Hey, remember when I said that China's debt holdings did not pose a serious threat to the United States? And remember when I banged my head against the desk because Very Serious People continue to insist otherwise?
I bring this up because, according to Bloomberg's Tony Capaccio and David Kruger, the Department of Defense has my back:
China's holdings of more than $1 trillion in U.S. debt and the prospect that it might “suddenly and significantly” withdraw funds don’t pose a national security threat, according to a first-ever Pentagon assessment.
“China has few attractive options for investing the bulk of its large foreign exchange holdings out of U.S. Treasury securities,” given their extent, according to the report dated July 20 and obtained by Bloomberg News
China is the second-largest holder of U.S. government debt after the Federal Reserve. Acting at the direction of Congress, the Defense Department studied the rationale behind the investments and whether “the aggressive option of a large sell- off” would give China leverage in a political or military crisis. China’s debt holdings have been cited as a sign of U.S. vulnerability by Republicans in this year’s election campaign....
“Attempting to use U.S. Treasury securities as a coercive tool would have limited effect and likely would do more harm to China than to the United States,” according to the report, which was sent to congressional committees by Defense Secretary Leon Panetta. “As the threat is not credible and the effect would be limited even if carried out, it does not offer China deterrence options” in a diplomatic, economic or military situation, the Pentagon found....
China decreased its Treasury holdings last year with little apparent impact in the market, Treasury data show. The world’s most populous country reduced its position in Treasuries in the first yearly decline since Bloomberg began tracking the data in 2001.
The holdings declined 0.7 percent, or by $8.2 billion, to $1.15 trillion last year. The decline was much steeper in the second half of the year when China’s stake plunged 12 percent, or by $163 billion, from an all-time high of $1.31 trillion in July 2011, the data show.
During that period, 10-year Treasuries rallied as the U.S. credit rating was reduced by Standard & Poor's to AA+ from AAA and the European sovereign debt crisis worsened, pushing the yield to 1.88 percent from 2.80 percent.
Foreign investors held 50.3 percent of the $10.52 trillion in outstanding Treasuries as of June, government data show. That’s down from April 2008, when they reached 55.7 percent of the $4.64 trillion in U.S. marketable debt....
The Pentagon said in its report that the Fed also is “fully capable of purchasing U.S. Treasuries dumped” by China and “reducing the economic impact.”
A Chinese move to “suddenly and significantly” reduce its Treasury holdings “would fundamentally change the international finance and business community’s perception of China as a reliable and respected economic and financial partner,” the Pentagon said.
This report isn't going to end the silly campaign rhetoric or the Niall Ferguson/Tom Friedman foreign policy community talking point, of course. But I thought it was worth posting here so I can link back to it the next time I need to bang my head against a desk.
If you're an American and want o worry about China, don't focus on the debt -- focus on the apparent disappearance of China's next leader.
For the past two years, staunch monetarists and economic conservatives have warned about the evils of massive deficit spending and quantitative easing. They have argued that such policy measures are inevitably inflationary and will debase the currency and raise nominal interest rates. By and large, supporters of Keynesian policies have responded by loudly pointing to the data on core U.S. inflation and the dollar's performance as falsifying the conservative argument. And, by and large, they have a point. If inflationary concerns really were prominent, the dollar should have depreciated in value an awful lot, and nominal interest rates should have soared. Neither of these things have happened. Point for Keynesians.
Right now, however, markets are providing a pretty powerful data point for Tea Party supporters who argue that hitting the debt ceiling is not the end of the world. Last week Moody's issued the following warning:
Moody's Investors Service said today that if there is no progress on increasing the statutory debt limit in coming weeks, it expects to place the US government's rating under review for possible downgrade, due to the very small but rising risk of a short-lived default. If the debt limit is raised and default avoided, the Aaa rating will be maintained. However, the rating outlook will depend on the outcome of negotiations on deficit reduction. A credible agreement on substantial deficit reduction would support a continued stable outlook; lack of such an agreement could prompt Moody's to change its outlook to negative on the Aaa rating.
Although Moody's fully expected political wrangling prior to an increase in the statutory debt limit, the degree of entrenchment into conflicting positions has exceeded expectations. The heightened polarization over the debt limit has increased the odds of a short-lived default. If this situation remains unchanged in coming weeks, Moody's will place the rating under review.
Make fun of the ratings agencies all you like, but this was front-page news last week. One would think that markets would be pricing in the possibility of institutional investors diversifying away from dollar-denominated debt, a collapse in the dollar, skyrocketing interest rates, a drastic reduction in nominal GDP, dogs and cats living together, and so forth. Or, as Tim Geithner put it, "catastrophic economic and market consequences."
And yet.... last week, the yield on 10 year Treasuries fell below three percent. Maybe markets are underestimating the likelihood that a debt ceiling deal won't happen, maybe they are underestimating the damage caused by hitting the debt ceiling, or maybe they think the Chinese will continue to buy dollar-denominated debt no matter what happens on the debt ceiling (though read this). Or... maybe the Tea Party activists have a point.
So, my question to readers, investors, and experts on the global political economy -- why aren't markets freaking out more about the rising probability of hitting the debt ceiling?
In my last post I mentioned how China was encountering resistance to its rising power. Now, via Kindred Winecoff, I see a whole mess of reportage about China's mounting internal difficulties. In no particular order:
1) Nouriel Roubini has focused his Dr. Doom-O-Vision on the Middle Kingdom, and doesn't like what he sees:
China’s economy is overheating now, but, over time, its current overinvestment will prove deflationary both domestically and globally. Once increasing fixed investment becomes impossible – most likely after 2013 – China is poised for a sharp slowdown. Instead of focusing on securing a soft landing today, Chinese policymakers should be worrying about the brick wall that economic growth may hit in the second half of the quinquennium....
[N]o country can be productive enough to reinvest 50% of GDP in new capital stock without eventually facing immense overcapacity and a staggering non-performing loan problem. China is rife with overinvestment in physical capital, infrastructure, and property. To a visitor, this is evident in sleek but empty airports and bullet trains (which will reduce the need for the 45 planned airports), highways to nowhere, thousands of colossal new central and provincial government buildings, ghost towns, and brand-new aluminum smelters kept closed to prevent global prices from plunging.
Commercial and high-end residential investment has been excessive, automobile capacity has outstripped even the recent surge in sales, and overcapacity in steel, cement, and other manufacturing sectors is increasing further. In the short run, the investment boom will fuel inflation, owing to the highly resource-intensive character of growth. But overcapacity will lead inevitably to serious deflationary pressures, starting with the manufacturing and real-estate sectors.
Eventually, most likely after 2013, China will suffer a hard landing. All historical episodes of excessive investment – including East Asia in the 1990’s – have ended with a financial crisis and/or a long period of slow growth. To avoid this fate, China needs to save less, reduce fixed investment, cut net exports as a share of GDP, and boost the share of consumption.
The trouble is that the reasons the Chinese save so much and consume so little are structural. It will take two decades of reforms to change the incentive to overinvest.
Now, Roubini is enough of a persistent doomsayer that it would be easy to discount this argument -- if it wasn't for the fact that this jibes with the opinion of other China economy-watchers. This coming-bust prophesizing comes on top of arguments made by Barry Eichengreen, Donghyun Park and Kwanho Shin that as China hits middle-income status, it will hit a "middle income trap" of slower growth. (One interesting question is whether, as China encounters rampant inflation, its eventual decision to let the RMB appreciate will help ease some of these pressures).
2) Meanwhile, China's political leadership appears to be engaged in a full-fledged freakout over the Arab revolutions and any whisper of a similar phenomenon happening in China. Rising food prices are leading to price controls and an anxious government monitoring if/when more expensive staple goods lead to political unrest. That said, Chinese authorities seem to be on top of the whole crushing dissent thing:
According to Chinese Human Rights Defenders, an NGO, by April 4th some 30 people had been detained and faced criminal charges relating to the so-called “jasmine revolution”—an inchoate internet campaign to emulate in China recent upheavals in the Middle East and north Africa. Human Rights Watch, another NGO, reports that a further 100-200 people have suffered repressive measures, from police summonses to house arrest. This has been accompanied by tighter censorship of the internet, the ousting of some liberal newspaper editors, and new curbs on foreign reporters in China, some of whom have been roughed up....
Even more worrying, however, is the increasing resort to informal detentions, punishments and disappearances. These are outside the law, offering the victim no protection at all. The government now dismisses the idea that one function of the law is to defend people against the arbitrary exercise of state power. On March 3rd a Chinese foreign-ministry spokeswoman told foreign journalists: “Don’t use the law as a shield.” Some people, she said, want to make trouble in China and “for people with these kinds of motives, I think no law can protect them.”
3) As for China's assessment of its external security situation, the State Council released its 2010 White Paper on defense last month. As this East Asia Forum summary suggests, there's a slight change in tone from the 2008 white paper:
The introductory assessment of the ‘security situation’ section notes that the ‘international balance of power is changing,’ that ‘international strategic competition centring on international order, comprehensive national strength and geopolitics has intensified,’ and that ‘international military competition remains fierce.’ Despite this sense of turbulence, and as was the case in 2008, the 2010 paper assesses that ‘the Asia Pacific security situation is generally stable.’ But the additional observation in the 2008 paper, namely, ‘that China’s security situation has improved steadily’ does not appear in 2010. One possible reason is that the 2010 paper reports that ‘suspicion about China, interference and countering moves against China from the outside are on the increase.’
In light of all these developments, yesterday's Economist editorial should come as no surprise:
The view from Beijing, thus, is different to the view from abroad. Whereas the outside world regards China’s rulers as all-powerful, the rulers themselves detect threats at every turn. The roots of this repression lie not in the leaders’ overweening confidence but in their nervousness. Their response to threats is to threaten others.
