An independent central bank and a treasury with some distance from political consideration is key to a healthy economy.

The obvious is neither China or the US can claim fiscally responsible economic policy, though at least the US has a higher degree of transparency (Sarbanes-Oxley) and public accountability working in its favor. That is no small advantage.

And I thought that you couldn’t predict FX markets… except with the benefit of hindsight of course. The United States has been running those deficits for decades, and even though it was clear knew that those deficits were unsustainable on the long-term, nobody could really tell when those imbalances would unwind.

Those deficits are unwiding today instead of 10 or 20 years ago beccause we have an unlikely combination of a credit crisis, a real-estate crisis and a commodity boom. Unless Baker correctly predicted those events back in 2001, which I doubt, he can’t seriously tell that “It is almost inconceivable that anyone who followed economic data did not realize that the dollar would decline from the level it has reached in 2001 and 2002″

At the risk of repeating what they’ve said…Maybe the socialist/pseudo-capitalist model works for exporting only. Maybe China is simply incapable of cultivating a thriving domestic economy. One of the hallmarks of western countries is the ability to seek recourse/liability. Regardless of how miserable our justice system is, it still acts as a huge deterrent to obvious fraud and corruption.

That said, the socialism/despotism that China adheres to and the capitalism that they need to succeed domestically look to be mutually exclusive.

I think Richard Kline made a comprehensive and objective conclusion.

Here is the short view of my take.

Paulson, as the point man for Goldman on China, was put at Treasury to oversee that relationship. The fear at the time was the the largest financial risk we faced was Chinese dissatisfaction with our policies that could pose trouble for the dollar. Paulson was supposed to take care of all that.

We live in an era of information warfare. Managing the news and perceptions is part of the battlespace.

Recall the 1980s, when the US was pushing Japan very hard to stimulate their domestic demand. My judgment at the time, drawn largely on inferences and not enough empirical data points, is that it seemed likely that the US was exploiting the Mayekawa vs. Miyazawa rifts at the Japanese Finance Ministry v. the Bank of Japan.

Keep in mind that Japan at this time had a ROTATING arrangement between the Finance Ministry and the Central Bank and very similar issues were at play back then as well.

For me there is a substantial likelihood that Paulson has panicked somewhat and has planted this “bright idea” into a vaguely competent NYT reporter, in hopes of stimulating Chinese domestic demand.

Matt Dubuque

Its possible the dollar bears become very very wrong in the next year or two.

The smallest of them is the actual losses on FX. Yes, these may be in the tens of billions, but that money ‘isn’t doing anything’ for China. It looks great, but they don’t have a plan for what to do with it (in part because absolutely no one expected they would acquire so much of it so quickly). Seriously, if $200B of FX vaporized, it would make almost no macrofinancial difference to China.

The next in consequence, are the turf battles over _blame_ for that loss, and over subsequent _control_ of future policy. I think that Anon of 2:41 cuts close to the bone on that one. China’s policy actors are not the monolith they are perceived of as offshore. There are institutional (if not ‘political’) factions, and their struggles for advantage and power are real. Whoever is successfully blamed for the bad net effects of yuan appreciation will be a MAJOR loser in internal Chinese factional politics.

Of more importance still is the perception of China’s begin stiffed, cheated, or taken advantage of, especially to the extent ot which this really happens rather then is perceived in the event of huge FX and foreign investment losses. What struck me most in reading the NYT piece was the reported pervasive animosity in the managerial bureaucracy to ‘foreign cheats.’ Now, some of this is a consequence of the diffuse sense of grievance in China which I’ve spoken to before here in comments. But some of it is a real political driver, that bigger richer players aren’t keeping to the rules and are expecting China to eat the losses in everybody’s game. The truth is sufficiently more complicated that we can’t all agree on it, but there is a knot of cartlidge about this perception. If the Chinese ‘political class’ thinks it’s been cheated in how the global credit bubble collapse plays out, that will have very bad consequences because very foolish policy acts may follow.

But by far the worst result of yuan appreciation is that it will sharply erode the exporter employment and industrial development ripple effects which are China’s macroeconomic strategy. The domestic political consequences of having that strategy hit even a rocky patch are so worrisome that China’s decision makers simply will not go that route. It seems clear that those deciders can’t agree amongst themselves what to do now; there may not even be a ‘first best option.’ And I do think that the Chinese would and will accept some yuan strengthening if it doesn’t gut the exporters. But very little. A great deal of firepower will be expended to defend the export strategy.

I am, as in the past, in favor of some Chinese domestic economic expansion—but it seems clear that the Chinese leadership is not. Corruption is a major issue, and they still don’t have a handle on it, not least because the courts are far weaker than the corrupt local and regional officials. And then there is the fact that domestic expansion _strengthens_ those regional officials into real power bases, something which I think the Party and Central bureaucracy fear, loathe, and will go to great lengths to dissipate. —And the easiest way to prevent regional powerbases is not to grow them in the first place. Then there is the issue that it is much in the interest of ‘the Center’ to keep Chinese individually small and weak. A wealthier citizenry tends to generate a politically efficacious middle class or a politically muscular oligarchy. The present powers in China have no liking for either outcome, and the easiest way again to prevent them is to have growth but little distributed wealth.

There really does seem to me to be A Plan, or at least a policy objective, in the _way_ in which growth is being pursued in China. It is very interesting from the sociopolitical standpoint as the first example of planned macrodevelopment on this scale ever attempted. It isn’t the way I would want to plan such a thing personally, but there does seem to be a strategy. And that strategy does not include major domestic economic stimulus, especially with regard to consumption.