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Read China's Lips
NEW HAVEN "“ The Chinese have long admired America's economic dynamism. But they have lost confidence in America's government and its dysfunctional economic stewardship. That message came through loud and clear in my recent travels to Beijing, Shanghai, Chongqing, and Hong Kong.
Coming so shortly on the heels of the subprime crisis, the debate over the debt ceiling and the budget deficit is the last straw. Senior Chinese officials are appalled at how the United States allows politics to trump financial stability. One high-ranking policymaker noted in mid-July, "This is truly shocking"¦ We understand politics, but your government's continued recklessness is astonishing."
China is no innocent bystander in America's race to the abyss. In the aftermath of the Asian financial crisis of the late 1990's, China amassed some $3.2 trillion in foreign-exchange reserves in order to insulate its system from external shocks. Fully two-thirds of that total "“ around $2 trillion "“ is invested in dollar-based assets, largely US Treasuries and agency securities (i.e., Fannie Mae and Freddie Mac). As a result, China surpassed Japan in late 2008 as the largest foreign holder of US financial assets.
Not only did China feel secure in placing such a large bet on the once relatively riskless components of the world's reserve currency, but its exchange-rate policy left it little choice. In order to maintain a tight relationship between the renminbi and the dollar, China had to recycle a disproportionate share of its foreign-exchange reserves into dollar-based assets.
Those days are over. China recognizes that it no longer makes sense to stay with its current growth strategy "“ one that relies heavily on a combination of exports and a massive buffer of dollar-denominated foreign-exchange reserves. Three key developments led the Chinese leadership to this conclusion:
First, the crisis and Great Recession of 2008-2009 were a wake-up call. While Chinese export industries remain highly competitive, there are understandable doubts about the post-crisis state of foreign demand for Chinese products. From the US to Europe to Japan "“ crisis-battered developed economies that collectively account for more than 40% of Chinese exports "“ end-market demand is likely to grow at a slower pace in the years ahead than it did during China's export boom of the past 30 years. Long the most powerful driver of Chinese growth, there is now considerable downside to an export-led impetus.
Second, the costs of the insurance premium "“ the outsize, largely dollar-denominated reservoir of China's foreign-exchange reserves "“ have been magnified by political risk. With US government debt repayment now in play, the very concept of dollar-based riskless assets is in doubt.
In recent years, Chinese Premier Wen Jiabao and President Hu Jintao have repeatedly expressed concerns about US fiscal policy and the safe-haven status of Treasuries. Like most Americans, China's leaders believe that the US will ultimately dodge the bullet of an outright default. But that's not the point. There is now great skepticism as to the substance of any "fix" "“ especially one that relies on smoke and mirrors to postpone meaningful fiscal adjustment.
All of this spells lasting damage to the credibility of Washington's commitment to the "full faith and credit" of the US government. And that raises serious questions about the wisdom of China's massive investments in dollar-denominated assets.
Finally, China's leadership is mindful of the risks implied by its own macroeconomic imbalances "“ and of the role that its export-led growth and dollar-based foreign-exchange accumulation plays in perpetuating those imbalances. Moreover, the Chinese understand the political pressure that a growth-starved developed world is putting on its tight management of the renminbi's exchange rate relative to the dollar "“ pressure that is strikingly reminiscent of a similar campaign directed at Japan in the mid-1980's.
However, unlike Japan, China will not accede to calls for a sharp one-off revaluation of the renminbi. At the same time, it recognizes the need to address these geopolitical tensions. But China will do so by providing stimulus to internal demand, thereby weaning itself from relying on dollar-based assets.
With these considerations in mind, China has adopted a very transparent response. Its new 12th Five-Year Plan says it all "“ a pro-consumption shift in China's economic structure that addresses head-on China's unsustainable imbalances. By focusing on job creation in services, massive urbanization, and the broadening of its social safety net, there will be a big boost to labor income and consumer purchasing power. As a result, the consumption share of the Chinese economy could increase by at least five percentage points of GDP by 2015.
A consumer-led rebalancing addresses many of the tensions noted above. It moves economic growth away from a dangerous over reliance on external demand, while shifting support to untapped internal demand. In addition, it takes the heat off an undervalued currency as a prop to export growth, giving China considerable leeway to step up the pace of currency reforms.
But, by raising the consumption share of its GDP, China will also absorb much of its surplus saving. That could bring its current account into balance "“ or even into slight deficit "“ by 2015. That will sharply reduce the pace of foreign-exchange accumulation and cut into China's open-ended demand for dollar-denominated assets.
So China, the largest foreign buyer of US government paper, will soon say, "enough." Yet another vacuous budget deal, in conjunction with weaker-than-expected growth for the US economy for years to come, spells a protracted period of outsize government deficits. That raises the biggest question of all: lacking in Chinese demand for Treasuries, how will a savings-strapped US economy fund itself without suffering a sharp decline in the dollar and/or a major increase in real long-term interest rates?
The cavalier response heard from Washington insiders is that the Chinese wouldn't dare spark such an endgame. After all, where else would they place their asset bets? Why would they risk losses in their massive portfolio of dollar-based assets?
