Are Rising US-China Tensions Pointing to a Rupture?

Relations between the US and China have been deteriorating. Although both sides have poked each other in various ways (Obama meeting with the Dalai Lama, China dissing Obama in Copenhagen by standing him up for a meeting, some tit for tat on tariffs), the major, unresolved bone of contention is China’s pegging of its currency, the renminbi, at a level most experts deem to be undervalued. This has widespread ramifications: a continuation of global imbalances (one of the causes of the financial crisis) and preserving Chinese employment at the expense of its trading partners.

The US has strengthened its push for China to Do Something about the renminbi, meaning revalue it, with Obama calling for a “more market-oriented exchange rate”. Some analysts have forecast a rise of 5% this year. But the noise out of Beijing suggests otherwise. From Bloomberg:

Chinese Premier Wen Jiabao rebuffed calls for the yuan to appreciate, risking a further downturn in relations with the U.S. where lawmakers and economists say his stance is hampering a global recovery.

“I don’t think the renminbi is undervalued,” Wen said yesterday at a press conference in Beijing marking the end of China’s annual parliamentary meetings, using another term for the yuan. “We oppose countries pointing fingers at each other and even forcing a country to appreciate its currency.”

Yves here. The reason this issue is coming to the forefront now is twofold. One is that the Obama administration’s falling poll ratings are forcing it to address a central issue that it has neglected, namely, unemployment. The measures so far, a stimulus packages that most economists deem to be inadequate, and extending unemployment benefits, have simply blunted the severity of the problem rather than solved it. A cheaper dollar would bring jobs back to the US (in fact, manufacturers like Caterpillar have already started repatriating jobs. And before readers start arguing in favor of cheap Chinese labor, most firms who have outsourced and offshored have found cost savings to come up well short of expectations. Why? First, labor costs are a relatively small component of most manufactured goods. Even in a supposedly-hopeless-for-advanced-economies field like apparel, some US manufacturers like American Apparrel are paying $12-$13 an hour for workers who make T-shirts and sweatshirts, supposedly commodity items, and still show a profit). Sending work overseas greatly increases administrative costs, which involves much higher paid workers, along with higher shipping and inventory financing costs).

Two is that the Treasury faces an April 15 deadline to decide whether to label China a currency manipulator. That in turn would allow the US to impose retaliatory tariffs. Even normally pro-trade economists like Paul Krugman have pointed out that countries that persistently undervalue their currencies are effectively stealing jobs from their trade partners. While allowing currencies to adjust is the best remedy, taking steps like imposing tariffs to counter the Chinese export subsidy of an artificially cheap RMB is a fallback.

Our initial take was that Team Obama would stage a repeat of its stance last year: saber rattle and do nothing. But there is now bi-partisan pressure on the Obama administration to act. Not only is this move likely to be a winner domestically (and Obama is in desperate need of a win), China’s position is untenable. It has no ready way to retaliate against the US without damaging itself. Stop buying Treasuries at auction? That would drive the RMB up, exactly what they are trying to avoid. Apply tariffs to US goods? Yes, that would hurt specific US exporters, but given China’s massive trade surplus with the US, we come out net ahead on any trade war. Withhold strategic US imports, like chips? That could be disruptive short term, but would lead over time to permanent relocation of production outside China.

Ambrose Evans-Pritchard in the Telegraph contends that China is badly overestimating its power, and will come out the loser if it does not back down:

China has succumbed to hubris. It has mistaken the soft diplomacy of Barack Obama for weakness, mistaken the US credit crisis for decline, and mistaken its own mercantilist bubble for ascendancy. There are echoes of Anglo-German spats before the First World War, when Wilhelmine Berlin so badly misjudged the strategic balance of power and over-played its hand….

Clearly, Beijing is in denial about is own part in the global imbalances behind the credit crisis, specifically by running structural trade surpluses, and driving down long rates through dollar and euro bond purchases. No doubt the West has made a hash of things, but the Chinese view of events is twisted to the point of delusional.

What interests me is Beijing’s willingness to up the ante. It has vowed sanctions against any US firm that takes part in a $6.4bn weapons contract for Taiwan, a threat to ban Boeing from China and a new level of escalation in the Taiwan dispute…

We have talked ourselves into believing that China is already a hyper-power. It may become one: it is not one yet. China is ringed by states – Japan, Korea, Vietnam, India – that are American allies when push comes to shove. It faces a prickly Russia on its 4,000km border, where Chinese migrants are itching for Lebensraum across the Amur. Emerging Asia, Brazil, Egypt and Europe are all irked by China’s yuan-rigged export dumping.

Michael Pettis from Beijing University argues that China’s reserves of $2.4 trillion – arguably $3 trillion – are a sign of weakness, not strength. Only twice before in modern history has a country amassed such a stash equal to 5pc-6pc of global GDP: the US in the 1920s, and Japan in the 1980s. Each time preceeded depression.

The reserves cannot be used internally to support China’s economy. They are dead weight, beyond any level needed for macro-credibility. Indeed, they are the ultimate indictment of China’s dysfunctional strategy, which is to buy $30bn to $40bn of foreign bonds every month to hold down the yuan, refusing to let the economy adjust to trade realities. The result is over-investment in plant, flooding the world with goods at wafer-thin export margins. China’s over-capacity in steel is now greater than Europe’s output.

This is catching up with China, in any case. Professor Victor Shuh from Northerwestern University warns that the 8,000 financing vehicles used by China’s local governments to stretch credit limits have built up debts and commitments of $3.5 trillion, mostly linked to infrastructure. He says the banks may require a bail-out nearing half a trillion dollars.

As America’s creditor – owner of some $1.4bn of US Treasuries, agency bonds, and US instruments – China can exert leverage. But this is not what it seems. If the Politburo deploys its illusiory power, Washington can pull the plug on China’s export economy instantly by shutting markets. Who holds whom to ransom?

Any attempt to retaliate by triggering a US bond crisis would rebound against China, and could be stopped – in extremis – by capital controls. Roosevelt changed the rules in 1933. Such things happen. The China-US relationship is no doubt symbiotic, but a clash would not be “mutual assured destruction”, as often claimed. Washington would win.

Contrary to myth, the slide to protectionism after the 1930 Smoot-Hawley Tariff Act did not cause the Depression. Trade contracted more slowly in the 1930s than this time. The Smoot-Hawley lesson is that tariffs have asymmetrical effects. They devastate surplus countries: then America. Deficit Britain did well by retreating into Imperial Preference.

Barack Obama has never exalted free trade. This orthodoxy is, in any case, under threat in the West. His top economic adviser Larry Summers let drop in Davos that free-trade arguments no longer hold when dealing with “mercantilist” powers. Adam Smith recognized this too, despite efforts by free-trade ultras to appropriate him for their cause.

China’s transformation has been remarkable since Deng Xiaoping unleashed capitalism, but as ex-diplomat George Walden writes in China: a Wolf in the World? you cannot feel at ease with a regime that still covers up Mao’s murderous nihilism. He reminds us too that China has never forgiven the humiliations inflicted by the West when the two civilizations collided in the 19th Century, and intends to exact revenge. Handle with care.

Update 12:45 AM: Team Obama seems to be laying the ground domestically for a serious spat, given the latest PR sighting via the New York Times, “China Uses Rules on Global Trade to Its Advantage.” Looks like the American populace is being “educated” that China plays dirty. Not that I disagree, mind you, but the timing and the placement of the story (front page) is revealing.

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  1. Mogden

    You know, I had a scary thought today… I’m not sure it’s possible, but is it conceivable that Obama could turn out worse than the execrable Bush? He’s already a bit of a disaster – add in some bad luck due to world events, a resumption of the depression, or something, and there you go…

    1. Kievite

      I’m not sure it’s possible, but is it conceivable that Obama could turn out worse than the execrable Bush?

      That’s actually the thought that came to my mind too. The main similarity is that in a way they both probably can be classified as puppets and that’s probably the worst variant of presidency.

      But Bush managed to preserve its base almost to the bitter end, while Obama lost large part of his base in a year. Also while by-and-large questionable, Bush used to have some convictions (neo-conservative convictions to be exact) and he did used the crisis (9/11) to his political advantage (to invade Iraq.)

