China

Following up on my dollar post from earlier this week, I see that Paul Krugman is talking a related issue in his New York Times column today -- the refusal of the renminbi to depreciate against the dollar:

Many economists, myself included, believe that China’s asset-buying spree helped inflate the housing bubble, setting the stage for the global financial crisis. But China’s insistence on keeping the yuan/dollar rate fixed, even when the dollar declines, may be doing even more harm now.

Although there has been a lot of doomsaying about the falling dollar, that decline is actually both natural and desirable. America needs a weaker dollar to help reduce its trade deficit, and it’s getting that weaker dollar as nervous investors, who flocked into the presumed safety of U.S. debt at the peak of the crisis, have started putting their money to work elsewhere.

But China has been keeping its currency pegged to the dollar — which means that a country with a huge trade surplus and a rapidly recovering economy, a country whose currency should be rising in value, is in effect engineering a large devaluation instead.

Krugman then goes on to excoriate the U.S. Treasury department for not upbraiding the Chinese more on this. 

Fair enough, but the thing is, the United States is not the country that's hurt the most by this tactic.  It's the rest of the world -- articularly Europe and the Pacific Rim -- that are getting royally screwed by China's policy.  These countries are seeing their currencies appreciating against both the dollar and the renminbi, which means their products are less competitive in the U.S. market compared to domestic production and Chinese exports. 

This leads to the title of this post.  Krugman presumes that the U.S. has the strongest incentive to talk to China about this issue.  If one thinks of the U.S. acting as the hegemon, that's possibly true.  As a matter of direct economic interest, however, why haven't the Europeans and East Asians been screaming bloody murder about this?  China's policies are forcing them to take actions they don't want to take -- so why aren't they complaining more loudly about this? 

Why? 

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. 

My latest column for Newsweek International is now available.  It looks at optimistic and pessimistic modes of thought with regard to China's future, and suggests that they can both be right: 

I belong to the third camp—the one that believes that the Bubblers and the Extrapolators can both be right. My camp looks at China and sees the parallels with America's rise to global economic greatness during the late 19th and early 20th centuries. From an outsider's vantage point, America looked like a machine that could take immigrants and raw materials and spit out manufactured goods at will. By 1890, the U.S. economy was the largest and most productive in the world. As any student of American history knows, however, these were hardly tranquil times for the United States. Immigration begat ethnic tensions in urban areas. The shift from an agrarian to an industrial economy led to fierce and occasionally violent battles between laborers, farmers, and owners of capital. With an immature financial sector, recession and depressions racked the American economy for decades.

It is not contradictory for China to amass a larger share of wealth and power while still suffering from severe domestic vulnerabilities. From the perspective of the rest of the world, however, this is not a good thing.

As for why it's not a good thing, well, you'll have to read the whole article. 

When the Obama administraton announced the decision to slap a 35% tariff on Chinese tire imports, I was pretty sure that free traders would be incensed.  And I haven't been disappointed -- even the financial markets are freaking out over this one. 

We trade enthusiasts are an excitable lot, however, what with everything leading to the falling off of cliffs, crossroads being reached, and red zones being breached.  Seven years ago, the allegedly free-trade Bush administration imposed steel tariffs that were found to be WTO-inconsistent.  There was a lot of gnashing of teeth and wailing at the time about the end of the open economy as we knew it -- yet the world trade system proved to be pretty robust.  So maybe my trade compatriots are exaggerating things a wee bit, yes?  In all likelihood, won't this be resolved via the WTO dispute settlement mechanism about 18 months from now?

For the first eight months of the Obama administration, I've been resisting the urge to shout "protectionism" at the drop of the hat.  This time, however, there are four reasons why I'm feeling much more nervous: 

1)  This isn't your garden-variety protectionism.  Last month, Chad Bown explained the Financial Times why this decision was a very special kind of protectionism: 

[A] little-known loophole in the rules governing China’s 2001 WTO accession makes it easy for a global protectionist response to spread faster and further than that which took hold in 2002. Nowadays, once any one country imposes a China safeguard on imports, all other WTO members can immediately follow suit, without investigating whether their own industries have been injured.

