The horizon is not so far as we can see, but as far as we can imagine

The China Syndrome

china-us-national-debt-holdings-by-lillith-newsBarack Obama came back from China and immediately announced that he was worried that about high deficits causing a double dip recession.  Notice the chronology.  Trip to China: announcement that deficits are a problem.  In other words, the Chinese told him to get the US deficit under control, or else, and he responded.

Why?  Because Barack Obama’s play, under Geithner, Summers and Bernanke’s controlling hands has been all about getting the financial play going again.  Instead of saying “financialization of our economy caused the crash so we should de-financialize” the lesson he learned was “don’t let the financial play fail” and the strategy is to reboot the system.

The Chinese own an awful lot of US assets.  If they were to decide to diversify out of those assets faster, well, that would be the end of the US financial play reboot.  There’s still a fair bit of appetite for US assets, but it’s far from infinite and there’s a lot of uneasiness about the value of US assets in the long run.  Any time it pleases China can remove as much value as it desires, simply by selling various assets.  And since the Chinese are convinced they’re never getting that money back anyway, the primary value of those assets to them is now the leverage over US policy which it enables.

So why wouldn’t the Chinese want the US to keep spending massive deficits?  After all, stimulus in the US equals Americans buying Chinese goods, and the Chinese need that, right?

Right.  But stimulus in the US also means increased US use of oil, which increases the price of oil.  And oil is hovering just under $80/barrel.  Oil is the bottleneck resource.  Every country’s growth is constrained by oil.  East Asia is seeing a recovery, without the US recovering.  The conclusion they have likely drawn from that is that they don’t need the US to recover fully, and that in marginal terms, it’s better to have cheap oil than some marginal American consumption which will drive oil up so high that the economy crashes out under the weight of it.

In the past the US has been able to pretty much unilaterally weaken or strengthen the dollar.  But right now the US does not have that ability.  On the one hand, if the US strengthens the dollar, the oilarchies will just increase the price of oil faster than the dollar rises, on the other hand, China can make the dollar worth whatever it wants relative to the Yuan any time it feels like by reducing its purchases of US assets, or even dumping part of its huge US dollar reserves.

The end result, then, would be more expensive oil and a Yuan that hasn’t moved any more than the Chinese want it to.  Even if the Yuan did rise relative to the dollar, contrary to what the weak dollar mavens think, it’s unclear that would help the US much.  The increase in the price of oil and other commodities would offset much or all of the value.  In addition, many of the things the US exports most of are items it has an absolute rather than comparative advantage in.  US military goods are simply better than anything comparable, for example.  People buy American entertainment, software and so on because there are no comparable goods available elsewhere  A weaker dollar just means the US gets less money for them.

In order for devaluation to work one of the key things the US has to do is break the ability of the oilarchies to tax the US with oil price increases.  That means it has to reduce the US dependence on oil significantly, turning energy into a capital good.  Unfortunately, the two areas making the largest commitment to alternative energy are China and Europe, not the US.

In addition, the US has to take control of its own spending needs, which means reducing dependence on foreign capital.  That’s easy enough to do, with some modest currency controls and taxes after having increased marginal taxation significantly (90% on all income over a million, say).  Once this has been done, with the majority of investment in the US coming from the US, it will matter a great deal less if the US dollar is crashed, in fact, it will have the good effects that low dollar evangelists think it should have now and which failed to materialize over Bush’s reign when the dollar dropped steadily.

But, since there is no significant move to do any of those things, and since there is no political possibility of any of these things happening before 2016 at the very earliest, get used to the fact that the late Clinton economy is the best economy most Americans have ever seen, or will ever see.

*(My guess is that the Chinese are going to increase the value of the Yuan somewhat in 2010.  Because that will generate internal growth for them. Obama and co will be surprised by how little US growth it generates.)


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  1. S Brennan

    One of the most foolish notions share by right and left is the idea that a weaker dollar will immediately effect the balance of trade…as if manufacturing plants will spring up like mushroom after a rain. Sorry Charlie, economics professors talk a lot of shit and this is one of their bright shinning turds. Manufactures don’t/can’t react to fluctuations, they have a need for long term commitments of cost control, not a two year commitment.

    China took our manufacturing by a combination of things…over a long period of time. US manufacturing could be reconstituted and the nation would be better for it, but it will take a industrial policy willing to manipulate currency, price supports [think government purchasing agreements that are margin controlled…ie you want the contract, you open your books], DIRECT subsidies [think DARPA not loans but seed money], import tariffs and outright embargos on goods that are not produce in compliance with internal enviromental/labor standards. EXACTLY the same things China did.

    In addition, control of “high wages” rudimentry. From yesterday:

    “…does anybody in their right mind not realize that wage demands are related to PRICE demands…or “rents” as they are now called. If people could buy a house for 15,000, groceries for 20 a week, a doctor’s visit for 10 bucks, a car for 2,000 do you really think workers would demand a six figure salary? High wages in America are directly related to high “rents” In spite of what economist say, prices are determined by inputs, margins, and demand, increase ANY one of these three and prices increase. If you want to produce with low wage, you must either suppress the worker with bullets, or suppress the margin on the “rents” he/she must pay.” Control unbridled greed, or be willing to murder good people for the privilege of overcharging them…or let the country continue it’s 3 decade long decline.

    Manufacturing will not come back with temporary currency manipulations, I don’t care how many pointy head professors of both the left and the right huff and puff. Even Dean Baker is wrong on this one.

  2. Ian Welsh

    Agreed on all points. Especially that, rents/asset inflation needs to be lowered significantly.

  3. S Brennan

    I should another comment on the subject from yesterday:

    By S Brennan on Sun, 11/22/2009 – 6:14pm

    …I don’t like what the US does with cotton or sugar. Trade should be fair. To be fair, trade needs to be bilateral and highly conditional.

    I export, the greatest structural impediments to US goods occurs in their own market. US chain retailers and distributors regularly block access to market because it is their undying belief that they can take your product over to China and get it knocked off and have a larger margin. US retailers actively work against US manufactures, that type of behavior is not seen in the rest of the industrial world. Suffice to say, a significant number of US made products are available in Europe that are not available in the US. Free trade & free markets are illusionary, the terms themselves are silly marketing gimmicks.

  4. BDBlue

    This post reminds me of Stirling’s excellent piece on peak oil, here.

  5. Unfortunately, we’re at the point where the Correct Solution (carefully planned/selective tariffs, confiscatory taxes on very high incomes, and so on) will not be followed, but something has to be done. The reason for supporting a lower dollar is that it is a weak substitute for some aspects of the Correct Solution, but it is the Available Solution at hand.

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