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Must Read Explanation Of China-US Trade Imbalance
Michael Pettis is by far the best trade theorist I’ve come across and is supremely prescient and logical. He has changed my thinking a ton since I’ve started reading him, but his latest post is perhaps the most world altering for me. It explains what China’s currency peg really means, and why their massive reserves won’t protect them from a financial crisis.
10 Responses to “Must Read Explanation Of China-US Trade Imbalance”
no one is “protected” from financial crisis, but with a 40% saving rate, they have far more actual money in hand, in the hands of their populace than we do. And actually more of their power over us stems from the fact that we've sacrificed our manufacturing sector and American jobs, to buy cheap goods from them. China protects its domestic market. We don't.
An interesting read but I'm not sure if it makes me feel more or less secure about things.
Part of the logic is premised on the idea that China would not do things which could be detrimental to their economy. That may not neccessarily be true.
But it is well worth the read.
I don't think that is the right way to look at things. Pettis has addressed the savings rate issue too and would say that they don't have more “actual” money, there is no such thing, there is only money in relationship to domestic and international dynamics. He argues that the high savings rate is really bad because it represents too much current economic production being used to save for future consumption, and that this is really bad because it means they have to have continued massive export gains or the balance sheet blows up. This savings rate is structural to the culture and is driven in large part by the lack of a social safety net, wherein everyone rationally saves as much money as they can in case of emergency, even though at any given time only a few need it for that reason. He (and others) have argued that better social insurance would improve their economy.
In fact he has directly stated that he views the high savings rate and money peg policies as not making the Chinese citizens richer but making them poorer. The argument is that they can only keep up their economy through insane amounts of investment, a growing amount which is unproductive malinvestment. This investment is being driven by the government (often localities) and when it goes bad then it will prove much of the wealth was illusionary. He sees the imbalance between local and external economy as a hidden tax on all the workers.
This post makes a similar argument except focusing on the central bank side rather than the individual side, and he wrote it primarily because people were objecting to his categorization of how the government would be forced to bail out their financial system in a way that was internal to the economy instead of using their dollar reserves.
His trade theory perspective (one that I really buy into because it does such a good job of explaining counterintuitive outcomes we're seeing not just now but historically) argues that yes the imbalance is terrible for the American economy but that it's also terrible for the Chinese economy…and it would be wise of them to start scaling back their investment/export driven economy or they are going to be hurt far more than even us.
This piece (and the body of his work) actually argues that what they believe isn't detrimental to their economy (i.e. build up massive reserves) is extremely detrimental because they don't understand trade dynamics. This is the same position as the US entering the Great Depression, where we were by far the “richest” country going into it but experienced the worst bust of any of the industrialized countries.
good points mikkel. Our economies are far different. China has a huge surplus of workers, a slave-wage labor force coupled with a middle and upper class confined largely to the eastern seaboard. This will allow them to be a low-wage competitor for quite a long time, where Japan was soon undercut by Thailand, Taiwan, Korea etc. With their legendary disregard for patent rights, they will soon have their own brands of computers, cameras and other gadgets they currently allow Nikon, Apple and Gateway to brand. In some ways they're investing more wisely than us, e.g. in terms of infrastructure. I certainly don't think they're protected from global economic collapse, but they are BUILDING infrastructure and manufacturing base, while we are neglecting the former and abandoning the latter.
As for OUR future, why can't the greedy oligarchs see that we're destroying our middle class consumer base? Apparently they just don't care as long as their pockets are lined. Same with their oligarchs I suppose, but without China's loans and their manufacturing, we simply don't have an economy. Nothing to buy and nothing to buy it with. That's a lousy “plan” for America.
The original post is an excellent explanation of a complex subject. But even if the subject is of no particular interest to you it effectively makes the point that in economics what seems the obvious explanation is very seldom correct.
