By Simon Johnson. This post is taken from testimony submitted to U.S.-China Economic & Security Review Commission hearing on “US Debt to China: Implications and Repercussions” – Panel I: China’s Lending Activities and the US Debt, Thursday, February 25, 2010. (Caution: this is a long post, around 1500 words; a summary of some key points will appear on the NYT’s Economix this morning.)
China is the largest holder of official foreign currency reserves in the world, currently estimated to be worth around $2.4 trillion – an increase of nearly $500 billion in the course of 2009 (on the back of a current account surplus of just under $300 billion, i.e., 5.8 percent of China’s GDP, and a capital account surplus of around $100 billion). These reserves are accumulated through arguably the largest ever sustained intervention in a foreign exchange market – i.e., through The People’s Bank of China buying dollars and selling renminbi, and thus keeping the renminbi-dollar exchange rate more depreciated than it would be otherwise.
China is also currently the second largest holder of US Treasury Securities – at the end of December 2009, it held $755.4 billion – just behind Japan (which had $768.8 billion).
The US Treasury data almost certainly understate Chinese holdings of our government debt because they do not reveal the ultimate country of ownership when instruments are held through an intermediary in another jurisdiction.
For example, UK holdings of US debt rose during 2009 from $130.9 billion to over $300 billion, despite the fact that the UK ran a substantial current account deficit last year. A great deal of this increase may be due to China placing off-shore dollars in London-based banks (Chinese, UK, or even US), which then buy US securities. China may also purchase US securities through other routes.
China is presumed by most observers to hold the majority of its incremental reserve accumulation in US Treasuries – this makes sense given that the other potential reserve currencies (euro, yen, and pound) all have serious issues – but according to the official US data, Chinese holdings peaked at $801.5 billion in May 2009 and fell by about $50 billion during the remainder of the year. A modest fall in true Chinese Treasury holdings – given slower reserve accumulation in December and the likely desire to diversify – is not completely implausible. But there are no indications that China is moving out of Treasuries in any large scale manner.
While the exact amount is not knowable based on publicly available information, a reasonable working assumption would be that China owns close to $1 trillion of US Treasury securities, i.e., perhaps half of the stock of treasuries in the hands of “foreign official” owners, which was $2.374 trillion (at the end of 2009, with the important caveat that other governments may also hold Treasuries through circuitous routes) and just under 1/7 of all US government securities outstanding ($7.27 trillion, of which $3.614 trillion was held by all foreign owners, official and private, at the end of 2009).
There is a perception that China’s large dollar holdings confer upon that country some economic or political power vis-à-vis the United States and, in particular, that Chinese reserves prevent us from putting pressure on that country’s authorities to revalue (i.e., appreciate) the renminbi. This view is incorrect and completely misunderstands the situation.
It is in the interests of both the United States and global economic prosperity that China discontinues its massive intervention in the market for renminbi. This intervention is a breach of China’s international commitments (as a member of the International Monetary Fund) and constitutes a form of unfair trade practice.
If China were to end its intervention, the renminbi would appreciate substantially – likely in the region of 20-40 percent. China would also stop accumulating dollars (and other foreign assets).
The primary effect would therefore be an effective depreciation of the US dollar against the Chinese renminbi – and against all other countries’ currencies that are implicitly pegged to the renminbi (more precisely, to the dollar rate with an eye on China’s competitiveness). On a trade-weighted basis – and in real effective terms (despite the fact that the currencies of our other major trading partners float freely) – the dollar would also likely fall in value.
Such a movement in the dollar would help expand our exports and improve our ability to compete against imports; this would aid in the process of recovery, job creation, and broader adjustment in the US economy. Even a substantial movement in the dollar – e.g., a 20 percent depreciation in real effective terms, which is most unlikely – would have no noticeable effect on inflation and therefore would not force the Federal Reserve to increase interest rates. The “hard landing” scenario for the dollar – feared by analysts since the traumatic experiences of the 1970s – is unlikely for the US today, given the low level of inflation expectations and the high “output gap” (reflected in measured unemployment near 10 percent and true unemployment of at least 15 percent).
The effect on short-term US interest rates would therefore likely be minimal or nonexistent, particularly as the Federal Reserve currently aims to keep rates close to zero. The effect on longer-term US interest rates would also be small – and could be offset by the Federal Reserve, as it currently seeks to limit all benchmark interest rates (most recently affirmed by Chairman Bernanke this week).
In fact, the current stance of monetary policy – and the low, stable level of inflation expectations in the United States – makes this an ideal moment at which to press China to revalue its currency.
In another potential scenario, there is concern that China would threaten to reduce its purchases of US government securities without allowing its currency to appreciate. But if China continues to intervene to maintain its currency peg, it will accumulate foreign reserves – so they need to hold increasing amounts of foreign assets of some kind. What else would the Chinese authorities buy?
- If they buy other dollar denominated assets issued by US entities, this would push down spreads on those assets relative to Treasuries. This would directly help private US borrowers – thus stimulating growth in the US.
- If they directly buy dollar denominated assets issued by non-US entities, this will still reduce spreads more broadly and help US borrowers – as there is a global market for dollar assets and there is not much high grade non-US dollar debt available for sale.
- If they buy dollar equities – which is most unlikely – this would help the stock market, household balance sheets, and firms’ access to funding (as well as helping to shift our economy from debt to more equity financing, which would a desirable move in any case.)
- If they buy non-dollar assets, given that the Fed will keep interest rates near to zero, this will push down the value of the US dollar and help boost US growth. Such a move would produce protests from the eurozone and Japan, but this change in currency value would be solely China’s responsibility.
If China stops buy foreign assets altogether, this would of course be equivalent to ending foreign exchange intervention. This is exactly the policy change that we should be seeking.
In addition, there are significant potential losses – in terms of net foreign assets – for China if their authorities sell Treasuries or otherwise undermine the value of the dollar (or intentionally roil markets) with negative comments. A depreciation of the dollar directly reduces the value of their foreign holdings and does not, under current circumstances, pose any kind of threat to the US.
