confuse the commitment of one nation to another for an act of
friendship. As mid-19th century British Prime Minister Lord
Palmerston once commented, nations don’t have friends;
nations have interests. The mutual interests of China and the
U.S. are the kind that kept the U.S. and the Soviet Union from going at
each other with nukes during the Cold War.
China and the U.S. are running inter-dependent bubble economies,
relying on the economic equivalent of Mutually Assured Destruction
(M.A.D.) to keep one from blowing up the other’s
economy. Whether by intent or accident, sooner or later
market forces will assert themselves and both economies will go through
tough transitions. How will the world look after that?
The U.S. and China are have distinctly different bubble
economies. The Chinese bubble economy runs mostly on credit
and corruption, like the Japanese bubble economy of the late 1990s
except more extreme.
the PRC has made some progress toward achieving other characteristics
of successful market economies, the PRC retains many of the detrimental
characteristics of command economies. In particular, the
major state owned banks and other depository institutions have extended
too many questionable loans to the state-owned enterprises and the
state-influenced enterprises based on industrial policy, guanxi (i.e.,
connections) with government officials, or outright
with below-market interest rates and distorted prices, non-market
lending has sustained the PRC’s unusually high rate of
capital assets (i.e., equipment, software, and structures) of 43.6
percent of GDP in 2004. In turn, this high investment rate
the PRC’s real GDP growth rate to 9.5 percent in
2004. However, many
state-owned enterprises and state-influenced enterprises are
unprofitable. Protected through guanxi from bankruptcy and
foreclosure, many state-owned enterprises and state-influenced
enterprises are either unable or unwilling to service their debts.
Consequently, non-market lending has saddled the PRC’s four
state-owned banks and other depository institutions with enormous
portfolios of non-performing loans. Private economists
the cost of resolving the PRC’s bad loan problem would be
percent of the PRC’s GDP. Non-market lending
state-owned enterprises and the state-influenced enterprises to invest
in too many capital assets and the wrong types of capital assets to
produce goods and services to satisfy market demand. The
liquidation of the resulting overinvestment or malinvestment poses a
significant long-term risk to the continuation of the PRC’s
growth. Given the PRC’s integration with the global
significant slowdown or recession in the PRC could diminish the
prospects for economic growth in the United States and other countries
around the world.
Jim Saxton (R-NJ)
Overview of the Chinese Economy Joint
Economic Committee, United States Congress, July 2005
bubble economy, as explained in The Big Bet is heavily dependent
on speculation in financial assets.
U.S.-centric global speculative financial system continues to operate
as a kind of perpetual motion machine, propped up by the "moral hazard"
of central bank policies and the willingness of foreign lenders to
support U.S. consumption on credit, in order to fund their own economic
expansion at home via export income and domestic savings.
long as the global system works this way, profit incentives, asset
markets, and resource allocation will remain distorted. The system will
continue to reward speculators with great wealth while it offers scraps
to the inventors. The U.S. educational system will cater to
speculators, who pay the endowments, and ignore the inventors, who
can’t give them as much money.
After more than 25 years of this,
is it any wonder that the entire U.S. economy has organized itself to
conform to this financial model: a gigantic, risky, one-way bet that
uses trillions of dollars of credit and massive leverage, relying on
the savings of foreign workers to fund the bet and foreign central
banks to cover the risks?
To keep its
credit-corruption economy going, China’s ruling party, the
CCP, needs the U.S. to buy Chinese exports at a rate that keeps its
economy growing fast enough to keep its new entrepreneur class growing
and supporting the regime. If they fail, the CCP loses their
core political support base.
Meanwhile, the U.S. needs cheap imports from China to balance out the
inflation created by its asset-speculation based economy.
Lacking cash savings, U.S. consumers cannot buy Chinese exports except
with credit. To get access to credit, U.S. consumers need low
interest rates. Thanks primarily to China now, and Japan and
the UK in the recent past, purchases of U.S. treasury debt keeps U.S.
interest rates low, allowing North Americans to re-finance their homes
to free up cash to pay for hammers and nails at Made in PRC.
Low cost labor is one reason why Chinese exports are cheap.
The wage rate for the average GM factory worker is about $74 per hour
versus $3.50 for a factory worker in China, where they are are more
than 100 auto companies in operation. When Chinese cars start to hit
the U.S. market in volume in a couple of years, they will be comparable
to Korean cars today but at two thirds to half the price if the current
exchange rate between the Chinese currency, the Renminbi (RMB), and the
U.S dollar hold. This is the most important factor keeping
Chinese exports cheap for North Americans; an exchange rate that favors
Chinese exports. U.S. officials say the RMB is too
cheap. The Chinese say the problem is not enough saving in
the U.S. Both assertions are true. Fact is, that in
addition to indirectly supplying U.S. consumers with the cash and
credit needed to buy Chinese stuff, the CCP’s purchases of
U.S. treasury debt also strengthens the dollar because every time the
CCP buys U.S. treasuries they need to convert RMB into
dollars. This help keeps demand for dollars high and the
dollar strong. That helps keep Chinese goods inexpensive
priced in dollars.
The Stand Off
As the political heat over jobs due to Chinese imports rises in
Congress, the U.S. threatens China with trade sanctions and tariffs if
the CCP does not let the RMB increase in value to make U.S. exports
more competitive. It’s generally believed by
members of Congress that the RMB is undervalued by about 40%.
