China’s leadership likes to communicate by brief but loaded signals, both to its own population and beyond. They are less inclined – have less need - to posture than politicians in the West. That is, they mean what they signal.
Whilst China is reliant on the U.S. as its biggest market and for the investments it has made there, the U.S. is reliant on China for ongoing cheap credit and goods. Given this inter-dependency, what is China signalling about its intent amidst current market turmoil?
The signals are clear but don’t seem to have been well picked up by the media. I suggest that there are three loud “No”s to be found in what China has been saying on the international stage, as well as some quieter “Yes”s.
The first “No”
Back in May 2008 the London Financial Times reported a “senior Chinese official” as saying “the western consensus on the relation between the market and the government should be reviewed. In practice, they tend to overestimate the power of the market and overlook the regulatory role of the government.” Then in November at the G20 conference, Chinese Premier Wen called for an expansion of the “scope of the regulation of the international financial system”. The Chinese spoke of a new financial system that is “fair, just, inclusive and orderly.”
New world orders, particularly of the bureaucratic type, tend to take a little time to arrange, so it might sound like that is one issue to put on the back burner, whilst the real and urgent business is done. Heck, why not keep the Chinese busy by setting up an international committee of enquiry informed by some high level studies by a panel of top economists to ensure that its findings are both incomprehensible and split.
But there is a serious and urgent signal from Beijing.
In 2005 a bilateral Strategic Economic Dialogue (SED) between China and the U.S. was set up. Reportedly, Beijing has put a lot of effort into this and sees the SED as the primary channel for dealing with pressing economic issues. It is the mechanism for dialogue between the G2 on strategic issues, including those of worldwide importance.
What all this boils down to is that China expects to be involved in the big decisions. The message is:
No more U.S. hegemony in the financial world
Lacking a suitable multi-national mechanism (memo from China: “don’t blame us – we’ve been calling for one”), the G2 will do fine instead.
The second “No”
On February 2, the Chinese Premier Wen Jiaboa made some interesting remarks at a press conference with Gordon Brown, the British Prime Minister. These were not well picked up across the Atlantic but are worth attending to. Asked the cause of the crisis, Wen didn't name the U.S. economy, but said "The main cause (is)...some economies...have imbalances in their economic structure … For a long period of time they have had dual deficits - trade deficits and fiscal deficits and they have been overspending by borrowing."
The U.S. has long run a trade deficit with China. The U.S. fiscal deficit by the government is more recent. It stems from the Bush years and is about to get much worse due to the various bail-out and stimulus packages. The Chinese can scarcely object to the trade deficit – they have funded it for years. So, the message is: don’t rely on us to buy your extra bond issues caused by your economic mismanagement.
So, the second Chinese “No”:
No extra U.S. bond purchases by China above the normal level
The third “No”
According to the most recent reports on Bloomberg, Chinese Premier Wen says his government’s focus is on safeguarding the value of China’s $1.95 trillion foreign reserves. Chinese officials speak of seeking “guarantees” that their holdings of U.S. government debt won’t be eroded by “reckless policies”. Reportedly, China will voice its concerns over U.S. government finances and the potential for a weaker dollar when Secretary of State Hillary Clinton visits China on Feb. 20. The idea has been floated that a guarantee might be “one of the prerequisites for more (bond) purchases”.
What’s going on here? The Chinese know full well that “guarantees” in the normal sense of the word can’t be given. What they are communicating is more than a bit of anxiety. It is the third “No”:
No policies that could lead to sharp depreciation of the U.S. $
The danger here is of loose monetary policy pushing inflation sharply higher or other measures undermining confidence in the U.S. $. Debt could be inflated away. I’ve commented before on the dangers for China here. Exaggerating just a bit I said “Imagine, U.S. to China in 2015: “Here’s the trillion we owe you. Buy yourself a beer with it.”
China has a lot at stake in the relationship and behind the three “No”s are three “Yes's":
Yes, let’s talk – provided it's meaningful.
Yes, we’ll keep buying bonds but only at around previous levels and provided that you give some serious undertakings about being prudent.
Yes, we understand you’ve got to take action but don’t try to inflate your way out of debt.
You’ve been bad but let’s still do business. Here’s our terms.
The U.S. response and where this is going
We don’t know what, if any, dialogue there has been in high level bi-laterals between China and the U.S. lately. We don’t know what briefing Hillary and her officials carry with them to Beijing. We do know that Treasury Secretary Geithner – quoting President Obama in aid – effectively threatened China. He accused China on Jan. 22 of “manipulating” their currency, the yuan, to give an unfair advantage to its exporters and suggested U.S. action might eventuate.
Geithner’s message appears contradictory because he also spoke of Obama’s concern for a “strong” U.S. $. So, that’s a “strong” $ except for, err, the Chinese Yuan. In fact, this does make sense. The strong dollar remark is perhaps signaling:
Yes, the U.S. government will act to avoid hyper inflation or sharp depreciation of the dollar.
The currency manipulation remark is saying to the Chinese:
You can do your bit too.
However, the U.S. position is murky and the only recognition publicly offered so far by the new administration to China has been negative.
Broadly, this leaves us three future scenarios.
First, current U.S. policy works pretty well, China and the U.S. reach some sort of agreement, inflation and the U.S. dollar remain within target bands, and everybody is left fairly happy. Life goes on.
Second, current U.S. policy doesn’t work well. A deepening or prolonged downturn leads to more and more action by the government and Fed, and thus more and more U.S. debt and possibly a lurch into high inflation. China abandons the bi-lateral relationship and takes the massive hit from the consequent collapse of the U.S. economy.
Third, current U.S. policy doesn’t work well but Washington broadly agrees with Beijing’s views on the way forward (or, is that, follows Beijing’s instructions) and Bernanke is encouraged to stay away from his printing presses. The U.S. depression is lengthy as the U.S. rebuilds from the debt binge. China becomes the dominant partner in the U.S. - China relationship.
“For the borrower is servant to the lender” (Proverbs 22, verse 7).
Stock position: None.