Sit back and relax: the US and China, this is gonna take awhile
China exported its way to a $2 trillion dollar fortress of F/X reserves ($USD mostly), while the US borrowed its way into a hole deep enough to spark a vast global recession. Who’s to blame?
Given the symbiotic relationship in the chart above, it’s hard to blame any one individual, group, or even country. But blame we do. Martin Wolf, at the Financial Times, wrote an interesting article about the need for a “co-operative adjustment” of global current account deficits and surpluses. He argues the following:
China’s exchange rate regime and structural policies are, indeed, of concern to the world. So, too, are the policies of other significant powers. What would happen if the deficit countries did slash spending relative to incomes while their trading partners were determined to sustain their own excess of output over incomes and export the difference? Answer: a depression. What would happen if deficit countries sustained domestic demand with massive and open-ended fiscal deficits? Answer: a wave of fiscal crises.
It sounds so imminent: re-balance now, or else. Sure the tides of portfolio flows must change; structural current account imbalances are now proven to cause economic catastrophe, as illustrated by the 2-yr case study of late. But it’s not going to happen over night. It takes a long time for re-balancing of any kind to fully pass through. Just look at Japan in the 1990’s.
Data note: you can download Japan Flow of Funds data here, and US Flow of Funds data here.
The chart above illustrates the debt bubbles in the US financial crisis and in 1990’s Japan. In Japan, the households didn’t accumulate as much debt relative to the non-financial business sector; however, both sectors dropped leverage. And notice, that it took about a decade for households and firms to do so.
What’s overly obvious is that the Chinese will not be bullied into revaluing the yuan just because the US says so. And also evident is that there is a (very lengthy) de-leveraging process underway in key economies. By default, the debt-reducing developed world will force the Chinese to focus policy more inward (domestic demand) and less outward (export demand), as US consumers drop debt levels. But sit back and relax, it’s gonna be a while.
Rebecca Wilder
But China is hurting other Asian exporters and Europe with their peg. Pressure to change could come sooner if things detiorate.
“Pressure to change”??!! Why should China do anything it doesn’t want to do? It is unquestionably in the driver’s seat and has all the power while the US has none. That is what is so frustrating to Americans used to giving orders to the world. It has now run up against an unmoveable object and periodically screeches and screams about it all to no avail. However much big bad Uncle Sam huffs and puffs he can’t blow the Chinese house down. And now the US, going around in confused circles with a failing President hated by large segments of the population because he is black and disrespected by many others for the same reason (never openly admitted of course) not able to get anything done, is slipping back relative to China every day. While Chinese growth will be around 9% this year and more next, the US will come in at around MINUS 3.3 growth for 2009 and probably hardly positive in 2010, assuming it doesn’t have a double dip recession. Oh….I forgot the US is bleeding money with an unwinnable war it can’t extricate itself from too. Scared of losing face.
hi downtownallday,
You bring up a good point – China’s peg certainly makes the region more rigid. But the transition is already underway.
South Korea and Indonesia, for example, are seeing real appreciation of their currencies. And Indonesia seems quite happy to let the rupiah appreciate in order to keep price pressures muted (good choice, economically). It’s different out there – but it will still take a very long time to switch trade flows. China has been building up its export sector for the last year and half – and for what? Change takes time.
Rebecca
Of course if the Yuan does not appreciate vs. the other Asian currencies, China will take exports away from those economies. I also forgot to add that Chinese public debt for 2008 was 15.6% of GDP and may well be less in 2009. Meanwhile US public debt is skyrocketing and is predicted to be 98.15% of GDP in 2010, thus limiting US options re the economy. Soverign risk looms for the USA while it is of no concern to China.
Given the symbiotic relationship in the chart above
It’s true: two series with a positive trend can be scaled so they line up on a graph. Hooray!
Seriously, the logic of the argument here is that the Fed policy is significantly limited by the balance of payments constraint. Where is the evidence for that?
I think” who to blame” is the wrong question. Who has been hurt?, might be a better one.
In the buildup of this trade “deficit” (why do we have this bad habit of listing voluntary trade imbalances and govt passing of financial assets to the private sector as deficits…………….sigh) we bought stuff that WE WANTED for prices we were willing to pay and the Chinese sold stuff they didnt want to keep for prices they were willing to accept. The Chinese then took their net dollars and bought US$ denominated financial assets that they wanted. How is this at all bad……………..for the US at least. Now, the chinese worker may eventually want to consume what he/she produces but right now they dont. When they start wanting their own stuff we’ll need a new source for our cheap goods.
We made mistakes by going in debt but most of that was to buy our own overpriced real estate.