But if China actually does as the U.S. asks, U.S. interest rates will
increase, the U.S. housing market will decline in earnest and the
asset-speculation based U.S. economy may go into a tailspin.
China counters by threatening to stop buying U.S. treasuries at the
same torrid pace if the U.S. slaps tariffs on Chinese goods.
But if the CCP actually carries out this counter-threat then
exports to the U.S. decrease and China’s credit-corruption
bubble economy may go the way of the Japanese bubble economy in 1991.
An economic version of M.A.D. keeps the two co-dependent bubble
economies “in balance.” Will economic
M.A.D. work as well as the nuclear version?
The Chinese government is a totalitarian capitalist regime that has
over the past several decades evolved from a communist into a capitalist totalitarian
state. With the notable exception of perennial hawk Michael
A. Ledeen, writing for the Wall Street Journal in 2002, few
have stated this in public, and you will never hear it out of a member
of the U.S. Congress for two reasons.
The first is obvious: the U.S. counts heavily on China for purchases of
U.S. treasury debt to fund outrages fiscal deficits (PDF File)
and for cheap imports to balance out strong inflationary forces within
the U.S. asset-speculation economy that show up dramatically in
commodities like oil that must be imported and in non traded goods and
services, such as health care and education. To enable
politically popular “Something for everyone!”
government spending and support the “Every ticket is a
winner!” asset-speculation economy, the U.S. relies on a
country that increasingly puts political dissenters in concentration camps,
shoots villagers who dare stand up to corrupt local politicians
who confiscate their land, and jails anyone who offers even mild
criticism of the government. This dependency eliminates the
incentive for the U.S to get its fiscal house in order, put an end to
reliance on asset-speculation for economic growth, and make a
principled choice to not finance a totalitarian regime that continues
to move away from the principles of liberty and freedom on which the
U.S. was founded.
The second reason given for engaging versus shunning the CCP is that a
policy of engagement is expected to lead to greater democratization of
China. By doing business with the CCP, the U.S. is
encouraging capitalism and trade. This will eventually lead
to greater democracy in China. If the CCP does not increase
personal freedoms to meet the demands of the nation’s
burgeoning entrepreneur class, growing political instability will force
the change. All these newly minted capitalists will press for
personal liberties to match their economic liberties. The old
– literally -- leadership will die off to be replaced by
younger, more democratic minded leaders who grew up immersed in Western
ideas of democracy and freedom. This line of reasoning is
justified with research that shows that the more a country is involved
in trade, the more likely that country is to address human rights and
other social issues.
This is a politically convenient confusion of correlation with
causation. Capitalism and trade may correlate to greater
political freedom but does not necessarily cause it. The
institutions of democracy do not grow naturally from the mechanisms of
trade. A strong political class has to build them with
outside help. How
about China's new middle
class and wealthy capitalists? Not likely.
The credit-corruption system is making them rich.
They are not motivated to rock the boat, especially when doing so can
land you in prison.
As Ledeen pointed out in his WSJ piece, “It is…
wrong to think of contemporary China as an intensely unstable system,
riven by the democratic impulses of capitalism on the one hand, and the
repressive instincts of communism on the other. Fascism may
well have been a potentially stable system, despite the frenzied
energies of Hitler's Germany and Mussolini's Italy. After
all, fascism did not fall as the result of internal crisis; it was
destroyed by superior force of arms. Fascism was alarmingly
popular; Hitler and Mussolini swept to power atop genuine mass
movements, and neither Italians nor Germans produced more than token
resistance until the war began to be lost.”
How does it
Dangerous as it was, M.A.D. nuclear policy worked. There were
a couple of close calls, but no nuclear war between the U.S. and the
Soviet Union. The U.S. and the Soviet Union developed
communications methods and checks and balances to help prevent
accidents. Luck played a big part. The U.S. applied
the economic screws on the U.S.S.R., raising the costs of military
confrontation until the Soviet economic system failed, which was
inevitable in any case.
The current economic version of M.A.D. between the CCP and the U.S. may
turn out to be as lasting and positive for the U.S. as nuclear M.A.D.
was between the U.S. and the U.S.S.R. but for three major
differences. Capitalism has made the CCP wealthy and
powerful, supported by a large and growing capitalist class, whereas
socialism brought the Soviet Union’s leadership to ruin, a
lesson not lost on the CCP. Maybe free trade makes democracy
more likely in China but shoveling U.S. capital assets and productive
capacity into China and increasing dependency on China’s
capital and labor to fund America’s fiscal profligacy and
economic dysfunction takes away U.S. leverage to press the CCP for
social reforms. Either bubble economy may go through a crisis
for reasons neither country either expects or desires, but
doesn’t mean such a crisis might not be instigated by one
that foresees an end-game advantage.
If the brewing confrontation between Iran and the U.S. breaks out into
open hostilities the result will be a spike in oil prices and interest
rates in the U.S. The asset-speculation economy will
take a major hit. How will China’s
credit-corruption economy fare? China has oil and gas deals
with Iran and it has been credibly asserted that the CCP played a role in the election
of Iran’s current anti-U.S. leadership. The CCP
also has oil deals with an increasingly dictatorial Russia
and overtly anti-American Venezuela. When the dust settles
after a possible a U.S./Iran crisis, China winds up with oil, enormous
productive capacity and trade partners across Asia, South America and
Europe. And what does the U.S. have?