China's answers to those questions are clear: it is no longer willing to risk financial and economic stability on the basis of Washington's hollow promises and tarnished economic stewardship. The Chinese are finally saying no. Read their lips.
Stephen S. Roach, a member of the faculty at Yale University, is Non-Executive Chairman of Morgan Stanley Asia and the author of The Next Asia.
Copyright: Project Syndicate, 2011. www.project-syndicate.org
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Username Password New registration Forgotten password vkratliff 03:44 27 Jul 11Please tell us why we should care. If China stops using surplus dollars to buy US government securities, how are they going to keep their currency wildly undervalued. If they can't keep their currency undervalued, their exports will become more expensive and our imports will become cheaper. Where's the downside to us?
vkratliff 03:51 27 Jul 11last sentence should read "our exports will become cheaper."
stevefromvirginia 06:51 27 Jul 11Steve from Virginia sez:
The premise of this article is that the USA economy is (mis)managed in ways the Chinese fantasize about managing their own economy.
It's not, never has been and neither is China's!
Roach is being used as a back-patting device by insecure Chinese economists.
China's underground economy is swallowing the overground version: witness empty cities as well as empty parts of cities visible from outer space built on foundations of bad 'loan shark' credit. Where is the control, China?
The real problem in all the countries is lack of return on energy use- you know, that gooey stuff that comes out of the ground? China won't admit as such b/c doing so would illuminate their utter and total failure in importing the waste-based USA 'way of life'.
Their reservations about whether they have made a good choice drives their endless and bottomless need for reassurance from all and sundry.
Guess what China! You screwed up... you needed to keep your proven sustainable three-thousand year civilization. You bulldozed it and traded for a fake!
USA goes bankrupt first, then China. Waste is waste whether it hoists the Red Flag high or not.
AUTHOR INFO Stephen S. Roach Stephen S. Roach, a member of the faculty at Yale University, is Non-Executive Chairman of Morgan Stanley Asia and the author of The Next Asia. MOST READ MOST RECOMMENDED MOST COMMENTED The Ideological Crisis of Western Capitalism Joseph E. Stiglitz What's Happening to the US Economy? Martin Feldstein Is Pornography Driving Men Crazy? Naomi Wolf Technology and Inequality Kenneth Rogoff The Eurozone's Last Stand Nouriel Roubini A New World Architecture George Soros No Time for a Trade War Joseph E. Stiglitz Did the Poor Cause the Crisis? Simon Johnson America's Political Class Struggle Jeffrey D. Sachs Avatar and Empire Naomi Wolf The Autism Generation Allen Frances Europe without Turkey Ian Buruma Debt and Delusion Robert J. Shiller Pity the Policymakers Mohamed A. El-Erian The Fall of the House of Murdoch Jonathan Schell ADVERTISEMENT PROJECT SYNDICATEProject Syndicate: the world's pre-eminent source of original op-ed commentaries. A unique collaboration of distinguished opinion makers from every corner of the globe, Project Syndicate provides incisive perspectives on our changing world by those who are shaping its politics, economics, science, and culture. Exclusive, trenchant, unparalleled in scope and depth: Project Syndicate is truly A World of Ideas.
Project Syndicate provides the world's foremost newspapers with exclusive commentaries by prominent leaders and opinion makers. It currently offers 54 monthly series and one weekly series of columns on topics ranging from economics to international affairs to science and philosophy.
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Please tell us why we should care. If China stops using surplus dollars to buy US government securities, how are they going to keep their currency wildly undervalued. If they can't keep their currency undervalued, their exports will become more expensive and our imports will become cheaper. Where's the downside to us?
last sentence should read "our exports will become cheaper."
Steve from Virginia sez:
The premise of this article is that the USA economy is (mis)managed in ways the Chinese fantasize about managing their own economy.
It's not, never has been and neither is China's!
Roach is being used as a back-patting device by insecure Chinese economists.
China's underground economy is swallowing the overground version: witness empty cities as well as empty parts of cities visible from outer space built on foundations of bad 'loan shark' credit. Where is the control, China?
The real problem in all the countries is lack of return on energy use- you know, that gooey stuff that comes out of the ground? China won't admit as such b/c doing so would illuminate their utter and total failure in importing the waste-based USA 'way of life'.
Their reservations about whether they have made a good choice drives their endless and bottomless need for reassurance from all and sundry.
Guess what China! You screwed up... you needed to keep your proven sustainable three-thousand year civilization. You bulldozed it and traded for a fake!
USA goes bankrupt first, then China. Waste is waste whether it hoists the Red Flag high or not.
Project Syndicate: the world's pre-eminent source of original op-ed commentaries. A unique collaboration of distinguished opinion makers from every corner of the globe, Project Syndicate provides incisive perspectives on our changing world by those who are shaping its politics, economics, science, and culture. Exclusive, trenchant, unparalleled in scope and depth: Project Syndicate is truly A World of Ideas.
Project Syndicate provides the world's foremost newspapers with exclusive commentaries by prominent leaders and opinion makers. It currently offers 54 monthly series and one weekly series of columns on topics ranging from economics to international affairs to science and philosophy.
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