      Unless Obama gave himself a year to get to speed, I do not see any convictions either in appointments or in policy. Everything is subject to compromise. And no ability of desire to use crisis as a huge lever to implement changes.

      His behavior during bailout was reprehensible to the last degree. Even if he came to power due to support of financial oligarchy, after obtaining power President has some (and pretty big) leverage having repressive apparatus of state at his fingertips. And prosecutions, even if used in purely Machiavellian fashion (which was not necessary in this case as all banksters crossed the line after which criminal prosecution became “slam dank” in an unforgettable words of George Tenet ), tend to cement power and increase independence from former handlers as well as the way to distance himself from former (failed) President.

      But Obama consciously or subconsciously decided not to rock the boat. He really wasted the crisis which is political blunder of enormous proportions. Everything in White House looks very similar to Bush II, in a way Obama administration can be called not Clinton II but Bush III administration (defense, Fed nominations, torture, etc).

      At some point I started to think that McCain probably would do not much worse and in certain areas (torture) might do better.

    2. PhilBen

      Im sorry, but as much as Obama has the potential to be a serious disappointment in the failure to address critical problems, mainly financial, it would take a serious moron a la Bush, to be comparable.

      Just go over the facts, everything Obama is doing is dealing with problems inherited, 2 wars, tax breaks that we couldnt afford, laissez-faire govt that put regulators in tha back seat, and of course the financial crisis and fiscal and trade deficits and Bush’s China policy.

      Some problems are inherited and others are created. Bush took a fiscal surplus and turned it into a massive deficit. He also entered into a horrific war under false pretenses and without the ability to pay for the war. Add to that NO significant legislation of any kind to reverse the known problems facing all adminstrations such as entitlement financing or foreign policy vis-a-vis China.

      As I see Bush as the worst president in a 100 years and likely to be so for another 100 years, even if Obama were to fail to fix our problems and in some areas continue the causes of the problems, he could not match Bush by a long shot.

      Dont mistake America’s disappoint on change for a return to the republican mantra. Bush sank that party for the next decade.

  2. Paul Tioxon

    The Chinese are doing what is in their best interests. At least based on what they think they know about how to play the new game they have recently entered on a global scale. And they have their own internal political problems as well as ticking time bombs to handle, before currency rates become the least of their problems. The levels of corruption among official government office holders, as well as corner cutting, baby food poisoning business men, the rioting minorities, the protesting proletariat and the 600 million or so rural poor who have been completely bypassed by the exploding coastal economies can put the Communist Party out of business quicker than mayhem the West might throw at them. Not to mention the regular reports on your site Yves, of near empty sky scrapers, customer free luxury shopping districts and bank lending practices that make Lehman look sane. I am not sure what to make of the media attention to some issues, but as far as China goes, we have had tensions with the Communist Party since the end of WWII. A lot worse than what conjecture is being presented today. If we are so worried about the lack of political freedom, human rights and cooperation of their government with our policies, they would be more than glad to solve the problem by sending as many Chinese to America as would make us happy.

    1. Kievite

      During the last crisis Chinese Communists proved to be more competent then the leaders of the USSR and managed to survive. They might manage to repeat this feat again.

  3. bob

    OK, take your money, WTF are you going to do with it? Open an account at citibank? Commodities? Sure. What’s the lead time on a $2 trillion dollar order of anything?

    If China lends the US $10 dollars is the US’s problem. If China lends the US $2 trillion, it’s china’s problem.

    Watching what appears to be brash overconfidence on a global scale has been the only entertaining thing about this mess.

    -We have all your money

    -yeah, that’s right, you have all of OUR money.

    They bankrupted the casino and didn’t have enough sense to realize it. Their behavior now only serves to add them to the global blacklist and close more borders to their trade.

    This doesn’t end well for anyone, less well for China.

    1. C

      “Watching what appears to be brash overconfidence on a global scale has been the only entertaining thing about this mess.”

      No, this is not entertaining–it’s scary as hell. Both sides have ignored economic reality for a long time and now, instead of owning up to what are going to be terrifying consequences, both sides are grandstanding in order to appease their home audiences, knowing full well that there will be very sharp and long-term consequences for doing so.

      “If China lends the US $10 dollars is the US’s problem. If China lends the US $2 trillion, it’s china’s problem.”

      What you are suggesting is that the US is the only country in the history of the world that can be a large debtor nation indefinitely, routinely run deficits on the order of 10%, and not face negative consequences for being such. I, for one, will side with historical precedent.

      1. Yves Smith Post author


        You really need to bone up on the Great Depression. You are 180 degrees wrong on historical precedent.

        The UK defaulted (read that twice, DEFAULTED) on its debts, depreciated its currency (by abandoning the gold standard early) and suffered far less than other European countries, and vastly less than the US.

        1. C

          OK, I’ll read up a bit and get back to you…
          (ignore my post to you on another thread, then, since it’s based on equally incorrect history)

          1. C

            OK, just to ensure we’re on the same page, those “two” defaults really occurred at the same time 1932)


            , unless you are talking about the IMF bailout (1976ish?) as being the second case. If so, I’d say that this was a complete anomaly–the UK just happened to start drilling a large chunk of the North Sea around that time, which makes comparisons to the rest of Europe (and present day US) unrealistic.

        2. renting_is_like_owning

          Spain comes to mind as a much better historical analogy of an empire that rose on the wealth of (generally looted) gold, and then faded away under a mass of unsustainable expenditures and debt.

        3. fresno dan

          so what is the official or most accepted version of the cause of the great depresssion? and who wrote it?

          1. attempter

            Milton Friedman wrote it. “Monetarism.” It basically goes, Nothing was fundamentally wrong; in particular there’s no such thing as debt bubbles.

            If the system has a temporary jam, that’s just a liquidity bottleneck to be solved through monetary flooding.

            So the job of central banks is to let bubbles blow, indeed to help blow them up (since there’s no such thing as bubbles), and then when “liquidity” problems accidentally happen (just out of thin air), central banks should bail out the big bank speculators, er, engage in “quantitative easing.”

            As Heckuva-job-Bennie put it: “You’re right, we caused it, it was our fault, but thanks to you it won’t happen again…I’ll drop money out of helicopters.”

          2. Fed Up

            Try these two links.



            From the second one:

            “The most glaring problem on first glance is that, despite Bernanke’s claim in Chapter One “THE MACROECONOMICS OF THE GREAT DEPRESSION: A Comparative Approach” that he will survey “our current understanding of the Great Depression”, there is only a brief, twisted reference to Irving Fisher’s Debt Deflation Theory of Great Depressions, and no discussion at all of Hyman Minsky’s contemporary Financial Instability Hypothesis (and a blogger informed me that his entire reference to Minsky in the book amounted to one discussion and one footnote, which I’ll get to later on).”

        4. Mickey Marzick in Akron, Ohio


          In the short term…

          Did this default affect Britain’s abilty to rearm with the result that in 1938 Britain appeased Hitler at Munich because it was not in a position to do otherwise? When it finally began to rearm, did it have to borrow at more unfavorable rates on through WWII because of defaulting?Even though it was one of the victors, in hindsight it does appear Phyrric, does it not? Postwar Britain… as the sun set on the British Empire. Fading into obscurity… a shadow of itself.

          Was the Nixon Administration’s decision to repudiate the gold standard in 1972 a “default” of sorts? Couple this with his “opening” to China in that same year and almost 40 years later …

          It all depends on the length of one’s historical perspective… short term gains with longterm, usually unforeseen, consequences.

          1. attempter

            I don’t know offhand the absolute state of Britain’s rearmament in 1938, but it certainly had nothing to do with their caving in at Munich, since the relative strengths were a joke.

            In 1938 Germany was so weak it’s not at all clear they even could have beaten Czechoslovakia itself (which had a strong army on paper, and definitely had excellent weaponry and a defensible frontier) in a one-on-one war. They definitely couldn’t have fought Britain and France.