There is still an open question of how best to push China to revalue the renminbi.
- Bilateral negotiations, as championed for example by former Treasury Secretary Paulson, have achieved essentially nothing since 2002. This is not a promising way forward.
- The International Monetary Fund (IMF) has proved itself incapable of calling China to account. The IMF’s much vaunted “Surveillance Decision” is a failure and the general Fund mandate of “multilateral surveillance” has (again) proved to be a paper tiger. Working with the IMF on this issue is not worth any additional effort by the US government.
- China is obviously a currency manipulator and should be so labeled by the US Treasury in its next report to Congress. China’s threat to react by selling Treasuries is – as explained above – at worst a bluff and at best a way to help the US with a depreciation of the dollar. This bluff should be called.
This, of course, raises the issue of what the US should do beyond applying labels. Bilateral trade sanctions are never a good idea and can easily get out of hand. Given the failure of the existing multilateral mechanisms around the IMF, the US should take up this issue at the level of the G20 – there are two summits of leaders this year and plenty of support around the world for addressing China’s exchange rate.
The most plausible proposal is to expand the mandate of the World Trade Organization – which should operate in this respect without the involvement of the IMF – in assessing exchange manipulation on the same basis as it deals with unfair trade practices (as proposed by Mattoo and Subramanian). While full implementation for such a rearrangement of responsibilities would take some years, concrete moves in this direction would concentrate the minds of the Chinese authorities in a potentially constructive manner.
——-
The remainder of this testimony deals with our broader economic baseline. Exchanges with Joe Gagnon were most helpful in preparing all this material.
The Baseline Scenario 
“The most plausible proposal is to expand the mandate of the World Trade Organization – which should operate in this respect without the involvement of the IMF – in assessing exchange manipulation on the same basis as it deals with unfair trade practices.”
Nice idea, except in fact totally implausible, not only because the Chinese will never allow exchange manipulation to come under WTO jurisdiction, but also because there is no clear consensus about which sorts of governmental interventions in currency markets are legitimate (and all governments do this from time to time), and which are not.
I don’t know that we should necessarily fear China. In any banking relationship, a healthy respect is requisite for whoever does your lending. Of interest to me is that when the US lends other countries money we seem to think that this gets us leverage some how and implies some level of sway. Suddenly the money is flowing in the other direction & we assume we’re on equal footing with our lender. Either its true or wishful thinking, but it would clearly render our assumptions about us lending other countries money moot wouldn’t it.
I’m reminded of how the US historically has called for other countries to allow troubled industries to fail as a condition for receiving assistance. Chile or South Korea comes to mind if memory serves. Suddenly when in the same situation, our advice is the complete opposite.
As such, when you find yourself in a situation upon which you’ve often commented on others, if suddenly your advice and outlook are opposite of how you normally view the situation sans you, then proceed at your own peril because your objectivity may well have abandoned you or you were lying when giving others advice and you will be recognized for the hypocrite you are. As the US has been accused of destabilizing the economies of other countries, it isn’t altogether unlikely that the thought hasn’t crossed the mind of China.
It would go well for us that the Chinese want a good return on their investment. This would mean that the money actually matters to them and that they’re playing fair. On the other hand what it really boils down to is what do they really want and whether or not they’re willing to pay what it would cost them to get it. If we are their biggest global competitor, why do we assume they’ve forgotten about all the times we stopped them or attempted to stop them from buying various companies in the past or formalizing partnerships that were advantageous for them, but was not beneficial for us. Why do we assume that they’ve decided to let bygones be just that instead of doing exactly what we’ve done to other countries; throw our weight around.
It would be great if they don’t ever wake up and say you know what, lets torch the money and sink the US. That they’d never care how much it would cost them to really stick it to us is great to consider when trying to sleep at night, but the fact that I’ve not seen anyone on our side seriously consider the possibility is concerning.
There’s more to it than I understand. I agree that ending the equivalent of ending foreign exchange intervention is probably a good thing and I’ll raise 1 let’s stop needing the money(credit).
On what basis do you claim that a 20 percent devaluation of our currency “would have no noticeable effect on inflation”?
Just out of curiosity, how much currency debasement would it take to have a noticeable effect?
…
Re: Currency pegs. Does the PBoC’s printing press work better than the Fed’s? If China can peg its currency to the dollar, why can’t the U.S. peg our currency to the renminbi? In other words, why not simply pick the exchange rate we want and intervene just like China does to make it so? (As a happy side-effect, we would finally learn the answer to the old saw of what happens when an irresistible force meets an immovable object.)
Seriously, though, if we are unwilling to fight fire with fire, then we are not that eager to see the renminbi appreciate. I wonder why.
Simon,
Just a quick comment for your readers not to get duped by your limited knowledge of China: if (a) the Chinese people were free to allocate their huge savings at home and abroad and (b) the renminbi were free to float, most likely (1) a much larger share of their savings would be invested abroad and (2) the renminbi would be trading at much higher rates than the current one (6.827 per US dolar) at least for a few years.
I hope you can spend a few years in China to learn about how the economy and the polity, in particular the financial system, work.
Cheers.
Sorry, but this post is typical IMF wishful and inverted thinking. America is not going to export its way to financial freedom.
China will not be strong armed into appreciating its currency because by continuing to flood our market with low priced useless drek it is making up for 5000 years of backwardness and learning what it needs to know. For now, China doesn’t care how much worthless Treasury paper it accumulates, because that is the price of developing its real economy, which is what matters to China. Today it buys aircraft from Boeing because it can force Boeing to assemble them in China. Soon, it will be using the same approach to weapons systems, if that is not happening already.
After sixty years of Communism (and 5000 years of uniquely Chinese predation and backwardness), China found itself starved of technology and had no choice but to play ball with Washington, which is delivering everything China needs in exchange for supporting the fantasies and life styles of our financial elite.
