from Follow the Money

US economic policy does not pass the Chinese test

November 22, 2004

Blog Post
Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

You could sort of see this headline coming: China tells the US to put its house in order.

Lenders never like receiving lectures on sound economic policy from their borrowers.

John Snow might have been well served if had asked the Europeans to leave the G-20 meeting (temporarily) and then started his comments with "my creditors, thanks for $400 billion plus in 2003, and, I hope, something similar this year." As Steve Roach noted today, we need China to keep lending to us at low rates to keep our current credit fueled expansion going --

Still, it seems the Chinese are getting a bit cocky. We knew China was going after the Carolina (textiles) and even Ohio (autoparts). But Kansas and the rest of the agricultural Midwest? The logic behind the statement that "The appreciation of the RMB will not solve the problems of unemployment in the US because the cost of labour in China is only 3 per cent that of US labour they should give up textiles, shoe-making and even agriculture probably" is, I suspect, a bit off as well. Some agricultural production is labor intensive, and China may have an advantage -- apple picking and apple packaging, for example. But never underestimate the power (the efficiency) of a tractor, a combine and a big expanse of flat land ...

China is right to note that the US -- and US policy makers -- bear primary responsibility for the US trade deficit. But China also needs to recognize that the US cannot import more than it exports indefinitely. The explosive growth in China’s exports to the US will have to slow unless US exports to China really, really take off -- and it won’t happen unless the US exports a few things other than planes.

For the past ten years the US has consumed more than it produced. In one or another, the US and the world will have to adjust, now or later. Adjustment will likely require more than just a smaller US budget deficit; the real exchange rate also will need to adjust. Chinese wages won’t continue to be 3% of US wages forever. If the exchange rate stays constant, the adjustment will come through some combination of Chinese inflation and US deflation. Far better, in my view, to let the exchange rate move.

China is right to note that the process of closing the current account deficit will be much harder if the US does not get its house in order: even considering ways of excluding the extra borrowing needed to finance the partial privatization of Social Security from the reported budget deficit sends the wrong message. Borrowing is borrowing; someone still has to lend you the money, accounting gimmick or not. But I hope China’s policy makers also recognize that it is in their own interest to think through the steps they can take to support domestic Chinese demand should US ever start taking their advice to tighten its belt.