            Even in 1939 Germany would’ve collapsed quickly if the Western allies had made even a moderate push. (And there’s no way they should’ve been able to win in 1940, if you look at the paper preponderances.)

            No, at Munich, in 1939, and even in 1940, the issue was psychological, spiritual, moral. Everybody just kept caving in.

            Sorry to go off on what may seem like a tangent, but I find myself thinking of Munich often these days……

            There are few things more topical.

          2. liberal

            The problem wasn’t economics; it was that Britain and France were unwilling to confront Germany.

    2. TC

      You should note that it is the US that takes on China daily in the press not the other way round. Who exhibits arrogance here.

  4. Doug Terpstra

    “Our initial take was that Team Obama would stage a repeat of its stance last year: saber rattle and do nothing.”

    Your initial take is certain. Obama is a eunuch. Witness Wall Street reform and financial regulation, Iraq wind-down, healthcare reform, Israeli settlement freeze, lobbying and campaign finance reform, shutting down GITMO, extraordinary rendition and black torture sites, NAFTA/SHAFTA re-nego, Patriot Act renewal, cap and fade and on and on. Not Cialis, Post-T-vac, nor Viagra could stiffen Obama’s flaccid resolve.

    1. Yves Smith Post author


      The only reason things might be different this time is that the course of least resistance might be to stand up to China rather than stand up to Congress and suffer the consequences of crappy poll ratings.

      1. Kievite

        Nothing can change poll ratings for Obama short of significant decrease in unempolyment rate.

        1. Yves Smith Post author

          That is precisely why he might pick this fight. It does not involve a fight with Congress or increasing the budget deficit, and it would have some impact even going into the mid-terms, much more by 2012. It is the ONLY move I can think of that might save his bacon.

          1. TC

            What are the downside risks if things do not work out the way the administration intends to? Can this quarrel get escalated out of hand?

  5. psychohistorian

    I want to ask why folks think it is not possible for China to stop buying our debt? In my opinion if China stopped buying US debt it would quickly bring the US down and China would not suffer, relatively speaking, as much.

    My other observation is that the timing of this new war is a great cover for the ongoing exposure of the criminality of Wall Street.

    I don’t share people’s belief that Washington wins this time….without cheating or using nukes.

    I need to get out and get more popcorn….

    1. Yves Smith Post author

      If they stop buying our debt, the RMB appreciates. This is precisely what they are fighting so hard NOT to do. We’ve had posts by highly respected Chinese in China saying that the domestic discord is serious and worsening. A higher RMB means higher unemployment, which is a direct threat to internal stability.

      Moreover, we do not need China to buy our debt. We are not inflation constrained. The US has a ton of capacity and labor slack. We do not need to issue bonds to finance our deficit. The Fed can print.

      1. psychohistorian

        Yes, the Fed can print and has been doing so since fall 2008. That is why the game will stop when China says it no longer wants to adhere to the dollar as Reserve Currency. If the EU is stopping America from buying its debt then, IMO, the stage is set for a economic chess move around the monetary base.

        What is the old carny saying about fool me twice……tell me how the US is playing from a position of strength other than down the barrel of a gun.

        1. nmtdoc

          Greetings psychohistorian,
          I used to ponder this same issue, mostly because I had no real understanding of how a fiat monetary system actually worked. I suggest you spend some time at Bill Mitchell’s billyblog. This will not be easy as this is an emotional and counter-intuitive issue for most. He has an excellent site and invests a large amount of time trying to educate people about how our monetary system works.
          Hope you find this helpful.

    1. TC

      I think some great economists should for once spell out clearly and objectively, if this is possible, what is the definition or rules of what constitute manupulation of currency and enshrine these definition/rules in some international organisation such as WTO so that the rules apply to every country and not subject to politician shifting goal posts as and when expedient for their purposes.

  6. Iok Sotot, Eater of Souls

    “you cannot feel at ease with a regime that still covers up Mao’s murderous nihilism.”

    You have to be a toffee nosed wanker writing in the last scrap of an imperial hegemon, exterminator of indians, notable for forcing china to import class A drugs and inventor of the concentration camp to come up with bullshit like that.
    Whatever happens, I’m rooting for China to give the west, especially the UK, a good kicking. As a nation they deserve their “revenge”.

    1. Yves Smith Post author

      Revenge is a dish best eaten cold. The Chinese are not weighing the calculus at all correctly. If this escalates, the US suffers a little, China loses big time.

      1. C

        “If this escalates, the US suffers a little, China loses big time.”

        I disagree. The US may suffer a little initially, but someone has to buy all this debt they are issuing eventually. Moreover, as you have noted elsewhere, China has some serious imbalances. Even if the RMB temporarily appreciates, those domestic problems may cause a longer term RMB crash (and Vietnam is already teetering, Thailand could go next). Would anybody care to guess the effects on the rest of Asia if the RMB (or the actual country) becomes unstable?

        Look, China will have to revalue (or better yet, float) its currency eventually. To insist that they do so on our terms, though, is stupid. To say that the US will be a winner, too, is highly optimistic. Any company that wants to offshore and is doing so in China will simply shift to, say, Vietnam (which has already basically devalued partly) or Mexico. The US will be in the same boat.

        “We do not need to issue bonds to finance our deficit. The Fed can print.”

        Are you serious about this???

        1. Yves Smith Post author


          Read up on modern monetary theory, which describes how fiscal and monetary balance work in our Bretton Woods II system.

          The record of EVERY major financial crisis is the creditor nation (the one in the position of China) fares much worse then debtor nations (ones in our position). Debtor nations depreciate their currencies and at worst, selectively default. Creditor nations have to fundamentally restructure their entire economies. It took the US more than a decade to do that during the Great Depression. Japan has still not succeeded in doing that.

          1. C

            “Read up on modern monetary theory, which describes how fiscal and monetary balance work in our Bretton Woods II system.”

            Bretton-Woods II was characterised by almost monotonically increasing credit. I suspect that you agree that credit is no longer going to continue increasing; if so, I suggest that very different circumstances now hold.

            “The record of EVERY major financial crisis is the creditor nation (the one in the position of China) fares much worse then debtor nations (ones in our position). Debtor nations depreciate their currencies and at worst, selectively default.”

            Well, what does it mean for a country that issues debt in its own currency to default? Most countries that have defaulted were no the margins of the economic order, not at the very heart of it. As I stated to Bob, you are suggesting that international default isn’t going to be a big deal–I am saying that it’s going to be a huge problem.

            “Creditor nations have to fundamentally restructure their entire economies. It took the US more than a decade to do that during the Great Depression. Japan has still not succeeded in doing that.”

            Creditor nations have the money to restructure their economies (the US, which will also have to fundamentally restructure its economy, lacks this money…). And yes, China is going to go through hell for quite a while–I am not debating that. I am just saying that even if China gets the worst of the situation initially, it will *eventually* recover and be in a stronger position than it is now because the rebuilding will be on more stable foundations.
            The US will *never* attain its current status if other countries don’t want to lend to it. And I am sure that Singapore, Korea, and Japan are highly unlikely to continue lending trillions to a country that defaults on China.

          2. renting_is_like_owning

            ‘The record of EVERY major financial crisis is the creditor nation (the one in the position of China) fares much worse then debtor nations (ones in our position).’

            Well, I don’t think the Germany of the 1920s as the debtor nation came out ahead of the creditor nations of France and the UK, but admittedly, that wasn’t exactly a financial crisis. On the other hand, at least part of the background information encompassed how the German Empire miscalculated its position. Empires tend to do that regularly, of course – after all, the British Empire just took longer to fade from view that its European competitors.

            It is quite reasonable to assume that the Chinese leadership tend to look at a longer time frame than the next American election cycle, though they certainly also face their own domestic pressures, both immediate and longer term.

          3. Yves Smith Post author


            Germany in the 1920s is in no way, shape, or form a comparable (starting from the fact that its debts were not the result of a sustained trade imbalance). Read Keynes’ Economic Consequences of the Peace. He describes, long form, that the conditions imposed on Germany were not simply reparations at an unsupportable level, as bad as that would be in and of itself. The treaty conditions were a deliberate effort on EVERY level to dismantle its economy. The book is simply devastating.

