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The China Syndrome: what the current talks with China tell us about America’s situation

Chinese and American flags flying together

Chinese and American flags flying together

The US/China talks are actually, in many respects more important than the healthcare debate. What China is willing to pay for may well be what the US can do, and what is being negotiated right now is what they’ll pay for.

Let’s take a look at the issues.

The exchange rate and Treasury purchases

First we have this:

At stake is continued demand by China, the largest foreign investor in U.S. Treasuries, for the unprecedented issuance of American government debt.

Sounds good.  But then we have this:

The value of China’s currency, the yuan, is also on the agenda. The U.S. regards China’s currency policy as a distortion and wants China to let the value of the yuan appreciate.

Here’s the problem. Those two things are in opposition.  The more treasuries China buys the more downward pressure there is on the Yuan and the more upward pressure on the dollar.  Buying treasuries (or any other dollar denominated assets) does not lead to the Yuan appreciating, unless China buys less of them.  But if China buys less of them, well, the US won’t have enough purchasers (actually the US already won’t have enough purchasers and the Fed will have buy treasuries, but how much is in question.)

US Savings Rates, the Death of the American Consumer and the everlasting great recession

What’s interesting about all this is how honest Geithner is being about the US economic situation with the Chinese.  Take for example, this:

In the talks today and tomorrow in Washington, U.S. officials said they plan to tell the Chinese the American rebound from a recession won’t be led as much by consumers as past recoveries.

Why is this?  Because employment is not going to recover before the next recession, and because the savings rate for the US has to stay relatively high so that Americans can de-leverage, as has also been admitted:

“We are committed to taking measures to maintaining greater personal saving and to reducing the federal deficit to a sustainable level by 2013,

What this means is that the consumer spending is not going to lead the recovery this time around.  Consumers are not going to dig the US out of this, because China is not willing to lend US consumers that much money anymore.

But the statement is contradictory on its face.  If deficits have to be brought under control, and savings rates have to be kept relatively high, who’s going to create the demand required by the economy to get out of the great recession?  Not government, because of the deficit issue.  Not consumers, because they are going to have a higher savings rate and their assets (read houses) aren’t going to look good to be borrowed from.

Which leads us to another point.  Both America and China did a stimulus.  China’s stimulus is already working.  It had 7.1% GDP growth.  The US is still mired in recession.

Why?  Two main reasons.

  • China did its stimulus right.  It wasn’t 40% bullshit tax cuts with almost no stimulative effect.
  • China, as a creditor rather than debtor nation with huge savings, can credibly be expected to continue its stimulus, while the US can’t.  When businesses make decisions about spending they need to know the money will be there next year, they don’t know that with the US.

Americans also want the Chinese to move to greater domestic demand,, to open up the Chinese market to US investment (because American companies desperately want to be able to invest in a country with real growth prospects, rather than the US) and to start buying more US goods.  This requires letting the Chinese currency appreciate against the US dollars and is needed long run for American health.  But in the shorter term it leads to a fiscal crisis.  If America doesn’t want to increase taxes to pay for its own spending, how can China buy less treasuries and US assets and thus allow the Yuan to appreciate?  And why should they, when right now in exchange for money the Chinese can afford to lose and crappy consumer goods, the US is exporting its industrial base to China?  An industrial base is worth any price.  Americans, with their unwillingness to tax themselves, aren’t willing to pay for the American industrial base.  The Chinese are.

Why can’t we get a good healthcare bill?

Because the US is a debtor nation, and China isn’t willing to pay for Americans to have healthcare.  That’s why it has been declared that the health reform bill must be deficit neutral (or close). On the other hand, since bailing out the financial system meant bailing out the value of a lot of Chinese assets, the Chinese were (grudgingly) willing to go along with that, since they benefited.  They do not benefit from Americans getting health care.

Can you say co-dependent?

I sure hope so, because that’s the Chinese/US relationship. But one side of the relationship is getting a lot more out of it than the other one and every year the Chinese need America less, and America needs China more.


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  1. BDBlue

    Ian, I’m very interested in what you think about deficits. I notice a lot of progressives seem to think that deficits don’t matter and mock the deficit hawks. I’m less sure of that approach. I think the deficit hawks deserve mocking, but not because they are worried about the deficit. I don’t know how anyone can look at the growth rate of the deficit, the plunging revenue from taxes, and not be worried about it. Instead, it seems to me the real problem is that the deficit hawks only care about spending that helps regular Americans. It isn’t that cutting the deficit isn’t important, it’s that the way to do that is to stop trying to occupy two Muslim countries and jail everyone who ever smoked a joint, not deny Americans decent healthcare and a social safety net. Also, of course, we could rationalize our tax system. I think the tax rate on the wealthy can be raised (the FICA caps are particularly regressive as is the ability of financiers to structure their pay as capital gains), but there was a chart up at zerohedge (I’ll try to find a link) that showed not that long ago corporations paid $4 in taxes for every $1 individuals paid. Now it’s 1:1. And, of course, a lot of those corporations are avoiding taxes by offshoring jobs. It’s a vicious cycle.

