from Follow the Money

China is starting to sound like a normal creditor country

December 4, 2008

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Most creditors believe that the debtor needs to take the lead in addressing their own problems. China is, apparently, no different. Geoff Dyer of the Financial Times reports:

Wang Qishan, a vice premier and leader of the Chinese delegation at the two-day talks, called on the US to take swift action to address the crisis and said the two countries needed to work together. “We hope the US side will take the necessary measures to stabilise the economy and financial markets as well as guarantee the safety of China’s assets and investments in the US,” Mr Wang said.

Zhou Xiaochuan, governor of the Chinese central bank, urged the US to rebalance its economy. “Over-consumption and a high reliance on credit is the cause of the US financial crisis,” Mr Zhou said. “As the largest and most important economy in the world, the US should take the initiative to adjust its policies, raise its savings ratio appropriately and reduce its trade and fiscal deficits.”

Jim Fallows’ interview with Gao Xiqing has a similar tone: the US should treat its creditors rather more nicely. Fair enough. China now almost certainly has well over $1 trillion in US Treasury and Agency bonds, and probably close to $1.5 trillion in total dollar exposure (more on that next week). That is a lot by any measure -- more than really makes sense.

On the other hand, I hope that Chinese policy makers recognize:

a) They, not the US, decided to intervene heavily and in sustained way to hold their exchange rate down, a policy that necessarily implies financial losses for China. China is effectively overpaying for financial assets (dollar reserves) that it doesn’t need in order to support its export sector. There is no way the US can guarantee China against losses on its holdings of dollars.

b) Investors in highly leveraged financial institutions risk large losses. China’s discomfort with its current losses suggests it never should have bought large stakes in major financial institutions. One of the concerns Larry Summers raised about sovereign wealth fund investments in large financial institutions is such investments would turn the always difficult decision to wipe out the equity of a failed financial institution into a foreign policy decision. That rings true.

c) Given how much the US imports from China, it is hard to see how the US can increase its savings (and reduce its trade deficit) without putting pressure on China’s export sector. Indeed, right now the US consumer seems to be following PBoC governor Zhou’s advice to save more - that is one reason why China’s exports have slowed. And that hardly has made Chinese policy makers happy. Right now a smaller US fiscal deficit would imply even bigger falls in global demand for China’s products.

d) If China wants to maintain its trade surplus -- and in the process to maintain a world where China’s exports are growing faster than the world’s imports, meaning that China’s global market share is rising -- other countries will necessarily have to run a trade deficit. If oil remains in the 40s, some of that deficit will likely come from the world’s oil exporters. But they can finance their deficit by selling existing US and European assets. They won’t necessary need to take on new debt and borrow China’s surplus. A lot of the offsetting deficit will likely come from the US. By the same token, China can only save more than it invests if someone else invests more than it saves, and thus needs to borrow from the rest of the world -- just as the US can only invest more than it saves if someone else (like China’s government) is willing to lend it the funds it needs. There aren’t many places in the world that are likely to absorb China’s projected $400 billion current account surplus.

Chinese complains about loose US policy are a bit at odds with other Chinese policy choices that are aimed at supporting China’s exports.

I would have more sympathy for China’s concerns about its export sector -- and the loss of jobs in its export sector -- if:

a) China wasn’t running a large current account surplus as a result of policy choices in this decade that had the predictable result of leading to over-investment in China’s export sector, and thus increased China’s vulnerability to a global slowdown (click here for a summary of the article I linked to above that is not behind a firewall).

b) If China wasn’t still widely forecast to grow more rapidly than almost anyone else, which admittedly isn’t saying all that much right now.

c) If China didn’t have the capacity to support employment through a large domestic stimulus. For example, the World Bank is forecasting a smaller swing in China’s fiscal balance in 2009 than seems likely in the US.

d) If China hadn’t pursued a capital intensive development path that has been creating many jobs for a long-time. Effectively China has substituted capital-intensive exports for labor-intensive exports; remember, it is exporting way more in 2008 than in 2007.

e) If Chinese exports weren’t expected to grow faster (or shrink by less) than the world’s imports. Remember China has been gaining global market share for the past several years. And yes, that is something that is, in my view, directly tied to the exchange rate -- China’s market share in Europe soared after the RMB fell v the euro. The World Bank forecasts that this will continue in 2009 even with the RMB’s recent broad appreciation ... (See figure 2 and the table on p. 9 of the World Bank Quarterly)

The slump in global trade -- Korea’s exports were way down in November, and given US auto sales, Japan’s exports likely will be too -- is sure to increase trade tensions. And as China starts to realize the costs of its export subsidies -- and the fact that avoiding incurring financial losses on its existing investment requires making an ever bigger financial bet on the US and the US dollar -- it sure seems that China wants a bit more say over US policy. That too is a potential source of tension.

China effectively choose to loose money lending to the US when it scaled up its purchases of dollars to resist pressure for the RMB to appreciate and in the process subsidize its export sector. But I doubt China sees it that way.

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