When China feels it has caught up, the ball game will change. It will abandon the dollar, create its own reserve currency and deal with America as we now deal with Argentina, because there will be no difference. China will tell us how much it will pay in oil for our grain, our beef.
Can America be saved? Only by rejection of nanny government and a permanent war economy, by intelligent attention to alternative energy, by a right turn away from globalization and toward renewed self sufficiency, by uprooting monopoly and creating a truly entrepreneurial economy engineered to serve people rather than financial predation and ceo aggrandizement. You cannot reform corruption and papering it over with currency manipulation and selective bailouts and lipstick on the pig doesn’t work either.
What we need is a Constitutional Convention, not IMF tinkering and mumbo jumbo.
it’s only a few hundred years of “backwardness”… they missed out on the Industrial Revolution and Enlightenment.
Interestingly, the PBC bought $15 Billion worth of gold, 454 metric tonnes, about a year ago (about 0.3% of all the gold ever mined). That’s an additional 23.5 cubic meters (a 9-foot-edged cube!).
But I’m a little skeptical about the $755 Billion, (or even $1 Trillion) help in US treasuries. If China holds $2.4 Trillion in foreign exchange, in what form is the other $1.65 Trillion? Maybe $450 Billion in Pounds, $550 Billion Yen and $650 Billion Euros?
These numbers are almost as big as the US holdings but at, I think, *much* larger ratios when compared to the total size of foreign holdings of those other debt market. Is this really plausible?
Or, what about Chinese-owned GSE debt and agency-insured mortgage-backed-securities. Those now act equivalently to US treasuries too, but are only part of our implicit debt, not explicit.
It seems possible to me that China now holds a *LOT* more US debt that either side is really willing to admit publicly.
I’ve wondered the same thing often. Our economy is still (at least) 5 times larger than China’s. We could bury them if we really wanted to. It might hurt us a bit, but it would hurt them a lot more.
My only answer is that importers and US companies that manufacture overseas have a strong lobby; and that Americans in general are too spoiled and would severely punish any political actor(s) who attempt to force China using fiscal, monetary, or trade policy because of the (relatively minor) effects such action would have on life in the US.
China’s leadership, OTOH, has little to fear from 1 billion people with no real voice and government and zero purchasing power.
Has anyone else noticed the physical resemblance between Senator ShellGame and Bob Hope?
Does Bernake’s little beard turn increasingly gray with each Congressional appearance? Is this like Pinnochio’s nose, or should I be adjusting my cable reception?
Is Elizabeth Warren cashing in yet on her respectable and timid reformist posturing?
Listening to these people talk and backpeddle and posture and prattle, watching them connive and jockey and justify and dissemble, almost makes you forget how deadly serious, how disastrous, this Potemkin Recovery really is.
Should we fear China? No; we should fear the clowns we are still trusting to resolve the mess just about all of them did his level best to create and exacerbate, and we should fear the tinkerers and the reformists who insist that a nip here and a tuck there will soon make everything hunky dory.
As I explained in detail on my site, http://patriceayme.wordpress.com/2010/02/04/history-the-enemy-of-the-chinese-dictatorship/, China is the most powerful dictatorship that ever was. Stalin’s and Hitler’s workers’ paradises were very small potatoes, relatively speaking.
World plutocracy has got in bed with the Chinese tyranny, as it did with the USSR, Mussolini, Franco, or the Nazis earlier. This sort of symbiosis is the maximal danger for plutocracy: not only the enemy is being armed, but it gets overconfident, and democracy gets stabbed in the back by its own rogue plutocrats.
The present crisis is probably the last occasion to draw a few lines that neither the plutocracy and its dictatorial ally should be allowed to cross.
If these lines are not established, they will be crossed, and we will end up just as last time, with world war. The choice is clear.
There are soft ways to reel in China and plutocrats: the carbon tax, applied worldwide would be one of them. (It’s easy, because it’s enough just to start with the EU and the USA).
Si vis pacem, para bellum.
http://patriceayme.wordpress.com/
PA
Can somebody point me to the last economic analysis that says it would be in a countries best interest to strengthen their currency (short term)? They have been few and far between. Demand has collapsed worldwide and every country is counting on exporting its way to prosperity. China and Germany are no different.
Every country can’t weaken at the same time. Race to the bottom here we come!
Of course we need to fear China and it’s extreme mercantist practices that have already caused great damage to America’s industrial base, abetted by weak U.S. trade policies. For the most recent 5 year period – 2004 -2008 – we ran a total trade deficit of $3.5 trillion, with the biggest part by far with China. Talk isn’t going to change their practices, despite Simon’s good reasoning. We need some negotiating leverage that can only come from strong U.S. legislation. The “Balanced Trade Restoration Act of 2006” was, and still is, the best known answer. It was sponsored by Senators Dorgan and Feingold but did
not move forward under President Bush. It should be updated and enacted ASAP!!.
Ken Davis, Former U.S. Ass’t Secretary of Commerce
The first Europeans who got to China, in the middle Middle Ages, were stunned to see that the Chinese were doing everything by hand. China was already backwards in its triangle between plutocracy, work and the people.
One of the first priests who got there related that he saw hundreds of Chinese move a big tree, a job that would have been done in Europe with only a few people (and lots of oxen and mechanical advantage).
It’s no accident that the Huns and their descendants the Mongols got turned thrice from Western Europe, severely defeated each time, although they came very close to decide to annihilate China.
China got backwards, philosophically speaking, went it adopted monolithically supine philosophies, such as Confucianism (such was the basic idea of the Cultural Revolution, and it was not completely wrong).
It is not a coincidence that China is rising now that it adopted a few Western philosophies (Marxism, rabid plutocracy, and various French like croissant oriented hedonisms, that Deng Tsiao Ping and his fellow French communist party members promoted).
PA
How exactly does the carbon tax help?
