A Plan for China to Bail Out the US

This proposal by Arvind Subramanian in the Financial Times makes quite a lot of sense, but given the collective denial in the US about how bad things are (despite the cratering of the markets, neither Presidential candidate was willing to say the economy would get worse, when that is a given) and our dependence on China. And by the time we might be ready to ask for help, it will probably be too late. Americans are too wedded to the idea of our superiority, wrapped in the only slightly less offensive packaging of "exceptionalism" to realize that our economic crisis will lead to a permanently diminished standing.

I am not in agreement with the focus on helping homeowners in the proposed plan (I agree with the idea of extended social safety nets, particularly since that money will be spent, providing a cost-effective boost), but directionally, the idea has merit.

From the Financial Times:

The financial rescue plan passed by the US Congress is viewed as flawed but necessary to head off panic in financial markets and loss of confidence in the economy. It seems a holding operation, a Plan C or D that might need augmentation via a Plan A.

A vital component of a Plan A is likely to be additional money,,,

Where will this additional money – perhaps as much as another $500bn – come from? ...

Enter China. Ken Rogoff of Harvard cheekily characterised the vast Chinese accumulation of US Treasury bonds over the past five years as the biggest foreign assistance programme in history. Why not push that further? Here is a thought experiment.

The Chinese government could offer to lend up to $500bn (from its current stock of $1,800bn) to the US government for the rescue of its financial sector. Its previous assistance – buying US bonds – was indirect and unconditional. Not so in this case.

China’s loan offer would be direct to the US government to be spent in the current financial crisis. More important, it would come with strings attached. Tied aid, the preferred mode of operation of western donors since the postwar period, would now be embraced by China.

What would be the nature of the strings – or “conditionality” as the US Treasury, a longtime practitioner of this art, has called it? Conditionality as imposed by the World Bank and International Monetary Fund was underpinned by an ideology that favoured markets and globalisation. But there was also an assumption that either borrowing third world governments did not understand their benefits or the reformers there needed a “spoonful of sugar” to help overcome any internal opposition.

China would impose two conditions. First, it would declare that the offer of money was conditional on the US government’s adopting a particular approach to rescuing the banks, namely to favour in the next round the use of government money to recapitalise the banks. Europe has been using this approach and evidence suggests it is the most effective way of dealing with large-scale financial crises.

The US government – like third world governments in the past – has been unable to adopt the most efficient course of action. This stems from an ideological obsession against “socialising” banks or because inducement is necessary to overcome any domestic opposition to it.

The second condition would relate to “social safety nets”, which had become standard embellishments to World Bank/IMF adjustment programmes. China would stipulate that monies be devoted to cushioning the impact on vulnerable homeowners, so that they would not be forced into forgoing the American dream of home ownership. Chinese conditionality on this front would achieve an outcome that several economists on the left and right have argued for on grounds of fairness, and also to address the fundamental problem in the housing market.

For China, this offer of help would have three virtues. First, it would be riding to the rescue of a situation partly created by its own policies of undervalued exchange rates, which led to lax global liquidity conditions. Second, its economic interest would be served because successful US efforts at rescuing its financial sector could help avert an economic downturn, protecting China’s exports, its growth engine.

Perhaps most important, it would seal China’s status as a responsible superpower willing to deploy its economic resources for the sake of protecting the world economy. And if the means for achieving that are by providing the current hegemon with the largest aid package the world has ever seen with a healthy dose of sensible conditionality, well, what could be more statesmanlike than that?

China: Less, Not More, Capitalistic?

Reader Michael passed along the Economist review of a new book, Capitalism with Chinese Characteristics: Entrepreneurship and the State by Yasheng Huang, which turns conventional wisdom about China on its head. It contends that, post-Tiananmen Square, new Chinese leadership shifted its approach to economic development to one that had more state direction than before, and also focused more on urban areas. Huang argues that the state's record has not been good, and the change has lead to slower growth and higher social tension.

From the Economist:

Most people, particularly those living outside China, assume that the country’s phenomenal growth and increasing global heft are based on a steady, if not always smooth, transition to capitalism...

This gradualist view is wrong, according to an important new book by Yasheng Huang, a professor at Massachusetts Institute of Technology. Original research on China is rare, largely because statistics, though plentiful, are notoriously unreliable. Mr Huang has gone far beyond the superficial data on gross domestic product (GDP) and foreign direct investment that satisfy most researchers. Instead, he has unearthed thousands of long-forgotten pages of memoranda and policy documents issued by bank chairmen, businessmen and state officials. In the process he has discovered two Chinas: one, from not so long ago, vibrant, entrepreneurial and rural; the other, today’s China, urban and controlled by the state.

In the 1980s rural China was in the ascendancy. Peasants, far from being tied to the land, as has been assumed, were free to set up manufacturing, distribution and service businesses and these were allowed to retain profits, pay dividends, issue share capital and even a form of stock option. State banks rushed to provide the finance. Nian Guangjiu, a farmer from impoverished Anhui province, built up a business selling sunflower seeds (a popular snack), employed over 100 people and made a million yuan (nearly $300,000) in profit in 1986—just a decade after Mao’s death. Because most of this activity was set up under the misleading label of “Township and Village Enterprises”, Western academics largely failed to spot that these ostensibly collective businesses were, in fact, private.

But then, in 1989, came the Tiananmen Square protests. A generation of policymakers who had grown up in the countryside, led by Zhao Ziyang, were swept away by city boys, notably the president, Jiang Zemin, and Zhu Rongji, his premier. Both men hailed from Shanghai and it was the “Shanghai model” that dominated the 1990s: rapid urban development that favoured massive state-owned enterprises and big foreign multinational companies. The countryside suffered. Indigenous entrepreneurs were starved of funds and strangled with red tape. Like many small, private businessmen, Mr Nian was arrested and his firm shut down.

True, China’s cities sprouted gleaming skyscrapers, foreign investment exploded and GDP continued to grow. But it was at a huge cost. As the state reversed course, taxing the countryside to finance urban development, growth in average household income and poverty eradication slowed while income differences and social tensions widened. Rural schools and hospitals were closed, with the result that between 2000 and 2005 the number of illiterate adults increased by 30m. According to Mr Huang, the worst weaknesses of China’s state-led capitalism—a reliance on creaking state companies rather than more efficient private ones, a weak financial sector, pollution and rampant corruption—are increasingly distorting the economy.

But what about the growing cohort of Chinese companies starting to strut the world stage? Surely that is evidence of a healthy and expanding private economy. Mr Huang’s evidence shows that, on closer inspection, these firms are either not really Chinese or not really private. Lenovo, a computer group, has succeeded because it was controlled, financed and run not from mainland China but from Hong Kong (a happy legacy of the founder’s family connections there—not something enjoyed by most Chinese businessmen). The subsidiaries of Haier, a white-goods maker, were also put out of reach of mainland bureaucrats early on. Wahaha, a food producer, Galanz, a maker of microwave ovens, and many others all depended on foreign protection and capital to grow and escape state strictures.

Indeed one of the main, and underappreciated, functions of foreign investment in China has been to play venture capitalist to domestic entrepreneurs. As for Huawei, a telecoms group and one of China’s much vaunted “global” companies, its structure and links to the state are so convoluted that the most diligent China-watchers have little idea if it is a private or state firm. They do, however, agree that Huawei’s opacity is a microcosm of China’s distorted economy.

