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?

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  1. bg

    I am confident that the US would debase its currency before it entered into such an arrangement with a regime it has been scolding for a generation.

  2. Anonymous

    I agree with bg. We’ll see a reverse 3:1 dollar split before anything like this happens. Besides, I doubt the terms the Chinese would offer us would be as benign as the article assumes. Oh, but be sure, we’ll be begging for that money soon enough!

  3. Anonymous

    The author of this article, Arvind Subramanian, seems to not understand the nature of any IMF backed bail out. The “conditionality” inside the Structural Adjustment Program calls for opening of domestic market for foreign investment (western exploitation) social safety net and banking reform ran exact opposite of that.

    A real IMF styled bail out would include:
    1. Raise interest rate by 1000 basis point
    2. Auctioning off insolvent banks to international bidder
    3. Reduction in US government spending on war, health care, social security
    4. Removal of any congressional oversight in foreign ownership of vital/strategic US asset

  4. Vaudt Varken

    The chinese government could do something even more statesmanlike: spend some of that money to raise the living standards of some of its population, or it might consider doing something about its thousands of coal power plants.

  5. doc holiday

    The main problem I see, is the same one with TARP, i.e, a very broad brushstroke of government discretionary spending that ends up burning cash by adding pork and stupidity into an already complex situation. These instant fix proposals are all highly theoretical and not based on anything but subjective concepts and experiments targeted at bailing out fraud. It doesn’t matter if the magic cash is pulled from a hat in China, India or Brazil, no one has a enough loot for these derivatives games — the derivatives market needs to be shut down ASAP!

    Plans like this do not fix fraud, or target derivative insanity, e.g, the $60 Trillion derivative market that dwarfs these tiny bits of socialist charity. Furthermore, these potentially large lotto buck pools of mega bucks may not trickle down from the top to the bottom, so IMHO, spinning money in circles is just an endless loop of repeating the same game — and obviously this casino game needs to be fixed!

  6. Anonymous

    And you will continue with high standard of living, huge trade deficits, huge budget deficits and cruel wars alike killing millions of iraqis.Aravind subramanian has brought disgrace to india by bringing such an idiotic article. The chinese will ask USA to give all their missile defense shields and aircraft carriers in exchange for that 500 billion dollars. They are not so stupid as this author expects them to be.

  7. Anonymous

    Interesting to see all honest laissez faire macro economists and bloggers across the web offering ideas and suggestions to save a corrupt and fraudulent system(also criminal), than allow it to collapse and create a new laissez faire econ system with a gold standard and REAL democracy

  8. bloggingchina

    nice in theory. but china is in no mood to do so

    did you notice the timing of the latest arms sale to taiwan? last week, in the teeth of the crisis.

    bush is a true moron. he just poked his biggest creditor in the eye for nothing at what may be our most vulnerable financial state in decades.

    if the chinese even want to do a deal now you can be pretty sure they will tie taiwan policy into the deal. and why shouldn’t they?

  9. Max

    What an idiotic piece. Even the Google bots got dumber for having parsed it.

    The contingency to help distressed homeowners? Responsible superpower? WTF?

  10. Max

    A real bailout would be like this: China takes the following marbles

    Taiwan island
    Geico (they need to save on auto insurance too)

  11. Richard Kline

    The proposal as stated would never happen. Period. The US would not accept it. More to the point, China gets absolutely _squat_ out of that ‘proposal.’ The perspective in the piece seems to operate in some parallel universe without the geopolitical realities of the ones we all, including the Chinese, live in. “Responsible global citizen” my ass. The whiff of the idea that China needs to _buy_ sovereign acceptability presumably in the eyes of such paragons as Japan, the UK, and the US is rather more odious a notion than the author of this piece seems to be able to get his head around. The government of China is far from perfect in its conduct, but look who’s talking.

    But . . . perception in these things is more important than reality. The Chinese have much to lose from a global recession, and if the US prints money the value of present Chinese dollar-valued holdings tanks anyway. If, for example, the US announced the kinds of measures proposed in the article, and solicited ‘financial backing for the stabilization plan from our strategic partners,’ that is an entirely different situation. That could be sold on both sides of the dateline. But I not only suspect that China would drive _far harder terms_ for any such ‘contribution,’ they would be nuts not to do so. And it is in those details that the Devil lies.