Now, as someone who's pointed out these problems on occasion on this blog, you might think I'm pleased as punch about these developments. Nope. First, from an economic standpoint, a recessionary China eliminates a vital engine of global economic growth. Second, as I wrote back in January:
Exaggerating Chinese power has consequences. Inside the Beltway, attitudes about American hegemony have shifted from complacency to panic. Fearful politicians representing scared voters have an incentive to scapegoat or lash out against a rising power -- to the detriment of all. Hysteria about Chinese power also provokes confusion and anger in China as Beijing is being asked to accept a burden it is not yet prepared to shoulder. China, after all, ranks 89th in the 2010 U.N. Human Development Index, just behind Turkmenistan and the Dominican Republic (the United States is fourth). Treating Beijing as more powerful than it is feeds Chinese bravado and insecurity at the same time. That is almost as dangerous a political cocktail as fear and panic.
Developing.... in very disturbing ways.
With the government not shutting down and all, Washington can now look forward to the next moment of Gotterdammerung, which is when the debt ceiling has to be raised. By risking minor things like the full faith and credit of the United States, that kind of shutdown really would have serious foreign policy implications.
That said, there is another possibility on the horizon -- a grand bargain on long-term fiscal rectitude. The good news is that there really is a bargaining core among the major players on entitlement reform, budget cuts, and tax reform. The bad news is that one could say the same thing about an Israeli/Palestinian peace deal, and look how that's playing out. The follow-up good news is that I think there are political reasons to be more optimistic about the U.S. situation.
Seasoned DC-watchers might immediately laugh at the prospect of the kind of bipartisan brand bargain on fiscal policy that hasn't been seen since the days of Gramm-Rudman-Hollings and the 1986 tax reform bill. That said, I think a bargain can be struck for the simple reason that there is at least a general consensus that the long-term fiscal picture for the United States is really daunting and in dire need of proactive policy measures. This jibes with U.S. public opinion on the question. The biggest question is what mix of spending cuts need to be taken -- though I think the fiscal picture is sufficiently dire such that there's gonna have to be serious steps taken in all possible spending spheres (Social Security, Medicare, Medicaid, discretionary domestic spending, Defense spending). The combination of the Bowles-Simpson deficit commission, Paul Ryan's proposed budget, and Obama's scheduled Wednesday address means there will be multiple proffers on the table, so at least there are concrete measures to talk about.
Furthermore, the tax code has gotten so complicated that there's actual room for a tax deal that would simultaneously raise revenues but be palatable to Republicans. For all the debate over raising or lowering tax rates, the key problem is that tax revenues as a percentage of GDP are at postwar historic lows. If distortionary loopholes were eliminated, it would be possible to keep marginal tax rates where they are, or even lower them, while still raising revenues.
Finally, the economic argument against fiscal tightening is that the economy is still in recession, except that's not really true. The economy has been growing at a steady clip for a yeat now. The real concern is the job picture, but if last month's numbers are suggestive of a more robust turnaround, then this would be exactly the moment to rein in spending and signal to financial markets that fiscal probity is coming.
So I think a grand bargain is possible. Now, the natural rejoinder to this is that the partisan split in Washington is too great for bipartisanship to work, the Tea Party will be unyielding, yadda, yadda, yadda. This is a possibility. It's certainly true that the last time something on this scale was attempted, in 1993, it was a straight partisan vote. If the Obama administration and GOP members of Congress see this as a zero-sum game that ends with the 2012 election, then no bargain will be struck.
There are two political reasons why I'm more optimistic this time around -- although these reasons normally don't count for much in political science. First, the personalities of the key players suggest that they want to make a deal. Barack Obama was the happiest I'd seen him in a long time when he announced on Friday night that a budget deal had been struck. John Boehner, and his staff, set a nice precedent of being able to bargain with the Democrats while holding his caucus together, and earned some praise from Democrats for his dealmaking. The personal inclinations of the pcvotal actors are biased towards cutting a deal. [But what about the Tea Party?!--ed. See this Dave Weigel post.]
Second, I think it's beginning to occur to GOP legislatures that their crop of 2012 presidential camdidates really and truly stinks:
A presidential primary favorite is emerging among the ranks of congressional Republicans: none of the above.
The dissatisfaction with the likely GOP field — long whispered among party activists, operatives and elected officials — is growing more audible in the House and Senate.
Interviews on both sides of the Capitol have revealed widespread concern about the lackluster quality of the current crop of candidates and little consensus on who Republican senators and House members would like to see in the race.
It's early, and the fundamentals suggest that the eventual GOP nominee might make it a close race, but still -- whoever gets the nomination is gonna have to run against a sitting president who's still surprisingly popular given the state of the economy.
If GOP legislative leaders calculate that they can't win back the White House in 2012, their preference flips over to cutting a deal with the Obama administration. Bipartisan deals help incumbents and hurt challengers, which means that in cutting a deal, the House Republicans would help Obama while helping themselves. That's not their first option, but in a political climate when Donald Trump can poll second in New Hampshire by embracing the birthers, it's not the worst calculaion either.
I look forward to commenters telling me how wrong I am about this. But let me close this post by pointing out something that I think is obvious but might pass by some foreign policy pundits
who get scared by economics that tend to focus more on matters of hard security. From a foreign policy perspective, whether or not a Grand Bargain can be struck is of far more importance than whether or not there's such a thing as an Obama Doctrine. Over the long term, America's hard power and soft power resides in its economic vitality. A close reading of Obama's rhetoric suggsts that he gets this point. It will be very interesting to see if he decides to invest his political capital in cutting a deal.
Last week Reuters' Emily Flitter filed quite the story, entitled "China flexed its muscles using U.S. Treasuries ," about China's financial power over the United States. Here's the opening:
Confidential diplomatic cables from the U.S. embassies in Beijing and Hong Kong lay bare China's growing influence as America's largest creditor.
As the U.S. Federal Reserve grappled with the aftershocks of financial crisis, the Chinese, like many others, suffered huge losses from their investments in American financial firms -- from Lehman Brothers to the Primary Reserve Fund, the money market fund that broke the buck.
The cables, obtained by WikiLeaks, show that escalating Chinese pressure prompted a procession of soothing visits from the U.S.Treasury Department. In one striking instance, a top Chinese money manager directly asked U.S. Treasury Secretary Timothy Geithner for a favor.
This story generated a lot of interest across the mediasphere. FT Alphaville called it "Diplomacy by US Treasuries." AFP reports that the "sensitive cables show just how much influence Beijing has and how keen Washington is to address its rival's concerns."
As someone who's published on this question, you'd think I'd be very happy at the attention this issue is receiving. And Flitter deserves kudos for going through the cables to find clear efforts by Chinese officials to use its financial muscle to get what it wanted from the United States.
The thing is, the reportage is framed to suggest that China not only asked for concessions, but the United States granted them. And Flitter's own story suggests that very little in the way of concessions actually happened.
Here are the portions of Flitter's story that discusses U.S. responses to Chinese pressure:
On Chinese requests to halt/restrict arms sales to Taiwan: Flitter records no response. These concerns were voiced in late 2008 and the arms sales went ahead in early 2010, so there doesn't appear to be much influence here. AFP suggests that this pressure led the U.S. to not sell F-16's to Taiwan, but I don't think that option was ever in the cards.
On Chinese demands that they be provided guarantees for Chinese re-entry into the U.S. repo market:
The U.S. government does not appear to have offered the Chinese a special setup guaranteeing U.S. banks. Instead, the cables show, American diplomats reassured the Chinese by pointing out that Washington had infused banks' balance sheets with $700 billion in fresh capital, effectively propping up the banking system.
On Chinese demands for providing explicit U.S. government guarantees of Fannie Mae and Freddie Mac debt:
To defuse the situation, the Treasury Department sent Undersecretary for International Affairs David McCormick to Beijing for two days in October 2008. The gesture went over well.
"All of Undersecretary McCormick's counterparts appeared to appreciate his willingness to come to Beijing in the midst of a financial crisis," Piccuta wrote in a cable dated October 29, 2008. "Interlocutors stressed that unless leaders' concerns about the viability of banks and U.S. government-sponsored enterprises (GSEs) are assuaged, lower-level officials will be constrained from taking on greater counter-party risks."
The cables show McCormick trying to reassure the Chinese. "In each meeting, Undersecretary McCormick emphasized that even though the U.S. government did not explicitly guarantee GSE debt, it effectively did so by committing to inject up to $100 billion of equity in each institution to avoid insolvency and that this contractual commitment would remain for the life of these institutions," [Deputy Chief of Mission at the U.S. Embassy in Beijing Dan] Piccuta wrote.
On Chinese protests regarding Federal Reserve purchases of Treasuries and agencies in March 2009: Flitter has no response, though the fact that the Fed went ahead with QE2 suggersts that Chinese pressure didn't deter the Federal Reserve.
On responses to Chinese requests that CIC be allowed to participate in bidding on Morgan Stanley's new equity issuance:
There's no record in the cable of how Geithner responded, but it was only a day later, on June 3, that CIC announced plans to purchase $1.2 billion in Morgan Stanley shares.
A spokesperson for the Fed said in the instance of the June 3 CIC investment, no application for an exemption was made to the Federal Reserve Board.
On the general dynamic of Chinese financial pressure:
The cables also indicate a high level of confidence among the Americans that China can't entirely stop buying U.S. debt, a sentiment shared by most economists who describe the dynamic as a form of mutually assured financial destruction.
So, to sum up, the Chinese maybe got a small break on being able to particupate in the Morgan Stanley auction. Beyond that, all of these efforts led to the dilomatiic equivalent of hand-holding and not much else. And, hey, what do you know, that's pretty much consistent with what I wrote about this back in late 2009. So, contrary to some deep-seated fears of mine, the Wikiliaks cables appears to buttress rather than contradict prior scholarship.
Flitter deserves credit for making explicit what had only been inferred, but I'm worried that commentators are drawing the wrong lessons from her article. The big reveal here is not that China tried to exercise its financial muscle. The big reveal is that these efforts generated next to nothing in the way of U.S. concessions. China's financial might does give it the ability to deter U.S. pressure -- but to China's growing frustration, it doesn't yield much else.
Earlier this week Treasury Secretary Timothy Geithner went to Brazil as part of a long-running effort to get that country to pressure China on its exchange-rate policy. This effort had yielded some marginal successes in the past, but it had also yielded comments like Brazilian Foreign Minister saying: "I believe that this idea of putting pressure on a country is not the right way for finding solutions. We have good co-ordination with China and we've been talking to them. We can't forget that China is currently our main customer (emphasis added)."