      1. Adam

        solely for clarification, but I believe the disgruntaled poster was refering to Native American’s (aka American Indian’s).

    2. TC

      China historically seldom display tendency for revenge as it has experience many upheavals and hardships either internal or due to many external invaders. The hardships and upheavals are part of life of a civilisation that not much one can about.

  7. Hal

    China overestimating its strength? I don’t think so. It is the US that is overestimating its strength and if it persists in confronting China I predict a big shock to its self esteem and its standing in the world.

    1. Yves Smith Post author


      With all due respect, what are you smoking?

      I am very critical of the US on many fronts, but the US is still the world’s preeminent military power. The US controls the seas and has unparalleled surveillance capabilities. And as Ambrose Evans-Pritchard points out, every nation on its borders is more likely to side with us if forced to make a choice.

      The US is also better able than most countries to function as a near autarky. We have a relatively small trade sector compared to most advanced economies. Our big need is imported oil and a fight with China does not threaten that.

      So tell me how China would hurt us, exactly? If they quit buying our bonds, we win, we get the higher RMB we wanted.

      1. C

        “So tell me how China would hurt us, exactly? If they quit buying our bonds, we win, we get the higher RMB we wanted.”

        Yes, and all those people who lied to get mortgages for overpriced houses also got what they wanted. This doesn’t mean that what they wanted was good for them.

        As for “how China would hurt us”, I think you are missing the point that China doesn’t have to WANT to “hurt us” for there to be severely negative consequences to their revaluing the Yuan. In fact, Britain is likely to suffer more initially, because nobody in their right mind would hold the pound if they can buy renmimbi or other Asian currencies (most Asian countries have said that they will revalue if China does).

        The US will *not* go to war with China over something like this, incidentally.

        1. Yves Smith Post author


          Your US going to war with China is a straw man. You were the one who argued, “It is the US that is overestimating its strength and if it persists in confronting China I predict a big shock to its self esteem and its standing in the world.”

          I challenged that and I have yet to see you provide any supporting evidence for your original assertion.

          The US is a fading superpower, but it is not past its sell by date.

          1. psychohistorian

            What sort of a negotiating position is it to be a banana republic that is not past its nuke sell date?

          2. C

            OK, Yves, I would like to continue this debate, but there is no need to do it on two different threads (I didn’t realize that I was replying to you twice).

            For the record, Hal and I are two different people. Also, the military confrontation comment was in reply to your statement that, “the US is still the world’s preeminent military power. The US controls the seas and has unparalleled surveillance capabilities.” Presumably, you were suggesting that should there be a war, the US would win it. I was replying that no war will come out of this particular issue.

          3. psychohistorian

            I forgot about the part where this banana republic has printed trillions of “Reserve Currency” dollars in the past couple of years and seem poised to abuse their position more.

            America is way past the sell by date and the rest of the world knows so, is learning quickly and will join in a global take down of the imperial America around a new exchange system.

          4. Yves Smith Post author

            With all due respect, neither of you is looking at who holds the better set of cards here. It is the US.

            China has promised its populace unsustainable levels of growth to maintain social cohesion. There are already sign of internal discord. That growth is now based on exports and an unheard of level of domestic investment, which is going more and more to unproductive activities. It now takes $7 of debt in China to generate $1 of GDP growth. That is a terrible number for any economy, particularly a developing economy. They just got over a banking crisis (2002) and are well on their way to another one.

            And per the US’s stand, it isn’t just us. The EU would be delighted to have us be the heavy on RMB revaluation. This is beggar thy neighbor with all their trade partners. So using exports as an engine of growth is not going to be the game it once was.

            Changing to a consumer led economy is at least a decade long project. The fastest step they could take would be to improve social safety nets. But that is impaired by corruption at the local level. They don’t have delivery mechanisms and the regional/local structure impedes creating them.

            And it ALSO has a looming demographic time bomb, that starts to have an effect in 5-7 years.

            Japan looked like the force of the future too in the 1980s, and its growth model was less imbalanced than China’s is. As much as the US is trouble, China’s position is much more precarious than it seems.

          5. C

            “As much as the US is trouble, China’s position is much more precarious than it seems.”

            I agree that China is in a bad spot–the disagreement is that youo appear to believe that the US is going to come out of this with only relatively minor scratches. I’m saying that the US is going to face a catastrophe.

            But OK, so what happens if the “precariousness” leads to severe problems in China? A flight away from China, reducing the value of the renmimbi, and into, say the US, increasing the value of the USD? So a similar situation as what we have now?

            And please let me cherry-pick your post:

            “XXX has promised its populace unsustainable levels of growth to maintain social cohesion. There are already sign of internal discord. That growth is now based on [imports] and an unheard of level of [foreign] investment, which is going more and more to unproductive activities. It now takes $[5] of debt in XXX to generate $1 of GDP growth. That is a terrible number for any economy. They just got over a banking crisis (2008) and are well on their way to another one.

            Changing to a [production-based] led economy is at least a decade long project. And it ALSO has a looming demographic time bomb, that starts to have an effect [now].”

            I’d be pretty adverse to betting on the long-term prospects of such a developed country…

      2. Hal

        Well China could send advanced weaponry to the Taliban and work to drive us out of Afghanistan; it could support Iran and refuse to agree to sanctions and also supply Iran with more weaponry for its defense; it could pressure Japan to remove US military bases from its territory; it could create a military confrontation over Taiwan which the US would lose, etc., etc. Americans are far too filled with hubris about our weakening position in the world. China could play on that very well.

        1. Hal

          I might add that any crisis with China would rile up the already intense discord in Washington so that the US would be fearful of provoking it. In contrast, China’s government isn’t rent with discord and stalemate and is free to do what it decides to do without fear of political repercussions. That gives them a strength we don’t have.

          1. Hal

            Again I agree with C. There need not be, and would not be, a full scale war with China. We both have nukes and that would prevent it. But in a limited skirmish around Taiwan, for example, the US would certainly lose due to the distance from the US at which we would have to operate and the power China could muster a short distance from its coast. The mere hint of trouble there would send our stock market into a tailspin and create a nasty, if temporary crisis, on Wall Street. We would fold very rapidly and get our navy out of the area. The US public would have no stomach for any real confrontation.

        2. MA


          China HAS been supporting Iran, where have you been?

          Japan is playing very carefully between the US and China, and it has every reason to be much more worried re China. The Japanese are even more appalled at the Chinese bullying than Americans.

          And we could ship some very advanced weapons systems to Taiwan and do the periodic “defense exercise” in the Straits of China. Let’s see how Beijing feels about that.

          Or we could encourage Japan to go nuclear. Wouldn’t take much. They have the technology. Just a case of putting together a few wires, I suspect.

          I’m sure the Chinese would love that.

      3. charcad


        The US controls the seas and has unparalleled surveillance capabilities.

        In any showdown with China this is the primary factor. But if we’re eyeballing a hot phase I’d like to know the initial goals of each side. Specifically, what would each regime expect to obtain as a result of operations?

        Now my own preference (I don’t fight “fair”) would be to hit China in places and ways where China can’t respond. Incidentally, such was my reading of Sun Tzu and his learned commentators. “Every battle is decided before it’s ever fought”.

        It seems to me China has already lost the moment such a confrontation turns kinetic. China must import oil, iron and other materials. It must export finished products. And it must do so over sea lanes it can’t possibly control.

        otoh the CFR gang could have easily decided the time has come to regime change China. Or even inaugurate another prolonged period of civil war and war lords to prevent fulfillment of the hyper-power fantasies now rife there.

        1. TC

          To be convincing, I think the US should demonstrate it could successfully handle N Korea, Iran who have for years bare their bottoms at US. The US performance in Iraq and Afghan despite overwhelming superiority is less tha desirable, not to mention Vietnam where US left with such hurry after 20+ years, leaving behind a job unfinished.

  8. ds

    An artificially low RMB is free lunch for us. We get better REAL terms of trade — China is sending us more stuff than we are sending back to them. All we do for this is credit the reserve or securities account China has at the Fed.