Not a coincidence, indeed, that France has been doing better than Germany in the present crisis, since she has a strong internal demand.
There is little doubt that the French intent to reorder the imbalances, be they with Greece, China, or the USA. Copenhagen was the last nail in the coffin of European passivity.
A target; one euro = one Sino-american dollar.
PA
agree with everything except the self sufficiency. trade _among equals_ makes all richer.
The carbon tax will augment transport costs. It will also look at Chinese pollution and slap it as a supplementary cost on all products made in China.
The end result will be the equivalent of a tax on Chinese made products (except for those which are produced with solar energy and brought over by sail boat)…
The Chantier de Nazaire (where the biggest and most modern boats in the world are made) are working on a giant sail boat, to transport cargo, BTW. So this not all fantasy. Also the French government is struggling with rewriting its carbon tax, after it got struck down by the French Constitutional Court (there were too many exceptions, violating the equality clause).
After the carbon tax works in France, it could be extended to the entire EU. It would be nice if Obama could climb on board (the sail boat).
PA
According to its proponent, Sen Feingold, your Balanced Trade Restoration Act would
“require importers to buy import certificates from exporters (indirectly or directly) at market value… these certificates are allocated to exporters in proportion to the value of each person’s or firm’s exports sold abroad.”
So, you advocate windfall gains to exporters (or trader financiers) and a further drain on consumption to support further increases in import prices?
Sounds like another Keep The Globalization Fantasy Going At Any Cost solution. Nice Try.
Rick: You properly picked up the one weak point in the Dorgan/Feingold Bill – that of having the exporting U.S. companies issue the IC’s (Import Cerificates). In the updated version the certificates would be issued by the U.S. government, and it would also manage the market trading of those certificates. The additional cost to importers should be in the 10% -15% range – about like a small tariff. What we’d be doing is being willing to share our huge market with the rest of the world, but we can’t and won’t give it all away. We’re the only industrial nation in the world that runs trade deficits, and we must borrow $2 billion a day, seven days a week to sustain the current trade deficit. We’ve lost thousand of producers and millions of jobs that would be restored by this simple, but very equitable Act.
Ken Davis
“…given the low level of inflation expectations and the high “output gap”…”
It seems that will the large loss of housing bubble “wealth” and current job numbers we could be heading into deflationary times.
What are the prospects for deflation? I am no economist, but aren’t there limits to what the Fed could really do?
It seems that much of the recent focus on surplus nations has settled on China and Germany. What of the other US$ surplus nations? What needs to be done to stoke consumption in Japan and the Gulf States. Both of which suffer from high corporate savings. Particularly, in the Gulf States wouldn’t dividends from national oil resources to the general population stimulate greater consumption.
To: Jake Chase
My apologies for not using your name in answering your
reply about the proposed “Balanced Trade Restoration Act of 2006”. I’m also interested in your mention of “the globalization fantasy”. Just as China is a real threat to our economy, globalization has proven to be a real problem for U.S. domestic industry, with our own U.S.-based companies adding to impact on U.S. jobs by moving production to low-wage countries. The result of i9mports and off-shoring is the severity of
the current recession. \A return to balanced trade is the single most important move the U.S can make for economic recovery and job creation.
Ken Davis 917-434-6114 cell if you’d like to discuss at any time
For an article told it would be a long read, this was one of the best and clearest to date.
I have had the pleasure to read Simon Johnson’s’ James Kwak thoughts for the past year. The many articles have assisted the learning curve and efforts to keep how this student is able to discuss and present papers to such complex subjects capturing and conveying the world crisis to fellow students and professor(s)alike.
Even the fact I stayed off from posting thoughts over the past week till today to make these few comments.
The reason was do to James Kwak article on the jobs metric and the comments I had read. The question for me was raised to the incredible Capitol structures showing on the books now of many of the 10-k filings. Further was that the unemployment blight is a pull right from the concept of business partnerships forged through the Asian Rim and that of Latin America and Africa and India. What chance does the American unemployed folks have against such a looming bailout that has shifted greed over the human spirit.
As it was said, “When Money is Making Money and There is Not A Product or Service leads to a very dangerous recipe for disaster”. This is conveyed clearly by this quick video clip…
Even the fact of media can cause a Country to fall deeper away from resolutions and push the failing metric of formulas as gleaned from Professor Stiglitz life’s works of theorems.
When the “Tea Party” as caused an eventual loss to come up with solutions and just political gains. The nation suffers deeply.
With respect to Bill Moyer, I apologize for bringing Bill O’Reilly of all people to use to get across this critical point, but he was truly spot on with his statements for this particular segment clip.
Just as China has over-calculated their positions to hold or not to hold US debt and loosen the PEG on their own currencies. They have signaled the cause for many traders of the commodity assets held in OIL pits and other held assets for a steep correction.
Far-fetched, this play supporting the 80s to high 79s is hedging play of China.
Not for long, as China who will be due to cash in on their Oil holdings driving down the market by the big money. The real possibility is in the cards for the return to 50s dollar range.
This metric due to the need to loosen pressure on global collapse on the back-burner of the Greenback and the “Carry Trade” of Greece, (TBFCTF) “Too Big For Countries Too Fail” play out to the over-leverage conditions bubbling up across the global plains of commodity trading pits.
Thanks again for a great think tank of bloggers and your timely insights to very complex subjects…
Far-fetched, Not Anymore!
James Gornick
What are the Chinese going to do with their dollars? Buy our stuff?
“Ooh! Scary, boys and girls!” — Count Floyd
Do you think you would like living on the wage of a Chinese engineer?
Who collects the tax and where does the money go?
Who’s Rick?
Is it your idea that the permanent war economy and the securitization, financialization, casino ponzi game just goes on and on with a 10-15 jolt to American consumers already drowning in debt? Well, no doubt the market trading profits of the financial sector will make up the difference.
