial base to China?  An industrial base is worth any price.  Americans, with their unwillingness to tax themselves, aren't willing to pay for the American industrial base.  The Chinese are.

Why can't we get a good healthcare bill?

Because the US is a debtor nation, and China isn't willing to pay for Americans to have healthcare.  That's why it has been declared that the health reform bill must be deficit neutral (or close). On the other hand, since bailing out the financial system meant bailing out the value of a lot of Chinese assets, the Chinese were (grudgingly) willing to go along with that, since they benefited.  They do not benefit from Americans getting health care.

Can you say co-dependent?

I sure hope so, because that's the Chinese/US relationship. But one side of the relationship is getting a lot more out of it than the other one and every year the Chinese need America less, and America needs China more. 

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Keynes once famously said (4.00 / 1)
that if someone owes you a thousand dollars, you own them, but if they owe you a million dollars, they own you. I actually don't think we need the Chinesse more than they need us.

The central question facing the US is whether additional federal deficits will cause long term interest rates to go up.  If they will, US fiscal stimulus will likely be ineffective.  So the Obama administration is trying to do two things:
1.  Pursue short term fiscal stimulus WHILE
2.  Argue that it will be fiscally prudent in the medium/long term.

Long term rates have gone up recently, and the fundemental question is why.  I think they have gone up, as oil has, because the markets think that economic disaster has been averted and growth will resume in the next 12 to 18 months.  That is Krugram's argument as well.  If that is right than the US could pursue additional stimulus if needed.


Our Future (4.00 / 1)
If you want to know what our future relationship with China will be, see England's current relationship with the US. At least if we are lucky it will look that way. If China decides to toss us to the curb, it could be worse.

The only way we can avoid this future, is to make a massive change in the direction in our industrial policy. That is the federal government must start making investments to build up our domestic manufacturing base, instead of subsidizing the outsorcing of our future. This is different than rescuing and/or investing in American corporations, which are more interested in the short term gains (for them) of foreign investments than the long term health of our economy. Investments/incentives must be tied to domestic manufacturing and foreign manufacturing by domestic firms must be penalized using either tax policy or by out right tariffs.

Unfortunately, nobody in Washington has the stomach for this kind of change in policy.  

Closer to America's (0.00 / 0)
relationship with England in the 20s, I'd say.

[ Parent ]
More like the 50's & 60's (0.00 / 0)
After the torch of the Empire had been passed to the US.

[ Parent ]
this is an absolutely excellent post (4.00 / 1)
i just had to throw that in.  very few discussions of u.s. china relations and the implications on what they're trying to do about consumer demand in the u.s. are as clear as this post.

the one thing i don't understand is why the american political and economic powers that be think that the chinese domestic market can lead to recovery in the next few years as opposed to decades and the second thing is why they think it's politically sustainable in the u.s. to run a u.s. and global economy based on chinese and other demand without actually preparing the american public for that.

not so sure about China's economic recovery either (0.00 / 0)
I read a really fascinating (and long) piece about how China has had enormous economic growth, but THAT THE GROWTH DID VERY LITTLE TO HELP THE AVERAGE CHINESE WORKER. Sound familiar? Should, its what's been happening in the U.S. for at least the last 30 years. Its important to look at job creation, social-economic mobility, and freedoms that came from such "growth". Remember, economic growth isnt necessarily a good thing in it of itself, what matters is how the people are affected by such growth.

I'd like to point you to a piece that completely blew me away on the Chinese economy. Definitely food for thought. http://newpolitics.mayfirst.or...  

China is in early industrialization (4.00 / 1)
think Englad in the mid/late 1800s, or the US from 1880 to 1920s or so.  Initial industrialization is ugly and unpleasant.  It increases the economy of a country, but results for ordinary workers are horrendous (this is what Marx and Engels, among others, were reacting to.)  There's no question that China has huge issues.  But they are industrializing and getting stronger.

Internally there are 3 economies - the coastal for export economy, the old state economy (the recent assassination of an executive planning to close a plan was in that economy) and the hinterlands, which are still subsistence agriculture, by and large.

But China is in a stronger position than the US becuase they are growing, and they are a surplus nation.  For example, they own over 95% of the world's supply of rare earths.  They have systematically bought up all the oil they can get their hands on, and so forth, while the US is systematically bundling up its assets and future revenue streams and selling them.

[ Parent ]
I'm not sure I buy your analysis (0.00 / 0)
If the yuan appreciates, that means that China would get more treasury bonds for the same number of yuan.  It also means that the value of their current treasury bonds, measured in yuan, declines.  But I don't see how either event is a fiscal disaster for the US.

In fact, I think you're wrong in claiming that the desire to get China to buy more treasuries, and the desire for the yuan to appreciate, are in opposition.  It seems to me that they can go together, since both American goods and American debt become cheaper for China to buy.


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