  12. doc holiday

    FYI: Worth a fast look IMHO:

    Key Signals and the CDS Cascade


    For many insurance companies, these CDS Contract settlement dates could be a kind of ‘waterloo,’ where billions of dollars in losses could come home to roost. A gander at the destruction wreaked on insurance company share prices shows a steep downside acceleration in the last few weeks with names like …

  13. bena gyerek

    i agree with richard kline @ 4.50 that there is a more materialistic incentive for china and the usa to cooperate in this way. unfortunately i think “exceptionalist” ideology and us elections will prevent any such deal being struck until it is way too late. by which time i agree with anon @ 2.59 that china will have its own problems to worry about – namely an export-led recession and a banking crisis all of its own..

  14. Max

    Richard Kline>But I not only suspect that China would drive _far harder terms_ for any such 'contribution,' they would be nuts not to do so.

    Do they get at least Taiwan and Geico?

    Actually, it’s less comic than it seems – the real sectors of the US economy are tiny compared to the borrowing binge of the US. All the geeky genius of Bill Gates could be bought for a song with the inflated fiatscos of Greenspan.

  15. patrick neid

    Here’s a suggestion, put forward two weeks ago, do nothing. The horse has left the barn. The bubble mania, credit, housing and commodities is over. The splat is everywhere.

    There is no plan of any nature or size that can figure out the myriad transactions that need to take place to resolve the debt contraction that is taking place.

    True, it is every man for himself but prior to the Federal reserve we survived these episodes, episodes I might add that occurred much more frequently.

    After the dust settles, probably around 7000 on the Dow, we can take stock of the situation and come up with a game plan. Similar to rebuilding after a tornado. Now is much too early. What we are witnessing is the hurricane caused by continued interventions of whatever kind since Greenspan initiated the famous “Put” on Tuesday October 20, 1987.

    Now we scream “do something, do anything” whenever the market attempts to correct prior imbalances.

    I don’t pretend to think anyone will listen. What will in fact happen is that a wild ass quess will be tried as the market is already bottoming and everyone will cheer, much as the rooster does thinking he raised the sun.

    When this is over history will again show that all these attempts impeded the process akin to all the claptrap we tried in the 30’s.

  16. Anonymous

    It would seem that the exact opposite is happening.

    Some long-expected policy decisions in Beijing appear to have begun to be implemented.

    The Greenback, December 27, 1945 – October 8, 2008. R.I.P.

  17. Richard Kline

    What kind of bargain _might_ China drive? Hmm. Purchasing physical assets in the US isn’t a good buy, and asset prices are not necessarily stable. Geopolitical position is better, vide Russia’s buying-in provision with Iceland in the thread of another of Yves’ posts here.

    China has already won in Taiwan; the US doesn’t get this, but it’s clear. Formal concessions there might not be the way to go, since China is going to collect the prize in any case. It would be better to do a partial deal on the US ‘building down’ it’s strategic commitment. Say, non-opposition to direct, major mainland investment in Taiwan, and an unannounced but signed agreement to not contest the results of any reunification negotiation or referendum in Taiwan, either. Not that I think the CCP wants a referendum, but still.

    As far as a hard asset, China bids and buys AIG’s Asian operations outright as part of their ‘contribution.’ Those are a real prize. The end to US opposition to direct Chinese investment in oil production anywhere in the Near East beginning with Iran. Once the Chinese buy in there, the game’s up.

    Some other stuff like that. $500B is still a lot for that; the list should be longer. None of this is as ‘public humiliation’ as policy concessions by an aid recipient, or a public abandonment of Taiwan. Not that Taiwan does anything for the US: It’s a huge strategic liability which we are too stupid to back away from, but that’s America: “We’re too big to have to play smart.” Soooo _not_.

  18. Anonymous

    An easier method would be for Washington to expropriate China and all foreign assets; immediately abrogate all debt – public and private, foreign and domestic; reduce the workweek below 16 hours; and eliminate all taxes.

    We can call this Plan Z – because Washington will try everything else before this, to save itself and its empire.

  19. River

    Arvind Subraminian of the FT? Is this a real person or a take off of the old deep water submersible, the ‘ARVIN’? Perhaps the name is some sly humor regarding underwater real estate, underwater governments, underwater countries?

    In any case, imo, it ranks as one of the ten stupidest suggestions that has been printed in the FT.

    People continue to underestimate the SCO in general and China in particular. One day it will become apparent, even to Arvind, that thier plans are on track.

  20. The Anecdotal Economist

    2008 will be known by future historians as “the year everything changed.”