The mild surprise is that Geithner's plea appeared to find a receptive audience in Brasilia. From the Financial Times' Joe Leahy:
Any alignment with the US on the issue of China’s currency would mark a fundamental shift for Brazil. Luiz Inácio Lula da Silva, Brazil’s previous president, had pursued a trade policy that was partially dictated by his vision of a grand “south-south” alliance among developing countries.
His pragmatic successor, Dilma Rousseff, is more concerned that Brazil exports primarily commodities to China while its domestic manufacturing industry is being undermined by a strong exchange rate and cheap imports.
Ms Rousseff has also toned down her predecessor’s criticism of US monetary policy, which Mr Lula da Silva’s administration blamed for exacerbating global capital flows....
One person familiar with the government’s stance said Brazil was considering a public declaration on global imbalances and China’s undervalued currency during Mr Obama’s visit.
“The idea is we might issue a communiqué in which maybe we can work in common language to try to stress this matter,” the person said.
What's going on? A few things. First, it's probably true that this shift won't amount to all that much in terms of affecting China's policies. Second, this is an effective way for Rousseff to distinguish herself from Lula, and she's backing up the rhetorical shift with action items. Third, Lula's foreign policy on this point was always based more on old-fashioned third world solidarity than anything approximating Brazil's national interest. Not that Lula's foreign policy was all that bad, mind you, but this seems more like a return to Brazil's equilibrium set of interests.
If the Obama administration was smart, they would capitalize on this newfound friendship with Latin America's largest country with some big, meaningful and yet highly symbolic foreign policy initiative. If only there was some moribund-yet-highly-useful foreign policy initiative that would cement the relationship. But that's just crazy talk.…
I'm at the point in my life when there are only three occasions that prompt the watching of cable news:
1) An election night;
2) A real-time breaking news event in which video has a comparative advantage over the web;
3) Being on the treadmill on a slow sports day with nothing good on basic cable.
So yesterday was no. 3, and I caught a report on Fox News about "pre-summit brinkmanship" on the part Hu Jintao. The headline was accurate: "China's President Hu Jintao: Dollar-Based System 'Thing of the Past.'" And I should stress that Fox News was hardly the only news outlet to jump on this turn of phrase.
That said, some perspective might be in order. The statement came from a
series of answers that
a committee of propaganda writers with the
stylistic panache of Andrei Gromyko Hu provided to the Wall
Street Journal and Washington
Let's reprint the question and answer in full, shall we?
Q: What do you think will be the US dollar's future role in the world? How do you see the issue of making the RMB an international currency? Some think that RMB appreciation may curb China's inflation, what's your view on that?
HU: The current international currency system is the product of the past. As a major reserve currency, the US dollar is used in considerable amount of global trade in commodities as well as in most of the investment and financial transactions. The monetary policy of the United States has a major impact on global liquidity and capital flows and therefore, the liquidity of the US dollar should be kept at a reasonable and stable level.
It takes a long time for a country's currency to be widely accepted in the world. China has made important contribution to the world economy in terms of total economic output and trade, and the RMB has played a role in the world economic development. But making the RMB an international currency will be a fairly long process. The on-going pilot programs for RMB settlement of cross-border trade and investment transactions are a concrete step that China has taken to respond to the international financial crisis, with the purpose of promoting trade and investment facilitation. They fit in well with market demand as evidenced by the rapidly expanding scale of these transactions.
China has adopted a package plan to curb inflation, including interest rate adjustment. We have adopted a managed floating exchange rate regime based on market supply and demand with reference to a basket of currencies. Changes in exchange rate are a result of multiple factors, including the balance of international payment and market supply and demand. In this sense, inflation can hardly be the main factor in determining the exchange rate policy (emphases added).
Meh. First of all, Hu isn't saying anything here that hasn't been said by other Chinese officials since early 2009.
Second of all, Hu didn't say that the RMB was going to be supplanting the dollar anytime soon. In fact, he pretty much said the opposite of that. China wants a multiple-reserve currency regime, and they're moving veeeerrrrrry slowly to bring their currency into the conversation. And minus the RMB, as I've said before, there ain't much in the way of viable alternatives right now.
If you read the rest of the answers, there's a lot of
"stiffly worded answers" mixed in with "a positive note on
bilateral ties," as Richard MacGregor of the Financial Times notes.
What I don't see is any brinkmanship.
Substantively, however, what about the future? Will a multiple currency reserve system work? It's a vision shared by Barry Eichengreen, Nicolas Sarkozy, and.... well, I'm not sure who else. I have my doubts, but I can't quite convey them in a single blog post.
What do you think?
In an ironic twist of fate, I don't have the time to fully comment on the global political economy of the G-20 summit outcomes (except to say I told you so) because… er… I'm attending a global political economy conference.
So talk amongst yourselves about the
massive fail demonstrably non-cooperative outcome to answer the following query: Who wins and who loses in a world of non-cooperation? And if the G-20 countries can't agree on what they're supposed to negotiate, what will they talk about instead?
You know, as insults go, this one is pretty bush league:
China's credit-rating agency on Tuesday downgraded its rating for U.S. sovereign debt and warned of further cuts, in a pointed move ahead of this week's Group of 20 major economies meeting.
Dagong Global Credit Rating Co. Ltd., the only wholly Chinese-owned rating agency, cut its rating on U.S. debt to A from AA, citing the Federal Reserve's move last week to initiate another round of asset buying, worth $600 billion. It also placed the U.S. sovereign credit rating on negative watch.
"The new round of quantitative easing monetary policy adopted by the Federal Reserve has brought about an obvious trend of depreciation of the U.S. dollar and the continuation and deepening of credit crisis in the U.S.," Dagong said.
"Such a move entirely encroaches on the interests of the creditors, indicating the decline of the U.S. government's intention of debt repayment," the agency said.
Sounds very, very serious, until we get to this part of the story:
The downgrade of the U.S. rating by Dagong comes just over a month after the U.S. Securities and Exchange Commission denied the firm's application to officially rate bonds in the U.S.
At that time, Dagong called the SEC's move discriminatory and said it was considering legal action.
The SEC said in denying the application that "it does not appear possible at this time for Dagong to comply with the record keeping, production and examination requirements of the federal securities laws."
Indeed, even the New York Times' now-thrice-weekly story about rising Sino-American tensions observes:
In the rest of the world, the United States is still the strongest of credit risks, and the Chinese downgrade is not expected to have much real impact....
[T]hose critics, mostly countries that fear that recent American policy will devalue the dollar and undercut their competitiveness, do not appear poised to offer an alternative to an economic order that has been led by the United States since the end of World War II, or to the role the dollar has played for decades as the de facto world gold standard.
The Chinese, who have protested that the Federal Reserve is trying to unilaterally manipulate the dollar for the purpose of creating jobs at home, have been accused of doing exactly that for years - the root of many of the world's economic tensions today, in the eyes of Mr. Obama and his economic aides.
Look, clearly China is suffering from... an insult gap. Americans have been leading the world in trash-talking for decades now. China is trying hard to catch up, but I think the authorities in Beijing need some assistance in their game of catch-up.
I hereby call on all readers to offer, in the comments, ways that Chinese authorities can really sharpen their rhetorical jabs at the United States. In the spirit of kicking off the conversation, here are a few suggestions:
"Chinese Halitosis Institute Downgrades American Fresh Breath Index to BB: 'Seriously, What's The Deal With All The BBQ,' Asks Agency Head"
"Chinese Election Monitors Accuse Obama Administration of Rampant Ballot Fraud During Midterm Elections: 'It's No Myanmar, I'll Say That' According to Chief Monitor"
"Chinese Dietary Institute says American Food Leaves Them Hungry After Only 12 Hours"
Go to it.
The unholy trinity in open economy macroeconomics is pretty simple. It's impossible for a country to do the following three things at the same time:
1) Maintain a fixed exchange rate
2) Maintain an open capital market
3) Run an independent monetary policy
One of the issues with macroeconomic policy coordination right now is that different countries have chosen different options to sacrifice. China, for example, has never opened its capital account. The United States, in pursuing quantitative easing, has basically chucked fixed exchange rates under the bus, no matter how many times Tim Geithner utters the "strong dollar" mantra
in his sleep to reporters.
These policies are generating a fair amount of blowback from the rest of the world, forcing President Barack Obama to defend the Fed's actions. And it appears that the developing countries are mostly following China's path towards regulating their capital account to prevent exchange rate appreciation and the inward rush of hot money.
How does this end? I think it's gonna end with a lot more capital controls for a few reasons:
1) It's the political path of least resistance;
2) Capital controls are seen as strengthening the state;
3) The high-growth areas of the world don't need a lot of capital inflows to fuel their continued growth.
What intrigues me is how the financial sector responds to a situation in which their freedom of action in emerging markets becomes more and more constrained. It's possible that they could pressure the Fed to change its position in the future. It's also possible, however, that big firms could see these controls as a useful barrier to entry for new firms.
My money is on the former response, however.
According to Bloomberg, Brazilian Finance Minister Guido Mantega would like the real to stop appreciating and for the rest of the world to cooperate on currency matters:
Brazil's real dropped the most in two weeks after Finance Minister Guido Mantega raised taxes on foreign inflows for the second time this month to prevent appreciation and protect exports from what he called a global "currency war."
Brazil, Latin America’s largest economy, raised the so- called IOF tax on foreigners' investments in fixed-income securities to 6 percent from 4 percent. It also boosted the levy on money brought into the country to make margin deposits for transactions in the futures market to 6 percent from 0.38 percent…
"This currency war needs to be deactivated," Mantega told reporters. "We have to reach some kind of currency agreement.” …
Mantega cited the Plaza Accord of 1985, when governments agreed to intervene to devalue the U.S. dollar against the yen and the German deutsche mark, as the kind of agreement that might be required. International policy makers failed to narrow their differences on intervention in currency markets during the International Monetary Fund’s annual meeting this month.
Hey, you know, I bet the G-20 would be a decent forum for Mantega to foster this kind of cooperation. It's a good thing that there's a G-20 Finance Ministers meeting this weekend in Seoul.
