Saturday, January 24, 2009

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: Herehere, 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.

14 comments:

Steel Phoenix said...

It is nice to see someone bringing up the thought that we don't want China to fail. I felt like we were at a crossroads not so long ago. China was becoming a threat to its neighbors and we brought them into the global market rather than trying to further sanction them. I think it was a good decision even if it causes us some economic hardship in some ways. I think it would be a shame to reduce their desire to trade via tariff.

I've been mulling and posting some crazy economic thoughts lately, and you are fast becoming my favorite economic blog, so please forgive me if I veer into the fringes a bit with my comments/questions. You know this stuff a lot better than I do.

If deflation is defined as the contraction of the money supply, and our money supply is a fiat currency which has a value relative to its purchasing power parity with foreign currencies, could we essentially have deflation due solely to the expansion of foreign money supplies, even when our own is expanding? I know you covered the subject of unilateral inflation the other day, I just wanted to make sure I had it straight in my head.

I'm really not a fan of subsidies and tariffs. They are nearly the same thing, really, as are bailouts. A nation that is working to its strengths shouldn't need to prop up its industry, and a propped up industry is a lazy, uncompetitive industry.

I don't have a great grasp on what exactly our debts to China entail. Would it be both possible and in our best interests in this pseudo-deflation to print money and pay off our debts?

S said...

"A nation that is working to its strengths shouldn't need to prop up its industry, and a propped up industry is a lazy, uncompetitive industry"

I would argue that this statement ignores the numbers - The US has a workforce of 100M or so vs. the billions in India and China. Technology is in and of itself labor saving. That is a problem.

NDK in your last post you runinated over what the US wanted -- stronger against Euro/commodities and weaker againt yen/Yuan. This post is inconsistent. And yet I agree fully. I mentioned in that post that by strengthening the dollar against commodities - in whhcih they are priced - would sour China to buy and hence create a kind of bilateral agreemeent to impoverish Europe.

The US is attempting to hold out as long as possible with a strategy of outlasting the rest. I think Washington is dragged to the table by the collective rest and forced to accept a battlefield demotion - of at least the dollar.

Kedrosky had in intersting post up this weekend opn something I have been thinking a lot about over the past month. That is the race to protect in ways other than tarriff. Swiss last week annoucned race to protect CHF appreciation. Singapore cut its corporate tax rate. Japan and South Korea are committred to spending to maintain a leadership in Green enterprice technologies. Euroep is backing the auto, airline other. The US is backing everything. Everyone is printing money to prevent the cleanse. Just becuase we don;t see smoot re-enacted doesn;t mean the same thing isn't happening. It is.

The tarp covering this reality is the collective lie that aggregate demand is "stalled." History as they say is a lie commonly agreed. Lies have a strange way of coming back to bite you in the ass

babar ganesh said...

question -- what exactly do the export restrictions cover?

Detroit Dan said...

Thanks for the post, and thanks to S for some interesting observations with which I agree.

S, what do you mean in your last sentence, "the collective lie that aggregate demand is 'stalled'"? Do you mean that the global economic problem is surplus supply, not stalled demand?

Anyway, the point seems to be that the U.S. and China will not be able to bilaterally continue the game. Europe is too influential to let that happen. Multi-lateralism is desperately needed, if only as a face-saving way for the U.S. and China to get themselves extricated from the current deadly embrace...

Steel Phoenix said...

S: I assume you are saying that the greater size of China allows them more anticompetitive force. If this is true, then we will lose with protectionism as well, since we can never outproduce or outsubsidize them. We will have raced into socialism only to fail at the end.

Why is technology being a labor saver a problem if aggregate demand is not stalled?

I've heard people coming home to the U.S. from Japan say it is like going from the Jetsons to the Flintstones. If that tiny island can do it, why can't we?

Detroit Dan said...

So to follow up on my last point (that multilateralism is required), the end of the peg will be mandated by the rest of the world. China will protest, but the rest of the world (esp Europe) will not go along with a continuance of the status quo. The U.S. will go along with the mandate that China remove the peg since we recognize that Chinese currency manipulation is part of the root cause of our economic malaise...

ndk said...

I felt like we were at a crossroads not so long ago. China was becoming a threat to its neighbors and we brought them into the global market rather than trying to further sanction them. I think it was a good decision even if it causes us some economic hardship in some ways. I think it would be a shame to reduce their desire to trade via tariff.

This has become a contentious position to hold, Steel Phoenix, and I'm not entirely sure why. China has offered extraordinary quantities of labor and investment at cheap prices, and with appropriate policies in place that should be a great advantage to both countries rather than a uniform detriment.

