Why Should China Change?

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by: John M. Mason

Paul Krugman takes on China in his column this morning (see: Taking on China). He begins, "Tensions are rising over Chinese economic policy, and rightly so" because it “has become a significant drag on global economic recovery.”

Why should China change direction at this time?

There was a time when the United States could do just about anything it wanted to. It was, by far, the strongest economy in the world. It had, by far, the most powerful army on the planet. It provided, by far, the best education anywhere. In essence, it could get away with about anything.

In fact, there are quite a few nations now in addition to China, such as Brazil, India, Russia, Canada to name a few, that can ask the same question, “Why should we change direction at this time?”

The gap has closed. There has been more and more talk about this diminishing gap. One of the more prominent books on the subject is by Fareed Zakaria titled “The Post-American World" and another is by PIMCO’s Mohamed El-Erian: “When Markets Collide.” The problem arises, not because the United States has been replaced at the top. No, the United States will remain the world’s number one power, economically and militarily, for many more years.

The problem is that the relative gap has changed putting the nations mentioned above relatively closer to the United States and this, consequently, gives them a stronger position in how things are played out. We see this in the shift to the G-20 rather than some other G-something. We see this in discussions around the World Bank and the International Monetary Fund. We see this in the growing influence of these other countries around the world.

The world has changed and we in the United States have not accepted the fact.

Why should China change direction at this time?

China is growing stronger and stronger. The United States, and most of the rest of the west, is in a weakened state. The United States, and most of the rest of the west, has gone through a very severe financial crisis and the worst recession since the 1930s. The United States, and most of the rest of the west, is beginning to recover, although the pickup has been very weak up to the present point.

Krugman is arguing that those big bad Chinese are hurting us when we are weak, when we are least able to defend ourselves.

Well, we got ourselves into this situation. We, the United States, created an inflationary environment which resulted in the purchasing power of the dollar declining by about 85% over the past fifty years or so. We, the United States, produced an environment that fostered, even celebrated, the creation of debt. We, the United States saw the value of our currency in international markets decline steadily, with a few exceptions, over the past fifty years. The only respite experienced recently has been that the dollar and U.S. Treasury securities have become a haven for risk-averse investors throughout the world.

Now, the United States is suffering through the consequences of this lack of discipline and is pointing its finger at the big bully that is taking advantage of the situation.

But, the big bully is pointing his finger back at the United States and even accusing the United States of not playing fair itself (see: Chinese Leader Defends Currency and Policies). China is even playing international economics against the United States (see: China Uses Rules on Global Trades to its Advantage.) and continues to acquire natural resources, companies, and trade ties throughout the world (see: CNOOC in $3bn Bridas deal.)

Imagine the nerve of these people!

In the end, the lack of fiscal discipline comes back to haunt one, whether it be a person, a family, a business, or a nation. On the upside, the ride can be great. However, once the bubble bursts, there are no good choices available to one. There is pain regardless of what one does.

Now, however, there are other players in the game and this lack of fiscal discipline can really hurt. The economy of the United States, and the rest of the west, is weak, budget deficits are projected to go on forever, and the dollar is expected to weaken again as international investors become less risk-averse. We need everyone to cooperate with us so that we can bail ourselves out of our past behavior.

Unfortunately, that is not how the world works. And, it is human nature to sense weakness in others. The United States, and the rest of the west, is in a weakened state right now. It will not always be so, but it is for the time being. Thus, others have an opportunity to increase their relative position within the world.

My guess is that China does not plan to overdo it for they have more to gain in the future if trade is more open than not. One piece of advice someone gave me several years ago about the Chinese has proven to be very perceptive. They said that whereas people in the West have very short time horizons, generally in the three to five year range or less, the Chinese have a much long perspective of history. They think in decades rather than years.

I believe that the Chinese know that they will be better off over the longer run if world trade is more open rather than more restricted. Hence, they will not go far so as to create a trade war that will be detrimental to achieving a more open world trade. China’s investments in natural resources and companies throughout the world underscore this bet.

However, the United States is in a weakened position. Thus, the Chinese can achieve more now by taking advantage of this weak position and still achieve the longer-term goal of more open trade. The United States is in no position to resist this and will not be in a position to resist this for some time. And, it would hurt us more to act aggressively at this time to introduce more trade protection than it would China. Hence, advantage China.

Quite a few other countries are also in a position of strength relative to the United States at this time. Brazil seems to be following a more and more independent line. India is acting more in tune with its own interests. Russia, except for its athletics, is also stepping out here and there. And, so on and so on.

It is interesting to see people from the school of economics that led the United States into the position it is in, like Krugman and Joe Stiglitz, begging for help from others in the world that are taking advantage of the weaknesses created by the application of the policies forthcoming from that school. The lack of discipline has consequences. Why should we expect or depend upon others to bail us out of the conditions that we ourselves have created? Why should China change?