  21. Anonymous

    If China’s foreign exchange holdings are equal to
    $1000 to $1200 per person, ($1.5 to 1.8 B) they may
    need all of it for their own domestic purposes, depending on the length and severity of the global
    contraction. Why risk flexibility now, at the beginning?

  22. Anonymous

    The key will be if we see in the next few days/weeks:

    1) remove of the USD peg to the HKD and replacing it with a peg to the Yuan; or

    2) re-pricing of Chinese exports in Yuan.

  23. Matt Dubuque

    An interesting article.

    I don’t believe China would settle for the two main terms described in the article, although they are the result of some careful and worthwhile analysis.

    The terms set forth in the article are necessary but not sufficient. The other is deeply informed on the Indian perspective, but that diverges in some important respects from the Chinese agenda.

    The Chinese want a strategic ADVANTAGE here. They are not our ally and they can easily withstand 100 billion dollar hits to their portfolio while they wait for the right deal.

    They want Taiwan back. They are FURIOUS at last week’s massive arms deal to Taiwan. Chinese newspapers are running headlines on this story daily.

    Additionally, they want the US out of Central Asia and, although it is horribly underreported stateside, the US to DRASTICALLY reduce its footprint in Pakistan.

    Matt Dubuque

  24. DD

    The article assumes—incorrectly—that China is a creditor of the US. That shipped sailed a long time ago. China’s not a creditor—it’s an equity holder, baby—and you can take that to the bank.

    The relationship b/w China and US is best viewed through the prism of pusher and addict. The pusher’s real currency is the addict’s drug of choice. The eventual debasement of the US$$ will be tantamount to the legalization of the drug of choice.

    The Chineese have hopefully studied up on their physics…specifically phase shifts. Today, they are calling shots as the “credit-pusher”, and tomorrow, prohibition ends, and they are suddenly a compromised, out of work liquor runner with cases of devalued moonshine.

    China’s position is at least as precarious as the States’.

  25. Anonymous

    China is not going to bail out US.
    Look what is doing the Arabs funds, they are migrating to gold.

    The Next crash is the dollar, interest rate decrease is going to hurt badly the green backs.

    Buy Gold, physical, Gold bouillon is a safe investment.

    Storage food, it seems crazy but if they destroy the currency everything will go skyrocketing.

  26. daveg

    Not that Taiwan does anything for the US: It’s a huge strategic liability which we are too stupid to back away from, but that’s America: “We’re too big to have to play smart.” Soooo _not_.

    Very true. An probably twice as true for Israel.

  27. daveg

    Not that Taiwan does anything for the US: It’s a huge strategic liability which we are too stupid to back away from, but that’s America: “We’re too big to have to play smart.” Soooo _not_.

    Very true. An probably twice as true for Israel.

  28. William Mitchell

    Exceptionalism ends with the baby boom. You see a clean break among people at about age 55.

    Above that age, most educated people think about US policy (economic and otherwise) from a basic assumption of unlimited resources.

    Below that age, most educated people think about US policy from a basic assumption of limited resources.

    You see this break vividly among political candidates. I’ll let you connect the dots.

    Limited resources require prioritization, compromise, and cleverness. We are about to relearn some very rusty skills, or get killed trying.

  29. CEO

    Idealistic but rather simplistic. Americans would never forgive any US president who goes begging for foreign aid, let alone a communist country it considers a threat to its hyper-power status. No americans alive today has ever lived through a period when the US wasn’t the pre-eminent exceptional power and saviour of the world. Neither US presidential candidate had anything good to say about China throughout their campaigns. If I were Chinese, I would not believe the Americans would abide by any IMF type conditions, how could Chinese trust American politicians when they openly lie about WMD to get at Iraqian oil?

  30. Anonymous

    “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.” Sure. And selling opium to China in the nineteenth century was the biggest trade of pharmaceutical products in history. Have a nice day.

  31. Sivaram Velauthapillai

    This is a ridiculous proposal. This is an example of how the business crowd–economists, investors, executives, etc–have little idea of political implications. I’m neither an American nor a nationalist but this article is basically calling for a foreign country to take over USA. The article only seems to mention economic conditions but purposely seems to ignore the politicial requests that would go along with that.

    Just like how many in the business world were shocked when the US Congress didin’t initially pass the bailout bill, the proposals being proposed now completely ignore political considerations.

    It’s better to be free and slightly poorer than be richer and controlled by foreigners. Obviously the author proposing the Chinese financing of USA wants to save the economic interests at the expense of political freedom.