If deflation is defined as the contraction of the money supply, and our money supply is a fiat currency which has a value relative to its purchasing power parity with foreign currencies, could we essentially have deflation due solely to the expansion of foreign money supplies, even when our own is expanding?

More rapid expansion of foreign money supplies in the presence of pegs or effective pegs -- IF reflected in inflation, and that's an enormously important and iffy IF -- would tend to weaken the dollar. We could deflate at 15% while China deflated at 5%, for example, and with the current exchange rate it might work out okay. With the current debt loads in the US, it would not work out okay.

In general, I think the connection between money supply and inflation is extremely tenuous at best.

I don't have a great grasp on what exactly our debts to China entail. Would it be both possible and in our best interests in this pseudo-deflation to print money and pay off our debts?

Sorta, but probably not, as I'll detail in a follow-up post in response to earlier comments about debt-to-GDP ratios. When you're in a deflationary environment, the difference between money and short-term debt becomes vanishingly small. At some point where the incentive to lend and leverage money returns, that difference becomes extraordinarily large, but we're not there yet.

I would argue that this statement ignores the numbers - The US has a workforce of 100M or so vs. the billions in India and China. Technology is in and of itself labor saving. That is a problem.

I too wonder whether the Luddites will yet have their day, S.

NDK in your last post you runinated over what the US wanted -- stronger against Euro/commodities and weaker againt yen/Yuan. This post is inconsistent. And yet I agree fully. I mentioned in that post that by strengthening the dollar against commodities - in whhcih they are priced - would sour China to buy and hence create a kind of bilateral agreemeent to impoverish Europe.

I don't see how the posts are entirely inconsistent, so much as I didn't discuss it here. That's because I see no way for the US to forcibly revalue the CNY downward, as mentioned in the section on capital controls. Maybe I lack imagination, but I don't think it's possible. Do you have some creative ideas?

Just becuase we don;t see smoot re-enacted doesn;t mean the same thing isn't happening. It is.

This is a very good point. Protection of domestic industry can be done in a thousand ways.

question -- what exactly do the export restrictions cover?

Mostly goods and technologies that could have military applications, babar. They're something of a joke with how leaky knowledge is today, but they're still in place.

Anyway, the point seems to be that the U.S. and China will not be able to bilaterally continue the game. Europe is too influential to let that happen. Multi-lateralism is desperately needed, if only as a face-saving way for the U.S. and China to get themselves extricated from the current deadly embrace...

I agree with this, Dan, but the OPEC problem is very important here. Every nation has every incentive to cheat on its exports and sell as much to the world as it can. I can't fathom cooperation on that scale in today's environment.

Why is technology being a labor saver a problem if aggregate demand is not stalled?

Technology might reduce the value of many forms of labor, in effect making capital more valuable and people less so. It's more revolutionary technologies that are disruptive than mundane progress, and I consider the Internet to be quite revolutionary. It's hosed a ton of business models.

I've heard people coming home to the U.S. from Japan say it is like going from the Jetsons to the Flintstones. If that tiny island can do it, why can't we?

I spent some time working in Tokyo. For some goods and services, I'd agree totally; for others, I'd say the situation is reversed. Japan didn't feel nearly as progressive as I'd imagined. This is though, of course, all subjective nonsense.

China will protest, but the rest of the world (esp Europe) will not go along with a continuance of the status quo.

I agree that the peg causes innumerable problems, Dan, but how can the world foil it without China's help, besides imposing serious trade restrictions that might well backfire as well?

ndk said...

Revalue the CNY upward, of course. Pardon me. :D

Steel Phoenix said...

I still don't see how tech being a labor saver is a problem. The ditch diggers don't want their jobs back from the backhoes, and with China having a greater labor advantage than tech advantage, we can once again play to our strengths. My general desire for progress makes me want to automate as much as possible so people can move up to bigger and better pursuits. I would rather my job be replaced by a machine than that I did a job that could be better done by a machine.

Detroit Dan said...


I agree that the peg causes innumerable problems, Dan, but how can the world foil it without China's help, besides imposing serious trade restrictions that might well backfire as well?
[ndk]

The alternative to a win-win agreement is a lose-lose trade war. China will want to avoid that, so they will have an incentive to cooperate in solving the world's problems.

Doesn't China have capital controls in place that could be loosened, helping to undermine the peg? This would require cooperation, but the rest of the world has enough leverage. Plus, China would benefit with the yuan becoming a reserve currency.

