Have the US and China Kissed and Made Up?

The recent jousting between the US and China had the look of a full on row. And the spectacle at last weekend’s G20 seemed to offer further confirmation, with Geithner proposing a cap on current account surpluses that was aimed at China above all.

But now the Financial Times tells us that relations are already on the mend:

China and the US have the basis for an agreement at the summit of the Group of 20 leading nations next month on setting targets to cut trade imbalances, according to an adviser to the Chinese central bank.

Li Daokui, a member of the central bank’s monetary policy committee and professor at Tsinghua University, said on Tuesday there had been “good progress” at the weekend meeting of G20 finance ministers in South Korea which had moved debate from the “surface issue” of nominal exchange rates to “talking about the substance of rebalancing world trade”.

“China should not be afraid of numerical targets for reducing its trade surplus,” said Mr Li in an interview. “China is well positioned politically and economically to make this adjustment.”

The Financial Times does point out that Li is not a government official, but the article contend that his remarks point to a real movement.

Or do they? The US was never going to push China hard. Not that it couldn’t; various analysts have suggested the US holds the better cards were things to get ugly. But it’s well known Team Obama blinks in any staredown. China was bound to prevail if it talked tough enough. And it isn’t clear Treasury had its heart in this fight. Geithner has consistently upped his rhetoric in response to Congressional pressure and dialed it back down as soon as possible. It seemed obvious that he intended to push the timetable of the war of words with China past the Congressional midterms, since the legislative saber-rattling would presumably abate.

However, in past serious financial crises, it is creditor nations like China that face a more difficult adjustment than debtor countries that the US. The debtors just need at worst to default on or restructure their debts or depreciate their currencies. The creditors, by contrast, actually have to restructure their economies in a major way. The US and China have both pushed back the day of reckoning with big liquidity injections, and in China’s case, a pretty hefty fiscal deficit. But China’s growth is becoming harder to sustain, with each $1 in growth requiring $7 to $8 in debt.

But if Li is right, and the US and China are about to see if they can agree on a timetable for China to reduce its surplus, what does that really mean? It appears China is trading getting out of immediate pressure on its to let the renminbi rise for committing to future action. Ah, but will these commitments be specific, and even if so, will China live up to them? Look how its widely touted June announcement, that its was moving to a more market oriented currency policy, turned out to be a PR ploy that the press lapped up. Is this to be more of the same?

In fact, if anything China wants to depreciate its renminbi. It has already increased interest rates to try to cool off its economy. Wen Jinbao has stressed that exporters can’t take a currency increase of even as much as 5%; many would go bankrupt. A 5% differential with US inflation, say the US at 1.5% and China at 6.5%, achieves the same result even with a fixed peg. It’s particularly hard to get a good reading on Inflation in China. There is reason to think that China has no intention of letting the renminbi rise and would lower it if could (one offset is that with the dollar having fallen versus the euro and other currencies, China has a little more wriggle room when you look across all its trade partners).

So it shouldn’t be surprising that after letting the renminbi increase 2% over the last month plus, presumably to avoid being branded as a currency manipulator, China pegged it lower by almost a half a percent overnight. From Clusterstock:

We don’t know if this is a glitch or a middle finger or what. It’s certainly odd.


The talks at the G20 were supposedly productive and all about ending currency wars and then China sets the Yuan above 6.69 after a close yesterday just above 6.66.

Elsewhere on the currency front, the dollar continues to make progress against the yen after hitting all-time lows on Monday.

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  1. Ted K

    Next time they have one of these trade meetings, the Chinese should hand out dunce caps for all the American trade diplomats and journalists to wear. In small print on the inside it could say “I was there for the 8888th Chinese
    head-fake, and I believed EVERY WORD”.

    These people are staunch Nationalists. It’s a country composed of 99% Xenophobes. They don’t care about global responsibility. What decade is this gonna dawn on you people?? Their lifetime credo is “China da best. China alway da best.”

    1. Paul Tioxon

      Even more to the point, The Chinese Communist Party, led by barely a handful of men, are the best. They are a true oligarchy. The capitalist roaders are not democracy proponents but rather admirers of the productive capacities unleashed by capitalism. More Vanderbilts, more Rockefellers, more Carnegies, No Lincolns-No FDRs-No New Deal. Just the grinding wheels of industrialization at any cost. Under the watchful eye of the party and its leadership.

  2. kezza

    China is in a very good position to deal with the surplus.

    They are banning export of rare earths to the rest of the world. That is a good move to reduce their trade surpluses. But what happened since then? Amerika is not happy about it, and wants to consume more, not less. You can’t point the finger to China and say they are the bad boys here when they are doing something which can have the effect of reducing their trade surplus with Amerika. And it is the high-tech stuff (embargoed by the USA government after 1989, incidentally made from the very rare earths that China is restricting exports) — something that China would want to consume from Amerika but is not available because of Amerika policy, not Chinese policy.

