China's looming problems, and ours

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The always excellent James Fallows has a superb piece in the April issue of The Atlantic. One portion in particular, which I’ve pasted below, concisely summarizes the U.S. rise to economic power in the 20th century, China’s current position of power but also of vulnerability, as well as our own, and he also gives some important details about recent protectionism by Beijing. Read the whole thing here.

Let’s begin by considering how bad things could get, for China and those it influences. The clearest approach I’ve heard to this question comes from Michael Pettis, the Beijing-based finance professor whose side business as a rock-music impresario I described in the March Atlantic. To think about China’s predicament in the late 2000s, he says, you should think about America’s in the 1920s.

Through the early 1900s, the United States played a role in the world economy surprisingly similar to China’s in recent years. Until the start of World War I, the United States had long been a “net debtor” country. It had relied on foreign loans and investments to build the factories and lay the railroads that ultimately made it an industrial titan. By the end of World War I, it had become a “net creditor,” as its undamaged industrial base supplied European combatants and the former customers of ruined European companies.

In the 1920s, its farms and industries made America the workshop of the world. It ran trade surpluses with most other economies, which meant that a disproportionate share of the world’s jobs were in America (it was doing work that other people consumed), and a disproportionate share of what it made went for other people’s use. Foreigners paid the difference by transferring gold reserves—John Maynard Keynes complained at the time that the United States was amassing “all the bullion in the world”—or taking on loans and investments from Americans. So far, this is like China’s story. And so far, so good.

This very role as global exporter made the United States unusually vulnerable when global demand collapsed in the 1930s. Having had more than its “fair” share of the world’s jobs to begin with, America had more of them to lose. This doesn’t mean that Americans suffered more deeply than Europeans. We got Franklin Roosevelt; they got Hitler, Stalin, Franco, and Mussolini. But as a matter of plain economics, the layoffs and unemployment of the Depression years were worse in the United States.

That is the problem for China now. Many Americans would assume that China’s recent history of trade surpluses would be its bulwark during a recession. In the long run, it will be, because it has provided a $2 trillion war chest in foreign holdings. But in the short run, China’s reliance on foreign customers turns out to be a serious vulnerability.

Pettis wrote recently that China’s worldwide trade surplus, “the cleanest measure of overcapacity”—factories that are running and workers who are employed only because of foreign customers—is by one measure at least as large as America’s was in 1929. China today, like America then, has a trade surplus equal to about 0.5 percent of global economic output. But as a proportion of its own economic output, China’s trade surplus is much bigger than America’s was. In proportional terms, today’s China is five times as reliant on foreign customers to create domestic jobs as America was in 1929. So unless China can find a way to keep selling when its customers have stopped buying, it will face a proportionately greater employment shock.

That China might indeed try to keep selling is the concluding part of Pettis’s cautionary analogy to the Depression era. As stock markets crashed and economies collapsed, the U.S. trade surplus nearly disappeared. American businesses, desperate to preserve markets and jobs, lobbied for passage of the infamous Smoot-Hawley Tariff, which increased duties on a list of some 20,000 imported goods. Soon afterward, other countries retaliated with similar tariffs; world trade dried up, and the Great Depression was on. When people use the words “Smoot-Hawley” today, they usually mean them as a warning that any interference with trade, especially by the United States, could again prove disastrous.

Pettis’s point is different, and in a way more worrisome. The real damage of Smoot-Hawley, he says, was less economic than political. Other countries understood that the United States was trying to protect its trade surplus and therefore its workforce. They didn’t like it as a political matter, and they struck back.

If that were to happen again, would it be because of “Buy American” provisions or other forms of American “protectionism” editorial pages so often warn against? That’s the wrong thing to worry about, according to this logic. The real counterpart to Smoot-Hawley would be Chinese protectionism—or rather, any effort by China to defend its huge trade surpluses, as the U.S. once did. China’s government is unlikely to rely on outright Smoot-Hawley–style tariffs. Instead it could increase subsidies to exporters; it could try to push the RMB’s value back down, after three years of letting the currency rise; it could encourage manufacturers to restrain wages; it could impose indirect barriers to imports, as with its recent pressure on China’s airlines to cancel outstanding orders for Boeing and Airbus airplanes. By early this year, China’s government was in fact doing every one of these things. As a result its global trade surplus, instead of shrinking as expected when the world economy deteriorated, grew dramatically. Exports fell, but imports fell much more: in January, exports declined by 17 percent and imports by more than twice as much—by 43 percent. This is an economic problem for other countries. But it could be an even more serious political provocation, if China is seen as forcing its share of unemployment problems onto everyone else. And thus, to bring this scenario to a close, the best China can expect from today’s shocks might be unemployment rates higher than America’s in the ’30s. The worst would be for China to start a trade war that makes things even harder for itself.

China’s emergence as America’s financier has steadily increased its leverage over the United States. But in the short run—rather, for however long the current crisis lasts—the two countries really are codependent in a way neither fully anticipated. Early this year, Chinese officials began saying more and more bluntly what Gao Xiqing, who manages some $200 billion of Chinese holdings in the United States, conveyed artfully in an interview in our pages in December 2008: that if America wants to keep using China’s money, it had better put its economy back on track. It should be saving and investing more, borrowing and consuming less. At the Davos conference in January, Premier Wen Jiabao made the point by outright scolding America for dragging down everyone with its excesses.

Okay already! But the more Americans obey these orders, the worse things look for China in the short run, since American overconsumption is exactly what has kept those Chinese factories a-hum. Americans are in a similar bind with their complaints about China. U.S. officials want China to reduce its trade surplus—while also hoping that China’s financiers will keep buying U.S. Treasury notes and stocks in U.S. companies with the dollars they get from that very trade surplus. We can’t have it both ways. The Chinese can give us money, or they can give us back some jobs, but not both.


— Jon Ward, White House reporter, The Washington Times

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