The situation seems pretty desperate around the world, from Spain to Shanghai and in between, so there will be tremendous pressure for change.

ndk said...

I would rather my job be replaced by a machine than that I did a job that could be better done by a machine.

I'm with you there in the longer run, Steel Phoenix, but I think concerns about finding good employment for displaced people are quite legitimate. I don't see a stimulus package as any kind of answer.

Doesn't China have capital controls in place that could be loosened, helping to undermine the peg? This would require cooperation, but the rest of the world has enough leverage. Plus, China would benefit with the yuan becoming a reserve currency.

Yes, they do, but you might go back to reread China's policy comments. At the very least, such a move would bankrupt the PBoC, which holds dollars as assets and yuan as liabilities.

It would also make employment of their numerous unhappy college graduates much more challenging. I don't think China's interested in having the reserve currency right now, so much as they're interested in development of domestic capital and employment.

While it's a good long-term change, the current regime has legitimate concerns that it wouldn't be easy to make it from here to that longer term.

S said...

NDK,

Luddite or not, the fantasy of a intelligence economy is a pipedream of the upper west side ulemma. Contrast that with the Caddyshack line made famous by none other than the Judge: "the world needs ditch diggers too."


I come back to the FT article today on countries turning to barter of all things. Is this not the ultimate repudiation of fiat? The whole idea of using different crosses obscures the greater truth, which is that any benchmark imposes discipline, which is inconsistent with the free hand of government. Read any commentary on the gold standard (correlated to the time line of crisis) and it would appeear to put the lie to the chokehold. In place of suffucation we get waterboarded with liquidity. What's really changed? The $ / Yuan debate seems to rest on the idea that the current exchange mechanism - $/debt standard - is the one that will be enduring. I am unconvinced of the durability. The move by China to the short end of the curve and away from agencies is a flashing yellow. I am numb enough to think this crisis will eventually abate and unreasonable enough to belive that the rest of the wiorld will not outsource its resources/savings to fund the profilgacy of the US, which after all rests on sustaining the outsourced undeclass - otherwise the model breaks down.


Perhaps we should stop talking about the Yuan and start to talk about the Saudis and the GCC currency union circ 2010? The last pillar of the dollar is the commodity benchmark> the US-Saudi axis took a hit with the Royal Kingdom firing a warning shot in the FT yesterday. (http://www.ft.com/cms/s/0/d68c910a-eb0e-11dd-bb6e-0000779fd2ac.html) - sorry don't know how to embed link.

The anwser lies in reviving some form of Bretton Woods (not Bretton Woods II). And for those who truly belive in the US intellectual superiority and intelligence economy, such a move should be welcome. Would it not put the lie to the manipulation meme...

...perhaps the real fear is exactly that.

Detroit Dan said...

Does China have liabilities to other countries denominated in yuan? If not, why would an increase in the yuan's value lead to China's bankruptcy?

I see that the Maverecon guy (Buiter) is mad at Geithner for saying that China manipulates its currency. Isn't that like being mad at the sun for being hot? I mean China does manipulate its currency, right?

ndk said...

Does China have liabilities to other countries denominated in yuan? If not, why would an increase in the yuan's value lead to China's bankruptcy?

They probably do, but in trivial amounts. It's not China being bankrupt; it's the PBoC. The PBoC holds almost exclusively foreign exchange reserves as its assets, and it has only RMB liabilities. It would have to be recapitalized immediately. The nation itself would be okay, but it would suffer a large capital loss, a little embarrassment, and an outraged populace.

I see that the Maverecon guy (Buiter) is mad at Geithner for saying that China manipulates its currency. Isn't that like being mad at the sun for being hot? I mean China does manipulate its currency, right?

He does grant the truism, of course. It's more a question of whether anything productive can come from declaring China a currency manipulator, or whether anything useful comes from forcing nominal revaluation.

Every fixed or managed nominal exchange rate is, by definition, ‘manipulated’. But only the most bone-headed of ultra-Keynesians believes that a country can influence its effective real exchange rate in a lasting manner by managing/manipulating its effective nominal exchange rate, let alone some bilateral nominal exchange rate.

He also gets at the heart of the point I was trying to make when Yves first said it was okay for the US to have domestic inflation because China had had significant inflation:

So China is undertaking actions to remedy its own external imbalances and global imbalances. The US is proposing measures to increase its external imbalances and aggravate global imbalances.

With the exception of imposing useful trade policy, I basically agree. China has played very nicely and cooperatively so far, and I think the world owes them a debt of gratitude for that.