    1. DF

      How does embargoing the REE’s reduce the trade surplus? They’re trying to force everyone to make their REE-using stuff in China. That would seem to actually *increase* the trade surplus.

      And yes, in theory we could sell China F-22’s to reduce the trade surplus. It’s certainly not going to happen for obvious national security reasons, and it will only work until China reverse-engineers them and uses the technology in their own home-built planes.

      1. kezza

        No, you get RE from other countries, so decreasing your trade deficit with China. As all Amerika interested in is the current account deficit with China, here you have some medicine. You haven’t dealt with this aspect.

        And what is this “national security interest” that you are referring to? It is obviously in China’s national security interest not to export RE for Amerika to produce weapons that will “mistakenly” used on Chinese, such as what happened in Belgrade 11 years ago.

        1. DF

          “No, you get RE from other countries, so decreasing your trade deficit with China.”

          Not at the moment, no. China produces over 95% of the world’s REE’s, so they’re basically the only game in town. In a few years, however, the Mountain Pass mine in California will fully re-open, which will make your statement more true.

          Most REEs are not used directly, but in finished goods. Right now, China is not embargoing finished goods with REEs in them (e.g. NdFeB magnets, fluorescent lights, NiMH batteries, etc.), just the raw oxides and pure metals. Finished goods = raw materials + value add. Currently, the value add is done by countries other than China (e.g. Japan for NdFeB magnets). If China requires everyone to do the value add in China too, that would increase China’s trade surplus at the expense of the other countries that previously did the value add.

          “And what is this “national security interest” that you are referring to?”

          Read the paragraph again. What I’m saying is that even if every aspect of the ITAR regulations (which restrict in the US what technology goods can be exported to certain countries) were repealed in the US, our trade deficit with China would only modestly shrink for awhile. Once China extracted the useful technology from the ITAR-restricted goods, the trade deficit would go right back up because they would just make these goods themselves.

          “It is obviously in China’s national security interest not to export RE for Amerika to produce weapons that will “mistakenly” used on Chinese, such as what happened in Belgrade 11 years ago.”

          Honestly, if the US couldn’t build its precision-guided munitions anymore (REE’s play important roles in them), more of these mistakes would happen, as we would have worse intelligence to work with (due to lack of sophisticated sensing) and having to use more primitive bombing techniques like carpet bombing.

          1. jil

            I have read reports that the developed countries have stockpile for more than 20 years’s use. Is this true?

      2. Alan

        I think Chna is trying to force every one with the reserve but producing zero share to sustain themselves and also be accounted for the associated environmental burden. I think that is unfair.

  3. charles 2

    China probably wants to emulate the Singapore strategy : hold the RMB price around the price of a secret basket and allow progressive increase from that basis. The RMB fixing “glitch” is consistent with that as EUR has gone down. It is worth noting that on a trade weighted basis,the RMB has not gained recently (to the great dismay of europeans…)

    1. Richard Kline

      So charles 2, I’m in agreement that China manages its currency against a _range_ of other currencies. Their strategy is not fixed on dollar rates alone. And yes, Singapore 10000 times larger (without the necessary miliatry accomodation to the US) is very much what China is aiming for, to my mind.

  4. jim

    Every country in the world got a little glimsp (with this unexpected manipulation of resources) of how China intends to act on the world stage as she gets more power, and frankly if China were ever allowed to become a dominate world superpower.I don’t think most informed people seeking safety and happiness would want to live in a world with the Chinese as the #1 world superpower.

    Obama is showing great restraint with his position of power, which I believe he feels is important to re-building world trust. I have no doubt Obama will do the right thing when it comes time to protect democracy and the rest of the free world from tyranny.

      1. Paul Repstock

        Sadly, I don’t think he was Colin..Some people actually claim to be able to distinguish qualitative differences between the kettle and the pot.

  5. Bruce

    The Chinese stared down the Obamaites, and they apparently just stared down the Fed also, if the WSJ article is correct. I would not be the least surprised that the Chinese were behind much of the 10% commodities “ramp” over the past month or so. The rare earths ban was no doubt the icing on the cake.

    The Fed got the message, loud and clear. They dont want $5/gallon. The Fed may have also figured that, as with Geithner, they got as much political juice as possible just by talking about QE2, so why actually implement it now.

    1. Richard Kline

      If the US moves to erode China’s dollar holdings by printing dollars, it would be in China’s interests to unload more of those dollars faaster. Commodities would be by far the most useful destination for such ‘purchase bombing.’ . . . China has a great many cards to play if we get a real trade war. And a domestic market with demand to cushion slowdowns in exports if it came to that. We’ve seen repeatedly the US kick China under the table so to speak and get a sprained ankle out of it.

      China would win any trade war with the US at this juncture, that is my considered view.