I still prefer a Constitutional Convention, an end of the Fed. We could try a parliamentary system, a house of lords, titles of nobility, a powerless monarch, an elected judiciary, a progressive tax on corporate capital, a serious attack on financial monopoly, recognition that the difference between campaign finance and bribery is no difference. The Eighteenth Century is long gone. Time for an update.
The Carbon Tax will be a tax, like any other tax. In Europe taxes are collected by federal states and local regions or cities (the situation is similar to the USA).
It is European Union law that all and any of the 27 member states collects a minimum 15% Value Added Tax (France and Germany have it around 17-18% and Britain throttled down to the minimum 15% last year, before re-increasing it).
The idea of the VAT is that a minimal revenue is insured. Without the VAT, the Greek situation would be much more horrendous, since tax evasion is massive there.
France is introducing a Carbon Tax on a zero sum basis (other, local, taxes on industry are reduced).
My idea would be to generalize the carbon tax to the entire Union on a similar basis to the VAT: make it part of every federal state legislation, with a minimum, like the VAT. It would actually help Greece. And other PIIGS…
Actually French ministers have already approached Central Asian countries about a Carbon Tax scheme, and are studying the complexities. Yes, Central Asia is not in the EU… yet…
PA
SJ: “through The People’s Bank of China buying dollars and selling renminbi”
Selling RMB to whom? Who’s buying? Who’s holding RMB?
To Min:
Golf courses, politicians, lawyers, beach houses, timber lands, corn fields, weapon systems, technology, young women, nothing you should be concerned about.
To peg a currency in a floating rate system – it takes two to tango. If China is “manipulating” its FX rate, why doesn’t the US impose trade tariffs?
As you can see, I missed your second reply to my rejoinder. To be as serious as I can, I don’t think you can solve a problem thirty or forty years in the making without some radical surgery. Balanced Trade is an Elizabeth Warren type fig leaf. It sounds intelligent and respectable and progressive, but it changes nothing important, continues to impoverish those already sinking fast and simply enriches the financiers and the Fortunate 500 export monopolies while doing nothing to diminish the power of giant corporation and bankster finance.
Thank you for taking on this issue – it’s pretty much dead accurate, and it’s impossible to really measure the full impact of the currency mismatch over the past 10 years.
However, I do suspect that a 20% devaluation would manifest in core inflation (and certainly headline inflation) in spite of the output gap in the US – this because of the US dependence on imports. Specifically, over the past 2 years we’ve seen a consistent _trade down_ in consumer purchases, with Chinese imports being among the lowest priced items. An increase in import prices would have several impacts – partly squeezing Chinese manufacturers who try to hold onto market share, but partly being passed through to prices because there are no close substitutes (at such low price points) available from the US or other countries in the short term. So I would expect a modest inflation jump, and probably a short term run on the dollar. (Hopefully the Fed doesn’t overreact.)
In the not-too-distant future, China will need to confront the issue. Part of the reason it’s experiencing inflation pressures internally (e.g. real estate market) is because Chinese actors are hedging domestically. But if China refuses to support the Dollar, then it all comes down to whether the Fed intervenes.
If the Fed (properly) intervenes and supports debt auctions, the dollar will devalue rapidly. This will pressure Chinese imports of raw materials (they’ve stockpiled a bunch, but still import a lot). If they maintain cheap exports (with a low Yuan), this will cost-squeeze Chinese factories. Eventually, it will break…
China is in a difficult situation (partly they have to save for the approaching generational hourglass, partly they have a weak domestic tax system, and they still have massive unemployment). But I think the western faith in ‘free’ markets underestimates the degree to which China can intervene through administrative mechanisms – including such measures as directives to banks on lending quotas.
China may sense something is wrong, but they could also be willing to milk the US for all it’s worth while they diversify (hence, rumors of China buying IMF gold stockpiles), and then directly engage the US in a more confrontational style.
Deep underneath all of this resides a real and enduring problem with the value of the dollar, and dollar indexing of transfer/pension programs that were not designed for long lived retired elders who require increasingly expensive care. The failure of finance to properly coordinate investments (due to the many problems Baseline covers) is allowing this to continue without making the needed systemic changes –
Namely, longer-lived investments that reduce future consumption needs (rather than mega mansions that increase future consumption needs). We talk about the “productivity gains” achieved by finance as being false, but there are “productivity gains” achieved by arbitraging low skilled Chinese labor that will not always be abundant.
Many on the right see this, but they also (mistakenly) think the solution is to _increase_ the value of the dollar… Unless spending is cut (and specifically transfers – either through efficiency gains or raw cuts) this won’t do anything other than lose jobs and increase debt. If spending is cut, this will _really_ lose jobs (Great Depression will look rosy by comparison.)
The ONLY solution that avoids disaster is to easy money to compensate for deleveraging, and cut spending (or raise taxes if you truly believe our expenses are value-adds at the national level, which some obviously are), and the best way to do this would be to partially de-index social transfer programs (so they only adjust by inflation -1% per year).
But with every day that goes by, and during which Team Obama demonstrates spectacular obliviousness and unwillingness to lead, people begin to think that the approach above is failing even though it was not implemented… and they start to listen more and more to the Deflationist Prophets of Doom (aka, gold-bugs).
East Asia has NEVER been a big import market for Euro/North America exports. A revaluation won’t make a difference( remember Plaza Accord?)-Asia will still close their markets to job destroying imports but the cost of exports to the US will rise, bringing on price inflation. Some factories might leave tChina but they won’t come back to the US. Mexico is the cheap labor alternative.
“CHINA BLUE (Documentary), which was made without permission from the Chinese authorities, offers an alarming report on the economic pressures applied by Western companies and the resulting human consequences, as the real profits are made—and kept—in first-world countries. The unexpected ending makes the connection between the exploited workers and U.S. consumers even clearer.”
jake chase: “America is not going to export its way to financial freedom.”