Could China genuinely embrace entrepreneurial capitalism again, as it did in the 1980s? Its current leaders under President Hu Jintao, who cut his teeth in Guizhou and Tibet, two of the poorest and most rural provinces, talk about supporting the countryside and reducing social inequality. But nothing much has been done. China’s deep problems demand institutional and political reform. Sadly, as Beijing’s heavy-handed control of the Olympics suggests, there is scant hope of that.

China Looking Vulnerable

Ambrose Bierce, in The Devil's Dictionary, defined an alliance as:

In international politics, when two thieves have their hands plunged so deeply into each other's pocket that they cannot separately plunder a third party.

The corollary is that when your ally stumbles, you fall down too. China is learning that lesson the hard way. By pursuing a relentless mercantilist strategy, and becoming dependent on the US as a customer, it is sure to show lower growth as the US economy pulls back.

While a decline to a growth rate of 8% no doubt sounds plenty robust to Americans, that magnitude of reduction would create pressures within China, which has used rising prosperity to paper over domestic fissures. And while we have no insight into China, somehow that 8% figure, which is presented in an article below, seems a tad optimistic.

Two sightings from reader Michael, first on the general conundrum facing China, and a more specific one that suggests that growth is faltering. First, from the International Herald Tribune:

After living beyond its means for many years, America will have to rebuild its savings, so consumption will fall. Exports to the United States from China, Taiwan, Hong Kong and now South Korea are already weakening.

"I think this is a wake-up call for China," said Stephen Roach, the chairman of Morgan Stanley in Asia.

Roach says that he expects U.S. consumption growth to halve - to about 2 percent - as debt burdens are pared.

As economic weakness spreads to Europe and Japan, the impact on China's exports could cut its growth rate from about 10 percent now - already down from 11.9 percent in 2007 - to about 8 percent.

"It just underscores the fact that when you have a vibrant but very large export sector, when you have an external shock and you don't have a lot of dynamism on the internal demand side, you have greater risks to growth," he said...

But stoking domestic demand also requires changes that sometime shake the foundations of an economy - like scrapping deterrents to foreign investment in Japan, ending protection for favored groups in Malaysia or subjecting dominant companies to more competition in the Philippines and Hong Kong.

These are politically arduous tasks at the best of times. That's why economists wanted governments to get cracking on them while the going was good.

Countries instead largely shirked the challenge, content to rely on export-led growth by holding down their exchange rates. Quite apart from hindering the needed rebalancing of the global economy, an undervalued currency acts as a tax on domestic demand, Hong Liang and Yu Song, economists who follow China for Goldman Sachs in Hong Kong, said in a report.

The result is evident in the case of China, where household consumption last year came to just 35.3 percent of gross domestic product - an unprecedented low in peacetime for a major country.

This means that a lopsided economy has scant domestic demand to fall back on as the global downturn deepens. "The real costs of China's resistance to yuan appreciation are now becoming more apparent," Liang and Song wrote.

So what is to be done?

In the case of China, Beijing must provide affordable health care and education and beef up its flimsy pensions system so people need to save for a rainy day. But setting up the administrative structures to ensure extra money is well spent takes time.

"My worry is that there are a lot of things that China can do to boost domestic consumption, including on the fiscal side, but none of these things are going to happen very quickly," said Michael Pettis, a finance professor at Peking University.

From Reuters, "China buyers default on India iron ore deals":

Chinese buyers of Indian iron ore are defaulting on import contracts and refusing to lift the ore unless the seller offers a discount on contracted prices, a top industry official told Reuters on Monday.

"Our exports are in deep red as there is no demand from China," said Rahul Baldota, president of the Federation of Indian Mineral Industries and managing director of miner MSPL Ltd.

Chinese appetite for Indian ore has fallen despite rival Brazilian miner Vale's demand for higher prices for the ore it exports to China -- a move that initially cheered Indian suppliers.

Nearly 75 percent of India's annual iron ore exports of about 100 million tonnes go to China, and shipments normally rise after the annual rainy season ends in September.

"The Chinese are backing off old contracts. They are saying either you reduce the price or we can't take the shipments," Baldota said. "I, myself, have had to suffer two cancellations."

He said importers were willing to buy high-grade 63.5 percent iron ore at about $75 a tonne, about 45 percent less than rates of around $140 in June.

Sesa Goa, Dempo and Salgaocar from India's western region and Essel Mining and the Rungta group of mines from the eastern sector are among the members of the Federation of Indian Mineral Industries.

Exports in the first half of September dropped to 1.99 million tonnes from 2.7 million tonnes in the same period last year. Shipments in August were also lower at 4.57 million tonnes against 5.39 million a year earlier, according to FIMI.

"If the situation continues like this, we will export only around 50 million tonnes in the year ending March. The problem has become severe in the last one month, though it was evident for the last three months," Baldota said.

The China Securities Journal reported on Friday that Chinese steel mills would not import iron ore from Brazil in the near term, after Vale asked for the price hike.

Export demand for even low-grade iron ore, 57 to 60 percent iron content, which are shipped mainly from the western Indian state of Goa, is also flat.

"Hardly any exporter is doing anything even though our shipments usually start picking up around this time," said Glenn Kalvampara, secretary of the Goa Mineral Ore Exporters Association.

This begs the question of whether China has suddenly decided to become a shrewd bargainer or whether the importers are retrading the deal due to a slump (in that scenario, they hope to break some deals). The latter seems a lot more plausible.

"Asia Needs Deal to Prevent Panic Selling of U.S. Debt"

It has been conventional wisdom that China, Japan, and other countries that run trade surpluses with the US, which means they fund our overconsumption by buying assets like US Treauries, would never restrict the flow of credit to us because it would lower their exports and hurt their growth. We've long been leery of the idea that unsustainable trends will have a life eternal, and Brad Setser has a simple reason why this process is self-limiting. Our foreign funding sources aren't just lending us money to buy their goods; they are also providing the funding for interest on the loans extended for past imports. At a certain point, the interest payments become so large relative to the value of the exports that the deal no longer makes sense.

The day of reckoning may be approaching well before Setser's tipping point. And the trigger is much simpler. We look like a lousy risk. The Freddie/Fannie conservatorship, the Lehman bankrutpcy, and the rescue of fallen Asian powerhouse AIG has, not surprisingly, lead to a reassessment of the US's creditworthiness.

Yu Yongding, who has advised China's central bank, urges Japan, China, and Korea to forge an agreement not to dump US bonds. Yu says in no uncertain terms that the Chinese are worried about their US holdings and see a US default as a real possibility.

We've said before that the US is in the same position as Indonesia and Thailand circa 1996, except we have the reserve currency and nukes. The precariousness of our position is now evident to all, save perhaps the average American citizen.

From Bloomberg (hat tip reader a):

Japan, China and other holders of U.S. government debt must quickly reach an agreement to prevent panic sales leading to a global financial collapse, said Yu Yongding....

``We are in the same boat, we must cooperate,'' Yu said in an interview in Beijing on Sept. 23. ``If there's no selling in a panicked way, then China willingly can continue to provide our financial support by continuing to hold U.S. assets.''

An agreement is needed so that no nation rushes to sell, ``causing a collapse,'' Yu said. Japan is the biggest owner of U.S. Treasury bills, holding $593 billion, and China is second with $519 billion. Asian countries together hold half of the $2.67 trillion total held by foreign nations....

``Whether some kind of agreement between them to continue to hold Treasury bills is viable, I'm not sure,'' said James McCormack, head of sovereign ratings at Fitch Ratings Ltd in Hong Kong. ``It would be unusual. If it became apparent that sovereigns in Asia were selling Treasuries the market would take that quite badly, it's something to be avoided.''...