      1. Yves Smith Post author


        That would drive the RMB to the moon against the dollar, which is the opposite of what China wants. Dumping dollar assets is an empty threat.

  6. Kevin de Bruxelles

    I think this post is correct and I will try to explain how each side got here within the broader historic context. (Sorry for the length)

    China was first united under the Shang dynasty in the 12th century BC but it was under the subsequent Chou dynasty that Chinese political theory was born. The Emperor had a universal Mandate from Heaven but interestingly enough flexibility was built into the system. Things not going well could be read as a sign that Heaven had withdrawn its mandate and the ruler could be overthrown. The key point is that the Chinese leader was universal and admitted no equals outside of China.

    The initial central Chinese governments were weak and the society quickly fell into feudalism where the Emperor still existed but true power was held by disparate noble warlords who eventually went far enough to call themselves kings (wang) but never so far as to claim the Mandate from Heaven. This Chinese feudalism featured many of the same characteristics as subsequent European feudalism did 1500 years later which I think points out the universal nature of the way human societies are organized and react to pressure, both internal and external.

    With the chaos of the Feuding States Confucius was born. William McNeill, in his classic “The Rise of the West” describes it so:

    But if the breakdown of the old political order brought benefits of a sort to the fringes of the Chinese world, if was far otherwise for the small states which clustered in the old centers of Chinese civilization along the middle and lower reaches of the Yellow River. From the sixth century BC onward, these states were reduced more and more to the status of pawns, subject of recurrent invasions, and diplomatic bludgeoning at the hands of the ruder, but also stronger, frontier principalities. The emperor’s domain, centered at Loyang, was no better off than its neighbours, despite imperial pretensions to supreme authority. Amid this political chaos, it was natural for the educated classes to hark back to the good old days, when imperial power was a reality. This nostalgia was one of the roots from which Confucius’ thought grew.

    In such troubled times, old-fashioned morality, and good government nowhere prevailed. Oaths and treaties concluded with the most solemn rites in the presence of the ancestors were repeatedly broken; all sorts of violence and intrigue flourished at the princely courts, and the most unscrupulous ruffians fared best. Where in such a world was Heaven? And how should a man behave when all traditional landmarks seemed to be tumbling down?

    If we accept that economic strife is just war by other means, and if we substitute the warlords for the financial industry, the current situation in the US is not so far from what the Chinese were facing in those days.

    Confucius’ answer was to go back to the old ways; but only some of them:

    Confucius’ doctrine clearly departed in important respects from older aristocratic mores. He decried violence and paid little attention to military training, which had been at the forefront of traditional education. Decorum, a concept dear to him, forbade resort to force in all ordinary circumstances and he seems to have believed in the feasibility of governing “by ritual and yielding,” i.e. by giving way gracefully to others all according to the rule precedence and propriety laid down by the code of good manners

    If we substitute violence and military training for economic competition and productivity, who is more Confucian now? As Yves said, “it’s well known Team Obama blinks in any staredown.” I would agree that while China may now again feign a desire to yield, in the end it is the US that backs down in the economic realm.

    Confucian thought was ignored at first. The Ch’in, after proving the maxim that what doesn’t kill you makes you stronger, defeated the barbarian steppe nomads by adopting their cavalry tactics. Once this task was accomplished they turned their new found skills onto the rest of China and quickly reunited all the disparate pieces. They were fairly quickly replaced by the Han, who both claimed the Mandate from Heaven and institutionalized Confucian thought. China had its ups and down but maintained its cohesion up until the early 20th century.

    But due to the conservative Confucian political ideology, and the lack of any competitive spirit, China only thrived as long as it remained superior to its neighbours. When the power of Europe exploded around 1500, the conservative Chinese society just looked down with disdain on these vulgar upstarts right up until the days Europe imposed its colonial will on the hapless Chinese society.

    So the Chinese leadership of today have learned the limits of passive Confucian ways and much like the Ch’in, are adapting the ways of the barbarians and are in fact turning these ways into a weapon with which to compete with and defeat these same barbarians.

    The concept of American Exceptionalism is quite similar to the Chinese idea of a Mandate of Heaven. The big difference is that there is no escape clause in the American version.

    And like the Chinese of old, the current American elites have also accepted a passive neo-Confucian attitude of holding its head aloof and yielding while the rest of the world switches the main arena of human competition away from the battle field and towards the factory and boardroom. In terms of political architecture, a strong center is an advantage when things are going well but it does tend to crush innovations from the periphery that may threaten its power, and it makes flexibility almost impossible when facing a new challenge. America has to find away to break loose of the now corrupt political center so that different groupings or states can become free to innovate and compete with the rest of the world. The idea would be a more decentralized America with a Warring States structure, but strictly keeping the strife to the economic realm. Then one region or another in America, through direct competition with other “barbarian” countries, can adapt and learn how to compete again, and then the region with the strongest solution will rise and impose this system on rest of the US much as the Ch’in did to China so many centuries ago.