No, and why should we? We are the richest nation on earth. We buy stuff from other nations. Just like Great Britain did when it was the richest nation. :)
Patrice Ayme: “There are soft ways to reel in China and plutocrats: the carbon tax, applied worldwide would be one of them. (It’s easy, because it’s enough just to start with the EU and the USA).”
A carbon tax would affect us much more than China. The key statistic is per capita CO2 production. Per capita, we produce (IIRC) something like 4 times as much CO2 as the Chinese.
There are laws against their acquiring certain of those things. We are not helpless.
“Not a coincidence, indeed, that France has been doing better than Germany in the present crisis, since she has a strong internal demand.”
And the French are already used to double digit unemployment.
There is no need to cut spending, and no need to worry about China holding less T-Bills. Monetary policy (aka “easy money”) is not helping the US. Someone has to spend!
I agree, explore expanding the mandate of the WTO, as you propose. However, increasing the Chinese’s underlying investment in the U.S. should happen simultaneously.
The hour is late… Our Executive Branch and Congress are focused on placating Wall Street. We will no longer waste our time and taxpayer dollars in designing systems to babysit trillions of contracts, credit default swaps, that add no value to our GDP.
Citizens are coming together to take action to put our taxpayer dollars into technology, infrastructure investments and education. Quite simply, we will no longer tolerate the synthetics that brought our economy down, destroyed our retirement savings and embarrassed us on the world stage, as a country devoid of ethics and values.
Simon,
I’ve asked this question of Paul Krugman and pose it to you. Why should China take any actions that benefits its trading partners? If the shoes were reversed, would we do it? For most of the twentieth century, we did our best to isolate China as one of the great Red threats. We sided with the Nationalists during China’s civil War; Battled their proxy in Korea; Our overtures to China during Nixon’s presidency was motivated by further isolating the USSR. Given our hostile history with China, I’d be riding this policy as long as possible to spite the U.S.
well there used to be a law against completely buying politicians…the supreme court campaign finance decision pretty much made sure that they are fair game now.
Still China is not scary, global economic imbalance is scary.
Here’s what I’d like to see happen in regard to our national debt. Do what we did after the Revolutionary War and WWII. Pay Americans to invest in America through savings bonds. Alexander Hamilton paid 6% interest to savers through his Bank of the US to pay back our debt, including foreign debt to places like France. He also charged borrowers 6% interest, but that doesn’t have to be part of our formula unless it’s required. After WWII our debt was 120% GDP and we paid it back by Americans buying Victory Bonds. We should do the same now. Sell the bonds paying 6% to American citizens only. This gives people in this country a chance to really save for something like retirement and college using the power of compounding that they can plan on for their future. It may hurt Wall Street as people move their money into savings bonds for security, but those people shouldn’t be in the market anyway. Wall Street has become a casino for day traders. Those who want to be part of the casino can stay where they are. Give the rest of us a safe and secure vehicle to save our money. Give the United States the money to deal with our debt and give China back their money. Paul Krugman wrote on his blog that if interest rates weren’t being kept artificially low by the Fed, they would probably be around 6%, so there you have it. I don’t want to rock our economy from recovery, but there should be a way to do both, savings bonds for American citizens that pay a good rate of return and have a recovery. I hate to say it, but greedy companies that are going to offshore will do it anyway. Those jobs will be gone. Raising the money for infratstructure repair makes more sense to me. The beauty of it all is that taxes may not have to be raised in the ways Republicans fear. Spending may be looked at carefully before wielding the ax for budget cuts like Democrats fear. Savings Bonds are voluntary. They’ve worked before and I can’t see why they wouldn’t work again now.
Jake: You obviously know your facts better than most -it did take more than 30 years, starting in the early part of the Nixon Admin. to create our massive huge deficit through wide open “free trade” policies. Their rationale was that by floating the dollar in 1971, we’d stay competitive by the adjustment process. Instead, the trade deficits kept climbing, until for the most recent 5 years 2004-2008 they totalled $3.5 trillion. This is no “fig leaf”. It’s national fiscal insanity. We’re the only industrial nation in the world that runs trade deficits, and we borrow $2 billion a day, seven days a week to support it! Contrtary to what you say, balanced trade will help the small manufacturers, not thr global giants. In fact, the big companies that have off-shored their
production and jobs will need import licenses to bring items back into the U.S. The shifting back of two or 3 hundred billion dollars of production annually would be a very big accomplishment – the very key to recovery of our domestic economy and millions of good jobs So, on your latest point, I beg to differ strenuously!
Ken Davis
This post is hilarious in a dark humor way.
China does not give care what the IMF says, or any other nation. This should be explicitly clear by now.
With labor costs surging and a possible trade deficit later in 2010, they have to keep the currency devalued.
If the WTO can’t get Doha rolling again, how will they be able to ‘fix’ this issue ?
Dear LJM: I’m glad you mentioned Paul Krugman. Like most economists, he avoids discussing the U.S. trade deficit like the plague. Economists have been saying ours is “unsustainable” for ten years,but like Paul haven’t offered any suggestions on how to fix it. The way to get anything this big changed in the U.S.is to pass a strong law that requires action and is enforceable. “The Balanced Trade Restoration Act of 2006” was drafted by Democratic Senators, but never moved forward under Bush. It should be updated and
enacted NOW.No government funding is needed, and the money that our domestic companies would earn and the taxes they’d pay would pay for good things like infrastructure repair that we can’t afford now.And several million good jobs would be created.
As I said in my answer to Jake above, greedy companies considering off-shoring will think twice before being required to pay import fees like any foreign company.
Dear Purple:
WTO and the DOHA round isn’t a solution to America’s world trade difficulties – they’re part of the problem. We must abide by WTO regulations, but we are allowed by those rules to take action to eliminate trade imblances. The “Balanced Trade Restoration Act” that I’ve mentioned above is fully in accord with WTO rules and is something we can do unilaterally – no negotiations with any ruling body or country. It could be in effect within six months if Washington would act now.