    Instead of pressuring China to re-value the RMB, the Obama Administration needs to use fiscal policy to employ the spare capacity that has been freed by the trade deficit. As a rule, we should aim to run a fiscal deficit at the very least equal to the magnitude of the trade deficit.

    1. Yves Smith Post author


      That is no longer true. The cost of sustained imbalances is financial system instability. The only way to get the banking system globally on a more even keel is to lower the level of cross border capital flows, which means lower trade imbalances.

      1. TC

        What is the difference between OPEC countries dumping cheap oil on US and China dumping cheap products in US? Why shouldn’t US welcome both?

  9. maniam

    re anton valutas’s report on Lehman scandal.could this china bashing a diversion by the bankster?
    the bankster should be the ones cruxified.
    later if china is found to be be a problem,deal with it later.
    what if china had had enough of this capitalist experiment and turn back to pre 1978? will this make everyone happy?will there be another opium war?
    cold war.europe ‘s ally usa.usa undermine euro through goldman sachs,jp morgan,etc.
    iran/iraq war.iraq’s ally usa.usa bombed iraq.
    (also latin america,ditto asian tigers,etc.)
    with afriend like usa who needs an enemy?

    1. TC

      I think it is a diversion. The US politicians suddenly find that China was the cause of most of their problems,..subprime frauds, CDS,all PONZI schemes,. homelessness, unemployment, recession,..and the MSM are in overdrive to pin these problems on China.

  10. jbmoore61

    Why does Obama have to have the Chinese the revalue their currency? I seem to recall that Reagan devalued the dollar 50% compared to the yen in the 1980’s. At least, that was how it was presented at the time. The Japanese were not happy about that deal. However, if the Chinese won’t play ball, we could always force the issue by revaluing our currency against theirs since the dollar is the reserve global currency. Of course, tensions would rise further.

    1. Yves Smith Post author

      China is actively intervening in currency markets to keep its RMB where it is. It also has currency controls.

      Google Plaza Accord. That “devaluation” was a coordinated effort…and Japan participated in it. The US most assuredly did not take that action alone.

  11. sam hampster

    2/10/10, Peter Morici points out:

    “..The president expresses outrage about Chinese trade practices and bank bonuses but refuses to take substantive actions — for example, countering Chinese protectionism with a tax on dollar-yuan conversions..”

    2/4/10,Dean Baker points out:

    The U.S. “can unilaterally set an exchange rate that has a lower value for the dollar against the yuan. This would be an extraordinary measure, however if China refused to raise the value of the yuan, the U.S. government could announce its willingness to trade yuan at a higher value (e.g. 5 yuan to a dollar) than China’s official exchange rate.

    12/28/09,On a C-SPAN show, they both joke about how Obama would do nothing since Wall Street was hungry to provide services to the new millionaires and billionaires in China and did not want them upset.

    The question, now, may be:

    Is Wall Street throwing us a bone?

  12. t0c0xx

    Of course the US would win in a military confrontation. Further, if there is a war, the US would be the first aggressor. Some people are itching for a showdown. See the Evans-Pritchard article you linked to. As per usual, his tone is hysterical, this time with war fever. The US has the best military in the world. When you’re a hammer, everything you see is a nail, as the cliche goes. And let’s face it we’ll probably be the one to start a war with China, if one occur. Ever since World War II, under any pretext, we are always the first to start war. We are a warlike people whether we like to admit it or not.

    Also, a benefit of a big war: one way to get out of the economic doldrums we’re in.

    1. Yves Smith Post author

      Evans-Pritchard is ALWAYS hysterical. I frankly enjoy the contrast with conventional bloodless business writing.

    2. TC

      People who clamoure for wars should be the one conscripted to the front line or if they are incapacitated, then their childrens should take their places. It is important to make people put their lives where their mouth is as far as staring a war is concerned. Let them feel the grief when their loved ones come back in body bags or maimed.

  13. purple

    No one would win in a military confrontation between China and the US and it’s irresponsible for people even to be remotely encouraging of it.

  14. kssong

    china could do the following to calm things down. ’08 olympics factories stop work for 2 to please usa&uk,china stop exporting to usa&uk for 6 to 12 months.and see what happens.
    2.before this china set up fund to buy and asset on firesale during this 6/12 months in case there are opportunities.(like HK in ’07/’08.)
    3.meanwhile usa allow china to buy a bank(name it People’s bank)&china pump in 100b,with fractional banking available funds=1 trillion.this fund is used to fund small medium industies or finance housing loans-hongkong style ie.purcahser required to put in 30 or 40% equity.
    profits from this,People’s bank,used it to fund communities/inner cities/any social friendly causes/etc.
    4.after the 6/12 months stoppage if markets improved and if there are profits from the firesale purchase,china pump more funds to People’s bank and increase lending to worthy causes.
    don’t go to war.its a stupid thing that only benefit banksters/crooks.(
    go to for more information on war.)

  15. Vinny

    Okay, lemme see if I got this right:

    The idea of this post is that it is better to owe 11 trillion than to have 3 trillion under the mattress?

    Please do let me know asap, because I’m itching to hit the mall and max out all my credit cards this afternoon… :)


    1. Yves Smith Post author

      I know you are only sorta kidding…

      The problem is China can’t “spend” that $3 trillion. They can’t “spend” it domestically, and if they were to try to “spend” it, the RMB would shoot to the moon and their economy would go into a tailspin.

      See, it only looks like savings. It isn’t. Beyond a certain level where FX reserves are useful to defend your currency when you might need to (and that level is way way below $3 trillion) the rest is export subsidy. If they try “spending” it, it becomes import subsidy, the very last thing they want (remember, they’ve already stockpiled a lot of commodities).

      1. True B

        It’s not saving. It’s never been saving. The big reserve is a by product of an economic strategy.

        1. They are emulating japan (low price win the globe, by way of peg)

        2. Lesson learned from 97 crisis. Amass reserve to fend speculator

        3. Control US behavior. (financial weapon. bond price)

        US perception that China is buying bond as purely “investment in value” is naive and silly.

        Knowing china, they will keep it steady and go forward, because they know they have a winning scheme. The more US whining, they more they can us it internally to wipe out nationalism frenzy. (eg. these imperialist can’t compete and start talking trash and start doing gun diplomacy again.) You think “tax without representation” causes patriotism flare wait until gun diplomacy in china does it magic to the chinese.

        What can china do? Recycle faster, use the dollar to buy any available hard asset inlatin america, africa, SE. Make the dollar on their hand compete against US commodity buyer.

        Do it all harder, until US cries “no more free trade”. Hell dump the dollar into Brazil and Iran, they can handle it.

        The weapon sale into taiwan plus tibet was a big mistake. China now consider Obama administration hostile.

  16. tomk

    “Not only is this move likely to be a winner domestically”

    I question this, wouldn’t the immediate effect be to drive up prices at Walmart? The ability to buy reasonable quality, ridiculously cheap stuff is the cornerstone of our current day American identity. Maybe we’re ripe for a change though, most of us have way too much stuff and would approve of an excuse to buy less.

    1. Borealis

      I can’t be the only middle-American consumer of everyday household goods who’s had it with ever declining quality and, yes, range of choice. Or who’s noticed that prices have been relentlessly creeping up as the craptastic index goes to 11.

      On the other hand, I have no interest in distracting China-bashing. China doesn’t make our trade policies, we (or rather, “we”) do. The PTB and their political lackeys sailed right into the trade and financial mess we’re in now, and could have taken corrective measures to prevent or reverse the imbalances that started piling up years ago.

  17. kevin de bruxelles

    Any US –China conflict has to be seen in a short term vs. mid-term perspective. My wild speculation is that short term the real issue is China’s support for Iran. We have all seen over the past week Israel’s incredible power over the US and again I can only imagine that this too reflects tensions between the Obama Administration and their Israeli masters over Iran (since they obviously agree on everything else). Throw into the mix the discussion of China getting the contracts for the coming high speed rail networks and I think we can see a short-term compromise to the rising tensions in the works. China abandons Iran, makes a token move on their currency, and in return China gets the US high speed rail contracts. In this way the Chinese leadership gets to own the delicious symbolism of righting all those trans-continental railroad wrongs of more than a century ago by making the American workers be the low-skilled coolies while the Chinese get to be the high-skilled designers and managers of this new rail system.

