Does the U.S. Need China to Pull it Out of Recession? 9 comments
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Fareed Zakaria usually writes very interesting pieces on international policy issues, but it seems to me that there is so much mystery about how the global balance of payments works that he, like so many others, makes simplifying assumptions that don’t take the balance into account, and for that reason just don’t make sense. In his latest piece for the current issue of Newsweek, for example, he says the following:
There is a consensus forming that Washington needs to spend its way out of this recession, to ensure that it doesn’t turn into a depression. Economists of both the left and right agree that a massive fiscal stimulus is needed and that for now, we shouldn’t be worrying about deficits. But in order to run up these deficits-which could total somewhere between $1 trillion and $1.5 trillion, or between 7 and 11 percent of GDP-someone has to buy American debt. And the only country that has the cash to do so is China.
In September, Beijing became America’s largest foreign creditor, surpassing Japan, which no longer buys large amounts of American Treasury notes. In fact, though the Treasury Department does not keep records of American bondholders, it is virtually certain that, holding 10 percent of all U.S. public debt, the government of the People’s Republic of China has become Washington’s largest creditor, foreign or domestic. It is America’s banker.
But will the Chinese continue to play this role? They certainly have the means to do so. China’s foreign-exchange reserves stand at about $2 trillion (compared with America’s at a relatively puny $73 billion). But the Chinese government is worried that its own economy is slowing down sharply, as Americans and Europeans stop buying Chinese exports. They hope to revive growth in China (to levels around 6 or 7 percent rather than last year’s 12 percent) with a massive stimulus program of their own.
The spending initiatives that Beijing announced a few weeks ago would total almost $600 billion (some of which include existing projects), a staggering 15 percent of China’s GDP. Given their focus on keeping people employed and minimizing strikes and protests, Beijing will not hesitate to add tens of billions more to that package if need be.
At the same time, Washington desperately needs Beijing to keep buying American bonds, so that the U.S. government can run up a deficit and launch its own fiscal stimulus. In effect, we’re asking China to finance simultaneously the two largest fiscal expansions in human history-theirs and ours. They will probably try to accommodate us, because it’s in their interest to jump-start the American economy. But naturally their priority is likely to be their own growth.
While I agree strongly with the thrust of Zakaria’s piece (cooperation between China and the US is extremely important to both countries), I disagree with his claim that “someone has to buy American debt, and the only country that has the cash to do so is China.” I was hoping that Brad Setser had already killed this argument, but apparently not.
Zakaria argues that the US needs a plan of massive deficit-financed fiscal expenditure in order to pull the US out of recession. This may or may not be true, but if it is true, the reason for the recession is that US households and businesses have found themselves overleveraged after years of excessive consumption, and must now cut back sharply on their spending as they increase savings. US fiscal expansion, in other words, will occur to offset the economic impact of a rise in US savings.
But if there is a rise in US household savings, don’t these increased savings need to be invested? Where will Americans put their savings? In fact almost all of it is likely to be invested in the US, and therefore the increase in savings is going to offset the need to finance a higher deficit (by the way, even if Americans decide to invest their incremental savings abroad instead of in the US, the net impact is the same). This is just another way of saying that the money that used to go towards financing private US consumption will now go to finance public US consumption, and by the way we all hope (I think) and expect that overall US consumption declines from its clearly excessive levels of recent years, so the total financing will be smaller.
The net impact is that the US doesn’t need foreign savings to finance the fiscal expansion unless the expansion is so great that the US economy surges and Americans (private and public) spend more than ever, in which case the problem is not a recession but a boom.
There is more to it. The $2 trillion in reserves that China has is already invested, so it cannot be used for additional investment. If the US really needs larges amounts of Chinese financing in the future, that is simply another way of saying that China must run significant trade surpluses with the US in order to accumulate the dollars necessary to lend to the US government (remember, China doesn’t finance the fiscal deficit, it finances the trade deficit).
Basically what Zakaria is implicitly saying is that in order to boost the US economy – which means boosting US production of goods and surpluses – the US must run very large trade deficits with China so that fiscal deficits can be financed by the Chinese. But a trade deficit, by definition, is consumption supplied by foreign production, not domestic production, so insisting on a large trade deficit with China cannot be the way to boost US production. And of course if the US does not run a large trade deficit with China, then China simply cannot fund the US fiscal deficit.
Zakaria continues:
People often say that China and America are equally dependent on each other,” says Joseph Stiglitz, winner of the 2001 Nobel Prize in Economics. “But that’s no longer true. China has two ways to keep its economy growing. One way is to finance the American consumer. But another way is to finance its own citizens, who are increasingly able to consume in large enough quantities to stimulate economic growth in China. They have options, we don’t. There isn’t really any other country that could finance the American deficit.
I have a huge amount of respect for Stiglitz but I also wonder about the logic of this claim. He says that China can either finance its own consumption or American consumption, and we should somehow hope they are kind enough to finance American consumption. As I have tried to argue in several previous posts, we should actually hope for the opposite. If China boosts domestic demand sufficiently, that will go a long way towards adjusting the global imbalance between excess US consumption and excess Chinese production. The main purposes of US fiscal expansion, I think, would be a)to slow down the US adjustment process so that it does not fall into a downward spiral, and b)to give the Chinese fiscal boost more traction – program of coordinated fiscal expansion by the world’s major economies would be better, I think, than leaving any one country to try to bear the brunt alone.
