from Follow the Money

Memo to Kirstof: China has some responsibility for global imbalances too

May 30, 2005

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Nick Kristof accuses the US -- Democrats in Congress in particular -- of scapegoating China, and blaming China for global economic problems (more accurately, the risk of global economic problems) that fundamentally are made in America.

Alas, the U.S. is mostly to blame for this. And the biggest culprit of all is the demagoguery of some Democrats in Congress. There are plenty of legitimate reasons to be angry with China’s leaders, but its trade success and exchange rate policy are not among them. The country that is distorting global capital flows and destabilizing the world economy is not China but the U.S. American fiscal recklessness is a genuine international problem, while blaming Chinese for making shoes efficiently amounts to a protectionist assault on the global trade system.

(Emphasis added)

The structural US fiscal deficit certainly contributes to the imbalances that hang over the world economy. The fiscal deficit is falling a tad right now on the back of a real-estate induced boom in tax revenues (corporate tax revenue is also way up), but the same real estate boom also is making the US external deficit bigger. The kind of fiscal adjustment that will reduce the US external imbalance requires slowing US demand growth -- not just riding the wave of revenue that comes with a real estate boom.

I don’t necessarily like the way the American policy makers, Republicans and Democrats alike, have gone about trying to change China’s peg. The Bush Administration certainly has been more willing to blame China for the US trade deficit than to look in the mirror.

But China also bears some responsibility for current global imbalances. For every bad borrower, there is a bad lender.

Specifically, I think China’s leadership can be criticized for:

1. China’s consumption deficit. Chinese household consumption has not been growing as fast as Chinese income. Less domestic demand means that more of China’s productive capacity is devoted toward exports. The absence of stronger consumption growth in China (and the associated rise in Chinese savings and growing Chinese savings surplus) is a global problem -- and one that is not made in America. China’s consumption deficit (and the resulting savings surplus) is one reason why China’s 2005 current account surplus is likely to be around 8% of its GDP. China’s consumption deficit also is a potential problem for China: China is becoming dangerously dependent on continued growth in global demand to make up for a shortage of domestic demand.

2. Continuing to peg to the dollar after 2002, when the dollar started to decline v. range of other currencies. Up until 2002, a rising dollar meant a rising Chinese currency, which made sense given China’s rising productivity. After 2002, the dollar -- generally speaking -- has fallen. The result of a weaker dollar: a boom in Chinese exports to the world. After the dollar started to fall, China’s export growth rate accelerated to 30% annually. Goldman Sachs estimates the RMB has depreciated in real terms by about 15% since March 2002. And since the RMB -- unlike most other currencies -- has not appreciated against the dollar since 2002, China remains a very attractive location for production aimed at the US market. In 2003 and 2004, booming commodity imports (and rising commodity prices) kept China’s trade surplus for soaring. But now that the commodity boom has tapered off a bit and China has slowed credit growth to (perhaps) more sustainable levels, China has started to run a huge trade surplus. Jonathan Anderson of UBS estimates China’s trade surplus could reach $120b in 2005. It just doesn’t make sense for a country with a large trade surplus to peg to the currency of a country with a large trade deficit.

3. Imposing potentially large costs on China’s future taxpayers to subsidize current Chinese export growth. The US and the EU have long subsidized certain of their exports. Subsidized financing for purchasing commerical aircraft come to mind. If two rich countries compete by subsidizing a product that poor countries don’t produce, poor countries benefit, at least so long as they don’t run up too much debt (it is a bit more complicated if the poor country also produces the subsidized good). But a system where the taxpayers of poor countries subsidize consumers in rich countries is a bit perverse. Yet by rapidly building up its reserves, that is exactly what China is doing. Through its central bank, China’s government is lending to the US -- call it "vendor financing" -- on terms that virtually guarantee that China will lose money.

Coastal China’s export success does not stem entirely from the efficiency of its factories and the (unquestioned) drive of its people: China’s willingness to spend huge, right now truly huge, sums to keep its exchange rate from rising has something to do with it as well.

My core beef with Kirstof: US fiscal deficits are not entirely independent of China’s willingness to finance them. China, after all, has a certain amount of influence over US economic policy. It China’s leadership really wanted the US to reduce its fiscal deficit, I suspect it could bring about a change in the Treasury market that would make the ongoing US deficit a bit harder for politicians and market participants alike to ignore.

It is darn hard to generate political momentum to close the budget deficit when the emergence of $350-400 b (3.0-3.5% of GDP) fiscal deficits in GOOD times has not prevented (to say the least) a boom in the most interest sensitive sector of the economy. Higher mortgage rates are usually one way most Americans feel the "cost" of running large, sustained budget deficits. Thanks in no small part to financing from China’s central bank -- and the central banks of a bunch of other countries, whether oil exporters or Asian consumer goods exporters -- those fiscal deficits have coincided with low long-term rates. (See among others, Richard Duncan)

If China chooses to subsidize the US Treasury market (along with the Agency market, and probably the mortgage backed security market), doesn’t it also bear some responsibility for the resulting US recklessness? China’s 2005 reserve accumulation may not be that much smaller than the US 2005 fiscal deficit. That may explain why US policy makers talk more about a global savings glut than the hard choices required to close the fiscal deficit.

End note: Data on foreign demand for US Treasuries is found here -- but be warned, the data almost certainly understate China’s role in US markets. Reported Chinese purchases of US securities of all kinds lag well behind China’s reserve accumulation. And for an amazing graph showing the close linkage between rising foreign holdings of Treasuries and the increase in the stock of Treasury debt outstanding, see p. 12 of this presentation. A final aside: I don’t agree with Amity Shlaes’ argument that the current peg creates constructive ties between the US and China. I don’t the surplus and deficit countries should have the same monetary policy or the same exchange rate. I also think she exaggerates the risks of a (small) 10% move in the renminbi. After all, the renminbi has moved by about 7% against the euro already this year. But she is right to note that the US policy of trying to manage its complicated relationship with China by keeping each bilateral issue in its own separate "lane" is bound to create some confusion.

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