    But mid-tern there is no question that China is the more dependant party in the Chimerica venture and that they are very vulnerable to US power. The turning point will be the next economic downturn, coming sooner rather than later, where American working / middle class anger will rise to dangerous levels against the US elites. These elites in turn will have every interest to divert this anger outwards. US wealth has destroyed the American worker with Chinese (and Central American) peasant labour but over time this becomes a question of diminishing returns – how weak is too weak? At some point the elite will give in and tell US labour that OK, they can have their jobs back – but only if they go over to China and fight for them.

    In the context of an economic crisis in China, a war would also be very attractive to their elite as well for the same reasons, to divert rising anger outwards. Given the strategic depth of China, their elite may calculate that they could have a reasonable chance of surviving a war if they could reproduce some modern version of Mao’s Long March.

    China is a growing power and one day could actually threaten US global dominance. Machiavelli says, “There is no avoiding war; it can only be postponed to the advantage of others.” and our elites are listening.

    Any eventual war would be dominated at first by naval battles. Here the US holds a huge advantage but there are also huge risks. Modern naval warfare basically comes down to shooting relatively cheap missiles at very, very expensive warships. This fact would seem to lead to at least the possibility of China holding their own, since they can produce endless numbers of inexpensive missiles faster than the US can produce costly warships. But no, while there may be a surprise or two, the other critical factor in naval warfare is control of port facilities. The US maintains an incredible global “fleet in being” able to project force without ever needing to leave a port and putting themselves in harm’s way while in order to project power China must leave their ports to protect shipping lanes. The US could very simply cut off sea borne energy supplies to China. Even if China did invade Taiwan the US would have options. They would at first fight but if the missile war got out of hand and the US Navy started suffering great losses, they could always pull back and continue a naval blockade from safe distances.

    As the war went on it would be obvious that China is huge and the US is not going to want to invade and conquer the whole thing. So the most likely strategy would be for the US to try to replicate Alexander the Great’s strategy against the Persians when he took every port along the entire Eastern Mediterranean coast line, from the Hellespont to Egypt. In China this would mean two columns marching towards each other, one starting in the south near the Vietnamese border and the other in the north near the Korean border (after dealing with North Korean if necessary). The goal of these two columns would be to conquer the entire Chinese coastline, taking each port city along the way until they met up in the middle, as well as taking any key interior cities close to the coast. Once this was accomplished the negotiations would start.

    The best Chinese strategy would be to take advantage of the exposed underbelly of America, also known as the failed state of Mexico, in order to infiltrate fourth generational insurgent forces (Mexican drug cartels among others?) into the US proper. Chine will never win a conventional war against the US but they could hope for a tie if they succeeded to destabilize the US through guerrilla warfare. This would lead to violent repression within the US and much instability.

    I know it’s not a pretty picture but war never is. I certainly hope for the future of all of us that the Chimerica global imbalances can be resolved peacefully.

    1. charcad

      China’s salient weakness is its dependence on imported oil that can only reach China by sea. There is no infrastructure – yet – for bringing this overland through Central Asia.

      I have every expectation the CFR gang will stop-punch China before it can develop the means to do so.

      Personally I expect the first guided bomb aimed at China will hit a target in Iran, followed by tens of thousands more. The most effective places to impose an oil blockade on China is at the sources, not the destination.

    2. TC

      China does not support Iran but think that the change for negotiation is still open and should be pursue by all means first. Many other countries have same positions as China.

  18. Rainer

    China a currency manipulator, why?
    Hasn’t Japan manipulated its currency much longer, while no one complained?
    What about the US printing press. Hasn’t the FED doubled its money base since 2008? Isn’t this a devaluation factor for the US Dollar.
    Why should one country be allowed to export its inflation to the rest of the globe by printing endlessly its fiat money, while others should take the blame?
    Maybe I’m missing something?

    1. alex

      “China a currency manipulator, why?”

      I assume you mean what’s the evidence that China is a currency manipulator. The evidence is the amount of their forex (mostly USD) reserves, the size of their trade surplus, and the fact that the yuan/dollar exchange rate is pegged by their forex purchases.

      If you mean why do they do it, it’s classic Asian style mercantilism – it helps their exporting sector to grow.

      “Hasn’t Japan manipulated its currency much longer, while no one complained?”

      No one complains? The Plaza Accord was 25 years ago. While Japan has continued manipulation since then, it’s not been as bad. And the Chinese manipulation has a greater effect on us.

      “What about the US printing press. Hasn’t the FED doubled its money base since 2008? Isn’t this a devaluation factor for the US Dollar.”

      Only if it causes high inflation in the US, which it hasn’t.

      “Why should one country be allowed to export its inflation to the rest of the globe by printing endlessly its fiat money, while others should take the blame?”

      The US is not exporting inflation. China is choosing, by its own policies, to import inflation by continuing the peg.

      1. TC

        Japan, German, Brazil, OPEC countries, India,… all have big surpluses against US. Why there were no compliants about them and only against China?

  19. middyfeek

    Yves, the correct quote is; Revenge is a dish best SERVED cold. And I never understood what the hell that meant in the first place.

  20. brandon

    “As far as the causes of the imbalances are concerned, we need to consider that the recent surge of the US de␣cit predates by several years the emergence of the Chinese surplus, and that the former is more than thrice as large as the latter (Fig. 3). It is dif␣cult to believe that a relatively small surplus be the cause of a larger and pre-existing de␣cit. The pattern and timing of the data suggest instead that the structural determinants of the Chinese surplus and US de␣cit are substantially unrelated. This is especially evident if we look at these imbalances from a saving–investment perspective. As Fig. 1 shows, from the beginning of the Nineties the worsening of the US external accounts is strictly correlated with the fall in US private saving ratio, while, as shown in Figs. 3 and 6, the improvement of the Chinese current account begins later, in 1995. Therefore, as far as the US de␣cit is concerned, the data are consistent with the hypothesis of excess private consumption in the US, rather than excess saving in China.”

    Bagnai, Alberto The role of China in global external imbalances: Some further evidence, China Economic Review 20 (2009) 508–526

    polemics fail

  21. brandon

    and here… menzie chinn of econobrowser fame talks about how current models to analyze undervaluation might not be good enough. so while he’s not discounting that RMB is in fact undervalued, well read the conclusion and the article for yourself

    “While the empirical results thus far point to the difficulty in establishing the claim that RMB is significantly undervalued, it is imperative to recognize that these results do not constitute evidence of no undervaluation. Indeed, the statistical evidence is so “weak” that we cannot reject a wide range of hypotheses. For instance, we could not reject the null hypothesis that the RMB is 20% undervalued. In other words, the empirical relationship is very imprecisely estimated. That is, the empirical models and data are not sharp enough to allow a definite statistical conclusion.”

    Cheung, Yin-Wong. Menzie D. Chinn & Eiji Fujii
    Open Economics Review (2009) 20:183–206 DOI
    Pitfalls in Measuring Exchange Rate Misalignment The Yuan and Other Currencies

  22. pebird

    “The reserves cannot be used internally to support China’s economy. They are dead weight …”

    Everyone else I know uses Treasuries they own as collateral – so the Chinese can’t? Ambrose isn’t as much of an economist as he likes to believe. But it sells papers.

    1. Adam

      “The reserves cannot be used internally to support China’s economy. They are dead weight …”
      That is correct. Think it through to the end.

      Why would China use US Treasuries as collateral to borrow Yuan to spend in China? And if it did, all it would be doing is transferring the foreign exchange risk to the Chinese banks which China would be likely bail- out like the US government – should the exchange risk prove to be bad.

      If China wants to use its dollars to support China internally means they need to convert those Dollars to Yuan – doing that would cause the Yuan to revalue upwards by definitions (assuming we’re talking a lot of them that is).