I think “forced” rebalancing is crazy. Why does a trade relationship need to be balanced? As long as each side gets what it wants for a price it thinks is good who cares who has the bigger minus sign?
We do have to be ready for the day that China wants to consume more of its own output but that should not viewed as more or less balanced?
Now from what I understand (which is limited) about currency relationships, the Chines peg to our currency is hurting them more than it is hurting us. A sovereign currency issuer should never peg themselves to something out of their control as I understand it.
Margery
How does a public debt of 98% limit the US options? What is the proper amount of debt level?
Is the public debt actually a debt in the same sense that your mortgage is a debt? Why do we have sovereign risks that the Chinese dont have?
Looks like competitive devaluation to me.
Obviously the higher the total national debt the more dangerous it is. Debt requires servicing, payments that go to holder of the debt, and this compounds the problem. The higher the debt the more reluctant the government is to increase it further with more borrowing. What do you think all the fuss about the stimulus is about and why it is probably not greater than it is? Over debted nations’ bonds are riskier than those of nations with less debt, the rest being equal. S&P is considering lowering the UK’s credit rating due to excessive debt and perhaps that of the US too. Are your questions serious or are you just naive? I have no doubt the world would love to purchase more Chinese debt if it could. The credit of the Chinese government is super solid as is its currency.
TOKYO (Reuters) – Japan’s government agreed on a $81 billion stimulus package on Tuesday, aimed at preventing the economy from tipping back into recession as deflation persists and a strong yen threatens exports.
Japan | Economy
Economists said the 7.2 trillion yen plan, equal to about 1.5 percent of gross domestic product, would not provide a significant lift to an economy dependent on overseas demand for machinery, electronics and cars.
While several other economies are already debating phasing out economic stimulus deployed to fight the financial crisis, Japan continues to struggle amid chronically weak consumer demand and falling prices.
The budget underscores the balancing act faced by Prime Minister Yukio Hatoyama and his Democratic Party. The Democrats are keen to avoid a recession ahead of an upper-house election next year but are also under pressure to make good on their pledge of fiscal discipline as the country’s public debt nears 200 percent of GDP, by far the worst among G7 nations.
“This may help the economy somewhat,” said Yasunari Ueno, chief market economist at Mizuho Securities. “But it doesn’t even begin to address the more fundamental issues facing Japan, such as weaknesses in the global economy and deflation.”
This is a paltry stimulus and the reason it is so small and probably ineffective is the mountain of debt already bearing down on the Japanese government.
Margery,
Your understanding of China as displayed in comments here and on another post is not thorough enough.
Growth rates generally don’t have a positive trend. Rebecca
http://www.reuters.com/article/idUSTOE5BA06R20091211?type=usDollarRpt
Margery
Debt “servicing” payments are simply interest payments to bondholders, who have willingly accepted low yields for the safety. There is NEVER a danger of having too big a payment. The higher “debt” is complete misnomer. The debt is not owed it is owned, it is an asset not a liability.
http://neweconomicperspectives.blogspot.com/2009/11/memo-to-congress-dont-increase.html
The fuss about the stimulus is needless fearmongering by the “deficit terrorists” who understand not a whit about reserve banking operations, current account deficits, federal debt or how fiat money systems operate.
S&Ps ratings of credit are ……lets just say part of the problem. They dont understand the system either or they do but they are working for the autocrats (probably more true) Our ratings agencies SHOULD be sitting in a corner sucking their thumbs after the recent debacle that they put their AAA stamps of approval on. Please, none of us should give one shred of credence to what they say.
Chinas sovereignty is MUCH more at risk with all the US$ they hold and the fact that their currency is pegged to ours. Yes they are a cheap goods factory and growing by the minute but it is they who have more “risk” not us. When you are a currency issuer you can NEVER miss a payment in your currency but as soon as you start messing in other folks currency you are destabilizing your self.
Oh really. So China has more soverign risk than the USA? So its growth rate is not way above ours? So it is not better to have a low level of national debt than an extremely high one? So the Chinese economy is not performing better than ours? So the Japan’s recent stimulus is paltry? If I have to go back to find the sources for stories that are commonplace in the news, I would have little time for anything else. China bashing and putting down China is comforting to many Americans. I don’t engage in it. What precisely, if I may ask, it wrong with my “understanding” of China? I’d like some specifics for that charge.