  32. Anonymous

    CEO called the idea “Idealistic but rather simplistic.” No, I think that Alexander’s conquest of Persia was idealistic but rather simplistic.

  33. Mark Amerman

    The “invisible hand” is a machine. It works, when it works, thru feedback. Without the vast flow of money from China, the oil states, Japan, and to a lessor extent others, the U.S. economy would have been getting the signal that it was uncompetitive as real income dropped or the rate at which it increased dropped. All across the board at a basic level people would be getting the message that they were doing something wrong.

    That’s the message we needed because we have been losing jobs, businesses, and factories to China and others. If we had been getting that message, painful as it was, people would have, of course, responded.

    Instead the vast flows of money into the U.S. sends the false signal that we’ve been doing just fine. To the extent we’ve adapted to new circumstances, it’s simply been to become dependent on that flow of money in.

    Let me try to count the ways the people of the United States have lost in this arrangement.

    1. All the jobs, businesses, and factories that would not have been lost if one our most basic feedback loops hadn’t been screwed up.

    2. Time to adapt.

    3. Independence. China is in a position to collapse the U.S. economy at will by pulling funds out or even more simply by not continuing to send more money over.

    4. Decentralization. The massive flow of money in has financed an expansion of the federal government. Many supposedly private companies are either mostly or completely dependent on the government for income.

  34. Anonymous

    Help! Help! Oh please, please Mr. communist government, save us, save us. We beg you, Please prop up our broken and corrupted way of life. We are to weak to help ourselves and lack the courage and will.

    After all our most dearest global corporations and Wall Street wizards (with the total support of our government) have “strategically” directed trillions of dollars of plant, equipment, and technology transfers to your backward country. Our hopes, of course, are you will see the errors of your ways and embrace our “free market” philosophy that has placed us in such a vastly superior position to your own.

    Please, Please save us! hee, hee hee!

  35. Anonymous

    China is one of the main reasons we are in this mess.If they paid even half of the american defaulted 1913 gold bonds that many americans, and our US goverment owns,we would not need any help..Their credit rating is a joke.They should not be allowed to sell any more bonds until the pay for the ones in DEFAULT.. or have their credit rating lowered.

  36. Mara

    Don’t forget that great Vulcan saying “Only Nixon could go to China”.

    Consider, if you will, a person who seeks to dominate others and to avoid domination; who considers that there are only enough resources for them; who can’t have help; whose ‘help’, when given to others, results in death and destruction; You’d think such a person was dangerous or crazy. Be thankful for the patience and help of others.

    Now’s the time to think outside the box. So often in the past we’ve pressed for far more draconian measures to be imposed on other countries (see Confessions of an Economic Hitman)

  37. Francois

    “What an idiotic piece. Even the Google bots got dumber for having parsed it.”

    Sigh! yet another slurp of coffee sprinkled all over the computer screen.

  38. Blissex

    «The Chinese have much to lose from a global recession,»

    I suspec they strongly disagree. it used to be that China was poor of capital and the only way it could earn a living was by importing it with a low exchange rate and import raw materials, add a little value, and sell them abroad. In this the main constraint on Chinese growth was access to foreign markets where the people who had the capital and purchasing power were.

    But some recent paper shows that China has already imported a lot of capital and exported a lot of goods to the point that it has kickstarted its own capital accumulation and consumer spending, and about 2/3 of China growth rate is generated in China, not by exports.

    In this situation the main constraint on China growth is not the availability of export markets, but of raw materials to turn into domestic sales.

    A recession by the biggest other buyers of raw materials would drastically reduce their demand for them and their prices and improve the terms of trade for China and boost the growth of the country more than continued of othr countries.

    If China have reached the stage where its immense internal capital and consumer markets have been kickstarted via a phase of export led growth, their best strategy therefore may be to stop lending their dollar reserves to the USA to support their economy, and then use those dollar reserves to buy raw materials and assets as much as possible.

    Perhaps losing something in sales to the USA would be more than compensate by lower global raw resource prices.

  39. Anonymous

    Would anybody with first-hand knowledge post some accurate info on current purchases of U S Treasuries by Russia.

    the Primordial Dwarf

  40. Anonymous

    People seem to assume that China can just pull its $1.5B out of the mattress and invest it in US T-bills. Isn’t half of it already in US Treasuries? And isn’t half of the rest in Fannie and Freddie securities? So what are their choices? They can crash the market for GSE bonds and force the USG to borrow to bail Frannie out again, or they can just offer to loan the US Treasury 3/4 of their T-bills. Sounds like a wash to me.

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