China's huge holdings of U.S. debt means it must bear a large proportion of the ``burden of sorting things out'' in the U.S., Yu said. China is not in a hurry to dump its U.S. holdings and communication between the two nations every ``couple of days'' is keeping Chinese leaders informed and helping to avoid a potential panic, he added.

``China is very worried about the safety of its assets,'' he said. ``If you want China to keep calm, you must ensure China that its assets are safe.''

Yu said China is helping the U.S. ``in a very big way'' and added that it should get something in return. The U.S. should avoid labeling it an unfair trader and a currency manipulator and not politicize other issues, he said.

``It is not fair that we are doing this in good faith and are prepared to bear serious consequences and you are still labeling China this and that, accusing China of this and that,'' he said. ``China knows what to do. We don't need your intervention.''

The U.S. financial crisis had taught China a lesson and that was: ``Why are we piling up these IOUs if they may default?'' China's economic expansion strategy, which emphasizes export growth that has led to trade surpluses and the accumulation of $1.81 trillion in foreign-exchange reserves, is the main problem, said Yu.

``Our export-growth strategy has run its natural course,'' he said. ``We should change course.''

China and Japan Post Deteriorating Growth

Two stories on Bloomberg discussed how the world's export powerhouses, China and Japan, are feeling the effects of the global slowdown.

First on China, which seems inclined to weaken the yuan to defend growth. That's a mixed blessing for the US. A stronger dollar hurts the export sector, the one sunny area of the economy, but means the Chinese will need to keep buying dollar assets to keep the yuan down.

China's industrial production grew at the slowest pace in six years on weaker export demand, power shortages and factory shutdowns during the Olympic Games.

Production rose 12.8 percent in August from a year earlier, the statistics bureau said today, after gaining 14.7 percent in July. That was less than the 14.5 percent median estimate of 22 economists surveyed by Bloomberg News...

``Growth concerns and moderating inflation will make the authorities more likely to cut reserve requirements and slow yuan appreciation,'' said Wang Qian, an economist with JPMorgan Chase & Co. in Hong Kong. She estimates the reserve ratio will fall 50 basis points from a record 17.5 percent by year's end, dropping to 15 percent in 2009.

Of the yuan's 6.7 percent gain this year against the dollar, only 0.1 percent has come this quarter, after policy makers shifted in July to placing extra emphasis on sustaining growth rather than cooling inflation. A stronger currency hurts exporters by pushing up the prices of their products....

As many as 67,000 medium-sized and small companies posted losses in the five months through May, according to the National Development and Reform Commission. In Guangdong province, an export hub, the number of toymakers fell more than 70 percent in the first seven months from a year earlier, as more than 3,600 shut down, the official Xinhua News Agency reported.

Policy makers have already loosened loan quotas -- restrictions on how much banks can lend -- and raised export-tax rebates for garments and textiles.

Extra infrastructure spending is another possible tool for stimulating economic growth to prevent a slump.

And on Japan:

Japan's economy contracted more than the government initially estimated last quarter after figures showed businesses cut spending...

Bank of Japan Governor Masaaki Shirakawa said last week growth in the world's second-largest economy is likely to ``remain sluggish for the time being.'' With little room for interest-rate cuts or government stimulus, Economic and Fiscal Policy Minister Kaoru Yosano said there's ``nothing to be done but wait'' for the country's export markets to recover.

``Japan's economy will keep slowing at least until the end of this year,'' said Hiromichi Shirakawa, chief Japan economist at Credit Suisse Group in Tokyo. ``Compared with previous recessions, this one will be very shallow. We're at the deepest point of the downturn now.''...

Stalled growth and the fastest inflation in a decade have created a dilemma for the Bank of Japan, which will probably have to keep interest rates unchanged for the rest of the year, according to economists surveyed this week. At 0.5 percent, Japan's key rate is the lowest among major economies...

Slumping U.S. demand has forced exporters including Toyota Motor Corp. to cut production and jobs. A Kyushu-based Toyota subsidiary reduced output of sport-utility vehicles by at least 10 percent and fired 800 workers since June.

Markets outside the U.S. are also deteriorating. The European economy shrank for the first time in almost a decade last quarter, and EU Commissioner Joaquin Almunia said this week that the outlook is ``unusually uncertain.''...

Even as exports weaken, economists say companies are better able to withstand the slowdown because they have shed the excess workers, factory lines and debt that contributed to a decade of economic stagnation in the 1990s.

"China's Central Bank is Short of Capital"

Either the Chinese do not understand banking and investing or the line being fed the Western press about the struggle over the Bank of China's reserves is a cover story of some sort.

Given the fact set, Dean Baker's reaction 'Is China's Central Bank Run By Morons?" is not unreasonable. I have a different theory, which we'll get to in due course.

The plot overview:

The Bank of China buys lots of dollar investments to keep the yuan from rising. However, as we all know, the yuan has been permitted to appreciate somewhat. Note that this means the value of those holdings in local terms has fallen.

However, the central bank has still had to keep buying dollars to keep the yuan from rising rapidly. It is running out of capacity and has to go to the Finance Ministry for a handout.

This is the bizarre bit. The Finance Ministry is mad that the central bank lost money on its dollar investments and wants no more yuan appreciation. This of course commits it to even greater dollar purchases, which guarantees that its eventually currency losses will be all the greater.

Key bits of the New York Times article:

The central bank has been the main advocate within China for a stronger yuan. But it now finds itself increasingly beholden to the finance ministry, which has tended to oppose a stronger yuan. As the yuan slips in value, China’s exports gain an edge over the goods of other countries.

The two bureaucracies have been ferocious rivals. Accepting an injection of capital from the finance ministry could reduce the independence of the central bank, said Eswar S. Prasad, the International Monetary Fund’s former division chief for China.

“Central banks hate doing that because it puts them more under the thumb of the finance ministry,” he said.

Mr. Prasad said that during his trips to Beijing on behalf of the I.M.F., he had repeatedly cautioned China over the enormous scale of its holdings of American bonds, emphasizing that it left China vulnerable to losses from either a strengthening of the yuan or from a rise in American interest rates. When interest rates rise, the prices of bonds fall....

The finance ministry, however, has pushed for investments in overseas stocks. Last year, it wrested control of the $200 billion China Investment Corporation, which had been bankrolled by the central bank. That corporation’s most publicized move, a $3 billion investment in the Blackstone Group in May of last year, has lost more than 43 percent of its value....

But even in a country that strongly discourages criticism of its economic policies, hints of dissatisfaction are appearing over China’s foreign investments.

For instance, a Chinese blogger complained last month, “It is as if China has made a gift to the United States Navy of 200 brand new aircraft carriers.”...

China finds itself hemmed in. If it were to curtail its purchases of dollar-denominated securities drastically, the dollar would likely fall and American interest rates could soar. China spent more than one-eighth of its entire economic output last year on foreign bonds, and then picked up the pace during the first half of this year....

Victor Shih, a specialist in Chinese central banking at Northwestern University, said that when he visited the People’s Bank of China for a series of meetings this summer, he was surprised by how many officials resented the institution’s losses.

He said the officials blamed the United States and believed the controversial assertions set forth in the book “Currency War,” a Chinese best seller published a year ago. The book suggests that the United States deliberately lured China into buying its securities knowing that they would later plunge in value.

“A lot of policy makers in China, at least midlevel policy makers, believe this,” Mr. Shih said.

If US officials privately assured the Chinese government that Fannie and Freddie debt were government guaranteed, as reader Scott's well-placed sources say, there is a germ of truth in the Chinese view.