I guess the US and UK have nothing to worry about and Moody’s is simply silly. It’s just as good to have extremely high levels of debt as low levels, right?
http://www.theglobeandmail.com/blogs/streetwise/sovereign-risk-remains-at-fore-as-moodys-cautions-on-us-uk/article1392377/
RE interest payments on the debt, you might read this before you call me ignorant:
http://en.wikipedia.org/wiki/United_States_public_debt
See section on interest payments. The higher the debt the higher the payments that tend to compete with other spending. I would have thought that obvious. Your claim that S&P doesn’t “understand” the system is laughable. So that is why people pay them vast sums for their work? By the way, if the holders of the debt demand their money or sell the debt to get the money I think you will find that “owning” it can be a problem. Or is all the talk of what might happen were China to begin to liquidate its holdings of US Treasuries, etc., just nonsense? I don’t see any articles re soverign risk for China, or “sovereignty” risk (whatever that is), as you put it. Where are they?
Hi Greg,
<<We made mistakes by going in debt but most of that was to buy our own overpriced real estate.>>
The Chinese (and Japan, of course) helped us here, too. You know they love the agency debt – gave a little extra spread for the same (or essentially the same) risk as a Treasury. Of course, the Chinese sold off most of their agency bonds and now own Treasuries again. That reminds me – I haven’t looked at the TIC data lately…must do that tomorrow.
Rebecca
The Chinese currency is forcibly held down by the government to keep it from appreciating. If that is not a strong currency, I don’t know what is. You think a currency that is begging, as it were, to appreciate is not stronger than one like the dollar that has constantly depreciated over the last eight or nine years? And that dollar holders worry about keeping its value. The only worry the Chinese have, aside from creating enough employment for their millions of workers, is that their hoard of dollar denominated bonds is depreciating or may depreciate further in value and they have said so.
So the US has no sovereign risk and it is not increasing? That is not what the insurance markets think:
On its face, the probability of the U.S. defaulting on its spiraling debts seems highly unlikely. But that’s not what the markets think. The price of insurance against such a default—using derivatives known as credit default swaps—has jumped by more than 50% in the private market in recent months. According to CMA DataVision in London, a specialist in these contracts, it will now cost you 0.34% of the principal per year to buy default insurance on U.S. government bonds. If you held $1 million in Treasurys, insuring against default would cost you $3,400 for the year. A few months back, insuring those bonds would’ve cost less than $2,000.
This is from the Wall Street Journal.
There are some certainties in life : Death, Taxes, and US Treasury Bond.
Fun things to know about the CDS on US Treasury bonds : the spread going up has NOTHING to do with the risk of US bond default increasing. Instead, the CDS were created because there is not enough US Treasury bonds for sale, so people jave to buy a derivative based on US Treasury Bond instead. An increase in spread means people are beginning to realize they really should be investing in something else.
The new PM of Japan adopted a ‘strong Yen’ policy as a way to increase the purchasing power of the ordinary Japanese. A weak yen may help with export, however increases the cost of imports, and Japan imports a lot of raw material.
Margery ,
First off I’ve enjoyed reading your comments on some of the other posts and I KNOW we will agree about most everything discussed in this blog. On this particular subject though I disagree with you and I’ll tell you why.
You are approaching this whole debt/trade deficit thing all wrong. Now, i didnt always understand this but over the last month or so I’ve been learning how wrong we ALL are about this whole debt/deficit discussion. I’ll direct you to the people who can speak much more in depth about this than I’m able if you wish, its absolutely stunning how twisted our economic conversations are. What I do understand is this. Government debt is not something we OWE is something we OWN. Its an asset. The only way to lower the debt is to take financial assets out of our hands. Do you want to give up anything you have? The politicians tell us we will HAVE to pay this back and its categorically false. There is not an IOU date.
If China liquidates their holdings the first thing that would happen is that the deficit/debt would go down. That alone should keep most of the debt terrorists happy. The second thing they would have to do is find something to do with their cash now. They could 1) Buy American goods; would anyone say that is a negative thing? Its stimulus AND it lowers the trade deficit 2) Bury it in the ground. Stupid on their part but no harm no foul 3) Buy an American non treasury security, anyhting “wrong” here?
4) Convert it to another currency but then whoever they trade currencies with has the same above options.
China liquidating is NOT a scary proposition for our general economy. Some bond trader might not get what he was hoping for but for the entire US domestic economy to be held hostage or forced into austerity because some bond trader doesnt want us to increase our national debt is insane. Those big boys make and lose billions every week BFD.
The rating agencies are in bed with the bond traders so while they do “understand” things (probably) they do slant things as well. They are talking their book so to speak.
There is no “right” or “wrong” amount of debt level. As its been explained to me, Our govt has to run an amount of debt high enough to meet the savings expectations of the private sector and offset any trade deficits. All this is(should be) done with an aim of full employment.