    You see this process work to some extent in Europe, only the mirror version of the Chinese experience concerning the periphery vs. the center. After the destruction of WW2, the center (Germany, France, etc) benefited from contact with a productive and competitive America. In contrast, in the first decade of the 21st century, this center thrived based in some part on their imbibing the old American values of productivity while the new parasitic, and consumer-based America corrupted some periphery nations with the ideology of consumption and credit. The recent financial crisis has shown the peripheral countries the error of the new American ways and they will now struggle to restructure their economies towards the German / Old American model.

    1. EmilianoZ

      Very thoughtful and original.

      You say the Chinese have an escape clause to the mandate of heaven which Americans don’t have. Correct me if I’m wrong but it seems to me that having that escape clause executed was never easy. No emperor would say: “OK, I fucked up, I’m standing down now.” You would have to mount a bloody rebellion against him. By comparison Americans have it easy. All they have to do is vote outside the 2 parties, which, for I don’t know what reason, they cannot bring themselves to do.

      More state autonomy is an interesting idea. I wonder what the corporatocracy thinks about that. On one hand we have seen during the foreclosure debacle that they would like a strong centralized state to make things easy for them nationwide. On the other hand I think some of them would relish the opportunity to transform some states into sweatshops, like China but without the transportation cost. I think they could live with that.

      1. alex

        “All they have to do is vote outside the 2 parties, which, for I don’t know what reason, they cannot bring themselves to do.”

        Because our plurality wins voting system makes it difficult for a 3rd party or independents to get elected. Voting 3rd party is quixotic. It only makes sense if you truly believe there’s no difference between the D’s and R’s, which most people, including myself, don’t. We may not believe there’s as much difference as there should be, but there is some difference.

        Our system for asserting a vote of no confidence in the mandate of heaven needs some serious fixing.

        1. traderjoe

          I believe any difference between the two parties is simply a smoke screen for them both representing the mega-corporations, the bankers, and the MIC. Any perceived difference allows the facade to continue for much, much longer. The entire process has been captured by the monied and corporate interests.

      2. kezza

        Correct me if I’m wrong but it seems to me that having that escape clause executed was never easy. No emperor would say: “OK, I fucked up, I’m standing down now.”

        True, no emperor ever _voluntarily_ abdicate the throne for someone outside the family (it is NOT true that no emperor ever stand down for someone outside the family, but since 420CE they were all killed almost immediately). But at least the emperor will issue a “crime edict”, repatriate and reform, not sure I saw anything like that in the Western equivalent.

        More state autonomy is an interesting idea.

        In the “history” of USA, didn’t they tried that route before? Indeed, from the Mason-Dixon line drawn up in early 1800s finally accumulated to the American Civil War half a century later was an experiment in state autonomy. It would certainly be “interesting” to see whether history will repeat itself.

      3. Kevin de Bruxelles

        Thanks Emiliano.

        You ask a very good question. There were already very good responses but I will try to sketch the dilemma in a different way.

        The Chinese kept the escape door closed but left room within the system for an usurper to claim the moral authority to smash this door down and grab power if circumstances presented such an opportunity.

        A democracy like America leaves the escape door open. The inmates can leave any time they want, all they have to do is vote a new party into power. But the combination of bread and circuses creates a dependency as well as a comfort. Do the fat and happy inmates really want to test the harsh realities on the outside? Moral cohesion is lost every time an inmate looks at that open door but doesn’t have the stones to walk through it. But I can rationalize this since the stakes of our Kabuki theatre elections are so very high each time. The tension is palatable, civilization rests on a knife edge. Sure I could walk out the door but if I did so the other side may win. And if the other side wins, disaster will strike. So much like WW1, the answer is stalemate. After much deliberation, the election results tell us the enemy only moved the front 20 meters towards our capital! A historic defence, but at the cost of being that much more exhausted and so walking out that open door will have to wait. But that doesn’t matter, only losing 20 meter is a sign of better things to come. We are going to change things around here. Maybe next election, if we give our best effort, we can hope to advance that front back another 40 meters, and then things will really start changing.

        In some paradoxical way, it is easier for a determined man to crash through a closed door than it is for a distracted man to freely walk through an open door.

        1. EmilianoZ

          I think I see what you mean. Having the moral legitimacy to usurp power is indeed important. Knowing so little about Chinese history I’m not sure every dynasty ended in a bloodbath. I think it could’ve happened in another way. The local leaders, seeing the emperor losing the heavenly mandate, could just become progressively emboldened. The process could be gradual until the periphery just functions by itself without minding the center.

          Most people think there’s a substantial difference between Republicans and Democrats. I agree with them but the problem is not there. The problem is that they both move in concert towards the right. It’s almost like an optical trick. They both move right but the relative distance between them stays the same so people stay fixated on this gap.