      Everyone should read Michael Pettis’ article on Chinese Reserves to understand them…

  23. Bates

    “We have talked ourselves into believing that China is already a hyper-power. It may become one: it is not one yet. China is ringed by states – Japan, Korea, Vietnam, India – that are American allies when push comes to shove. It faces a prickly Russia on its 4,000km border, where Chinese migrants are itching for Lebensraum across the Amur. Emerging Asia, Brazil, Egypt and Europe are all irked by China’s yuan-rigged export dumping.”

    Table 8: China’s Top Export Destinations 2008 ($ billion)
    *Percent change over 2007
    Source: PRC General Administration of Customs, China’s Customs Statistics

    Rank Country/Region Volume % Change*
    1 United States 252.3 8.4
    2 Hong Kong 190.7 3.4
    3 Japan 116.0 13.8
    4 South Korea 74.0 31.0
    5 Germany 59.2 21.5
    6 The Netherlands 46.0 10.8
    7 United Kingdom 36.1 13.9
    8 Russia 33.0 15.9
    9 Singapore 32.3 7.9
    10 India 31.5 31.2

    SCO from Wiki:



    Dialogue Partners

    Sri Lanka
    Guest Attendances


    ‘Economic cooperation
    All SCO members but China are also members of the Eurasian Economic Community. A Framework Agreement to enhance economic cooperation was signed by the SCO member states on 23 September 2003. At the same meeting the PRC’s Premier, Wen Jiabao, proposed a long-term objective to establish a free trade area in the SCO, while other more immediate measures would be taken to improve the flow of goods in the region.[10][11] A follow up plan with 100 specific actions was signed one year later, on September 23, 2004.’

    ‘On 16 June, 2009, at the Yekaterinburg Summit, China announced plans to provide a US$10 billion loan to SCO member states to shore up the struggling economies of its members amid the global financial crisis.[18][19] The summit was held together with the first BRIC summit, and the China-Russia joint statement said that they want a bigger quota in the IMF.’

    It is worth noting that China is opening swap lines, using the Yuan currency, with more of it’s trading partners. China has a long term plan and it may or may not come to fruition. This entire post sounds somewhat hysterical and is pointing fingers at the ‘bad guys’ in China while the real bad guys in DC and Wall St are still not being indicted in any significant numbers according to the havoc they have created. Great distraction Yves!

  24. Mickey Marzick in Akron, Ohio


    William Randolph Hearst would be proud – YELLOW journalism at its best.

    Good to see that rabid nationalistic blood lust isn’t dead in Amerika! REALPOLITIK by peace loving Americans… who are we kidding? Next it will be a crusade to save US from the yellow ant hordes…

    Pathetic!!! Pathetic!!!

    1. Adam

      What’s Pathetic is how ignorant American’s are about how monetary policies work – ours or China’s.

      Please read Michael Pettis’ article on China’s reserves…

      “The reserves cannot be used internally to support China’s economy. They are dead weight …”
      That is correct. Think it through to the end.

      Why would China use US Treasuries as collateral to borrow Yuan to spend in China? And if it did, all it would be doing is transferring the foreign exchange risk to the Chinese banks which China would be likely bail- out like the US government – should the exchange risk prove to be bad.

      If China wants to use its dollars to support China internally means they need to convert those Dollars to Yuan – doing that would cause the Yuan to revalue upwards by definitions (assuming we’re talking a lot of them that is).

      Everyone should read Michael Pettis’ article on Chinese Reserves to understand them…

      Their reserves are nothing but unrealized losses do to an export subsidy to Chinese exporters. Think toxic mortgage assets that a bank refuses to sell for fear of booking the loss.

  25. Siggy

    China is a country whose population numbers 1.3 Billion. Its GDP is estimated to be $3 Trillion and growing rapidly. The US is 330 Million with a GDP of roughly $14 Trillion and flat to very low growth.

    What China is trying to do is to grow to be the economic size of the US. It’s a command economy that is moving away from communisim to some form of socialism. The US is a republic that is moving toward some form of socialism.

    The circumstances of each of the US and China are such that it is imperative that China buy US debt if it wants to continue to exploit its labor arbitrage to fund its domestic social programs. Relations between the US and China will be strained; nonetheless, each will make concessions until China approaches economic parity with the US.

    Now wars are most the obscene undertaking conceived by man. Given the population differential, China would prevail if a ground war occurs. If a robot war is waged, it is probable that the US would prevail. In that, however, the victory would be very hollow and bear extraordinary cost. Quite simply, someone would have to pay to rebuild the country.

    However much we might decry the actions of China we should bear in mind that its government is the spawn of a century of corruption that was exploited to bring to power a state that spewed communist propaganda while being totalitarian.

    Big debtors tend to prevail because they tend to control the means of production. Controling and owning are not synonymous. You can control a production process by owning it. From that position you can cede ownership away in the form of debt. That is precisely what has been occuring in the US over the past forty plus years.

    What is so negative about the level of US debt is that it has been incurred to fund consumption itself. Had the level of US debt been achieved as a result of investment in the means and methods of production we would be in a very different circumstance than we are today.

    Net we’re not confronted with the potential for a rupture, we are confronted with a serious strain. It is in the mutual best interests of China and the US to achieve accomodations that support each nation’s domestic political situations.

  26. brandon

    as for debunking the polemics that are, quite frankly a bit racist, trying to paint all Chinese as one big monolithic hive mind capable of only simplistic unidirectional decision making….

    “The paper updates the answer to the question: what precisely is the exchange rate regime that China has put into place since 2005, when it announced a move away from the dollar peg? Is it a basket anchor with the possibility of cumulatable daily appreciations, as was announced at the time? We apply to this question a new approach to estimating countries’ de facto exchange rate regimes, a synthesis of two techniques. One is a technique that has been used in the past to estimate implicit de facto currency weights when the hypothesis is a basket peg with little flexibility. The second is a technique used to estimate the de facto degree of exchange rate flexibility when the hypothesis is an anchor to the dollar or some other single major currency. Since the RMB and many other currencies today purportedly follow variants of Band-Basket-Crawl, it is important to have available a technique that can cover both dimensions, inferring weights and inferring flexibility. The synthesis adds a variable representing “exchange market pressure” to the currency basket equation, whereby the degree of flexibility is estimated at the same time as the currency weights. This approach reveals that by mid-2007, the RMB basket had switched a substantial part of the dollar’s weight onto the euro. The implication is that the appreciation of the RMB against the dollar during this period was due to the appreciation of the euro against the dollar, not to any upward trend in the RMB relative to its basket.”

    Frankel A. Jeffrey
    Harvard University – John F. Kennedy School of Government; National Bureau of Economic Research (NBER)

    February 2009

    NBER Working Paper No. w14700

  27. brandon


    “3.3. Recent policies for capital account liberalization and RMB convertibility in China
    On March 18, 2006, the People’s Bank of China (PBOC), the Chinese central bank, announced major changes in China’s capital account control policy. The PBOC stated that the sharp rise in its foreign currency reserve holdings (amounting to $1.43 trillions in early October 2007) requires major changes in capital control policies. The policy changes consisted of relaxing restrictions on private holdings of foreign currencies. For example, according to the new rules, Chinese residents could purchase up to $20,000.00 worth of foreign currencies, a 150 percent rise from its previous allowable sum of $8000.00. Furthermore, Chinese institutions were allowed to open foreign currency denominated accounts at the commercial banks. Moreover, qualified Chinese insurance companies (companies with genuine needs for foreign exchange transactions) were allowed to invest in foreign securities, and Chinese commercial banks were permitted to invest in overseas securities on behalf of their clients, Wu (2006). Finally, the capital control was further relaxed by the State Administration of Foreign Exchange (SAFE) announcing on August 20, 2007, that the citizens of China are free to purchase any amount of foreign currencies for investment in the Hong Kong stock market (Wu, 2007).

    What is the rationale of the Chinese authorities in adopting this particular policy sequencing? The Chinese reason that developing viable, well-functioning spot and forward markets is a prerequisite for adopting a more flexible exchange rate regime.”

    *gasp* you mean China actually IS doing something about these problems? that political posturing is just that? posturing?