Still, this is breathtaking reading. How could the Chinese have thought they could maintain a currency peg forever? At some point, the scale of the purchases becomes so large that they are unsustainable, the pegged currency rises and the country takes huge losses on its FX reserves. However, all of its local currency denominated assets are worth more in global terms. If this is a net plus, wealth-wise, why is there a problem? The computation of gains and losses is far from complete.

Equally worrying, neither of the two parties at odds is considering the only way out of this box: encouraging growth of China's domestic economy so it is less export focuses and therefore less in need of managing its currency. Admittedly, this would be a long-term program, while the question of the central bank's capital base is immediate, but it appears that no one is looking at the real problem, which is an economy overly dependent on a big customer.

Baker was more withering than usual:

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. The United States had a large and growing trade deficit...

It was understandable that China's central bank might buy up dollars in a conscious effort to keep the dollar high and thereby sustain its export market to the United States. This would mean that China was effectively paying people in the United States to buy its exports. This would be a reasonable growth strategy if China for some reason lacked the capability to generate this demand internally....

However, it would be bizarre if China's central bank bought up dollar denominated assets in the last 7-8 years thinking that they were making a good investment.....Apart from buying bonds from Zimbabwe, it's hard to imagine how they could have made a worse investment.

If the people who run China's central bank are really this ignorant, that should have been the headline of the article, which should have been on the front page.

Given the ferocity of bureaucratic battles and the anger in the public at large, the Times may have the story 100% right. But there is one way this might be a brilliant bit of gamesmanship.

Recall that China is suffering from a bad bout of inflation. That inflation is exacerbated by hot money inflows which have reached mind-boggling levels this year. The money is coming in in anticipation of a currency revaluation, and by pushing inflation higher, increases the odds of a revaluation.

Remember the ploy used by Henry Kissinger in his negotiations with the North Vietnamese? He presented Nixon as crazy, not the paranoiac that he was, but violent, impulsive, prone to extreme reactions if provoked. The notion that Nixon was an utter nut who would do something unthinkable (presumably the unspoken threat was dropping a nuclear bomb) was believed to have served Kissinger well.

Something like that may be at work here. Perhaps a genuine internal power struggle is being played up and positioned to persuade the hot money speculators that the finance ministry may soon have the upper hand, and the finance ministry is crazy enough and determined enough to keep the yuan weak, no matter how dangerous that might be in the long term. That would hopefully convince the hot-money players that their fast-profit revaluation hopes were misguided, and they'd shift their mony back overseas, providing some relief to inflationary pressures.

But it is just as plausible that the Finance Ministry is willing to cut off China's nose to spite the central bank's face.

Stephen Roach: China Needs to Get Tough About Inflation

Morgan Stanley economist and Asia chief Stephen Roach's current offering at the Financial Times, "Beijing’s Olympian task is to curb inflation," says that the Chinese officialdom is focusing overmuch on growth in its policy mix. And Roach most assuredly believes that a serious slowdown is just starting.

The article oddly underplays its bottom line. China will face a slowdown due to faltering export demand, and its leaders are determined to keep growth going at a good clip. The policy bias has shifted towards expansion. That means giving short shrift to inflation-fighting. Roach points out that the Chinese officialdom has rationalized inflation, seeing it as structural, a notion Roach dismisses. He says, in effect, that even though the cost of tackling inflation now is unacceptably now, the cost of dealing it with it later will be even larger.

But that may happen on another leadership's watch. And although Roach draws on the US's experience in the 1970s, he misses an important lesson. We did not embark on inflation-strangulation until we perceived that inflation had become too costly. China simply isn't there yet.

From the Financial Times:

China was slowing before the onset of the XXIX Olympiad and is likely to continue to slow in the year ahead. Elsewhere in Asia, a similar outcome appears to be in the offing.

Significantly, most of the Olympics-related construction activity in Beijing – some $42bn (€29bn, £23.6bn), according to the official Chinese tally – was completed more than a year ago.....Yes, there were plant closings in Beijing and the neighbouring city of Tianjin for a few weeks before and during the Olympics. But these two metropolitan areas collect ively account for less than 6 per cent of total Chinese output – hardly enough to make much of a dent in the Chinese production juggernaut.

At work, instead, are powerful repercussions of an external shock that has nothing to do with the Olympics: post-bubble adjustments bearing down on the US consumer, along with collateral damage now starting to show up in Europe and Japan. Developing Asia is the most export-intensive region of the world, with a record of more than 45 per cent of its pan-regional output now going to foreign markets. China’s export share is close to 40 per cent. As the industrial world slows, China and the rest of export-dependent developing Asia will feel the effects of a shortfall in external demand with a lag. Any gyrations traceable to the Olympics are likely to be overwhelmed by these much broader, more powerful macro forces bearing down on the region.

Policymakers in China are very much aware of the mounting downside risks to economic growth. Bank lending quotas, which have been the centrepiece of recent tightening initiatives, have now been relaxed. The pace of currency appreciation has also slowed – a sharp departure from the accelerated rate of revaluation that had been evident in late 2007 and early 2008. And policy interest rates have been left unchanged in a rising inflationary climate – keeping real short-term interest rates close to zero, a highly stimulative position....China’s pro-growth policy bias is once again coming though loud and clear...

In this context, inflation remains the biggest riddle for China. The recent pro-growth policy initiatives suggest that Chinese authorities are attempting to put a floor on the gross domestic product growth shortfall of somewhere in the 8 to 9 per cent range. Perhaps the biggest macro question for China over the next year is whether such a slowing – from the torrid growth pace of nearly 12 per cent in 2006-07 – is sufficient to stem the recent build-up of inflationary pressures.

There is good reason to believe that inflation risks will remain China’s most daunting macro challenge over the next few years. Particularly worrying is a growing inclination of Chinese officialdom to dismiss the build-up of inflationary pressures as “structural” – traceable to special forces that are argued to be beyond the control of domestic monetary policy. Three such developments are cited most frequently: recent labour reforms that have boosted minimum wages, an outbreak of “imported” commodity inflation, and international price equalisation that is presumed to bring the quotes of Chinese products up to world standards.

This structural excuse for China’s inflation problem is painfully reminiscent of an equally erroneous dismissal of US inflation risks in the 1970s. Back then, three structural forces were also cited as being beyond the purview of the US Federal Reserve, namely wage indexation to CPI shocks that created a wage-price spiral, imported inflation due to the worldwide commodity boom of the early 1970s, and mandated increases in production expenses traceable to regulatory initiatives in pollution abatement and worker safety.

The most important lesson of the 1970s is that the Fed proved to be dead wrong in dismissing inflation risks as structural. While inflation eased off in the middle of the decade as the US went through a deep recession, it roared back.... in the latter half of the 1970s, hitting a high of 13 per cent by the end of 1979. It took a new, courageous Fed chairman, Paul Volcker, to put the structuralist inflation argument to rest by driving up the federal funds rate to extraordinary levels and putting the economy through a wrenching hard landing.

That is an outcome that China – and an increasingly China-centric developing Asia, long fixated on social stability and poverty reduction – simply cannot risk. A hard landing could prove devastating to regional development imperatives. Yet to the extent that China and other Asian countries dismiss mounting inflation risks as structural and fail to heed the most salient lesson of the 1970s, the risk of an eventual hard landing will only grow.

That poses a serious question for the rest of Asia as well as for the broader global economy: can a build-up of inflationary pressures be contained to China? In the near term the downside of the global business cycle may limit the spread of inflation. But over the medium term that could change. The cross-border linkages of globalisation may make containment of Chinese inflation exceedingly difficult.