  7. jake chase

    All this trade negotiation talk is simple horseshit. China understands that by continuing to accumulate worthless US fiat money it increases its power to demand access to critical technologies it could not develop internally in another one hundred years. It understands how to play the short term greed of US elites. Nothing will change until China identifies some real advantage in changing. The idea of China as a surplus country with Bretton Woods type adjustment responsibilities is another globalization fantasy.

    Meanwhile, the corporate elites understand the important expanding markets are India and South America. The US consumer is no longer critical from a profitability standpoint.

  8. zjin

    Smith, I think that you certainly have a deep knowlodge of the US economicy and politics, but you are still lack of a deep understanding of what is going on in China. It is the consensus in China that exporting to the developed countries is not longer the main driver of the economy. Hoever any sudden move will disrupt the economy (looking at Japan in 1989-1990 monetary policy). The government will make the transition process as gradual as possible. So you see the exchange rate fluctuating—to screw those speculators, because hot money is coming to China since the expectations of further rising interest rate and exchange rate, not to mention Fed’s loose print machine.

    In summary, Bejing does not trust the US market anymore, but it cannot live without it for the moment. So when Bejing is turning to internal demand, it will not give the external markets easily.

    1. alex

      “The government will make the transition process as gradual as possible.”

      How gradual is that, in geologic time?

      It would be mutually advantageous to rebalance gradually, meaning over a few years, in a controlled and mutually agreed upon manner. But China has given no (none, zero, nada, zip) indication of any willingness to do that. Chinese pronouncements are laughed at by anybody who follows this issue, although true derision is reserved for those non-Chinese, like Geithner, who at least pretend to believe them.

      If you’re familiar with the old Peanuts comic strip, think Lucy and the football. Even Charlie Brown has got to wise up someday.

    1. kezza

      In Asia
      “Yes” means I understand
      Not necessarily that I agree

      Not sure I agree with that. “Yes” has two incompatible meanings:
      (1) I agree
      (2) I propose we agree to disagree
      both (1) and (2) have “I understand” implicit.

  9. Jim the Skeptic

    The liberal Democrats always seem to blink in a confrontation with other countries. When they do act, it is half hearted and doomed to failure.

    By the way, it is fall and the North Koreans are negotiating with their brothers to the south over family reunions. The fear of famine will mean that all is well, until next spring. The cycle continues.

    As for the Chinese, actions speak louder than words.

    We do need to understand China’s history to develop a better understanding of them today. We are certainly trapped by our own vision of our history.

    1. alex

      “The liberal Democrats always seem to blink in a confrontation with other countries.”

      First, “liberal Democrats” is, in contemporary reality, a contradiction in terms.

      Second, how hard did George “Tough Guy” Bush bargain over this issue? There’s nothing new about it – it’s been a serious matter for at least a decade.

  10. Rick Halsen

    Well then, these comments coming from China’s commerce minister must be faux chow mein. This one in particular has the ring of an “Ahhhhhhhhhhhhhhh sooooooooo, hoary shit” tone to it in the best voice of Bonanza’s, Hop Sing……

    “But because the issuance of dollars is out of control, and international commodities prices are continuing to rise, China is confronted with imported inflation, which has created major uncertainties for businesses,” he said.


  11. emca

    Again I.F. Stone’s immortal quote:

    “Governments lie, all governments lie!”

    Links lead to strange places at times.

    On the tainted infant milk from China scandal (remember that)I found this from Newzglobe.com:

    A dangerous game of Chinese whispers

    The article is only indirectly about tainted milk. It main trust is the price of doing business in China or as Alistair Nicholas, chief executive of AC Capital Consulting in Beijing put it:

    “there is a mentality in China that one of the ways you do PR is to get bad stories out there about your competitors…..PR is played in a pretty dirty sort of way in this market sometimes.”

    In this case, Yili Industrial Group Co the supposed culprit was a victim of planted stories by its competition, Mengui Dairy Group (or possibly one of its overeager employees), who, to make the story more realistic, paid for testimonials:

    “The campaign which cost USD 41,000 involved engaging dishonest writers who pretended to be expectant mothers or mothers of infants. At the heart of the rumour was the claim that Yili formula contained fish oil that might cause premature sexual development which was in some cases illustrated by doctored photographs”

    The story is based on an Associated Press article, which reaches slightly differing conclusions, although neither are favorable to Chinese business, which needs to worry about internal market conditions as much as external.

  12. DF

    Actually, the real experiment in states’ rights was the Articles of Confederation (the US government structure prior to the Constitution). Each of the former 13 colonies was highly independent. Didn’t work out too well, as there was no good way to collect money from the states (federal taxation wasn’t allowed) to provision for common defense.

  13. DF

    Sorry, this was supposed to be in response to kezza’s comment:

    “In the “history” of USA, didn’t they tried that route before? Indeed, from the Mason-Dixon line drawn up in early 1800s finally accumulated to the American Civil War half a century later was an experiment in state autonomy. It would certainly be “interesting” to see whether history will repeat itself.”