    “Based on the observation of a small real effective RMB movements, there is no urgent need for a deliberate exchange rate revaluation that under the best of circumstances would have a short run effect on the real economic variables. Economic fundamentals will re-value the currency over the long-run. This does not mean that there are no other methods of dealing with the issue of US trade deficit vis-a`-vis China. Alternative methods to address the immediate concerns of the United States are available.”

    HOLY SH*T, economic fundamentals will revalue the currency over the long run?!?! then what will be grist for the pundit mill if things really do work themselves out in the end, or if logic, even wonky economic logic plays itself out?

    and for your pleasure, some numbers in order to understand how important it is to recognize how interdependent economies are, if the call for revaluation or any other drastic economic/political action is taken, how local shocks reverberate globally but similarly how positive actions also tend to have ripple effects:

    “By reviewing Table XXI, we conclude that a 1 percent rise in the final demand expenditure by Chinese government, increase US agricultural exports to all nine countries in the model by 0.7246 percent, US mining exports by 0.175 percent, manufacturing exports by 0.6138 percent, and US trade and transport exports by 0.8655 percent. By the same token, a 1 percent increase in US government expenditure would induce additional Chinese exports of 0.019829 percent, 0 percent, 0.5171 percent, and 4.53743 percent, by agricultural, mining, manufacturing, and Trade and Transport sectors, respectively.
    It is clear from the data in Table XXI that Chinese spending would have the most powerful effects on the exports of Japan and the United States[5].”

    and of cousre this is all contingent on teh US getting its stupid shit together too:

    “The empirical results presented in the tables of the appendix to this paper have an important policy implication for the current Sino-American exchange rate policy debate. They show that China can lower or eliminate her trade surplus with the United States by adopting expansionary fiscal policy. However, the ability of China to affect this outcome to a large extent depends on the US government’s desire or ability to address the United States’ structural budget deficits.”


    China’s exchange rate policy and the United States’ trade deficits Abdol S. Soofi
    Department of Economics, University of Wisconsin-Platteville, Platteville, Wisconsin, USA

    its unfortunate that a lot of these recent scholarly articles i’m excerpting are written by people with icky brown sounding names like “SOOFI”, but i think it would be wise to pay heed anyway.

  28. brandon

    Why China Won’t Revalue
    by Steve H. Hanke professor of applied econ, johns hopkins

    this hot button political issue ignores some long term facts:

    ” Now add to these factors the thoughts of Nobelist Robert
    Mundell. In July of last year he hosted some of his friends at Palazzo Mundell, a Renaissance villa near Sienna, Italy. When it came to China, I took careful notes. According to Mundell, a renminbi appreciation would cut foreign direct investment, cut China’s growth rate, delay convertibility, increase bad loans, increase unemployment, cause deflation distress in rural areas, destabilize Southeast Asia, reward speculators, set in motion more revaluation pressures, weaken the external role of the renminbi and undermine China’s compliance with World Trade Organization rules. Mundell is not a fan of revaluation.

    I recount these points because on October 28, 2004 Beijing announced the establishment of the Mundell International University of Entrepreneurship. It will be located in the Zhongguancun area, the “Silicon Valley of China.” Connect the dots and you get a fixed exchange rate. “

  29. sacmac

    The Chinese premier also responded to criticism of China’s actions at the recent Copenhagen climate change summit. He defended his much-criticised decision to send a junior minister to a meeting which included Barack Obama, US president.

    Mr Wen said the Chinese delegation had not been informed about the meeting and only found out about it from another government.

    “So far no one has given us any explanation of this, and it is still a mystery to me,” Mr Wen said of the alleged snub.

    sacmac: It seems that China is dealing with a group of very dangerous people.

    1. Yves Smith Post author


      The idea that Wen’s staff did not get a memo/communique for a meeting with Obama is wildly implausible. This is “the dog ate my homework” at its worst.

      Either this was a snub, or his staff screwed up. And if the latter, someone owes the US an apology. This bizarre story is all about not apologizing or fessing up to a snub.

      1. TC

        It would be very easy for the Climate Change meeting organiser to prove Wen wrong. I did not think a Chinese leader of Wen’s stature made this type of stupid mistake.

  30. sacmac

    Is there an objective definition or rules of what constitute currency manupulation (which are not subjective to political interpretation or motivations)? Is the same definition/rules applicable to every country? Why not make these rules in WTO so that evry country has got a clear goalposts instead of shifting ones as dictated by political needs.

    1. Sundog

      The IMF has rules about currency manipulation, and Simon Johnson (former IMF chief economist) has stated that he believes China is in violation of these rules. However, there are no enforcement mechanisms for violating IMF rules.

      The WTO does have means for enforcing its rules, but it has no rules on currency manipulation.

  31. i

    Bottom line: Eventually the USA defaults on all debt to China. Both countries go belly up economically for a little while. Then when wages and prices in the USA are more in line with the rest of the world, both countries begin to recover.

    Sort of. By this time, the energy crunch misnamed “peak oil” (with its plethora of continuous negative feedback effects so charmingly ignored my Ms. Smith) rears its ugly little head and we all get much poorer, worldwide until alternative energy is exploited and deployed in significant ways, which will be neither easy nor cheap.

    1. Yves Smith Post author

      I suggest you look at the Great Depression record. The sovereigns who defaulted then did so only selectively, on their war debt, not on all their obligations.

  32. anon

    The amount of dollar-denominated assets held by foreign central banks is huge. Besides China, Japan, S. Korea, Taiwan, Singapore, Brazil, Russia, the Arab petroleum states are all major holders of dollar-denominated assets. This is in addition to approximate 70% of US total debts held by Americans and American institutions. So devaluation of the world reserve currency is not a feasible task. Yes we will experience some devaluation (inflation) but not to the scale seen in the 80’s. The perks and advantages gained by being the issuer of the world reserve currency are tolerated and accepted worldwide with implied adherence to responsible currency management. If we embark on this dollar devaluation path, it is the dollar reputation as the reserve currency that will take a hit. It is naive (or too arrogant) to think that this likely scenario has not already been considered and prepared for by other nations’ planners. Evidences are more and more deals struck directly among creditor nations, circumventing the anglo-axon dominated financial markets; and new economic alliances are formed beyond the US influence. To clearly comprehend the current global economic crisis, one must look into the coupling of the ascendancy of finance and the subsequent asset-dependent economy in the West to the reverse flow of capitals (developing to developed) and the eventual export-dependent economy in the East. Instead of allocating this cheap capitals to technologically innovative industries which we must carry out continuously as an advanced economy, we squandered the cheap capitals on unproductive housing and phantom financial assets (we did well with the development of internet/computer generation before). Really, can we trade houses and other financial derivatives among ourselves and consider that our sustained economic strength? Remember the end of the British empire ambition came abruptly as the rising Americans refused to finance her debts. Yes we are far away from this infamy but the relevance of rising creditors can’t be dismissed as history has documented.

  33. /L

    No surprise there, the €urocrats is wholeheartedly on the same side of the fence as the Chinese when it comes to mercantilism, wouldn’t be surprised if Prodi eat Eisbein mit Sauerkrat at least once a week.

    Some said that at the beginning of the early 90s crisis Americans did put forward to the Europeans that they should take on the baton and engage in a more expansionist economic policy’s to boost demand, the Americans was a bit restrained after feeding the long boom cycle of the 80’s, of course the €urocrats shunned such a folly when there was an opportunity to engage the Europeans in some flagellation.

  34. /L

    The common wisdom in Europe in this time of crises is that what’s wrong is that not everybody is like Germany, an frugal export surplus country. And this is the wisdom touted by the overpaid educated European Brussels elite. That it’s easier said than done don’t seems to bother them at all when scribbling prescriptions for the healing of the thoughtless sinners. Germany have 2/3 of its export inside EU and also the other members have a majority of its export inside EU.

    The utmost gist of this intellectual effort must be that Europe achieve an substantial surplus against the rest of the world, does the high minded thinkers in Brussels realize that it is tantamount to starting a global trade war?

  35. Mike

    Will China just listen to what we tell them or is this dispute going to take more than just words to settle. Many feel that the US just telling China what to do will not fix anything, but some major action is going to have to happen:

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