Temporary growth risks should not be the dominant concern in post-Olympics China. Stagflation may well be the greatest risk: an externally induced growth shortfall coupled with a significant deterioration of underlying inflation risks. Chinese officials are fixated on the growth side of the stagflationary equation, but they ignore the inflation piece of the outcome. That remains the greatest worry in the aftermath of an otherwise spectacular Olympics.

Bank of China Cuts GSE Holdings by 25%

We wrote yesterday about Japanese retail and institutional investors exiting Freddie and Fannie holdings, and didn't consider it as worrisome as it might seem on the surface, since at this juncture, the funding of our current account deficit is coming almost from central banks and to a lesser degree, sovereign wealth funds.

Tonight, the Financial Times reports in "Bank of China flees Fannie-Freddie," that the Bank of China has cut its Freddie and Fannie positions. Although it went public in 2006, state entities still have majority control, and the bank is generally described as a state-owned bank. Thus one must wonder if the bank's move is an early sign of changing official sentiment.

Doc Holiday commented yesterday that the low yields on Treasuries relative to inflation constituted a huge, largely unrecognized bubble. The FT provides a possible explanation. In the last month, foreign investors were sellers of Agencies and made much-larger-than-usual purchases of Treasuries.

From the Financial Times:

Bank of China has cut its portfolio of securities issued or guaranteed by troubled US mortgage financiers Fannie Mae and Freddie Mac by a quarter since the end of June.

The sale by China’s fourth largest commercial bank, which reduced its holdings of so-called agency debt by $4.6bn, is a sign of nervousness among foreign buyers of Fannie and Freddie’s bonds and guaranteed securities.

Foreign investors have been a mainstay of the market for such debt, but uncertainty over the mortgage financiers’ capital positions and the timing and structure of a potential government rescue has made some investors reassess their exposures. Asian investors in particular have become net sellers of agency debt, said analysts.

Federal Reserve custody data shows that for the year to July, foreign official and private investors bought an average of $20bn of agency debt a month, including debt issued by other government agencies such as Ginnie Mae and the Federal Home Loan Banks. Purchases of US Treasuries averaged $9.25bn.

From July 16 to August 20, foreign investors sold $14.7bn of agency debt, trimming their overall holdings to $972bn. They purchased $71.1bn of Treasuries in the same period.....

This weekend, the Group of Twenty developed and advanced developing countries will be holding a preparatory meeting in Brazil. Although the crisis at Fannie Mae and Freddie Mac is not on the agenda, there is speculation that Treasury officials could informally encourage big holders of agency debt and mortgage-backed securities not to scale back their investments..

We'll see in the next few weeks if the sales campaign succeeds.

Credit Suisse: "Most of the slowdown is not Olympics-related"

Reader Michael sent us a Credit Suisse Equities research report dated August 27 and called our attention to the section on China. Note that the analysts did some primary research to try to get a grip on the post-Olympics outlook. They expect a widespread, albeit not too severe, slowdown (click to enlarge, and yes, it is quite readable once you do so):

China Considering Stimulus Package, Oh My!

If you had any doubt that China would remain unaffected by the global slowdown, that should be put to rest by various stories discussing that the Chinese government is mulling a stimulus package. Yes, you could argue that the economy might need a tap on the gas pedal to compensate for all the factory closings and pre-Olympics restrictions. But the flip side is there was a lot of infrastructure and prettying-up spending in anticipation of the sporting event, so those might offset each other in the macro sense. Similarly, even though the tourist turnout was disappointing, the Chinese apparently bought quite a bit of Olympics memorabilia.

I seem to remember that the assumption heretofore that China would still have 8% growth (versus its recent 11%-12%) even with a global slowdown. But anything much below that level would be deemed to be a Very Bad Outcome. So the unanswered question at this juncture is what level of growth the officialdom foresees without a stimulus program in place.

This sighting came from Forbes today (hat tip Ben Bitroff):

China is considering a 370 bln yuan package of fiscal expenditures and tax cuts to stimulate the economy, the Economic Observer reported, citing a source close to the matter.

The report said said the plan includes 220 bln yuan in government spending and 150 bln worth of tax cuts.

The plan received initial approval from the Central Leading Group on Economic and Financial Affairs, a body under the State Council, but further details will be finalized by the finance ministry and other government departments.

Michael Pettis, in his China Financial Markets blog, gave longer form commentary on the fiscal stimulus plan rumors, and more important, some signs that the economy might be weakening (as opposed to growth merely slowing):

Economic numbers are ambiguous, and I think most participants are hoping for some sort of fiscal stimulus, while at the same time dreading that it won’t make much of a difference anyway. I think there is also a lot of nervousness about a psychological post-Olympic let-down. After all the anxious excitement of the Olympics, with the constant, non-stop coverage in the press and on television, there will be little left of the color and excitement and a lot of work repairing the disruptions. I don’t know when and how the many migrants and poor who were ejected from the city will return, but I would guess that their welcome will be muted. Meanwhile we have been getting sporadic press reports about the cost to farmers within the region of the Olympics water policies.

The main thing is that now that the Olympics are finally over, we should quickly return to a less colorful reality, and policy-makers and analysts will get back to trying to figure out what the next few months are going to look like. Today there was confirmation of sorts of the fiscal stimulus package reported last Tuesday in a JP Morgan note. One of the most widely read of local financial periodicals, the Beijing-based Economic Observer, had an article in today’s paper citing unnamed sources who claimed that the CPC’s Central Financial Leading Group had put together a fiscal plan to support a faltering economy, although this plan had yet to be revised by the Ministry of Finance or approved by the state Council....

If there really is such a program and if it is executed, and the newspaper cites an unnamed MoF official who claims that the proposal would have to go through many more stages before it became policy, the total fiscal stimulus would amount to a little under 1.5% of GDP.

Meanwhile Gregor Neuman alerted me to an article in today’s ChinaStakes. According to the article, in July, for the first time since 2003, tax growth has experienced a dramatic decline:

According to Ministry of Finance (MoF) statistics, China’s total revenue in July was RMB 532.325 billion, an increase of 13.8% over the same month last year. But this growth rate is 19.3 percentage points lower than in July, 2007, and 19.7 percentage points lower than the growth rate in the first half of the year.

The article goes on to say most sources of tax revenues showed sharp declines in growth rates, with corporate income tax actually down 4.2% from last July....

[I]t is worth noting that these numbers seem extremely volatile....

Meanwhile, tax from land and real estate, a major source of the local governments’ incomes, has also declined drastically...Land transfer income has also decreased, due to the real estate market doldrums....

Liu Heng thinks the tax decline “won’t be a big problem”, since China has put a certain amount of money from its tax income every year into a rainy day account.

Perhaps. Unfortunately, as the saying goes, when it rains, it pours.

While this may be a short-term blip, one of the comments in the ChinaStakes article was that the decline in corporate tax receipts would probably persist. If a real slowdown is in the offing, neither China nor the world is prepared for it.

"China: Humiliation & the Olympics"

This is a great piece by Orville Schell in the New York Review of Books. These essays tend not to lend themselves to editing, but this one does in reviewing several works both for their immediate content and how they relate to the larger issue of China's deeply held sense of insecurity. I've taken the bits that relate to the latter theme, but readers are encouraged to read this piece in full.