Unemployment is the worst thing an economy can have. The deficit terrorists want to scare you with inflation (think Al Qaeda here). That is their boogie man. Dont fall for it.
Margery
I also meant to add that I agree that China bashing is not only unhelpful but wrong. I dont think I engaged in any but maybe you werent directing that at me.
My comment about China is that they are playing a dangerous game by pegging their currency to ours. They are taking away some of their options in this floating exchange rate currency regime that much of the world is playing by. They are not hurting us but they are depriving their own citizens of some advantages in the name of becoming a manufacturing giant.
Hey Rebecca
You are right, we got lots of help………but we solicited it for the most part. We convinced them that Americans were suckers for real estate. They were convinced we all wanted to be little Donald Trumps and would spend every bit of our income not necessary to eat/drive/drink beer with on maintaining our mortgage payments.
http://news.yahoo.com/s/ap/20091211/ap_on_re_eu/eu_climate_china_us
According to the US negotiator in Copenhagen China has a “dynamic economy” and is “sitting on two trillion dollars of reserves”…so it is in danger of “soverign default”???? Hmmm… interesting.
Ronin…ah yes, commodities are extraordinarily important.
Margery,
You misinterepret…I never called you ignorant. That is you take on the matter. You asked if Rebecca was naive or could ask a serious question. Your presentation was by fiat and implied knowledge not demonstrated at that point in time. So I asked you to demonstrate.
You said China has all the power and the US has none…but you did not establish the point. The Chinese have their own quite serious economic contradictions to solve, which limits their options no matter what we do, so Rebecca’s point that it will take awhile is true. The round about trade talks will continue. The trend is becoming clearer, but none of this is even remotely guaranteed.
Thank you Greg.
Also, agreement is not necessary. It is a fluid situation…
a key to our own welfare with jobs anyway is to deal with the trade deficit and employment. China has a different approach than our so called free trade approach. There are some coastal cities that are a third migrant population to service factories and such…I doubt the democracies could handle such a situation. It looks as if China can, but only with tight control.
There is talk that coastal areas are resisting efforts to locate factories in interior areas such as Hunan, which the gov. is sponsoring. Such efforts are currently succeeding, so we see bigger income disparaties as part of their future.
The US gov. debt level is only one side of the issue, and US private debt is little discussed.
There is talk of a ‘basket of currencies’ as the trade currency for China, especially in Asia, but that is not imminent.
The US has set up its own contradictions and needs to respond to real problems concerning trade for its own citizens as part of the deal. Nations have become the arbiter of last resort for workers (wage, salaried and includes much more than the manufacturing sector), but we call these things trade deals.
A big worry is actually private healthcare debt, and the boomers will be only a small part of that given the status quo.
Actually Margery if you’ll read my post I never said China was in danger of sovereign default. They are however holding a lot of “someone elses” currency. As a rule if you only deal in your own currency you are much safer. I dont think either China or US is a default risk( in fact I know they arent as long as its in THEIR currency) BUT China is in a riskier currency position by accumulating all those US$.
Since we are such a safe investment though, no risk really.
That’s what I’d like to see:
The BRIC’s spend on upwards mobility and domestic demand.
The US taxes consumption (and the froth off the top of any new asset bubbles) and spends aggressively on R&D (and possibly shortens the work week or compresses tax brackets to attain a fiscally sound “full employment” in the meantime).
Let currencies float freely.
In a nutshell: Tax Away the Imbalances and Spend on Growth.
Well, China is still pursuing the policy of being a platform for exports. One can say the peg hurts them…but remember, if the gain is considerable FDI and a growing infrastructure. The cost of such in human terms will remain unkown for us for a long while.
But the Chinese beat us so far hands down through loopholes in WTO rules, rules which we thought would help us. What we did not count on is that international companies interests are not American oriented nor free trade oriented, and the emphasis on capital is beginning to put us at a disadvantage (relatively, of course, since we are still the big guy) but capital was our emphasis in the national dialogue…the road to success.
Globalization needs to include more than freedom of movement for capital as we will learn as a people. Some business folk will do much more than quite well.
How long will USD be reserve currency if china Unpegs yuan from USD? I think 5 yrs max. i think china is already buying resources all around the world and putting itself ready for unpeg. it would be fun to see people fleeing USD. Being a third person (not from USA or china) this is what i think would happen.
China knows well itself and the adversaries. As long as China’s economy will increase, they will stay in the status quo, but when the china’s economy growth will level at 3 percent increase or so, then will be the time to be worried. Unfortunately this will happen one day, and they will have nothing to lose but to win ….
Keep well in mind that, not long ago they were communists, and still remember the saying:
The proletarians have nothing to lose but their chains. They have a world to win. …