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Everyone knows that the US and China are in a weird kind of persistent economic imbalance, where China exports manufactured goods to the US at discount prices, and the US extensively borrows from China (see Economic M.A.D.). The imbalance is evidenced in a ~$20bln per month trade deficit just with China (when you add in a similar amount with the oil exporters, that accounts for most of that deficit).
The arrangement is achieved, mainly, by a currency peg (keeping China's Yuan artificially low), as well as other minor contributing factors that nevertheless add up (such as poorly-controlled lending from the government, little environmental regulation, and slight protection for labor).
What China gets out of this is rapid industrialization -- I would call it "hyperindustrialization" -- and the ability to rapidly enlist rural migrants into the urban workforce. Were it not for this ability, unrest might reach levels that would topple the government. Not only is this avoided (so far, at least) by China's quasi-capitalist path, but communist bureaucrats can take advantage of their positions to loot the country on their way out.
What the US gets is endless cheap financing: China ends up with a surplus of dollars on an ongoing basis, and it must find something to do with them. Since there is a trade deficit with the US, then by definition, there is not enough stuff to buy from the US. Thus, the Chinese "park" the money (largely held at the central bank) in US financial assets. This is chiefly US government securities (Treasury and government-backed enterprise securities, i.e., mortgages). This all has kept interest rates down in the past few years (despite Fed rate increases, hence the inverted yield curve) and kept the financial bubble binge going -- most notably, the housing boom. The result has been a euphoric general sense of wealth; and for many people, plenty of paper wealth.
The popular argument goes that China cannot break out of this imbalance, because they'd be hurt by losing the US as their primary customer for exports. I've already argued that this seems unlikely to hold, given that the US now accounts for less of China's exports than the Eurozone (less than 16%, and falling).
But today I read a related claim by Shilling, which is that a slowdown in the US would propagate to China, causing deflationary financial distress there (essentially, a depression). This may be the case, but I do not see how it necessarily follows.
The key reason is that this assumption neglects the fact that the imbalance with China is artificial -- it primarily comes from financial giveaways to the exporters, in the form of currency pegs and easy money from the state banking system. If it had formed naturally and was set to reverse by virtue of change in the US alone (i.e., endogenous, "business-cycle" demand slowdown), Shilling would have a strong point.
But the Chinese have already paid heavily for this unnatural arrangement, where gravity is defied and their capital flows back "uphill" to the US. That capital, in sum, has flowed away from the bulk of the Chinese people (bureaucrats and export magnates notwithstanding). The situation is in fact worse: when capital flows and wealth fails to (the Chinese do not receive full value for the goods they export), then wealth is flowing uphill. The Chinese are actually giving away wealth to the US.
You can tally the magnitude of this effect in the excess dollar reserves (estimated by Setser and others to be in the ballpark of $1 trillion) and bad loans (also likely around $1 trillion). That is, at the end of the day, money not being spent on the Chinese people. And this massive bias in the Chinese system is indirectly the cause of the massive unrest that remains, as there is a serious failure to evenly distribute the gains of China's recent development.
China is shortchanging themselves of wealth. The direct implication of this insight is natural but surprising: China can only benefit by being decoupled from the US, because this wealth would stop flowing out of the country and away from the Chinese people.
To put it in concrete terms, the money China now spends on propping up the dollar (and holding down the Yuan) and making bogus loans to exporters could be diverted to bail out individuals and companies (likely the very same exporters) that are hit by the effects of a US slowdown. The very same domestic Chinese agents that are hit by this slowdown, as Shilling rightly observes, could in fact be supported by the money now being sent out of the country to the US. This is likely what would have to happen to keep domestic unrest under control.
Realistically, China could see maybe 1/3rd of the US-based demand fall off (China's manufacturing costs really are inherently lower than the US's, due to the lower cost basis), which would translate to something like 5% of output volume. Due to razor-thin margins at Chinese exporting companies, this would be a widespread problem, but likely not so much that it can't be subsidized away with the currency-peg money that would be freed up.