From the New York Review of Books:

Dark Matter
a film directed by Chen Shi-Zheng

Olympic Dreams: China and Sports, 1895–2008
by Xu Guoqi
Harvard University Press, 377 pp., $29.95

China's New Confucianism: Politics and Everyday Life in a Changing Society
by Daniel A. Bell
Princeton University Press, 240 pp., $26.95

China's New Nationalism: Pride, Politics, and Diplomacy
by Peter Hays Gries
University of California Press, 215 pp., $21.95 (paper)

China's Great Leap: The Beijing Olympic Games and Olympian Human Rights Challenges
Edited by Minky Worden, with an introduction by Nicholas Kristof
Seven Stories, 231 pp., $18.95 (paper)

The Incident

On a snowy winter day in 1991, Lu Gang, a slightly built Chinese scholar who had recently received his Ph.D. in plasma physics, walked into a seminar room at the University of Iowa's Van Allen Hall, raised a snub-nose .38-caliber Taurus pistol, and killed Professor Christoph Goertz, his thesis adviser; Robert A. Smith, a member of his dissertation committee; and Shan Linhua, a fellow Chinese graduate student and his rival.

Next, Lu went to the office of the chair of the Department of Physics and Astronomy, Dwight R. Nicholson, who was also on his dissertation committee, and fired three more fatal shots. Then, he walked over to Jessup Hall and demanded to see T. Anne Cleary, associate vice-president for academic affairs. When she emerged from her office, he killed her and then shot and maimed her twenty-three-year-old assistant. Finally, in an empty conference room, Lu raised the pistol to his head and killed himself.

Why a brilliant, hard-working young Chinese physicist, who had come to the US six years earlier filled with pride and hope, had come to such a bitter end is the subject of Dark Matter...

But what gives Dark Matter wider significance is the filmmakers' use of the Iowa incident to explore—indirectly—some important psychological dynamics between China and the West: China's deeply felt sense of historic injury by foreign nations, and the ways its often thwarted efforts to gain acceptance among leading world powers have exacerbated such sentiments. In the past, feelings of injury have arisen from such events as the Opium Wars and the Japanese occupation; and most recently after the Tibetan demonstrations this spring and during the run-up to this summer's Beijing Olympic Games.

By retelling the tragic story of a Chinese graduate student attempting to complete a Ph.D. at a prestigious American university, the film suggests, obliquely, a larger parable about China's ambivalence toward the developed world, especially the United States...What interests Chen is how his anti-hero's initial willingness to revere and submit to American academic authorities becomes transformed into its opposite, so that by the end, after his dissertation is rejected, he sees them as oppressors.

And yet Chen and his co-scriptwriter Billy Shebar's treatment of Dark Matter's antihero is surprisingly sympathetic. Chen was himself a Chinese graduate student in the US during the 1980s, and has since—as a well-known director of both Chinese and Western operas—become one of the artists who have been able to bridge the cultural divide between China and the West. He understands the sensitivities that linger around questions involving insult, humiliation, and loss of face to China, especially when foreign arrogance is involved. And in the film, Liu Xing's American Ph.D. adviser is arrogance incarnate. When Liu arrives in his lab, he is smugly told, "Well, feel free to challenge me all you want. Just keep in mind, I'm always right!"

When an assistant reminds Liu's adviser that his student has "been pulling a lot of all-nighters" doing research for him, he contemptuously replies, "Oh, come on! These kids are grateful for whatever work I give them. They come from a place where astrology is considered a science and toilets a luxury."

Such exchanges in the film echo a kind of condescension that has historically marked many kinds of relationships between the West and China and slowly formed a kind of "dark matter" that continues to exert a powerful, if unobserved force.

The question the filmmakers seek to explore in Dark Matter is not simply the personal one but the larger question of China's sensitivity to foreign dominance and criticism. Here the film is masterful in illuminating how any suggestion of foreign superiority, or even condescension, toward Chinese may intersect with their own sense of historical victimization and insecurity to create a volatile chemistry.

"We Chinese carry the burden of our history with us and the question of Western humiliation is always unconsciously inside us," Chen told me.

Thus, we feel sensitive to any kind of slight and often have a very sharp reaction to perceived unfair treatment or injustices. On an emotional level we cannot help but associate treatment in the present with past injuries, defeats, invasions, and occupations by foreigners. There is something almost in our DNA that triggers autonomic, and sometimes extreme, responses to foreign criticism or put-downs.

....As Peter Hays Gries has written in his thoughtful book China's New Nationalism: Pride, Politics, and Diplomacy, like it or not, "The West is central to the construction of China's identity today; it has become China's alter ego."

"A Century of Humiliation"

A particularly important element in the formation of China's modern identity has been the legacy of the country's "humiliation" at the hands of foreigners, beginning with China's defeat in the Opium Wars in the mid-nineteenth century and the shameful treatment of Chinese in America. The process reached an understandable high point with Japan's successful industrialization and subsequent invasion and occupation of China during World War II, which was in many ways psychologically more devastating than Western interventions, because Japan was an Asian power that had succeeded in modernizing, while China had failed.

In the early twentieth century, a new literature, with a new historical narrative to match, arose around the idea of bainian guochi, "100 years of national humiliation." By taking up its own victimization as a theme and making it a fundamental element in its evolving collective identity, China ensured that certain traits would express themselves again and again as it responded under stress to the outside world. Highlighting their country's history as a victim of foreign aggression led Chinese leaders to rely on what Gries calls "the moral authority of their past suffering." Indeed, China's suffering at the hands of foreigners became a badge of distinction....

As a result of the insulting terms of the Treaty of Versailles in 1919, by which the West cravenly gave Germany's concessions in China to Japan, an expression, wuwang guochi, "Never forget our national humiliation," became a common slogan in China. Indeed, to ignore China's national failure came to be seen as unpatriotic. Since then, Chinese historians and ideological overseers have never ceased to mine China's putative past sufferings "to serve the political, ideological, rhetorical, and/or emotional needs of the present," as the historian Paul Cohen has put it....

In 1997, when Hong Kong reverted from British colonial status to Chinese sovereignty, the Communist Party returned to the theme of China as victim to help encourage greater nationalism. General Secretary Jiang Zemin pointedly reminded the world that "the occupation of Hong Kong was the epitome of the humiliation that China suffered in modern history." Since then, much of the talk about victimization has concentrated on Japan, China's brutal and still incompletely repentant World War II occupier.

Yves here. I am no social anthropologist, but it is important to stress that this theme of humiliation was far from a necessary or inevitable choice. The Vietnamese, which has suffered far worse indignities (multiple occupations by foreign powers, including over 1000 years of rule by China) nevertheless saw themselves as a people who would eventually prevail against oppressors, no matter how long the struggle took. The French and Americans underestimated Vietnamese tenacity. Rand experts who had dealt with prisoner interrogation material from World War II, Korea, and Eastern Europe had never seen interviews like the ones of Viet Cong, the North Vietnamese army fighting in South Vietnam, and concluded that unlike other opponents, they could not be coerced.

Back to the article:

The idea that a nation might restore itself to greatness by emphasizing, even "celebrating," weakness may seem counterintuitive. After all, why would any leader seeking to gain global respect want to constantly remind his people and the world of his country's former humiliation? Perhaps Chinese leaders (both Nationalist and Communist) calculated that if Chinese could become sufficiently aware, even ashamed, of their weakness, they would be goaded into rising up and reclaiming their national greatness....

This dream was of reunifying China as a multiethnic state composed of Han (central Chinese), Man (Manchurians), Meng (Mongolians), Hui (Muslims), and Zang (Tibetans), as well as bringing back into the fold of "the sacred motherland" those parts of the old Chinese empire that had either been pried loose by imperialist powers or had broken away during times of weakness. (These included Hong Kong, Macao, Taiwan, the Spratly Island in the South China Sea, and the Diaoyutai Islands near Japan. And, of course, it also meant holding onto Tibet and Xinjiang, whose peoples have long flirted with independence.)