I thought China was more advanced than most of Europe for infinity less 500 years(most of Europe was advanced only starting the end of dark ages)
Paul Krugman discusses it all the time:
http://www.google.co.uk/search?hl=en&q=+site:krugman.blogs.nytimes.com+krugman+trade+deficit&ei=cdmGS9i7DcqNjAfG7KSuDw&sa=X&oi=manybox&resnum=4&ct=all-results&ved=0CAIQqAQwBA
“Per capita, we produce (IIRC) something like 4 times as much CO2 as the Chinese.”
Not counting what the Europeans produced in last few hundred years of industrilisation.
You need to brush up on the world’s history, probably a good book on world history should help. Roman Emperor described non Greco/Roman europeans as barbarians who grew beards over their faces and whose kids grew up naked and filthy. If I am not wrong, most of Europe came amongst the last to the world’s civilisation club.
vimothy:
I’m not going to dig through those links. Just tell us what his recommended solution is – i’ve reasd his columns for years and I’ve never since a suggestion
on reducing the trade deficits, but I’ve seen many where he recommends even more open “free trade” than we already have.Somehow it would all work out for the better – like the DOHA round or some such.
Ken D.
Other countries do not spend trillions on their military and invading other countries. Americans used to drive 4 litre cars, 5 tvs and 3 fridges in home, half the populations are overweight. Don’t you think doing something about the above excesses will go a long way to eliminating deficit?
The Huns sacked Rome twice, ending western Roman empire) and the Ottoman turks sacked Constantinople, ending Eastern Roman Empire.
For the 15% unemployed perhaps that engineers wage would be attractive if the local housing and food prices were equivalent to what they have in China.
agreed
StatsGuy:
I enjoy reading your posts. They have great depth of allowing simplicity to a subject to give clarity.
I commented before on the “think tank” of bloggers who have add their thoughts as well. There are some pretty smart cookies that got the act together…
Again, great post at 12:52 PM on Feb. 25th 2010…
What are your thoughts of the morals and ethics of the emerging countries and the current relationship to our American loss of way to declining social-order?
Here are two quick video clips of thoughts that can be interesting what others take on this matter raised…
PART 1
PART II…
Far-fetched, Not Anymore!
James Gornick
Very good angle caught by Rickk…
Good video to watch that say a thousand words of why the loss to moral and social order…
Constantinople fell to the Franks in 1204.
In 1453 it’s Hungarian engineers and Christian shock troops who made the difference.
Learn.
I write the book.
Rome sent a Senatorial delegation to the Chinese government. Not conversely. Learn.
Oh, by the way, you are not right. Or maybe you think the Aztecs were first?
Other thing: Attila never made it to Rome. His army. nearly annihilated in Orlean and Champagne the year before, got terminated half way between Aquila and Rome. I do not expect you to know what Aquila was.
PA
After the recent idiotic tire dispute with China, I had to pay 30% more to replace my car tires than I originally had to.
A carbon tax in this situation as an indirect form of tariff would raise the prices on EVERYTHING. Truth be told, I’m not down with that.
Common wisdom is not necessarily wise, nor even knowledgeable. Parrots squawk, and fly as a flock, but that does not mean much beyond that.
What is said above about the Carbon Tax is not correct, the way I think of it.
As I said, the way it’s introduced in France it’s zero sum; so prices in the average do not augment.
All what would matter is the carbon content of products just made, or made in the future. The information is already found on all products sold in France, by law.
Taxation will be next, a matter of months. Hopefully.
PA
…And to French bashing by Americans.
Never mind that French unemployment is lower than that of the USA presently.
Carbon Tax strikes absolute content of carbon in PRODUCTS, not people (so to speak).
Ken,
I note the suggestion that the free-market pricing of an import license is expected to be in the order of 10-15%. Is my recall correct? Now if Chinese failure to appreciate the Renmimbi impacts us by about 30-40%, surely the import license free market price would be also 30-40% plus the financial brokers fees. I think Goldman Sachs et al would add just a little for old times sake?
Sounds good in theory but there is some deviltry in the detail methinks. Surely import duties would be a cleaner impost and not subject to brokerage additions?
You may care to correct this non-economist thinking.
“Fear” is an irrational reaction brought on by lack of understanding or knowledge, and it tends to cause mistakes. Better to respect China’s power and position, but not fear them.
I don’t know the official numbers but employment number is NOT something that the French should boast about.
Perhaps you’re not familiar with the concept of Génération Précaire?
Jake Chase … you crack me up … Is this a dead pan question or what? No need to answer.
Ummm …. for some reason I found myself cracking up reading thru the comments :)
I suppose one approach would be to have the Fed buy remimbi on the foreign exchange markets.This would tend to push down the dollar and would give us some reserves.
China may be hiding US Treasury bonds: experts
February 26, 2010 – 1:54PM smh.com.au – excerpts
“China, a top owner of US government debt, appears to be secretly buying bonds via third locations to hide its importance as a major creditor to Washington, experts told a congressional forum. They said China-linked entities may be scooping up US bonds in London, Hong Kong or other locations, pointing out that official data almost certainly understates Beijing’s US government debt holdings.
Some say the massive holdings by China have implications for US national security, making it harder for Washington to carry out policies in conflict with Beijing.”
http://tinyurl.com/yco3uw7
Anything is possible to exist in one’s mind.
Very true. Chinese culture brings a tendency to *really* hold a grudge where other societies would drop it. (See: China’s Taiwan policy)
I expect that so long as China doesn’t think they’ll hurt themselves, they’ll bring everyone that was against them previously down as hard as they can.
This is not a characteristic in the past history of China.
China is not a static case study. As far as the Chinese are concerned, the Graham-Schumer is perhaps not all that consequential, and it’s entirely up to the Americans to speculate what or why they would do with their forex reserve.