In fact, this money would, handily, come in the form of more yuan earnings for the exporters, on an ongoing basis. They might not need bailouts at all.
(This post syndicated from autoDogmatic).
The arrangement is achieved, mainly, by a currency peg (keeping China's Yuan artificially low), as well as other minor contributing factors that nevertheless add up (such as poorly-controlled lending from the government, little environmental regulation, and slight protection for labor).
What China gets out of this is rapid industrialization -- I would call it "hyperindustrialization" -- and the ability to rapidly enlist rural migrants into the urban workforce. Were it not for this ability, unrest might reach levels that would topple the government. Not only is this avoided (so far, at least) by China's quasi-capitalist path, but communist bureaucrats can take advantage of their positions to loot the country on their way out.
What the US gets is endless cheap financing: China ends up with a surplus of dollars on an ongoing basis, and it must find something to do with them. Since there is a trade deficit with the US, then by definition, there is not enough stuff to buy from the US. Thus, the Chinese "park" the money (largely held at the central bank) in US financial assets. This is chiefly US government securities (Treasury and government-backed enterprise securities, i.e., mortgages). This all has kept interest rates down in the past few years (despite Fed rate increases, hence the inverted yield curve) and kept the financial bubble binge going -- most notably, the housing boom. The result has been a euphoric general sense of wealth; and for many people, plenty of paper wealth.
The popular argument goes that China cannot break out of this imbalance, because they'd be hurt by losing the US as their primary customer for exports. I've already argued that this seems unlikely to hold, given that the US now accounts for less of China's exports than the Eurozone (less than 16%, and falling).
But today I read a related claim by Shilling, which is that a slowdown in the US would propagate to China, causing deflationary financial distress there (essentially, a depression). This may be the case, but I do not see how it necessarily follows.
The key reason is that this assumption neglects the fact that the imbalance with China is artificial -- it primarily comes from financial giveaways to the exporters, in the form of currency pegs and easy money from the state banking system. If it had formed naturally and was set to reverse by virtue of change in the US alone (i.e., endogenous, "business-cycle" demand slowdown), Shilling would have a strong point.
But the Chinese have already paid heavily for this unnatural arrangement, where gravity is defied and their capital flows back "uphill" to the US. That capital, in sum, has flowed away from the bulk of the Chinese people (bureaucrats and export magnates notwithstanding). The situation is in fact worse: when capital flows and wealth fails to (the Chinese do not receive full value for the goods they export), then wealth is flowing uphill. The Chinese are actually giving away wealth to the US.
You can tally the magnitude of this effect in the excess dollar reserves (estimated by Setser and others to be in the ballpark of $1 trillion) and bad loans (also likely around $1 trillion). That is, at the end of the day, money not being spent on the Chinese people. And this massive bias in the Chinese system is indirectly the cause of the massive unrest that remains, as there is a serious failure to evenly distribute the gains of China's recent development.
China is shortchanging themselves of wealth. The direct implication of this insight is natural but surprising: China can only benefit by being decoupled from the US, because this wealth would stop flowing out of the country and away from the Chinese people.
To put it in concrete terms, the money China now spends on propping up the dollar (and holding down the Yuan) and making bogus loans to exporters could be diverted to bail out individuals and companies (likely the very same exporters) that are hit by the effects of a US slowdown. The very same domestic Chinese agents that are hit by this slowdown, as Shilling rightly observes, could in fact be supported by the money now being sent out of the country to the US. This is likely what would have to happen to keep domestic unrest under control.
Realistically, China could see maybe 1/3rd of the US-based demand fall off (China's manufacturing costs really are inherently lower than the US's, due to the lower cost basis), which would translate to something like 5% of output volume. Due to razor-thin margins at Chinese exporting companies, this would be a widespread problem, but likely not so much that it can't be subsidized away with the currency-peg money that would be freed up.
In fact, this money would, handily, come in the form of more yuan earnings for the exporters, on an ongoing basis. They might not need bailouts at all.
(This post syndicated from autoDogmatic).
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