  14. whoami

    “Wen Jinbao has stressed that exporters can’t take a currency increase of even as much as 5%; many would go bankrupt. A 5% differential with US inflation, say the US at 1.5% and China at 6.5%…”

    Yves, you are obviously very knowledgeable and a treasure (like Jane H), but I am sorry to say you are seriously misreading the situation wrt China.

    Wen is clearly lying here. He is being clever by feeding Western perceptions of their own importance in these times.

    The dependence of China on US is far less than Western commentators imagine. The economic data and “analysis” carried out by most of economists is highly dubious—like ignoring differences between PPP and exchange rate. Most of the trade in the two huge Asian countries (China and India) is internal (90-95%). So the adjustment is not going to be as painful as many seem to think; the increase in domestic purchasing power will offset loss of US market.

    The adjustment will be harder for America, nothwithstanding the various “analysts”. Any default will seal the diminished role of the America; perceptions matter in political and economic matters. A result would be withdrawl from Asia (like the small-scale version that Britain is going through). I’d say China is far better positioned than we are.

    Finally, how exactly is the little depreciation going to help US economy? This is just kabuki for election purposes, and will end once Repubs take over. At least on this, the Repubs are correct.

    1. Richard Kline

      So whoami, I’m broadly of your view yes. Exports are grossly over-weighted in Anglo-American estimations of trade ‘balances’ with China. A post tonight elsewhere:


      estimates exports as only 10-15% of China’s investment, with the rest being internal. India, as you suggest is even more heavily weighted internally. To my mind as well, this situation puts them in a much stronger position in a trade dispute than is being fully reckoned. Let’s see: US depreciates, boosting the cost of our imports >>> That slaughters our retail, being broadly demand-surpressive from job declines and higher costs for the same basket of goods >>> China et. al. just sigh and stimulate their economy a tad to make up for the single digit loss in export volumes to them, while saying good riddance to the ultra-low end low-value manufacturers who take the brunt of the losses. Hu cries crocodile tears over that, but he has larger fish to fry. And Team Obama making motions on this for the midterms go back to peep-lessness from 3 Nov 10 on.

    2. Marshall Auerback

      It’s not simply a question of currency. The currency is symptomatic of a bigger problem in China. The most recent parallels to China were Japan during the 1980s and emerging Asia ex China in the first half of the 1990s. We all know what followed.
      The problem with trying to predict an end to the Chinese bubbles is that they are truly different. China is not a market economy. It is a command economy directed by a communist party which has many and complex vested interests. China’s dirigisme has come to the fore again and again to thwart market processes that would have ended China’s excessive level of fixed investment and high and rising real estate prices. China’s “management” of its exchange rate is an example. The most recent example has been the increase in Chinese domestic credit relative to GDP which, in real terms, may be the greatest in history for any major economy. This government-driven credit expansion implemented through government controlled banks, government authorities at all levels, and state-owned enterprises have kept China’s massive disequilibrium going, but only by raising yet further its fixed investment ratio and real estate prices.

      Because China’s dirigisme has made the China bubble economy different from all other bubble economies, history and economic theory provide no guide to when the Chinese bubbles will burst. Therefore, it has been my opinion that they will not burst until the Chinese authorities find themselves in such a bind that their dirigiste ways will no longer be able to keep the raging disequilibrium going.
      The other day, I passed around a piece on a threat to China’s disequilibrium path arising from a possible inflation stemming from the mega money and credit expansion of 2009. In that piece it was argued that the most elementary monetary theory would point to a double digit inflation in China and a consequent rise in China’s real effective trade-weighted exchange rate. Such a real exchange rate appreciation would deliver a double whammy. First, China’s export position would be eroded. Second, such a revaluation of the real exchange rate might squeeze the tradeable goods sector to the point where its fixed investment would fall enough to take down China’s overall level of fixed investment, thereby threatening a recession. As long as China’s exchange rate remains fixed, another round of money and credit expansion and government-sponsored expenditures would then not work because they would only fuel further domestic inflation. That would squeeze further the tradeable goods sector and would price China’s export-oriented economy out of global markets all the more. It would also tend to depress its excessive investment in the tradeable goods sector. It would be the final Catch-22 that would end the Great Chinese Disequilibrium.
      Of course, China like any economy could offset its high inflation with a currency devaluation and thereby prevent both the squeeze in the tradeable goods sector and a reversal of past penetration of export markets. However, it has seemed to me that China has overplayed its mercantilism for so long and has pushed its trade surplus and penetration into global export markets so far that its trading partners might not tolerate such an escape route of devaluation.
      The growing global tensions over currency parities have emanated above all from China’s “pegged” exchange rate. The threat of a “currency war” has now moved to the forefront. Protectionist measures have begun. I think the prediction that both Yves and I have made in the past that China would have great difficulty using the escape route of currency devaluation from a Catch-22 created by its excessive use of money and credit and its fixed investment expansion is now being validated.