As the scholar William A. Callahan has recently noted, despite fifty years of Maoist revolution—when "anti-Communism" was often perceived as being "anti-Chinese"—and then as even China began to surprise the world with its recent economic success,

the national-humiliation narrative is [still] painstakingly reproduced in textbooks, museums, popular history books, virtual exhibits, feature films, dictionaries, journals, atlases, pictorials and commemorative stamps.

In 2001, the National People's Congress even passed a law proclaiming an official "National Humiliation Day." (However, so many historical dates were proposed that delegates could not agree on any one, and thus, no day was designated, although one of the leading candidates is now September 18, the day in 1931 that Japan began its invasion of Manchuria.) As if to remind the world that China was still an aggrieved party, Chinese Ministry of Foreign Affairs spokesmen not infrequently describe unwelcome actions by other countries—such as the bombing of the Chinese embassy in Belgrade in 1999—as "wounding the feelings of the Chinese people."

It would be tempting to dismiss such language as empty rhetoric, but like so much that is said in China, such code words still tap into a reservoir of sentiment that is exemplified by such slogans as "The Chinese people cannot be bullied; the Chinese race cannot be insulted!"....

References to "the 'Century of Humiliation'...both reflect and powerfully shape China's relations with the West today," writes Peter Gries. "By evoking the people, events, and symbols of China's early modern encounter with the West, Chinese continually return to this unresolved trauma...."....

Tibet

Having originally been scheduled for release during the spring of 2007, Dark Matter's première was delayed by yet another shooting on an American university campus, this one at Virginia Tech. As it turned out, the film did not arrive in theaters until this spring, just as Tibetans, hoping to extract concessions from the Chinese—who were increasingly anxious that the 2008 Summer Olympic Games in Beijing not be marred by dissent because of Darfur and Burma—began their protest. As Nicholas Kristof has written in the introduction to China's Great Leap, "The world has a new lever to try and win better behavior from China," and, in the case of Tibet, the world used it. Soon Tibetan exiles and their foreign supporters joined in challenging the progress from country to country of the Chinese Olympic torch, which quickly came to be viewed as a symbol of the PRC rather than the Olympic Games. Repeatedly torch carriers were besieged by protesters decrying what they viewed as China's forced occupation of Tibet.

While patriots from other countries would doubtless also have felt affronted by the sight of such a potent symbol of their nationhood under assault, the response of many Chinese to these confrontations revealed in dramatic fashion how sensitive China still was to foreign insult. What these Chinese at home and abroad chose to see on television was not oppressed Tibetans seeking a redress of grievances, but China again under siege and again being demeaned in the most public of ways.

China's restless search for a more self-confident, less-aggrieved persona has paradoxically been made more complicated by other wounds not directly related to foreign attacks: for much of the past hundred years Chinese themselves have also been engaged in a series of assaults on their own culture and history. These frequently uncompromising self-critiques first started in the early part of the twentieth century when Chinese reformers began denouncing traditional Confucian culture, above all because it seemed to have left them so weak before the technological superiority of the West.

By the 1930s and 1940s, these attacks began to turn against the nationalists. Having begun to fashion a new identity that combined elements of both East and West, Chiang Kai-shek and his Wellesley-educated, Christian wife were criticized for, among other things, being too Westernized and closely allied to America. Then, after Chiang was defeated, Mao came to power, and the Chinese Communist Party had spent three decades attempting at great human cost, to refashion a new revolutionary Chinese identity of their own, along came Deng Xiaoping to perform yet another act of demolition, this time on Mao's revolution itself.

The cancellations of these successive efforts at self-reinvention have left Chinese with an uncertain sense of cultural or political direction. The country has tended to swing from one experiment to another, seeking refuge in a series of large-scale, but never definitive, makeovers. It is therefore perhaps understandable that a more robust sense of cultural and political self-confidence has remained elusive. So, partly in shock, and partly in disappointment, China responded to the demonstrations against its Olympic torch with incensed outrage....

The protests ended up highlighting a China that was not what most Chinese had hoped to see on display during the run-up to the games. Old-fashioned police controls were tightened and rhetoric that harkened back to Mao's revolution made China look retrograde, just when it desired most to look modern....Militant attacks on China's critics and foreign broadcasters like CNN and the BBC that reported the torch's interrupted progress around the world soon flooded the Internet. In cities like Seoul, protesters began to be shouted down, even beaten, by Chinese counterdemonstrators.

What was surprising was that many of the most indignant counterdemonstrators were young Chinese, born during the post-Mao era. Better educated and more worldly than older Chinese, one might have expected them to have been exempt from the China-as-victim syndrome. But, perhaps because they, too, were products of the Party's propaganda, many of them have turned out every bit as nationalistic, perhaps even more so, than their elders.[*] But what made these demonstrations against the torch such an affront to so many Chinese was the way in which they intruded just when they had allowed themselves to imagine that their national identity might actually metamorphose from victim to victor, thanks to the alchemy of the Olympic Games.

Instead, at this penultimate moment, as Xu Guoqi, author of the timely new book Olympic Dreams: China And Sports, 1895–2008, has noted, "Through their coverage and handling of the Beijing torch relay, the West seemed to remind the Chinese they were still not equal and they were still not good enough."

The Olympic Games

The irony is, of course, that not for two centuries has China been more "equal." Indeed, to visit Beijing as it approaches the 2008 Summer Olympic Games is to be dazzled by the city's single-mindedness of purpose. Anyone arriving in China is bound to be impressed by the magnificent new Norman Foster–designed Capital Airport that opened just this February and by the new Beijing Olympic Park with its dramatic Herzog and deMeuron–designed "bird's nest" stadium and its equally startling bubble-skinned, transparent National Swimming Center, known as the "swimming cube." The dingy Soviet-style apartment blocks, disheveled courtyard houses, and defoliated streets that I first came to know in the 1970s Beijing during the Cultural Revolution have all but vanished. Now, one is everywhere overwhelmed by new "development," or fazhan, a word that has attained almost sacerdotal overtones in this new China whose leaders have, indeed, sponsored an economic revolution that has transformed their country. That so many people are now able to imagine a better future has gone a long way toward explaining the durability of Communist Party rule.

Beijing has seemed bent on making the upcoming games so magnificently endowed with new facilities and so flawlessly run that they will be unforgettable. Indeed, in speaking with Chinese, it is impossible to miss the feelings of pride and patriotism that the games have generated. Almost everyone I spoke with, whether high or low, seemed to feel some identification with this dashi, or "great enterprise," as Chinese used to refer to the efforts of Confucian dynasties to gain and hold the "mandate of heaven" that legitimized an emperor's right to rule.

After a century and a half of famine, war, weakness, foreign occupation, and revolutionary extremism, a growing number of Chinese—overseas as well as inside China—had come to look to the Olympic Games as the long-heralded symbolic moment when their country might at last escape old stereotypes of being the hapless "poor man of Asia"; a preyed-upon "defenseless giant"; victim of a misguided Cultural Revolution; the benighted land where in 1989 the People's Liberation Army fired on "the people." In one grand, symbolic stroke, the Olympic aura promised to help cleanse China's messy historical slate, overthrow its legacy of victimization and humiliation, and allow the country to spring forth on the world stage reborn —"rebranded" in contemporary parlance—as the great nation it once had been, and has yearned for so long to once more become....