So this trade dispute can metastasize more quickly than most. 

2)  Beijing is not lying down on this.  China's furious and swift reaction points to another problem:  the United States is not the only country feeling protectionist urges at the moment.  Economic nationalism in China is riding quite high at the moment, as Keith Bradsher suggests in the New York Times: 

The Chinese government’s strong countermove followed a weekend of nationalistic vitriol against the United States on Chinese Web sites in response to the tire tariff. “The U.S. is shameless!” said one posting, while another called on the Chinese government to sell all of its huge holdings of Treasury bonds....

China had initially issued a fairly formulaic criticism of the tire dispute Saturday. But rising nationalism in China is making it harder for Chinese officials to gloss over American criticism.

“All kinds of policymaking, not just trade policy, is increasingly reactive to Internet opinion,” said Victor Shih, a Northwestern University specialist in economic policy formulation.

Methinks Shih and Bradsher are exaggerating things a wee bit -- imagine for a moment if U.S. foreign policy was driven by people getting upset on the Internet -- but you get the point.   

The U.S. use of this provision is doubly troubling, because from Beijing's perspective their WTO accession negotiations were seen as a humiliating kowtow to the power of the West.  China is not going to be selling its bonds anytime soon, but Beijing has not quite mastered how to cope with these kinds of domestic pressures, so they could do something really, really stupid.

3)  Politically, Obama has boxed himself in.  As egregious as the Bush steel tariffs were, they were targeted at a sector and not a country.  Furthermore, the Bush administration responded to the hubbub very quickly by watering down the worst effect of the tariffs. 

The Obama administration's new tariff is expressly directed at China.  And I'm not saying that China is blameless here.  But because it's country-specific, the administration has less room to maneuver -- either the tariffs are applied against China or they aren't.  It can't walk this back without it looking like a flip-flop.  Which means that there's little room for concession or negotiation. 

4)  Obama's base scares me on trade.  When the Bush administration did what it did, it was fulfilling a campaign promise to the state of West Virginia steelwokers.  Fortunately, the rest of Bush's winning political coalition was not seeking trade relief.  So the protectionist instinct pretty much ended with the steel tariffs -- and everyone in the Bush administration knew that they'd be overturned by the WTO eventually. 

With the Obama administration, however, this feels like the tip of the iceberg.  Most of Obama's core constituencies want greater levels of trade protection for one reason (improving labor standards) or another (protecting union jobs).  This isn't going to stop.  "Trade enforcement" has been part and parcel of Obama's trade rhetoric since the campaign.  The idea that better trade enforcement will correct the trade deficit, however, is pure fantasy.  It belongs in the Department of Hoary Political Promises, like, "We'll balance the budget by cracking down on tax cheats!" or "By cutting taxes I can raise government revenues!"  It.  Can't.  Happen. 

If I knew this was where the Obama administration would stop with this sort of nonsense, I'd feel a bit queasy but chalk it up to routine trade politics.  When I look at Obama's base, however, quasiness starts turning into true nausea. 

Developing.... in a very, very scary way. 

UPDATE:  More from Brad DeLong, Dave Schuler, and Shadow Government's Phil Levy. 

In a legen -- wait for it -- dary blog post, Belle Waring mentioned the pony problem in public policy.  Namely, "an infallible way to improve any public policy wishes. You just wish for the thing, plus, wish that everyone would have their own pony!"

I bring this up because of David Sanger's New York Times story about the prospects of imposing a gasoline embargo on Iran:  

The Obama administration is talking with allies and Congress about the possibility of imposing an extreme economic sanction against Iran if it fails to respond to President Obama's offer to negotiate on its nuclear program: cutting off the country’s imports of gasoline and other refined oil products....

But enforcing what would amount to a gasoline embargo has long been considered risky and extremely difficult; it would require the participation of Russia and China, among others that profit from trade with Iran. Iran has threatened to respond by cutting off oil exports and closing shipping traffic through the Strait of Hormuz, at a moment that the world economy is highly vulnerable.