      1. Richard Kline

        So Marshall, we’re looking at the same phenomenon–China’s internal expansion of liquid capital–but seeing somewhat different things in structure and process.

        It is not accurate to call China a command economy at present. Thirty years ago, yes; now, now. The labor market is very much open. The agricultural markets are largely free floating. Many production plants start, and prosper or fail on the basis of their own numbers. I would characterize China as a socialized economy. The public authorities have many powers and are not shy about using them. They have a development program, and while they have fierce internal disputes about it there is no question that the central authorities can enforce their choice relative to capital. The financial sector is under government control even if much of it is not directly government run. The legal system is vestigal, and no check on central power. So a socialist hybrid, but not a communist owned-and-operated.

        China’s creation of both money and fixed investments over the last, say, twenty years have been absolutely enormous by any historical standard; I’m certainly in agreement with you and other commentators there. The money supply has grown by a factor of 40 and isn’t stopping for example. China’s fixed investment rates are far, far off the charts for any modern parallel. . . . And yet the putative inflationary supernova is conspicuous by its absence. Yes, statistics from China leave much to be desired, an issue Yves has down fine work keeping in view regarding econ analysis and China. One conclusion might well be, then, “inflation is just around the corner,” which I take to be a poor but not inaccurate characterization of your views. And indeed there is, for example, upward pressure on food prices in China which are inflationary in result and have been a leading indicator for more overt inflation in the past there. There is more fuel for this argument, but I’m sure you’re familiar with it, and probably more so than I.

        There is an additional perspective which I seldom see in present commentary on China which, in my view, makes a different picture. Yes, the vectors of investment and liquidity expansion are extreme, but they begin from a a context which was (and still is) itself extreme and an extreme outlier for valid comparison. Thirty years ago, China wasn’t even really a money economy. Fifteen years ago, there wasn’t really a property market. Chinese saved once money became more widely available, but there weren’t assets to buy, real or paper. Infrastructure was lame outside of core population centers, and financial investment vehicles were also few and distorted in distribution outside of a very few investment centers. Large parts of the country have minimal electrical generation even now. Productivity was correspondingly extremely low. Internal demand was wildly distorted because people had no money, no assets, many had nos skills from education to vend, no mobility, and large numbers received food and shelter directly from public structures. In short, the Chinese economic base was an extreme outlier in _undercapitalization_ and underdemand when development started. And that’s before we discuss the sheer size of the population, or the size of the underemployed or unemployed labor and demand capacity which in sheer numbers equals the entire population of the EU but at subsistence agricultural levels of economic movement. Relative to this backcloth—massive demand potential but miniscule liquid capital—China’s vectors of liquidity expansion simply do not look as extraordinarily eruptive as they would IN ANY OTHER CONTEXT. If we were looking at, say, Brazil in the 1980s, or Russia in the 1900s, or Turkey or Egypt pick your time, and saw the kind of investment and money creation vectors we see, I would certainly expect what you expect here, specualtive mania and nuclear fusion in the financial sector. Even if, for that matter, all of this investment was being focused in, say, China’s Maritime Southeast and Hubei-Tianjin, as was the case ten years ago, I would concur, and likely we’d have already had major property blow-offs. China has made an effort to spread this capital expansion more widely, though. That infrastructure investment they have pushed very hard as a stimulus process has real impacts on productivity if done even half-right, and increased productivity gives that capital moving around somewhere to go that yields output and it’s secondary demand from the output-ers. My point at its broadest is that China has an enormous backwater of underdemand to soak up some of that _aggregate capital expansion_ if said underdemand can engage with it in contrast to that capital expansion simply bloating speculative churn. Of course there _will_ be speculative churn in places, and malinvestment, &etc. But that won’t be the sole absorber of the expansionary capital vectors were are seeing: much of this is going into REAL expansion.

        I don’t know how much of this capital is going to real expansion. I do think that this is part of the explanation for the absence of severe inflation in China now. It isn’t just that those ‘manipulative communists’ have somehow got there thumb on the monetary scales but that there’s more to the picture. Will the Shanghai property market have a blow-off? Oh, probably; hard to see otherwise. Will China _as a whole_ have a bubble blow? I am much more skeptical of that proposition. The internal expansion of China’s economy to engage with China’s forcibly starved underdemand is the real story. The export sector is entirely secondary, and its principal importance in the larger picture is technology and skills transfer. China is certainly as capable as any other economy with market processes to produce bubbles. They _had_ one recently, in equities, and boy did it crash. That didn’t bruise China much at all because the vast bulk of Chinese did not own significant or any equities and the banking system was not strongly linked to the process as opposed to hot money speculators which kissed a lot of their own export profits bye-bye. It’s harder to conclude that China as a whole will get bubble trajectories from its present levels and foci of capital movement given the huge buffer of underdemand being hooked up to skills and infrastructure—i.e. productivity—to absorbe that capital in _production_. (I’m not going to enter into this particular point further since it’s not the focus of your remarks as I understand them.)