Brazilian Finance Minister Guido Mantega will not attend a meeting of Group of 20 member-country finance officials in South Korea this week, a Finance Ministry spokesman said Monday.
The spokesman said Mantega would remain in Brazil while the government studies possible introduction of foreign exchange policy measures to curb the strengthening of the country's currency, the real.
Brazil's government will be represented at the meeting by Finance Ministry International Affairs Secretary Marcos Galvao and Central Bank International Affairs Director Luiz Pereira.
Is this rank hypocrisy by Mantega? Not entirely. It's something worse -- a judgment by Brazil's policy principals that more will be accomplished by staying in Brasilia to stem the tide of inward capital flows than to go to Seoul to seek a multilateral solution to the current lack of macroeconomic policy coordination.
There's plenty of blame to go around on this, but if Brazil thinks the G-20 is not going to accomplish much… then the G-20 is a dead forum walking.
The past week has seen an escalating series of news stories about a looming "currency war," as country after country tries to drive their currency downward, the United States blames China as the source of original sin on this, and China
pisses off yet another country responds by digging in its heels, and the IMF wrings its hands.
If you need to read one article on why things are going down the way they are, it's Alan Beattie's excellent survey in the Financial Times of how countries as responding to this situation:
Washington is looking for allies -- particularly among the emerging economies, who complain about their own competitiveness and volatility problems -- in its campaign for exchange rate flexibility. Trying to take on Beijing single-handed makes the US vulnerable to the charge that it is a lone complainant blaming its own profligate shortcomings on the country that is kind enough to lend it money, holding the best part of $1,000bn in U.S. Treasury bonds…
Yet despite U.S. claims of broad support, backing appears sporadic…
[S]ome U.S. policymakers privately complain that European backing is patchy and tends to go up and down with the euro. In the first half of the year the euro was pushed lower by the gathering Greek crisis, by early summer falling 17 per cent below its January level. Focused on local difficulties, and with the German export machine powering ahead, European officials saw little need to take on Beijing over currencies and had little energy to do so…
Across the emerging economies, the plan of attack seems to be to keep quiet and pass the ammunition. Despite widespread recognition of the distortions China’s exchange rate policy appear to be causing, governments have generally preferred unilateral intervention to a public slanging match.
True, in April the governors of the Reserve Bank of India and the Central Bank of Brazil complained that Beijing was hurting their exporters.
But recently Celso Amorim, Brazil’s foreign minister, told Reuters: "I believe that this idea of putting pressure on a country is not the right way for finding solutions." Significantly, he added: "We have good co-ordination with China and we’ve been talking to them. We can’t forget that China is currently our main customer…"
With the prospect of diplomatic progress limited, currency policy in the U.S. and Europe may end up being conducted through domestic monetary policy. If, as seems possible, the U.S. Federal Reserve, the Bank of Japan and the European Central Bank return to quantitative easing in order to boost growth, their currencies are likely to weaken -- as the yen briefly did after the Bank of Japan’s announcement of looser monetary policy this week.
So, to sum up:
1) Every country is free-riding/buckpassing on this issue, hoping that the United States can dislodge China on its own.
2) The international regimes designed to prevent free-riding like this -- namely the G-20 and the IMF -- are not up to this task. [What about the WTO? -- ed. Fuggedaboutit.]
3) The source of China's rising power is not its hard currency reserves or its command over scarce rare earths, but its burgeoning domestic market.
4) Ironically, the United States and other countries want China to accelerate the growth of its domestic market, which would in turn give it more power. Even more ironically, China doesn't want to do this right now.
5) The sum effect of all of this will be a series of uncoordinated interventions into currency markets that will increase market volatility, political posturing, and eventually lead to the erection of capital and/or trade controls.
Developing… in a very disturbing manner.
MANDEL NGAN/AFP/Getty Images
A few days ago Brazil's finance minister mentioned the phrase "international currency war." The Financial Times' Jonathan Wheatley and Peter Garnham are all over it.
An “international currency war” has broken out, according to Guido Mantega, Brazil’s finance minister, as governments around the globe compete to lower their exchange rates to boost competitiveness.
Mr Mantega’s comments in São Paulo on Monday follow a series of recent interventions by central banks, in Japan, South Korea and Taiwan in an effort to make their currencies cheaper. China, an export powerhouse, has continued to suppress the value of the renminbi, in spite of pressure from the US to allow it to rise, while officials from countries ranging from Singapore to Colombia have issued warnings over the strength of their currencies.
“We’re in the midst of an international currency war, a general weakening of currency. This threatens us because it takes away our competitiveness,” Mr Mantega said. By publicly asserting the existence of a “currency war”, Mr Mantega has admitted what many policymakers have been saying in private: a rising number of countries see a weaker exchange rate as a way to lift their economies.
A weaker exchange rate makes a country’s exports cheaper, potentially boosting a key source of growth for economies battling to find growth as they emerge from the global downturn.
The proliferation of countries trying to manage their exchange rates down is also making it difficult to co-ordinate the issue in global economic forums.
South Korea, the host of the upcoming G20 meeting in November, is reluctant to highlight the issue on the gathering’s agenda, also partly out of fear of offending China, its neighbour and main trading partner.
On the other hand, South Korea is putting together an awesome ice sculpture for the summit. Seriously.
The FT's Alan Beattie details the abject lack of policy coordination and its implications in further detail:
Aside from China, whose intervention is one of the main causes of the global currency battle, several big economies have been intervening for some time. Switzerland started unilateral intervention against the Swiss franc last year for the first time since 2002 and did not sterilise it by buying back in the domestic money markets what it had sold across the foreign exchanges.
In common with several east Asian countries, South Korea, host of the Group of 20 summit, has been intervening intermittently to hold down the won during the course of this year. Deliberately weakening a currency while running a strong current account surplus has raised eyebrows in Washington.
Recently it was revealed that Brazil itself, which has been expressing concern since last year about inflows of hot money pushing up the real and unbalancing the economy, had given authority to its sovereign wealth fund to sell the real on its behalf.
The resort to unilateralism bodes ill for US hopes of assembling an international coalition of countries at the forthcoming G20 meeting to put pressure on China over its interventions to prevent the renminbi rising. While most of the countries currently intervening would be likely to welcome a revaluation of the renminbi, few emerging market governments seem to want to stand up to China publicly – barring sporadic criticism such as that from Brazilian and Indian central bankers earlier this year.
Last week Celso Amorim, Brazil’s foreign minister, said that he did not want to become part of an organised campaign. Following a meeting of the Brics countries – Brazil, Russia, India and China – in New York, he told Reuters: “I believe that this idea of putting pressure on a country is not the right way for finding solutions.”
Mr Amorim added: “We have good co-ordination with China and we’ve been talking to them. We can’t forget that China is currently our main customer.” Brazil exports commodities to China. (emphasis added)
It's also possible that Brazil and others fear a security dilemma kind of response from China. Either way, this demonstrates that, on the economic front, China's deterrent power is formidable (even if its compellence power has been exaggerated).
Now, there are some who argue that this kind of beggar-thy-neighbor policy could be a blessing in disguise, because it might amount to massive monetary easing. I tend to side with Michael Pettis, however:
[W]e know how that game ends. In 1930, following France’s very successful 1928 devaluation and Britain’s tightening of trade conditions within the Commonwealth, the world’s leading trade-surplus nation passed the Smoot-Hawley tariffs in a transparent attempt to gain a greater share of dwindling global demand. This would have been a great strategy for the US had no one noticed or retaliated, but of course the rest of world certainly noticed, and all Smoot-Hawley did was accelerate a collapse in global trade which, not surprisingly, hurt trade surplus countries like the US most.
We seem to be following the same path, and in a beggar-thy-neighbor world any country that does not participate in retaliatory policies will suffer. The only question is which retaliatory policy. I suspect that countries that can intervene in the currency and manipulate domestic interest rates will select those polices as the most efficient way of intervening in trade. Countries that cannot will almost certainly resort to trade tariffs. And it is probably too late for global policy coordination to make much of a difference.
To be fair, the demand for global policy coordination since 2008 has been much higher than normal. That said, it seems that on this issue, the G-20 has fallen flat on its face.
Developing … in a very depressing way. Literally.
This week Japan has provoked the ire of the United States and Europe by unilaterally intervening in currency markets to depreciate the yen against other major currencies. Japanese Prime Minister Naoto Kan has responded to these criticisms by
telling the US and EU to go suck a lemon stating that further "resolute actions" would be taken on this front.
This comes on the heels of mounting U.S. frustration with China's "go-slow" policy on letting the yuan appreciate against the dollar. [What do you mean by "go slow"?--ed. Let's put it this way: the tortoise thinks that China is being pokey on this question.]
So, is this the beginning of beggar-thy-neighbor? Will other countries start intervening in foreign exchange markets to gain a competitive advantage for their export sectors?
The New York Times' Hiroko Tabuchi thinks not, because Japan can't unilaterally devalue its currency like in the old days:
It is unlikely, though, that intervention by Japan alone will sway currency markets in the long term. The global volume of foreign exchange trading has grown rapidly in recent years, which prevents intervention by a single government from countering bigger market trends.
Other countries are unlikely to help Japan’s cause, because they need to keep their own currencies weaker to bolster exports. A weak currency makes a country’s exports more competitive and increases the value of overseas earnings.
Much of the yen’s weakening came from investors selling the currency on expectations that the Japanese government would be more active in keeping the yen in check. Japan did not disclose how much it had spent in currency transactions, but dealers put the initial amount at 300 billion to 500 billion yen ($3.5 billion to $5.8 billion).
But as Switzerland found this year, a single government’s efforts to weaken its currency can prove futile. Switzerland abandoned that effort, after its central bank had lost more than 14 billion Swiss francs ($14 billion) in foreign currency holdings in the first half of the year, after a fall in the euro’s value ate into the bank’s reserves.
The Swiss franc is also seen by investors as a relative haven and has also strengthened amid global financial unrest. This month, the franc hit a record high against the euro.
Hmmm.... maybe. Japan's economy is much larger than Switzerland, so I'm not sure the comparison holds up. The real problem, however, appears to be that countries perceived of as "safe havens" wind up with overvalued currencies.
