Pondering Sino-American Economic Tension

Because this is contentious territory, let me disclose up front my biases.  I'm a proud American who has visited many parts of China.  I've got endless affection for both countries and the extraordinary contrast between them.  Here are my views on the underlying imbalances.  I strongly advocate trade and mutually beneficial solutions.  This post is solely intended to assess choices I see available to involved parties and the ramifications of those choices.

America's Policy Preferences: Here, here, and here.

China's Policy Preferences: Here, here, here, and here.

While prepared for public consumption, I believe they reflect internally held views well.

Each side clearly holds the other to blame for this crisis, while the reality probably falls somewhere in between.  Regardless of the root issue, the preferences for adjustment in trading terms are not at all congruent, and friction can be expected.  What could each party do to improve the chances that their preferences are realized?

Trade Provisions: China is unlikely to impose further tariffs to protect domestic industry from international competitors, though it may increase export subsidies.

The US has a higher propensity to impose import tariffs or limitations, particularly under the Obama administration.  But the US does not have large domestic industries that compete with Chinese industry.  The US economy is heavily services based, while China primarily exports goods, particularly textiles and machinery.  Imposing tariffs on Chinese exports could eventually foster domestic US industry in those categories, but consumers would face stiff cost increases on necessary goods at a time when disposable income is at an absolute premium.

Subsidizing US exports would be an alternative.  China has complained that the US is unwilling to export high technology products.  However, a large proportion of China's own exports are high technology.  The remaining sectors may be entirely off limits for reasons of national security or other political aims.

I'm not convinced that there is sufficient export volume in categories where the US is competitive for tariffs to be even a net win for the American worker.

American Capital Controls: Some commentators have suggested the US impose capital controls.  I have to confess to not understanding how this could help.  Any implementation would be a severe shock to the global financial system and the immediate end of the USD as a reserve currency.

The US could try to prevent capital from coming in, or prevent capital from going out.

On the outbound side, the US faces no capital flight by private investors at present.  Much of China's investment is already basically trapped in USD, as using it for any practical purpose over a reasonable period of time is basically impossible.  Such capital controls could be used in a true emergency, but I don't anticipate that eventuality at present.

Could they be used to prevent the PBoC from sustaining its peg?  Probably not: China is receiving an excess of dollars not through capital flows, but through trade flows.  Exporters want to convert USD to CNY.  We can't help them do that, and even if we could, the PBoC would offer a better rate.

China Dumping Treasuries or letting the CNY appreciate: This has long been held as China's "nuclear" option.  Revaluation of the CNY upwards may have been an option in better days, with inflation and the cost of raw commodities soaring along with exports, but now with every trend reversed it's a distinctly unsavory prospect.

China could still sell its long treasuries and agencies, which would drive long interest rates higher.  But central banks have already been moving aggressively into shorter-dated paper, while interest rates have been maintained at very low levels as the Fed steps in to purchase the agencies and treasuries that China no longer wants.  This option has thus far been a paper tiger, at best somewhat reducing China's exposure to a resurgence of US inflation.

China "Diversifying":  I think this is China's real nuclear option.  Rather than letting the CNY appreciate or float, China could purchase EUR, commodities, etc. with USD.  This would force the USD down and the pegged CNY down along with it, driving down the price of exports to Europe or securing a large base of commodities for future domestic use.  Such a move would be harmful to European exporters or countries that depend on commodity imports to maintain economic growth, but beneficial to China.

The optics for such a move are very good.  Who, after all, could blame China for wanting to diversify their vast dollar holdings at a time when the US appears unstable and uncooperative?

China Weakening the CNY Further: As the ultimate in beggaring thy neighbor, China has pledged to avoid further devaluing the CNY in this environment.  Whether temptation will prove too much is unclear.  If this were performed, some version of Bretton Woods 2 would revive itself for a little while, increasing China's exports and growth and providing more credit to the US, but all the imbalances built up to this point would be worsened.  It's no permanent fix, and may not even be a temporary solution now that the US consumer is collectively puking its guts up in an alley somewhere off Fifth Avenue.

The most important point is one I haven't touched on here.  There are many nations in the world.  China may be the Saudi Arabia of manufacturing, and the US may be, well, the US of consumption, but there are many other manufacturers and consumers, leading to the OPEC problem redux.  Any action may be foiled by other desperate countries less willing to play nice.

I see few productive steps available to individual countries with the restrictions of current policy goals.  Counterproductive actions, by contrast, abound.  I hope earnest negotiations are performed to reach a better outcome, but heck if I know how to get from this A to that B.