The rest of the story is kind of irrelevant -- because without China and Russia, this is just a theoretical exercise.  In fact, here's a good time-saver:  if you read any story about a gasoline embargo o Iran, just scan quickly and get to the part where the reporter explains how and why Russia and China would go along.  If it's not mentioned, the story is inconsequential. 

If you want China and Russia to agree to sanctions, should you wish for the free pony as well?  Here the growth of dissent in Iran complicates an already complicated picture.  I'm betting that Moscow and Beijing have observed the "Death to Russia!" and "Death to China!" chants among the protestors.  This is likely going to make them even more reluctant to do anything that undermines the current regime (even if this hurts their long-term interests).  Which a gasoline embargo would most certainly do. 

Do I think a gasoline embargo is a good idea?  Absolutely.  Do I think it will happen?  No, I don't. 

UPDATE:  Spencer Ackerman reacts the same way I do.  The Weekly Standard's Michael Goldfarb is more optimistic. 

This bit from the Los Angeles Times' account of today's Tehran protests is veeeeeeeeerrrrrry interesting. 

At times the two camps appeared to be shouting directly at each other, exposing the still-festering election rift within Iranian society and the political establishment underneath both at the Friday prayer enclosure on the university campus and on the streets outside.

As Mousavi supporters chanted "Death to the dictator," against Ahmadinejad, his supporters chanted "Death to opponents" of Khamenei.

As hard-liners repeated their signature cries of "Death to America" and "Death to Israel," riled-up Mousavi supporters overpowered them with chants of "Death to Russia" and "Death to China," the Islamic Republic's powerful United Nations Security Council protectors.

This little exchange underscores the fact that the United States is not the only great power with a stake in the outcome of what happens in Iran. 

That said, one wonders if Russia and China will respond by doubling down on the current regime -- i.e., aiding and abetting Khamenei, Ahmadinejad, and the Revolutionary Guards in order to ensure a friendly Iran. 

If this happens, 2009 could be a bizarro-world replay of 1953, when the United States backed a coup in Tehran order to ensure a U.S.-friendly regime.  That move gave the United States 25 years of a friendly Iranian government,  immediately followed by thirty years of a hostile Iranian government. 

Readers, does this analogy hold up? 

The Financial Times' Peter Garnham reports that China is getting serious about internationalizing the use of the renminbi:

China has kick-started a major plan to internationalise the renminbi and the process is likely to be faster than many expect, according to HSBC....

“China is beginning an ambitious scheme to raise the role of the renminbi in international trade and finance and to reduce reliance on the US dollar,” said Qu Hongbin, China chief economist at HSBC.

“This will likely be a multi-year and gradual process. Yet, we believe the pace is likely to be faster than many expect.”

HSBC said the internationalisation of the renminbi was long overdue, given China’s rising economic power relative to the limited use of the renminbi overseas.

If you read the whole story, you discover that the FT's evidence for this assertion rests entirely on assertions by HSBC officials.  Which leads one to wonder whether maybe, just maybe, the FT should have checked to see whether HSBC has any financial stake in globalizing the use of the renminbi. Crazy talk, I know...

Loyal readers are surely aware that this is not the first time the Financial Times has hyperventilated over Chinese moves that don't necessarily amount to all that. 

Now before anyone accuses me of going all Brad DeLong on the FT, I think a lot of their China coverage (particularly by Jamil Anderlini and Geoff Dyer) has been very informative.  That said, this kind of thinly sourced story does lead one to wonder just how much of the coverage of China's financial moves is hype from financial players with a vested interest in feeding the China bubble. 

Readers -- am I underreacting to this? 

Not everything going on in international relations is about Iran.  My latest column at The National Interest Online evaluates yesterday's BRIC Heads of State summit in Yekaterinaburg.  The closing paragraph:

[T]hink of the BRIC grouping as an homage to other toothless international groupings. Indeed, most of the official BRIC communiqué consisted of pledges to do things that will clearly not be done, like finish the Doha trade round. In doing this, the BRIC coalition appears to be quickly learning from the grand tradition of fruitless G-8 and G-20 communiqués.

Go read the whole thing.