This little parable also makes me wonder whether we might see beggar-thy-neighbor policies in a different guise this time around. This is going to sound a little crazy, but here goes: rather than explicit exchange rate intervention, what if countries decided to play fast and loose with Basle III and other measures to strengthen financial integrity?
This really does sound crazy -- it suggests that governments would be willing to tolerate a higher risk of domestic banking collapse in order to avoide being a "safe haven" status for capital. That said, think of how much Europe benefited from the depreciation of the euro due to the Greek crisis. Basle III, by taking so long for banks to meet standards allow those countries with more insolvent financial institutions **cough** Germany **cough** to take their own sweet time in having them meet new capital adequacy standards. This would allow Germany to have the euro stay relatively cheap without abandoning its anti-inflationary zeal.
Now, in all likelihood, not even the Germans would purposefully do this. This is crazy talk. What I'm suggesting, however, is that there is more than one way for a country to have its currency depreciate, and these policies are substitutable. Looking only at explicit exchange rate intervention might be just a bit too narrow. And if more countries find more ways of keeping their currency undervalued, well then, the days of beggar-thy-neighbor would have arrived.
At APSA today I attended a panel on what political scientists can offer to political journalists. Mark Schmitt, Marc Ambinder, Matt Yglesias, Mark Blumenthal, and Ezra Klein all offered interesting advice. Two messages that came through loud and clear:
1) Be willing to advertise one's research wares; and
Mr. Gorbachev, tear down these paywalls Make the research accessible to people without a JSTOR account.
So, in that spirit, let me announce that I have an article in the latest issue of International Relations of the Asia-Pacific entitled "Will Currency Follow The Flag?" It's on the future of the U.S. dollar as the world's reserve currency. The abstract:
The 2008 financial crisis and its aftermath have triggered uncertainty about the future of the dollar as the world's reserve currency. China and other countries in the Asia-Pacific region have voiced support for a new global monetary regime. There are both economic and geopolitical motivations at the root of these challenges. Going forward, what will the future hold for the international monetary system? Crudely put, will currency follow the flag?
This article addresses this question by considering the economic opportunity and geopolitical willingness of actors in the Pacific Rim to shift away from the current international monetary system – with a special emphasis on China as the most powerful actor in the region. While the dollar has shifted from being a top currency to a negotiated one, neither the opportunity nor the willingness to shift away from the dollar is particularly strong. The current window of opportunity for actors in the region to coordinate a shift in the monetary system is small and constrained. The geopolitical willingness to subordinate monetary politics to security concerns is muted.
The entire article is free for anyone to download and read. So read the whole thing, political journalists!!
I have a review essay of four books about Big Finance in the latest issue of The National Interest entitled "First Bank of the Living Dead." The books reviewed were: Sebastian Mallaby's More Money Than God, Robert Reich's Aftershock, Nouriel Roubini and Stephen Mihm's Crisis Economics, and John Quiggin's Zombie Economics. Despite my obvious affinity for zombies, I tried to avoid any favortism towards Quiggin's
awesome brilliant spot-on unorthodox metaphor.
The opening paragraph:
Earlier this year, Goldman Sachs CEO Lloyd Blankfein attempted to justify his professional existence, proclaiming, “We’re very important. We help companies to grow by helping them to raise capital. Companies that grow create wealth. This, in turn, allows people to have jobs that create more growth and more wealth. . . . We have a social purpose.” This all sounds good enough, except that finance went from being responsible for 2.5 percent of GDP in 1947 to 7.7 percent in 2005. And at the peak of the housing bubble, the financial sector comprised 40 percent of all the earnings in the Standard & Poor’s 500. The incomes of the country’s top-twenty-five hedge-fund managers exceeded the total income of all the CEOs in that index. And by 2007, just about half of all Harvard graduates headed into finance jobs. If capital markets merely serve as conduits from savers to entrepreneurs, then why does such a large slice get siphoned off to compensate people like Lloyd Blankfein? To put it more broadly, what is the role of finance in a good and just society?
And the thesis paragraph:
Some of these books address some of the big questions some of the time. Most of the authors, however, focus on the retrospective at the expense of the prospective. With the partial exception of Roubini and Mihm’s Crisis Economics, these authors seem more concerned with looking back at the halcyon days of the postwar era than looking forward to the twenty-first century. Unfortunately, none of these books recognizes two important facts of life. First, at present, no economic model perfectly captures the interrelationship between the financial sector and the global economy. Second, no matter what regulatory arrangements are put in place, the next global financial order will last no longer than a generation—because whatever ideas replace the current ones will also prove fallible over time.
I fear that last paragraph reads a bit harsher than the rest of the essay. I learned something from all four books, and enjoyed engaging with all of them.
Western readers of this blog tend to bemoan the status of their national economic fortunes on a regular basis. It's worth noting, then, that the traditional economic basket cases of the world have weathered the Great Recession remarkably well, thank you very much.
First, there's Africa. Last month the McKinsey Global Institute released a report noting "Africa's increased economic momentum" and that momentum's likely staying power. Some of their figures:
Africa's growth acceleration was widespread, with 27 of its 30 largest economies expanding more rapidly after 2000. All sectors contributed, including resources, finance, retail, agriculture, transportation and telecommunications. Natural resources directly accounted for just 24 percent of the continent's GDP growth from 2000 through 2008. Key to Africa's growth surge were improved political and macroeconomic stability and microeconomic reforms.
Future economic growth will be supported by Africa's increasing ties to the global economy. Rising demand for commodities is driving buyers around the world to pay dearly for Africa's natural riches and to forge new types of partnerships with producers. And Africa is gaining greater access to international capital; total foreign capital flows into Africa rose from $15 billion in 2000 to a peak of $87 billion in 2007.
Read the whole thing here.
[Um.... doesn't McKinsey have an incentive to pump up Africa to gain more business?--ed. Perhaps, but that incentive is revealing -- if McKinsey thinks there's profit to be made from consulting in sub-Saharan Africa, that's very good news for sub-Saharan Africa. It's also not just McKinsey: the Boston Consulting Group is also clearly interested in Africa's "lions."]
Meanwhile, Simon Romero reports in today's New York Times that Latin America has also had a surprisingly good global economic crisis:
While the United States and Europe fret over huge deficits and threats to a fragile recovery, this region has a surprise in store. Latin America, beset in the past by debt defaults, currency devaluations and the need for bailouts from rich countries, is experiencing robust economic growth that is the envy of its northern counterparts.
Strong demand in Asia for commodities like iron ore, tin and gold, combined with policies in several Latin American economies that help control deficits and keep inflation low, are encouraging investment and fueling much of the growth. The World Bank forecasts that the region’s economy will grow 4.5 percent this year.
Let's step back a bit and acknowledge the great news here. First, in the fall of 2008, as private capital was developing an extreme home bias, there was a lot of fretting that the developing world was about to get royally screwed. Instead, it appears that the world's traditional basket cases have found a way to survive and thrive even during tough times. The robustness of these economies is sufficient enough to be optimistic that the United Nations thinks the Millennium Development Goals still look doable.
Second, contrary to claims about the Beijing Consensus, the manner in which these countries are prospering has little to do with either state-run capitalism or economic isolation. Indeed, as Romero notes/links, the Latin American boom has bypassed Chavez's Venezuela -- it's economy shrank by 5.8% in the first quarter of this year. The state is still very important to these growth spikes -- but mostly by doing things like not starting wars and running prudential macroeconomic policies.
Third, if this is right, it suggests that some modest economic decoupling is taking place -- i.e., the entire global economy does not rise and fall with the American consumer. Maybe a world without the West really is possible.
Here's the thing, though: I'm not completely convinced about any of this. To be fair, neither are the linked articles. McKinsey notes that Africa experienced surges in the past, with nothing remotely resembling takeoff before. And as Romero notes, an awful lot of this boom has to do with China:
Some scholars of Latin America’s economic history of ups and downs say the robust recovery may be too good to last, pointing to volatile politics in some places, excessive reliance on commodity exports and the risks of sharply increasing trade with China.
Michael Pettis, a specialist at Peking University in Beijing on China’s financial links with developing countries, said the region was especially exposed to Chinese policies that had driven up global demand for commodities, including what appears to be Chinese stockpiling of commodities.
“Within China there is a ferocious debate over the sustainability of this investment-driven growth,” Mr. Pettis said. “I’m worried that too few policy makers in Latin America are aware of the debate and of the vulnerability this creates in Latin America.”
Other economists, including Nicolás Eyzaguirre, director of the Western Hemisphere department of the International Monetary Fund, suggest that low international interest rates, another factor supporting Latin America’s growth, will not last much longer.
China's domestic consumption has undoubtedly increased, but let's face it, much of China's growth in demand comes from its exports to the developed world. With the OECD economies continuing to experience sluggish growth, China's manufacturing boom is starting to run out of steam. The knock-on effects of this downturn will be reduced demand for Latin American and African imports.
It's the knock-on effects of that reduction which what have me fretting about Latin America and Africa.
ELMER MARTINEZ/AFP/Getty Images
The People's Bank of China had a busy weekend.
In view of the recent economic situation and financial market developments at home and abroad, and the balance of payments (BOP) situation in China, the People´s Bank of China has decided to proceed further with reform of the RMB exchange rate regime and to enhance the RMB exchange rate flexibility....
The global economy is gradually recovering. The recovery and upturn of the Chinese economy has become more solid with the enhanced economic stability. It is desirable to proceed further with reform of the RMB exchange rate regime and increase the RMB exchange rate flexibility.
In further proceeding with reform of the RMB exchange rate regime, continued emphasis would be placed to reflecting market supply and demand with reference to a basket of currencies. The exchange rate floating bands will remain the same as previously announced in the inter-bank foreign exchange market.
This is central bankese for, "yes, we're going to allow the RMB to float, get off our backs now."
This sounds great, except that 24 hours later the PboC issued a second, Chinese-only statement, according to the New York Times' Keith Bradsher:
The central bank, the People’s Bank of China, said on Sunday that it was determined to “keep the renminbi exchange rate at a reasonable and balanced level of basic stability.”....