One-Child policy has finally forced a turning point in China’s labor picture this year. Better educated and more liberal 2nd generation migrating workers are seeing a surplus of jobs in the order of millions developing all across the country. Wage inflation is about to become the most dominant feature of the Chinese economy for years to come.
By government’s admission that China may even see its first trade deficit mid year 2010. And perhaps that is the real issue for the currency manipulation accusors to think about — how to get a step closer to modern issues, and not to be bogged down by the old war.
exactly, viking. hence the emphasis on “equals”
Thats utter BS. If China was so “backward”, why during 2 thousands years (from Roman times till the opium wars) Europe had buy with gold and silver the luxury products produced by China? The answer is that the chinese didnt need or want any of the stuff produced in Europe. Great Britain had to wage a war to force open the chinese market. Since the european expansion started in the XVth century until the industrial revolution, the only aspect where Europe´s productive system was decisively superior was military technology.
And the mongols didnt “almost anhiliate China”, they suplanted its ruling dynasty and adopted the cultural models of a more sophisticated and advanced civilization.
Its amazing that such historical fallacies and eurocentric prejudices are still in vogue, when they were discarded by historians a long time ago.
I think this is a great question.
Does the US legalize elicit drugs and focus on demand side solutions to alleviate Mexico’s drug violence? It is a similar question because the US is the #1 consumer and they are the supplier that is most badly hurt by prohibition.
I think the answer to Mr. Cohen’s question is that China will clearly continue to pursue any policy that they perceive to be their best interest.
China is still considered to be an emerging market by many (BRIC is still relevant). Would we really be able to prove that the Chinese purchase of treasuries is for currency manipulation to gain unfair competitive advantage rather then stability? Not in these markets.
Johnson is a great economist I think he is right Chinese currency policy is at the point where they are manipulating their currency for unfair gain. China is a 3000-year-old civilization you cant twist her arm with the IMF or WTO they have to be convinced that currency intervention to this extent is counter productive for their own growth which is not completely evident.
I read in the news today that Hillary has said our national debt is a national security issue. It’s interfering with the shape of our foreign policy. Another really good reason to find a way to deal with our national debt issue as well as our economic recovery needs. Like I said before, savings bonds, sold to Anerican citizens only, paying 6% interest. Pension funds would qualify as US citizens in purchasing these savings bonds. Wall Street can keep the gamblers. I’d call them Civic Duty bonds. People need to be asked to do something besides shopping.
The point is that it may be better to get Americans to solve Americans’ problems. Getting the Chinese to solve Americans’ problems would be too problematic. Trade imbalanceness is last decade’s issue. China’s import is decidedly on the rise, and rapid chinese wage inflation as a result of the one-child policy may soon change China’s GDP distribution and reshape world economic landscape.
If you understand how Beijing mandarins see their economy you may come to the same conclusion Gary Locke did: how to get the Chinese to buy more from the Americans? China’s January auto sales hit 1.61 million, both Chevy and Buick virtually doubled their sales year on year. If you take into consideration the output from China based US companies, China would be running a trade deficit vs the US.
Branding China as a currency manipulator would not help Americans’ cause by grossly oversimplification of the issues.
Chinese holding of the US treasuries may not fall even if China one day began to take on a trade deficit, since China’s current account surplus may not narrow at all. China has not been buying the US treasuries with an aim to achieving a trade surplus vs the US or any country. Therefore the premisis of the debate on prof Johnson’s article is at best questionable.
Totally totally misguided. We should fear Japan, which is the true No.1 holder of US treasuries. Now, with Toyota selling millions of Weapons-of-Mass-Destroyer Prius disguised as motocars with hacked drive-by-wire systems, how soon we will find our roads piled up with Prius and Camry run-over-bodies.
“Its amazing that such historical fallacies and eurocentric prejudices are still in vogue, when they were discarded by historians a long time ago.”
Thanks Anonymous.
The Tang Dynasty was the apogee of civilization when Europe was in the Dark Ages. Apparently the — stirrup — was only introduced to Europe about 700 AD by Central Asian tribes. Read it on the internet. :)
from Xinhua
China remains largest holder of U.S. Treasury securities: report
http://news.xinhuanet.com/english2010/video/2010-02/28/c_13191111.htm
I think the Americans are trying very hard to figure out if this is really what they want to ask China. Be careful what you ask for.
Questions to everyone:
Did not China use USD to buy all of the USG debt that it holds?
What would be different if they instead held USD as FX reserves and no USG debt? Both are liabilities of the USG.
If China then liquidated its USD FX reserves, isn’t that what the US claims it wants China to do?
We can’t ask China to stop “manipulating” its currency and to continue to buy US denominated debt at the same time because one is the opposite side of the same coin!
Jake – The “windfall” for exporters means a subsidy for labor-added-value within the U.S. and a corresponding penalty for products which contain foreign labor-added-value. So the price of imported things goes up, but the price of domestically-produced things goes down. Which would you rather have: domestic jobs producing things which may cost more but with that added ‘labor-related’ cost being recycled domestically, or cheaper imported items which support workers and investment in other countries and bleed our country to economic death? If you prefer the latter, you are definitely management material for WalMart.
The only question I would have is whether China can always or will always be a “reasonable man”. They could decide their geopolitical ambitions are served by a higher risk strategy if they believe they are more resilient than we are.
Johnson should read more about China’s domestic situation. An appreciation of the Yuan would lead to the loss of millions of jobs and social instability. Yes, I know that doesn’t sound like a big deal to Americans, but if you are a Chinese leader, that is your primary concern. There is no absolute right or wrong and the US often does not abide by trade rules either so johnson should not use a moralistic or even legal argument to claim that the Chinese are currency manipulators (this itself has a strong subjective, negative connotation. China is instead using inflation to rebalance the value of its currency which is much more effective than immediately ending currency controls. I’m sure Johnson is very knowledgeable about economics, but he should not be writing about what China should do without understanding its domestic situation just like someone who doesn’t understand how the american government or mindset works should not comment on how america’s policies or government works.