  2. The way you put it, the solution is for Americans to become willing to tax themselves, but this is considered treyf in American political culture (not to be confused with the actual will of the people, which is largely irrelevant). But the real solution is to reduce dependency on foreign trade.

  3. Ian Welsh

    The real solution is both, actually, Mandos. But if you stop importing so much, you also run into inflation issues, China (and offshoring) is the engine of deflation. And to get off the treadmill, you have to reduce dependency on oil, as well, because every time the world has even the slightest hint of a recovery the price of oil spikes through the roof. Bush’s economy was not that good, and oil prices went sky high (you also need to discourage traders from driving up oil prices, but the problem is that everyone knows that’s where to go now if you think there might be a recovery. It’s the brain-dead play right now.)

    And yes, American political culture is deeply broken on taxation, just like on every other issue I can think of.

    Unfortunately, Americans are going to find that the rest of the world is not willing to lend to them forever, just until they’ve extracted as much value as they can get and until the Chinese economy hits internal demand ignition.

    At that point, the US gets to experience what the Russians did in the 90’s, but won’t handle it nearly as well.

  4. You think so? I thought the Russian situation was a bit different: a very sudden selloff of industrial assets, among other things. Whereas, for the USA, it’s been a very slow selloff of industrial assets. Generally, things that happen suddenly tend to have more catastrophic consequences and reactions…

    Nevertheless, it is always at the back of my mind, living in the USA—how much of a career to try to build here, or not or both.

  5. Ian Welsh

    I think so, yeah. Could be wrong, but the numbers I’ve seen require about a 20% reduction in the US standard of living to even things out. Problem is, there tends to be overshoot…

    However, it’s worth bearing in mind that if the US really goes down, Canada probably will too, though we can hope not quite as much. It’s why when I was back at Tilting I used to try explaining to politicians that they needed to stop the American/Canadian integration project. Not reverse it, necessarily, but stop trying to increase trade with the US and start pushing it with others and start building up internal manufacturing and so on.

  6. jo6pac

    Oh sure blame the usa and ws. We are the greatest manufacturing country in the world. What about all of those mortgages, ya it didn’t turn out well but there those CDOs that were going to save us, Oh right. Well there’s always high speed trading, oh right that only helps gs and friends. Well I’ll have to get back to you right after I finish digging this hole.
    Everything is on schedule, please move along. Uncle Milton here we come.

    Sad Day in The USA and I’m sorry to all that we have f*&^ with in the world.

  7. BDBlue

    Ian, have you done any posts (my apologies, but I stopped reading FDL some time ago) that outline your 20% decrease in US living standards – why that is and, even better, what the Government should be doing to change or soften the impact of that and how that compares to what the Obama Administration and Congress are actually doing? Because I’d love to see the numbers crunching behind that conclusion. I suspect it’s dead on and that has a lot of impact on policy and the future of politics in this country.

    Personally, I don’t see how we lose that much of our living standard and not have a lot of internal turmoil, including various popular movements (some positive, some not).

  8. jbaspen

    Ian, I see two very corrupt elites posturing for their lapdog medias. That venerable Bear and shy genius, James Grant is worried, as always. He sees a “Global policy-making consensus” of massive injections of money and credit. “China is… seeding bad loans right on top of the previous cycle’s only partially harvested crop of desperate debts”. Chinese banks will have lent 1 trillion (US) in the first half of 09′; straight into an environment of falling corporate earnings. The question for all of us, quips Grant, is how long can the Chinese keep this going? Compounding all this, as if loans by quota aren’t dicey enough, are the 70 million members of the Chinese Communist Party. Dogma doesn’t inspire these people anymore – money does. Grant was reporting over three years ago that Chinese banks had over 900 billion in NPLs (to the above-mentioned “Marxists”), loans that were either off-balance sheet transactions or simply rolled over and extended.
    Grant compares the Chinese Banking system to the infamous Oklahoma bank from the Mark Singer classic, “Funny Money”. The little oil patch bank was named Penn Square and its chief energy loan officer was known around the Bank as “Monkeybrains”. Penn Square was able to keep its juiced and fraudelent schemes going for quite some time – from the middle 70s right to the oil crash/recession of 1982. They took the Country’s 7th largest Bank, Continental Illinois right down with them!
    Corrupt transnational elites are a mutual admiration society whose loyalties lie with the corrupt but oh-so-lucrative “System” with they perpetuate.

  9. Blue, when we lose that much – 20% – we will have internal turmoil.

    And we will. Things are gonna’ get uglier before they get pretty.

  10. However, it’s worth bearing in mind that if the US really goes down, Canada probably will too, though we can hope not quite as much.

    Oh, for sure. The difference for me at least is that I have the illusion of being protected by my Natural Born Citizenship of Canada.

    It’s been impossible to discuss protecting Canada from the vagaries of the US economy due to regional divisions in Canada. Certain regions of Canada feel like any such measure is an attack on them, especially the one most invested in pumping oil at great environmental cost (*cough*Alberta*cough*).

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