The issue has become a tricky one internally for the Chinese government. While China still muzzles its media through censorship, public opinion expressed on the Internet has become an increasingly influential force.
Even though some Chinese economists and most Western economists say that a stronger renminbi is clearly in China’s best economic interests — because it would help China fight inflation by making imports cheaper — many Chinese see the issue mainly in terms of a rivalry with the United States.....
The central bank’s statement on Sunday was issued only in Chinese and was clearly intended for domestic consumption. In contrast, its announcement on Saturday was issued almost simultaneously in Chinese and English.
Today, the PBoC also left the midpoint trading for the RMB unchanged, indicating that there would be no initial appreciation of the currency, unlike what transpired in 2005. That said, the RMB appreciated by 0.42% today, its largest appreciaton in five years.
The PBoC also released an English-language Q&A that elaborates its thinking. This part is intriguing:
As its economy becomes more opened, China´s major trading partners now include a long and diversified list. During the period of January-May this year, trading volume with top 5 trading partners (EU, the U.S., ASEAN, Japan and China´s Hong Kong SAR) accounted for 16.3 percent, 12.9 percent, 10.1 percent, 9.4 percent and 7.5 percent respectively in China´s total trade. Meanwhile, capital and financial account transactions have also diversified across various regions in the world. RMB´s floating with reference to any single currency can neither meet the diversified demand currencies in trade and investment with different partners, nor reflect its effective level. A basket of currencies can meet such demand and reflect the effective RMB level more accurately. Therefore, it is necessary for the managed floating exchange rate regime to be based on market supply and demand with reference to a basket of currencies, and thus make the RMB exchange rate more adaptive to market behaviors. As China´s trading and investment partners become more and more diversified, it would be more appropriate for enterprises and households in China to switch their attention from just RMB-to-dollar exchange rate to the RMB´s value in terms of a basket of currencies.
So, has anything of significance happened?
The Economist is doubtful. The FT editorial team -- and Geoff Dyer in particular -- think the Chinese are being politically deft. I have to concur. China's aim is to do just enough to placate the G-20 without enraging its domestic producers and online nationalists. By switching to a basket -- one in which the euro seems headed downward -- China has greater flexibility to do whatever the hell it wants with respect to the exchange rate.
Going forward, I'm curious about the extent to which Chinese authorities will play up their domestic constraints. It's very chic to point out the ways in which China's government does have to deal with nationalist pressures -- but the government also has an incentive to play those up as part of a two-level game. One of the great unknowns is the extent to which Beijing can turn that nationalist sentiment up and down like a volume control. I don't know the answer, and I'm not convinced that China-watchers know either.
LIU JIN/AFP/Getty Images
Over the weekend, Paul Krugman trotted out his "let's pressure China" argument but expanded it to Germany. This prompted some quality IPE snark from Kindred Winecoff, followed up by the same points written in less snarky fashion.
Ordinarily, I would be eager to enter this debate full of vim and vigor. Unfortunately, I spent the weekend
at my college reunion at an important networking conference in which I drank a lot and caught up with old friends a lot of retrospective analysis and discussion took place over cocktails and I'm still exhausted from pretending to be a 21 year old for a few days still processing the exciting intellectual synergies that took place during the free-flowing dance party breakout sessions.
Fortunately, I really don't have to add too much. I'll just link to my old post about this debate and note that the questions I raised in that post have yet to be answered.
Well, I'll say one more thing. Between then and now, I've had the opportunity to enjoy a conversation with Krugman over dinner on these questions, and I think I can say where, exactly, we disagree. He believes that, as the deficit country, the U.S. has vast reservoirs of economic power that can be exercised over China. I would argue that the U.S. position is such that America can deter China but can't unilaterally compel the country to alter its own policies.
More importantly, Krugman -- and most economists engaged in this debate -- are seriously underestimating the extent to which nationalism will affect China's response to any unilateral move by the United States. Even if China's response to an increase in U.S. trade barriers would be counterproductive to their own economic interests, it might serve the regime's political interests. In an ordinary world economy, China wouldn't want to do anything to upset its expoert engine. In a world where the leading open economy basically says "f**k it," well, they're going to reassess. Riding the nationalist tiger will look politically appealing in a slow-growth world.
Two nights ago I recorded a podcast with the American Chamber of Commerce in China, which you can listen to if you
have no outside life whatsoever are so interested.
In the podcast, I repeated my mantra about mounting multilateral pressure on China to revalue the yuan. This week, in the run-up to the G-20 finance ministers meeting this week, Bloomberg reports that the other BRIC economies are now starting to vent on the issue,
Central bank governors in India and Brazil backed a stronger Chinese yuan, siding with U.S. President Barack Obama before a meeting of the Group of 20 nations this week.
Exports from China to India have grown faster than Indian shipments to its northern neighbor “and that obviously is a reflection of differences in the exchange-rate management,” Reserve Bank of India’s Duvvuri Subbarao told reporters in Mumbai yesterday. Brazil’s Henrique Meirelles told a senate hearing yesterday in Brasilia it was “absolutely critical” that China should let its currency appreciate.
Obama, who considers the yuan “undervalued,” is seeking to gain broader support from finance officials of the G20, who will discuss outlook for the global economy in Washington for three days starting April 22. Speculation that China may scrap the yuan’s peg to the dollar intensified this month after Treasury Secretary Timothy F. Geithner delayed a report that could brand the nation a currency manipulator.
“This meeting will be the first test by the U.S. to use a multilateral forum to press China into action on its currency,” Philip Wee, a Singapore-based senior currency economist at DBS Group Holdings Ltd. wrote in a research note yesterday.
The discussions will include a range of topics including currencies and a communiqué will be released on April 23, a U.S. Treasury Department official, who declined to be identified, said yesterday.
The Financial Times' Geoff Dyer follows up:
China is facing growing pressure from other developing countries to begin appreciating its currency, providing unexpected allies for the US in the diplomatic tussle over Beijing’s exchange rate policy....
Lee Hsien Loong, prime minister of Singapore, added his country’s voice to the debate last week, saying it was “in China’s own interests” with the financial crisis over to have a more flexible exchange rate.
Some in China have fended off US pressure for a stronger currency, describing it as a distraction from the real causes of the financial crisis. However, criticism from developing countries is not so easy to bat away. “If the rich and emerging economies are united in asking China to revalue, it would be harder to dismiss the request as an example of superpower arrogance,” said Sebastian Mallaby at the Council on Foreign Relations.
Mallaby's argument sure sounds familiar.
There's been a spate of stories over the past few days suggesting that China is about to shift its policy on the yuan, allowing the currency to appreciate against the dollar. Keith Bradsher's latest in the New York Times has the most detail, so let's look at his story:
The Chinese government is set to announce a revision of its currency policy in the coming days that will allow greater variation in the value of its currency combined with a small but immediate jump in its value against the dollar, people with knowledge of the consensus emerging in Beijing said Thursday....
The model for the upcoming shift in currency policy is China’s move in 2005, when the leadership allowed the renminbi to jump 2 percent overnight against the dollar and then trade in a wider daily range, but with a trend toward further strengthening against the dollar. For the upcoming announcement, however, China is likely to emphasize that the value of the renminbi can fall as well as rise on any given day, so as to discourage a flood of speculative investment into China betting on rapid further appreciation, they said.
The emerging consensus within the Chinese leadership comes as Treasury Secretary Timothy F. Geithner held meetings on Thursday with senior Hong Kong officials and prepared to fly on Thursday evening to Beijing for a meeting with Vice Premier Wang Qishan.
Now, given the degree of hostility between China and the United States as late as last month, we have to ask the question: what caused the shift in China's policy? Bradsher provides multiple answers:
China’s commerce ministry, which is very close to the country’s exporters, has strenuously and publicly opposed a rise in the value of China’s currency over the past month. But it appears to have lost the struggle in Beijing as other interest groups have argued that China is too dependent on the dollar, that a more flexible currency would make it easier to manage the Chinese economy and that China is becoming increasingly isolated on the world stage because of its steadfast opposition to any appreciation of the renminbi since July, 2008....
People with knowledge of the policy deliberations in Beijing said that Chinese officials had made the decision to shift the country’s currency policy mainly in response to an assessment of economic conditions in China, and less in response to growing pressure from the United States and, less publicly, from the European Union and from developing countries.
So, what's going on? First, it's possible that the policy shift will just be a token move. I'm confident that China won't appreciate as much as, say, Chuck Schumer wants. That said, this doesn't sound like a token-y move.
If China's shift is a real one, there appear to be three possible sources of change:
1) Domestic factors and actors convinced China's leadership that diminishing marginal returns for keeping the yuan fixed and masively undervalued had kicked in;
3) China responded to threats of unilateral U.S. action, such as being named as a currency manipulator, and/or calls for a trade war;
These are not mutually exclusive arguments, and we might never know exactly what caused China's . But for the record, I think (1) and (2) maqttered a hell of a lot more than (3). That said, I can't rule out the possiblity that their antics helped scare China into action.
Am I missing anything?
Treasury Secretary Timothy Geithner makes it pretty clear how he thinks the next few months will unfold with respect to China's exchange rate policy:
I have decided to delay publication of the report to Congress on the international economic and exchange rate policies of our major trading partners due on April 15. There are a series of very important high-level meetings over the next three months that will be critical to bringing about policies that will help create a stronger, more sustainable, and more balanced global economy. Those meetings include a G-20 Finance Ministers and Central Bank Governors meeting in Washington later this month, the Strategic and Economic Dialogue (S&ED) with China in May, and the G-20 Finance Ministers and Leaders meetings in June. I believe these meetings are the best avenue for advancing U.S. interests at this time....
China's inflexible exchange rate has made it difficult for other emerging market economies to let their currencies appreciate. A move by China to a more market-oriented exchange rate will make an essential contribution to global rebalancing.
Our objective is to use the opportunity presented by the G-20 and S&ED meetings with China to make material progress in the coming months.
In layman's terms, the Obama administration has decided that it will rely on multilateral pressure to get China to change its policy rather than take the unilateral route -- for now. In blog terms, the administration rejected the Krugman/Bergsten/Schumer approach to pressuring China in return for... well... my preferred approach.