        MA: ” . . . China like any economy could offset its high inflation with a currency devaluation . . .” Come again? Your point in most of your commentary if I understand it is that China’s inflationary pressures are principally due to domestic money and investment creation. (I agree.) Devaluation will do nothing to ameliorate that driver. Some of China’s capital surge is hot money inflows through the membrane of China’s foreign investment partners, largely in the Chinese diaspora. Devaluation would certainly punish them brutally and knock some pressure down. But the Chinese financial authoritities are driving capital creation at this point insofar as is evident. I’m mystified by your remark here.

        MA: ” . . . China has overplayed its mercantilism for so long and has pushed its trade surplus and penetration into global export markets so far that . . . .” I don’t know what it’s going to take for the realization to spread that China’s export trade is really the minor story in China’s economy and economic development activity. I just don’t know what it’s going to take. Another ten years of unparalleled expansion? Will that happen? I certainly don’t know. By the time the US fully understands (if ever) that China’s trade surplus and penetration is the result of American imbalances but secondary to China’s development we’ll be living in a different world. That is my view.

        1. jil

          Great post Richard!

          If you don’t mind me asking….Is it plausible that Renminbi is overvalued already, judging from property and investment overcapacity in China that follows the enormous increase in the Renminbi money supply over the years?

        2. Marshall Auerback


          Well, you do need a permit to migrate and exports are a huge part of the economy. And, yes, it’s been somewhat liberalised, but to suggest that there are no longer any “dirigiste” elements to China’s economy is naive in the extreme.
          I find that many people who have a visceral dislike of what is going on in the US (and I am one of them, as I know Richard is as well) tend to look at China through extreme rose coloured glasses. But there are big problems there.
          I’ve looked pretty closely at the data. Because of the difficulties of interpolating true quarterly growth rates from the oddly presented Chinese statistics I did not want to take the extra step and say that in Q3 real growth had fallen to 8% or 9% and GDP inflation was 11% or 12%. I also did not want to do this because I believe the Chinese economic data overall is very poor and I did not see in more reliable parallel economic indicators sufficient evidence that real Chinese GDP growth had fallen into single digits by the third quarter.

          I have always considered the Chinese electric power output data as a better guide to Chinese GDP growth than the Chinese official GDP statistics which are compiled from provincial sources who, in Communist party fashion, have incentives to meet preset GDP “quotas”. However, Simon Hunt has provided me with the most recent data on Chinese power output. The year over year power output change from June through August was running at a 12% rate. It had come down from much, much higher rates from May and further back. Such a plunge to a 12% rate in the year over year data implies that the annualized sequential rate of change in those June through August months had probably fallen into high single digits, but perhaps not significantly so. However, the year over year increase in Chinese power output in September has just been reported at 8%. This takes the July-September third quarter year over year power output change to less than 11% and with a sharply declining trend. This implies that the annualized sequential rate of change of power output in Q3 was well below 10% and falling. That is consistent with a Q3 GDP growth rate closer to Strazheim’s 8% than Lombard Street’s 12%.

          As a result, given the September power output data it now seems to me that the Chinese nominal and real GDP data, reported in their peculiar year to date way, are implying a significant deceleration in real growth to an 8% rate coupled with an even more significant rise in inflation towards a 12% rate.

          This is a bad split in the inflation/real growth consequences of the mega money and credit expansion of 2009. It is also exactly what classic monetary theory would suggest. Support for this inflation/growth outcome has been provided by the Chinese authorities in their decision to raise interest rates immediately after the meeting of the State Council despite opposition from vested interests and political incentives to do otherwise given the leadership change ahead.

          Much will depend on the strength of the global economy. If the principal developed economies of Europe, Japan, and the U.S. do well, the programmed future incursions into global tradeable markets arising from China’s all time record over investment might be possible. However, if these economies remain weak and weaken further, which is very possible, there will not be the global demand for the output onslaught that will arise as China’s new mega increment to capacity comes on stream.

  15. nip

    “Japan’s Half-Year(April~ September 2010) Trade Surplus Expands 83Pct”

    Nobody says this is a problem.

  16. Paul


    That would drive the RMB to the moon against the dollar, which is the opposite of what China wants. Dumping dollar assets is an empty threat.”-

    I don’t think Richard meant “dumping dollar assets”, I think he meant outbidding the United States for every resource, (even more than they do now). That would drive up costs for Americans and absorb all those QE dollars without any benifit to the economy. It might drive up the RMB, but only in terms of the dollar, and therefore make the current account balance even worse than it is now.

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