So, like Liu Xing's Ph.D. orals, the games had come to be anticipated as the cathartic act in a long agonizing historical drama in which China would finally fulfill its almost mythic destiny: its quest for fuqiang, "wealth and power." Like Dark Matter's antihero, who imagines himself arriving triumphantly back in China heaped with prizes and his American Ph.D. to fall into the welcoming embrace of proud parents and country, many Chinese dared hope that China, resplendent with Olympic medals and with new respect, would come closer to attaining their long-denied dream of greatness.

It was into this atmosphere of hopeful expectation that the Tibetan protests intruded. "Chinese felt: This is our time!" Chen Shi-Zheng told me.

And then, along come the Tibetan demonstrations, which made them feel as if they were again being thwarted, as if what they finally rightfully deserved was going to be denied.

Given the lens of disappointment through which many Chinese saw the Tibetan uprising, it was hardly surprising that indigenous protesters, the exile Tibetan movement, and even the Dalai Lama himself quickly came to be viewed as traitors, creatures of foreign forces conspiring to snatch China's prize—its new world status— from its grasp, much as the protagonist in Dark Matter had come to view his Chinese rival as having betrayed his Chineseness by selling out to foreign masters, their American professors, and denying him his rightful prize.

That may be confusing to outsiders trying to make sense of all this is that despite China's stunning accomplishments, few Chinese of my acquaintance, at least, have yet allowed themselves to be psychologically convinced by China's success, to embrace a new national belief in China's establishment as a leading nation. To do this, I suppose, they would have to fully believe that they already are, in fact, successful and powerful; that the world has already begun to look on their country with a growing sense of wonder, even envy; and that the past is, in fact, the past.

As Xu Guoqi suggests in Olympic Dreams, Olympic medals may not be the answer to what ails. "China," he writes,

has been obsessed with winning gold metals in major international competitions to demonstrate China's new status as an economic and political powerhouse....

Although China's pursuit of Olympic gold medals clearly coincides with the nation's journey toward internationalization and achieving new status in the world, the state-driven championship mentality still reflects a combination of Chinese can-do confidence and the country's lingering inferiority complex. A nation that obsesses over gold medals is not a self-assured nation.

Xu goes on to caution that

Beijing has used its so-called gold medal strategy to demonstrate China's rise in power and wealth, but the political system that the Communist Party has tried to legitimize through sports and other means cannot produce a healthy and strong nation when its citizens have been forced to give up their independence and even personal dignity.

When it comes to accepting outside criticisms related to sensitive topics such as the Olympic Games, Tibet, Darfur, and Burma, Chinese leaders undeniably are thin-skinned. Their defensive reactions suggest that their memories of historical weakness and humiliation still burn with intensity. And while honest criticisms should not be muted just because Chinese leaders find them grating, as we foreigners interact with China, we should become more mindful that much dark matter generated by this history still floats around our common universe....

While we often imagine ourselves to have escaped the confines of that history—or that history somehow ended —it would be naive to forget that we remain part of the equation. Whether we choose to recognize it or not, America can still have a powerful psychological gravitational pull on China, which grows as much out of history as out of current foreign policy.

A film like Dark Matter helps us see the complexity of this relationship more clearly, because it is able to probe the psychological recesses of our complex relationships far more deeply than any kind of policy analysis.

If there is one certainty in all of this uncertainty, it is that, because there exists no more important bi-lateral relationship in the world today than that between the US and China, it is crucial for us to understand as much as we can about its almost infinite complexity. Chen Shi-Zheng's absorbing film helps us see into the complex and sometimes dark well-springs of feeling between East and West that, because of their deep historical origins, are still able to intrude in myriad destructive ways into our collective present.

To go against the grain of this essay, Japanese have said to me, "China has 5000 years of not living up to its potential." The humiliation obsession, while it may be highly useful in the short run as a motivating force and a means of social cohesion, seems destined to impede China's assumption of a leadership role on the global stage. The US has learned that unilateralism and "us versus them" posturing only succeeded in weakening our international position, even though we had the advantage of being the world's sole superpower. China's sense of isolation and persecution is more deeply rooted and unless it has skilled diplomats at the helm, it may wind up undermining the success it is so desperate to achieve.

China Desk

Brad Setser thinks that China is again holding the RMB down to maintain export volume in the face of softening global demand. From the comments (my emphasis):

China prefers subsidizing US consumption of Chinese goods to subsidizing Chinese consumption of Chinese goods... if China’s foreign asset accumulation continues at $800b a year, it will add $3.2 trillion to its foreign portfolio over the next four years — more than it added in the preceding twenty...

Bloomberg also points out that by dodging the debt bubble bullet China's banks have drifted to the top of the market cap tables as well as providing some of the only investment gains for their competitors:

Chinese banks hold three of top six spots among the world's largest financial companies based on market value... The Chinese banks owe their rankings in part to having avoided almost all of the $480 billion in writedowns and credit- market losses that have sent bank stocks tumbling worldwide... Only two years ago, the world's biggest banks were led by Citigroup Inc. and Bank of America Corp. of the U.S. and UBS AG in Europe... ICBC's unaudited figures... show first-half profit rose more than 50 percent... Beijing-based China Citic Bank Co. said earnings jumped more than 150 percent in the same period. China Construction Bank followed, saying net income may have advanced more than 50 percent... Chinese funds and companies spent $19.3 billion buying stakes in Blackstone Group LP, Morgan Stanley, Barclays Plc, Fortis and Johannesburg-based Standard Bank Group Ltd. since May 2007 that are now worth $7 billion less on paper... China Investment Corp.'s $5 billion purchase of a 9 percent stake in New York-based Morgan Stanley, the second-biggest U.S. securities firm... has declined 18 percent... The $200 billion sovereign wealth fund also invested $3 billion in shares of New York-based Blackstone, manager of the world's largest buyout fund, only to see their value decline 41 percent... By contrast, foreign banks' investments in Chinese financial firms have fared much better, showing $50 billion of paper profits... HSBC is sitting on a $16 billion gain... Bank of America, which bought 9 percent of China Construction Bank for $3 billion in 2005, has a $14 billion paper profit...

And, for those many investors bullish on both oil and the RMB, has the FT got a deal for you:

Shareholders in Petrochina have approved a plan for China’s largest corporate bond sale by a listed company... up to Rmb60bn ($8.77bn) through one or more tranches of bonds with maturities of up to 15 years... In the first half of this year, 21 listed Chinese companies issued a combined Rmb74.5bn of domestic bonds. While tiny compared with more developed economies, this amount was 6.35 times larger than the corresponding period last year...

The moment of truth for the un-coupling thesis is at hand; as pretty much everyone agrees (which is a sign for extreme caution) that there will be a post-olympic slump in China. In order to beat the rush, the IHT has already come out with their announcement: "China's post-Olympics economic slowdown has started before the Games have even begun."

New orders at Chinese factories plunged last month. Exports are barely growing, after adjusting for inflation and currency fluctuations. The real estate market is weakening, with apartment prices sinking in southeastern China... Any slowing of growth, which has been spurred in part by China's herculean investment program to showcase the Olympic Games that open this week, could prove a shock to Chinese workers who have been receiving double-digit pay increases each year... any significant slowing below its recent pace of 11 percent or more a year would also make it much harder to find jobs for the millions of people moving from rural areas to cities each year in search of work. Economists have been forecasting growth of 9 percent to 10 percent over the coming year, and these estimates are being ratcheted downward.

I'm pretty sure this is just MSM type spin and speculation - no sources, no hard data. Rodger