By the way the view that the Chinese authorities will have an easier time in this crisis than the US because “They have options, we don’t” is not, fortunately in my opinion, universally held among Chinese authorities. It is increasingly obvious that policy-makers here are very worried. Yesterday’s Bloomberg pointed out that the RMB is depreciating:
The yuan headed for the biggest weekly decline in almost two months on speculation China is seeking to protect exporters and prevent a recession in the world’s fourth-largest economy. Bonds fell. …”There is some pressure for depreciation as the dollar is strong and other Asian currencies are softening,” said Patrick Bennett, a foreign-exchange strategist with Societe Generale SA in Hong Kong. “Still, record trade surpluses and strong investment flows suggest appreciation pressure is intact.”
The currency declined 0.17 percent this week to 6.8356 a dollar as of 11:44 a.m. in Shanghai, according to the China Foreign Exchange Trade System. The yuan is allowed to trade by up to 0.5 percent against the dollar either side of the so- called central parity rate, which was set at 6.8317 today.
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This article has 9 comments:
Eventually a new capital-based economy would emerge to replace the failed one built on debt. But are we willing to work through the pain? And if we are, will our business and political leaders allow it to happen?
and it would follow that the stimulus packages if aimed at stimulating consumer demand would be off target, and a waste of money. in fact, if what michael is suggesting is true, then the best course of action of the government is to cut the budget and reduce the debt. this would create a situation over time where too much money was trying to finance the debt driving rates lower. the money would then seek other sources to make money, or simply be spent recreating consumer demand.
The US consumer will eventually save more? Save more but spend less are not synonymous. Unemployment growth will result in less spending but lower compensation will cause the consumer to make "ends meet". The end result could well be stagnation. IMHO
we on the other hand, are stuck with 280 trillion or so in dangerous derivatives that can take down what is left of our big banks....So we are in deep doo--doo. Nobody wants to talk about the $1.1 trillion in interest only and option mortgages held by thinly capitalized speculators who are upside down and cannot get any refinancing.----The resets start in May 2009 and run until late 2012. think what is going to happen to the derivatives 1.1 trillion in badloansareburied in when the mess we are in currently was caused by "only" 615 $billion going bad----gee--we are starting to talk about real money...
What i find scary is that the new administration is being packed with the very people who brought on the current destruction to our system and economy and who benefited from it.
As long as the US spends more than it makes, it will have to borrow the difference. The dollars that are already out there are a done deal. China could spend them on oil and commodities, but that would just mean some other country has the dollars. As water flows downhill, dollars ultimately flow to the oil producers.
The bottom line is that those dollars can only be "spent" in the US. Moving them from one non-US country to another non-US country doesn't change the US's balance sheet. Foreigners holding dollars can park them in treasuries, but that's still only a temporary solution. Sooner or later, those dollars have to be used to buy something from or in the US. So either the US becomes a net exporter (the world buys our goods) or we sell assets.
We can't be a net exporter with the dollar anywhere near its current level. We aren't going to become net savers enough to matter. If China and other dollar holders were smart, they would use their dollars to buy property and businesses in the US, assets of real value. If they wait too long, they will find that the US has printed many trillions of dollars to finance all these bailouts and stimulus programs, and they have lost the major part of the value of their US-dollar "assets".
It's in nature a reluctant yet de facto socio-economic self-sabotage in addition to economic and financial suicide, albeit many consumers neither have the sense of economic security nor the perspectives to have actually been able to realize it, collateral damage. Ok, you stop spending and start saving [which is totally justifiable in such environment]. And the scenario gets problematic, you are buying less, which translates into lower corporate profits, which translates into fire-thine-back en masse, [plus some side effect: cascading stock prices, etc.] which translates back into "you" are less able to buy to the next level, and this goes on and on, at corporate level. At government level, you are buying less, corporate america reaps less, in turn signs you even scanter paycheck, so you are having to buy less, state and federal collect less from your consumption tax, you are buying less, the businesses make less, disbursing less business tax, the government receiving less in revenue, issuing more bonds, devaluing more of the currency, intending to bail more out...
The underlying question here, is that the over-panic consumers have forsaken the key momentum driving the U.S. economy to outperform for half a century - consumerism. Bad or good, it offers the incentives for business to increase capital expenditure [by generating ginormous demand], in terms of hiring more, investing more in R&D, making efforts to keep their desired staff, equipping more and better. And such impetus reverberates throughout the processes, the IB will underwrite that 8 zillionth deal , the CB and credit card companies will issue 12 zillion more loan, the EM will manufacture 100 zillion more goods, yet sustaining 0.000 digit sweatshop salaries for underemployed [who are nevertheless overapperciating such engagement, after all, a meager income is nonetheless more appealing than nada] so that their children could also buy iPOD, enjoy frappuccino, and laptop, which albeit locally-produced and but US assembled, in turn, cementing uncle sam's balance sheet and financing the U.S. consumers.
Perhaps after a quarter or so go with this saving like there is no tomorrow strategy, people should start to spend again.
Big inventory increases produce new production cuts and lowered future expectations which lead to higher unemployment rates and an extension of the No Tommorow scenario.
Whether it is the local nightly news or CNBC, the average american is being inundated with negatives.
The Lowest " everything " in decades, in the last 50 years, since statistics on this started, since The Great Depression are currently seen in the news on a daily basis. The continued push for Bailouts from current employers is not lost on them either, "will my job be next?"
How does one Save in this environment? Everyone spends less, thats a Gimmee, but if they are going to buy anything, they will look for the cheapest equivalent items for their every day needs.
The sales will entice buyers only if they are remarkably large. I have a Circuit City store which is closing in my area, they advertise a 30% cut on everything in the store. I didn't even bother to go in, 30% is meaningless at this point in time.
The Government may think the consumer will buy once credit is readily available, I think they will continue to fortify until employment ads start to rise. IMO