Which automatically makes me nervous, of course, because I could easily be wrong. Still, there have been signs that other members of the G-20 feel the same way as the United States. And it's also true that the hour-long conversation between President Obama and President Hu seems to smoothed over a lot of recent contretemps. Indeed, Nicholas Lardy told the New York Times that on Iran and North Kotrea the U.S. was getting a fair amount in return for deferring the report.
A few Chinese central bankers and think-tankers are now making noise about movements on exchange rates. Making this shift via G-20 and bilateral channels -- rather than in response to a Treasury finding of currency manipulation or Congressional threats of protectionism -- gives China a more politically palatable justification for policy change. Beijing will likely move in the right direction, albeit more slowly than anyone else would like.
And, if nothing happens from these meetings, China can be named in the fall. Indeed, the paradox of two-level games is that there needs to a rising but manageable possibility of protectionist action by the United States to give China an incentive to alter their policy.
In many ways, this is put-up-or-shut-up time for the G-20. If the U.S. has no option but to name China, it starkly demonstrates the limits of the G-20 process at forcing policy coordination. If, on the other hand, China pursues a more accomodationist approach, then that augments the G-20's prestige as a useful forum.
UPDATE: Simon Lester has a round-up of reactions.
Both the Guardian and the New York Times have stories today suggesting that the Sino-American relationship is on the mend. Last night Barack Obama and Hu Jintao spoke on the phone for, like, a whole hour. It was such a good chat that Air Force One sat on the tarmac at Andrew Air Force base for ten minutes so Obama could finish the call.
There has been an appreciable shift in the past week. Hu pledged to attend the Obama's nuclear proliferation summit a few weeks from now. U.S. oficials sound confident that China is on board for another round of United Nations sanctions against Iran -- though the negotiations for that could take a while. It also appears that China has not followed through on sanctions against U.S. companies for arms sales to Taiwan. On the American side, at a minimum, the Treasury Department has deferred submitting its report to Congress on Chinese currency
manipulation practices for a little while. The headline for this Vikas Bajaj story suggests that Hu's visit "may signal easing by China on currency," though there's no actual evidence in the story backing up that asserrtion.
1) Economic tensions. Tim Geithner, the US Treasury Secretary, has just publicly expressed his concern about the very high levels of US unemployment and many American economists, including in the administration, blame America’s problems in large part on “Chinese mercantalism”. If the Chinese refuse to let the RMB appreciate, or even allow only a modest appreciation, then a clash will eventually happen.
2) Climate change: Remember Copenhagen? There is no sign that the two nations are going to move any closer on this most divisive issue.
3) Iran - A new pacakge of sanctions could head this one off. But they are unlikely to be strong enough to satisfy the US or - let us not forget - to achieve their objective.
4) The mega-trend in the background is the rise of China and the relative decline of the US - and the expression of this will be the gradual challenge to American military hegemony in the Pacific. This will not be a comfortable process.
So look beyond today’s headlines. I can assure you, the Chinese do.
Well..... let's think about this for a second. The first three issues are all about more than the bilateral Sino-American relationship. On the economic front, there's evidence that China has ticked off other countries beyond the United States. On Iran, the U.S. was careful to line up support on sanctions from the Britain, France and Russia, leaving China as the sole P-5 holdout. And on climate change, at a minimum, China came out of Copenhagen looking like something of a bully.
My take of the past six months is that the Chinese overplayed their hand very badly across an array of issues, irking not just the United States but other significant countries. In response, the U.S. has been able to exploit multilateral resentment as a way of
teaching Beijing about the security dilemma putting subtle pressure on China to moderate its tone and actions. As for the mega-trend, well, that's happening, but it's still quite a ways off.
Rachman still makes some decent points. There are fundamental conflicts of interest. Going beyond the issues Rachman mentions, there's also minor stuff like the fact that China and America's domestic regimes look a wee bit different.
For now, however, much of China's recent bluster turned out to be self-defeating. What will be interesting to see is how both Washington and Beijing will learn from the recent spot of unpleasantness.
UPDATE: Hmm.... this Financial Times story by Jamil Anderlini and Alan Beattie is very interesting:
Beijing may adjust its policy of pegging its currency to the dollar provided a visit this month by Chinese President Hu Jintao to Washington goes smoothly, according to a top adviser to China’s central bank.
Li Daokui, a professor at Tsinghua university and a member of China’s central bank monetary policy committee, said as long as the US respected China’s “core interests” the currency disagreement could be easily solved.
Barack Obama and his Chinese counterpart talked for an hour on Thursday evening, during which Mr Hu stressed that the “proper handling of Taiwan and Tibet” was the biggest factor in Sino-US ties, according to China’s state media.
“As long as this is understood, everything else will be easy to handle and we will find the key to unlock the exchange rate problem,” Mr Li told the Financial Times.
MANDEL NGAN/AFP/Getty Images
Two weeks ago the New York Times' Keith Bradsher noted that China was not fully complying with information provision obligations at the G-20.
Now the Financial Times' Chris Giles and Alan Beattie suggest that a growing number of G-20 players are venting their frustrations at China:
Five prominent members of the Group of 20 leading economies, including the US and UK, sent a coded rebuke to China on Tuesday against backsliding on economic agreements.
In a letter to the rest of the G20 that shows frustration at slow progress this year, the leaders warned: “Without co-operative action to make the necessary adjustments to achieve [strong and sustainable growth], the risk of future crises and low growth remain.”
G20 officials said the letter – signed by Stephen Harper and Lee Myung-bak, the Canadian and South Korean leaders who will chair the group’s two summits this year, Barack Obama, US president, Gordon Brown, UK prime minister, and Nicolas Sarkozy, French president – was an attempt to restore flagging momentum to the international process.
Ottawa and Seoul are concerned that the G20 summits they will host, in June and November respectively, might fail to live up to expectations.
In a move that will irritate China, the five leaders specifically raised the issue of exchange rates in relation to reducing trade imbalances, a topic the G20 avoided in 2009 to help secure agreement at the London and Pittsburgh summits.
“We need to design co-operative strategies and work together to ensure that our fiscal, monetary, foreign exchange, trade and structural policies are collectively consistent with strong, sustainable and balanced growth,” the letter said....
As well as refusing to budge on its currency, China has been obstructing the G20 process this year. It has hampered efforts by the International Monetary Fund to issue a report which Dominique Strauss-Kahn, managing director, told the Financial Times in January would conclude that national strategies for growth around the world “will not add up”.
The leaders’ letter makes reference to the slow progress of this process, urging all G20 members to “move quickly” to “report robustly on what each of us can do to contribute to strong sustainable and balanced global growth”.
It's becoming increasingly difficult to figure out China's strategy here. Lying low isn't going to work for much longer. Ian Bremmer suggests that China has decided it doesn't need the United States anymore. I'm not sure that's accurate, but even if it is, I'm pretty sure Beijing does need at least a few other countries in the G-20.
Of course, maybe they think letters like this will lead to nothing. They might be right. Distrubingly, this same letter urges a completion to the Doha round. Not that there's anything wrong with that. At this point, however, pledges to complete the Doha round are kinda like my pledges to lose weight -- they're mostly ritualistic and have disturbingly little effect on actual behavior.
If the exhortation to redress macroeconomic imbalances falls into the same category, the G-20 will quickly acquire the perception of other dysfunctional multilateral structures.
Question to readers: will China find itself isolated at the G-20 if it continues its noncompliance?
I see I was not the only blogger to point out the Paul Krugman = neoconservative argument -- see Ryan Avent's recent posts over at Free Exchange, which also challenge Krugman on the question of whether an appreciating yuan would actually reduce macroeconomic imbalances. It's safe to say that the neocon meme got Krugman and his supporters a wee bit snippy.
Krugman has posted a more substantive reply, however, and Avent has responded as well. They are debating across a number of issues: 1) whether the Chinese government can truly control China's consumption rate; 2) whether a revaluation would in fact lead to an improvement in U.S. exports/macroeconomic imbalances; and 3) The best way to get China to alter its status quo policies.
On the first two questions, I find myself siding with Avent on the first point (it's going to take a looong time for China's consumption rate to increase) and with Krugman on the second point (revaluation would still make a difference). Scott Summer, Michael Pettis, and Tom Oatley have all also posted thoughtful responses/critiques of Krugman that are worth checking out.
I want to focus on the third question, however -- what's the best way to pressure China into altering its position? Krugman's proposal in his op-ed was Nixon redux -- slap on a 25% import surcharge and let slip the dogs of a trade war. It was the unilateralist (and violation-of-WTO-trade-rules) aspect of Krugman's proposal that sparked the neocon snark on my part. In my opinion, the U.S. should not act in a unilateral manner on the currency issue when other countries are also seriously put out with China's behavior. I'm not saying it should be off the table, either -- but it's a policy of last resort rather than first resort. Coordinated action to isolate China -- through the G-8, G-20, and other international bodies -- seems like the next step, rather than slapping on an import surcharge.
Krugman elaborates -- a bit -- here:
Here’s how the initial phases of a confrontation would play out – this is actually Fred Bergsten’s scenario, and I think he’s right. First, the United States declares that China is a currency manipulator, and demands that China stop its massive intervention. If China refuses, the United States imposes a countervailing duty on Chinese exports, say 25 percent. The EU quickly follows suit, arguing that if it doesn’t, China’s surplus will be diverted to Europe. I don’t know what Japan does.
Suppose that China then digs in its heels, and refuses to budge. From the US-EU point of view, that’s OK! The problem is China’s surplus, not the value of the renminbi per se – and countervailing duties will do much of the job of eliminating that surplus, even if China refuses to move the exchange rate.
And precisely because the United States can get what it wants whatever China does, the odds are that China would soon give in.
