February 22, 2009
China and the U.S. Depression
China and the U.S. Depression--Posner
I agree with Becker that China is not responsible for our current depression. It is true that China's trade imbalance with the United States--it exports much more to us than we to them, and so has built up huge dollar balances that it has invested in the United States, mainly as Becker points out in the form of purchasing federal government bonds--was a factor in keeping interest rates low in the 2000-2005 period. And it is true that those low interest rates are a major culprit in the housing bubble and the ensuing financial collapse. The usual effect of an increase in the supply of money is to lower interest rates, because interest is the price of money. But low interest rates were a policy of our Federal Reserve under the chairmanship of Alan Greenspan, who remained chairman until the end of the 2000-2005 period; the Federal Reserve can create all the money it wants; and so even if there had been no Chinese investment in the United States, interest rates would probably have remained low. I say "probably" rather than "certainly" because the cheap Chinese exports to the United States were one of the factors that enabled the Federal Reserve's policy of low interest rates to avoid creating serious inflation. Had there been inflation, the Fed would have raised interest rates, killing the housing bubble before it became serious. Because houses are bought mainly with debt, cheap credit encourages home buying; and since the stock of housing expands only slowly, an increase in the demand for homes can and did result in a steep increase in home prices, which turned into a speculative bubble.
Furthermore, China is of course not the only country with a positive trade balance with the United States.
I do think that China's trade policy was bad for the United States. I do not think that it is healthy for the United States to run huge budget deficits, whether they are financed by China or by anyone else. One reason that we are in a depression and not merely the "severe recession" that is the preferred euphemism is that, because of those deficits, we cannot spend our way out of the depression without increasing the national debt to a point at which either horrendous inflation or huge tax increases will be required to pay it down.
But I would not "blame" China for giving us what we very much wanted, which was cheap goods and the financing of our debt. Nor do I think that China's trade policy is foolish from China's standpoint. In a fascinating chapter of The General Theory of Employment, Interest and Money, Keynes offered the following qualified defense of mercantilism (the policy of accumulating foreign exchange by running a persistent export surplus). Suppose a country has weak domestic demand for goods and services, perhaps because its people are poor or they lack confidence in their economic prospects and therefore hoard money rather than spending it. Because of this weak demand, labor and other productive resources will tend to be underemployed--unless producers have foreign markets. By stimulating exports, the nation can increase the utilization of its productive resources, which by reducing unemployment can increase consumer confidence and thus increase spending and in turn investment. Average incomes in China are very low, domestic demand therefore weak relative to potential output, and so it may make sense for China to encourage production for export, especially if it has a comparative advantage in producing goods that foreign countries such as the United States demand.
Moreover, because average incomes in China are so low, there may not be much demand for the types of product that the United States produces, and this would be an independent reason for our trade imbalance with China. But it would not explain China's large dollar balances, unless no other country produces the types of product that Chinese consumers could afford to buy.
China Bashing Once Again-Becker
During his confirmation hearing before the United States Senate toward the end of January, Secretary of the Treasury Timothy Geithner accused China of "manipulating" its currency. This is not a statement that helps to further China-US cooperation on trying to stimulate the depressed world economy and on other issues- Secretary of State Hillary Clinton is now in China trying to mend some fences. Yet Geithner's statement is a correct evaluation of the Chinese policy of keeping the value of its currency, the yuan, low relative to the dollar and other currencies. It is far less clear, however, whether this and related Chinese policies harm the US and other countries.
By keeping its currency cheap, China encourages greater exports since that policy makes Chinese goods cheaper on world markets. This policy also discourages imports by Chinese consumers and producers since it raises the cost of foreign goods in terms of the yuan. Partly due to its manipulation of the value of the yuan, China has run large surpluses on its current account in recent years because the value of its exports has been significantly above the value of its imports. China has accumulated over $2 trillion of reserves. The world recession has sharply reduced China's exports, but surprisingly the recession has reduced China's imports by much more, so that its foreign trade surpluses have grown greatly during recent months.
Some American producers have had trouble competing with cheap Chinese imports, and have either gone out of business, or shifted production overseas, mainly to China itself. Since China mainly exports goods produced with low priced labor that is not available in richer countries, their exports have not had a major impact on production in the richer countries. Far more significant to developed countries are the reductions in the cost of imported clothing and many other goods from China. Consumers, especially low income consumers, now take for granted their ability to buy cheaply many everyday goods that would cost perhaps five times as much were they made in the US, Western Europe, or Japan.
The Chinese government holds most of its more than $2 trillion in official reserves in US Treasury securities. China gets a bad deal from selling goods made by Chinese labor and capital in exchange for large amount of paper assets that yield low returns. China has accumulated far more reserves in the form of these assets than can be justified as a buffer against fluctuations in its imports and exports, or than is wise given its low standard of living. The US seems to have made the better bargain by exchanging low interest paper assets for a rich variety of consumer and producer goods.
Does China's ownership of large quantities of US government bonds give China the opportunity to "blackmail" the United States into more favorable policies toward China through threats to flood the international capital market with these assets? China has not made such threats, perhaps mainly because they would not be credible. Since China owns only a rather small fraction of US Treasury obligations, and an even smaller fraction of total liquid assets traded on world capital markets, a threat to sell their US governments would give China only a little leverage on world interest rates, including those paid by the United States government. Moreover, China, along with other governments, holds US Treasury assets because they are considered among the safest of all assets, especially during these turbulent times. By selling their US Treasury bonds, China would have to take on riskier assets at a time when China is trying to cut its exposure to risk.
To be sure, the high savings rates of China and other Asian countries during the past decade are partly responsible for the low world interest rates that contributed to the housing bubbles in the United States and other countries. To that degree, China bears some indirect responsibility for the financial crisis that is afflicting much of the world. However, China too is being badly hurt by the world recession. Moreover, excessive bank lending and borrowing, and government encouragement of sub prime loans, were much more important culprits in generating excesses in the housing market.
The extensive protectionist policies practiced by the Chinese government do hurt the United States and other countries, including China itself. Chinese protectionism is especially common in the financial sector; while foreign banks are being allowed greater access to China markets, they are still subject to considerable discrimination. The general trend in China (and other nations) toward less protectionism has been set back by the global recession, as China has recently introduced various "buy China" programs in its steel and other industries.
China bashing during past decade is reminiscent of the Japan bashing that occurred during the 1980s. It turned out that Japan's substantial export surplus with the US, its extensive accumulation of US Treasury bonds, and its purchases of assets in teh US did not hurt the United States, but were for the most part foolish actions on the part of the Japanese government and businesses. I believe that similar conclusions will be reached about the parallel Chinese practices.