Like when dealing with any complex subject everyone tends to try to simplify it by relating to something they already feel they understand. And in economics this always results in a kind of personalization of the economy. It is bad for me to have to much debt, especially in bad times. So the same holds true for the economy as a whole. Likewise it is better for me to save rather than consume so the same is true of the economy. And of course this must be true of the other player in the economy, the government.
Actually the opposite is true. Since everyone is saving in a downturn the government is better off spending. The deficit the government runs during a recession is not only dependent on the depth of the recession, it is also dependent on its duration. If running a high deficit for a short time ends the recession quickly you stand a good chance of limiting the total debt taken on to less than it would be if you work to reduce annual deficit and prolong the recession. Not to mention that in purely human terms it is better to end a recession as quickly as possible.
Conversely in good times, when everyone is spending and investing, the government should be saving. This, of course, is the hard one to sell.
Likewise the high savings rate in China is not necessarily a good thing. As the post emphasized in economics it depends entirely on the why. In this case why their savings rate is high. If the government suppresses the cost of food and other necessities to keep wages low while artificially inflating the cost of other goods which are largely imported or are Chinese goods the government prefers to export, as was the case when I lived in China in the early nineties, the high savings rate is an unavoidable consequence of bad economic policy. They have excess money but nothing to spend it on or invest it in. (I don't know if this is the case today, I haven't been in China in more than ten years).
As usual my slow typing made my response unresponsive to the discussion.
Yes, there is no comparison between the United States' and Chinese economy. We are having to forge a post industrial economy with no clear direction. The Chinese are following a well worn path to an industrial economy from a rural one. But don't envy the Chinese. Their ultimate success depends on how quickly they can spread the benefits of industrialization to the vast majority of their population still living in rural poverty before these same people take matters into their own hands.
GreenDreams – “As for OUR future, why can't the greedy oligarchs see that we're destroying our middle class consumer base? Apparently they just don't care as long as their pockets are lined.”
Our oligarchs, as you point out, are looking out for themselves. They are absolutely amazed that so many of our fellow citizens are willing to do the one thing the oligarchs would never do, vote against their own economic self-interests. While we have been fighting the culture war we lost the class war without realizing we were even in it or who was fighting.
“China protects its domestic market. We don't.”
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Bingo. Malignant capitalism, Greendreams, is the source of its own demise. Socialism ironically is the cure, partial socialism in an appropriate dose. Malignant capitalism truly is the dragon devouring its own tail. It is so blind to all but its appetite that it literally cannot see the logical end to its insatiable greed.
“Like when dealing with any complex subject everyone tends to try to simplify it by relating to something they already feel they understand…And of course this must be true of the other player in the economy, the government. Actually the opposite is true. Since everyone is saving in a downturn the government is better off spending. “
Again, from a trade/systems theorist perspective your statement is not inherently true. They would say that depends what the government spends it on and whether they are a net creditor or debtor. The key to them is to restore balance, so creditor countries need to have the government spend money to create more of a domestic economy and let their trade surplus fall with the idea it should eventually be a deficit, while debtor countries need to rebuild their manufacturing/domestic economy to have their trade deficit fall and eventually move to a surplus. However if the deficit countries have a lot of debt it will cause their currency to fall and this will make their exports more competitive but they have to make sure that they don't let it fall too much so the import material costs kill all the margins. If that starts happening then they should not take out much more debt at all, and perhaps even partially default. The whole idea that Keynes said government should everywhere and always increase spending isn't true…he very clearly said it depended on context and in what area. We just pay attention to his prescription for the US at the time — which was the largest creditor country — and it is repeated as dogma, but my understanding of his work was that it was much more nuanced.
“Not to mention that in purely human terms it is better to end a recession as quickly as possible.”
Often economics should fall not into what we “ought” to do, but what we can do politically. In general these theories don't give workable guidance because they lead to outcomes that are against the status quo and there is no will to go there. I view trade systems theory as being a very taoist like foundation of balance and ebbs/flow, but when people get to the extremes and things start breaking they try to make it more extreme and that leads to catastrophic failure.