Look, I know that many economists have a visceral dislike for this kind of confrontational policy. But you have to bear in mind that the really outlandish actor here is China: never before in history has a nation followed this drastic a mercantilist policy. And for those who counsel patience, arguing that China can eventually be brought around: the acute damage from China’s currency policy is happening now, while the world is still in a liquidity trap. Getting China to rethink that policy years from now, when (one can hope) advanced economies have returned to more or less full employment, is worth very little. (emphasis added)
Look, Krugman is blogging here -- I'm sure that he's thought about the political economy dimension a bit more that a single post suggests. That said, Krugman is talking exactly like the most neocon of neoconservatives was before Iraq. He evinces complete disregard for existing multilateral structures, makes casual assumptions about how allies will line up behind the United States and adversaries will simply fold, and underappreciates the policy externalities that would take place if his idea was implemented.
On the multilateralism point: as Simon Lester points out, a countervailing duty applied against all of China's imports across the board because of currency manipulation would be a flagrant violation of WTO rules. So, question to Krugman (and Bergsten): are you prepared to jettison the WTO to alter China's behavior? Because that's exactly the policy choice you're setting up in your proposal.
This leads to the next problem -- Krugman/Bergsten's assumptions about how other countries would react. First of all, I'm not sure at all that China will roll over. I agree with Krugman that China's compellence power over the United States is limited. The thing is, America's compellence power over China is also limited. It's the larger economy and the deficit country, so it does have some leverage. What Krugman is suggesting is a huge demand, however -- one that would have wrenching effects on China's domestic political economy. Expectations of future conflict between the two countries are quite high, and have escalated in the past two months. Chinese nationalism is pretty robust at the moment, and nationalists are willing to make economic sacrifices rather than suffer a perceived blow to their country's prestige. This is not a good recipe for concessions, even if China is hurt more than the United States by a trade war.
Because that's what would happen -- Beijing would immediately respond with its own retaliatory tariffs on U.S. imports. They would likely harass U.S. companies with significant amounts of FDI in China. These moves would hurt China a little, but hurt the United States more. Like Michael Pettis, I think the chance of a full-blown trade war at this point becomes pretty high.
Krugman's assumption that Europe would automatically follow suit without prior consultation seems awfully casual. As the New York Times reported today, there are a lot of European companies that are not thrilled with volatility in the value of the euro -- and what Krugman is proposing is guaranteed to increase volatility. European authorities might prioritize bolstering the EU's reputation as an actor that doesn't violate multilateral norms over the economic issues at stake (and if you think that materialist explanations always trump arguments about political prestige, well, then, the euro should never have been created in the first place). I'm not sure how keen the Europeans will be about the unilateral move Krugman is suggesting. It's far from guaranteed that the EU would even be able to speak with a single voice on the issue.
Krugman's ignorance about how Japan would react (to be fair, Japan is not the easiest read right now), and his omission to mention how the rest of the G-20 or ASEAN would respond, suggests that he really hasn't thought this all the way through. I'd like to see some contingency planning in case the rest of the world doesn't line up the way he thinks.
Finally, there's no discussion -- none -- about what the political and economic effects would be during the period of uncertainty and/or if China decided they weren't going to acquiesce. Let's keep this within the economic realm and consider the following question: what's the effect of political uncertainty on investment behavior? Consumption levels? I would posit that it would increase risk-averse behavior -- particularly if this kind of trade war roiled financial markets. Wouldn't this simply exacerbate the liquidity trap concerns that Krugman has been fretting about?
Note that much of the last paragraph was framed in the form of questions. I'm not sure my answers are correct -- but I'm really not sure that Krugman's assertions/assumptions are correct.
Apparently the Chinese premier feels like everyone is picking on his country and that's not fair:
China’s premier Wen Jiabao on Monday lashed out at the growing number of countries pressuring Beijing to strengthen its currency, making it clear that European officials made little headway in their efforts over the past two days to persuade the country to allow the renminbi to appreciate.
Speaking at the conclusion of an EU-China summit in the eastern Chinese city of Nanjing, Mr Wen said: “Some countries on the one hand want the renminbi to appreciate, but on the other hand engage in brazen trade protectionism against China. This is unfair. Their measures are a restriction on China’s development.” (emphasis added)
Wen has a legitimate complaint here about the rise in protectionism directed against China in particular. Of course, this begs the question of whether maybe, just maybe, the undervalued yuan might be driving some of that protectionist sentiment.
It would be interesting for the U.S. Trade Representative and the EU Trade Directorate to make the following proposal:
Hey, Wen, you're right about the unfair tire tariffs and the like. Let's make a trade deal: you allow the yuan to appreciate, say, 20% against the dollar over the next twelve months. In return, we will announce a voluntary two-year moratorium on any new anti-dumping and escape clause measures targeted against Chinese imports. What do you say?
To be honest, I'm not sure if this is legal, but it would be an interesting gambit.
Question to readers: which side would blink first at this deal?
It took me forty pages of pretty dense prose to explain why China's massive dollar holdings do not translate into increased foreign policy leverage.
Over the weekend, Saturday Night Live's cold open managed to summarize the subtleties of the Sino-American economic relationship in under seven minutes. Go ahead and watch it. I'll wait.
Note that, although it appears that President Hu has the power because he is repeatedly berating Obama, the content of the skit suggests otherwise. Hu's repeated complaints that the United States is, er, "doing sex" to him demonstrates the very limited leverage China has over U.S. policy.
My only complaint with the skit is that it fails to mention why China is buying up dollar-denominated assets in the first place.
Your humble blogger has a rather long essay in the Fall 2009 issue of International Security. What's a lowly IPE scholar doing publishing in a high and mighty security journal? Assessing whether China's massive holdings of dollar-denominated assets is a big deal or not. The title may or may not give away my argument: "Bad Debts: Assessing China's Financial Influence in Great Power Politics."
Here's the abstract:
Commentators and policymakers have articulated growing concerns about U.S. dependence on China and other authoritarian capitalist states as a source of credit to fund the United States' trade and budget deficits. What are the security implications of China's creditor status? If Beijing or another sovereign creditor were to flex its financial muscles, would Washington buckle? The answer can be drawn from the existing literature on economic statecraft. An appraisal of the ability of creditor states to convert their financial power into political power suggests that the power of credit has been moderately exaggerated in policy circles. To use the argot of security studies, China's financial power increases its deterrent capabilities, but it has little effect on its compellence capabilities. China can use its financial power to resist U.S. entreaties, but it cannot coerce the United States into changing its policies. Financial power works best when a concert of creditors (or debtors) can be maintained. Two case studies—the contestation over regulating sovereign wealth funds and the protection of Chinese financial investments in the United States—demonstrate the constraints on China's financial power.
Read it and weep.
Rob Reich is upset that the New York Times and Center for American Progress are taking the question about rising levels of U.S. debt seriously. He is so upset that he goes back into 1990s memoir mode and starts rolling out the conspiracy theories:
Odd that it would return right now, when the economy is still mired in the worst depression since the Great one. After all, consumers are still deep in debt and incapable of buying. Unemployment continues to soar. Businesses still are not purchasing or investing, for lack of customers. Exports are still dead, because much of the global economy continues to shrink. So the purchaser of last resort -- the government -- has to create larger deficits if the economy is to get anywhere near full capacity, and start to grow again.
Odder still that the Debt Scare returns at the precise moment that bills are emerging from Congress on universal health care, which, by almost everyone’s reckoning, will not increase the long-term debt one bit because universal health care has to be paid for in the budget. In fact, universal health care will reduce the deficit and cumulative debt -- especially if it includes a public option capable of negotiating lower costs from drug makers, doctors, and insurers, and thereby reducing the future costs of Medicare and Medicaid....
Why are the ostensibly liberal Center for American Progress and New York Times participating in the Debt Scare right now? Is it possible that among the President’s top economic advisors and top ranking members the Fed are people who agree more with conservative Republicans and Wall Streeters on this issue than with the President? Is it conceivable that they are quietly encouraging the Debt Scare even in traditionally liberal precincts, in order to reduce support in the Democratic base for what Obama wants to accomplish? Hmmm.
I actually think Reich has half a point -- if you read either Tim Geithner or Paul Volcker's speeches over the past few years, they've been sounding the debt alarm for some time.
That said, the notion that this is a non-issue being pushed by conservatives and conservative lackeys borders on the absurd. Daniel Gross is pretty sympathetic to Reich's substantive view on the U.S. debt issue, but in this Slate essay he's also pretty clear about why the debate has moved to the forefront:
The interest rate of the 10-year Treasury bond has spiked from 2.07 percent in December 2008, when the world was falling apart, to a recent high of 3.715 percent on June 1—a 79 percent increase. The 30-year bond has risen from 2.5 percent last December to about 4.5 percent today.
You can debate about why this is happening (Gross is worth reading). A simple dismissal of the issue, however, seems kinda loopy.
[So you think Reich is wrong on policy?--ed.] Right now, no -- jumpstarting the economy has priority over mounting levels of U.S. government debt.
I suspect, however, that my concerns about rising U.S. debt levels will start rising before his. Anyone who can write this sentence scares me:
Hey, we're not as indebted now as we were after a decade of depression and four years of World War II!! Yippee!! We can all breathe easy now!
True, [the debt/GDP] ratio is heading in the wrong direction right now. It may reach 70 percent by the end of 2010. That’s high, but it’s not high compared to the 120 percent it was in 1946, after the ravages of Depression and war.
My latest Newsweek column is online. It looks at China's recent moves to challenge the dollar's status as the world's reserve currency and what to make of them.
The closing paragraphs:
If these moves do not amount to much, then why all the hubbub? To be blunt, America is out of practice at dealing with an independent source of national power. For two decades the United States has been the undisputed global hegemon. For the 40 years before that, America was the leader of the free world. As a result, American thinkers and policymakers have become accustomed to having all policy decisions of consequence go through Washington. Our current generation of leaders and thinkers are simply unprepared for the idea of other countries taking the lead in matters of the global economic order.
Most of China's recent actions do not constitute a real threat to the United States; indeed, to the extent that China helps to boost the economies of the Pacific Rim, they are contributing a public good. Obama—and Hunstman—need to make the mental adjustment to a rising China, welcoming many of China's policy initiatives while pushing back at those that threaten American core interests. If they can make this cognitive leap, then Sino-American relations can proceed on the basis of shared interests rather than mutual fears.
Daniel W. Drezner is professor of international politics at the Fletcher School of Law and Diplomacy at Tufts University.