Saturday, December 27, 2008

Examining China's Role in the US's Economic Woes: The Times Takes the Lead

BOSTON, Mass. -- The New York Times today published a piece on the Faustian Bargain of our day: the tacit agreement between China and the US for China to produce most of what US consumers buy for their various quotidian needs while US buyers act as an easy market for China.

The piece, by Mark Landler (view it here), is a good summary of something that is both so obvious and so significant that it almost doesn't need to be reported, yet it is appalling that it's reported so seldom: China's role in the easy-money, cheap-credit binge the US economy has been hydrophobic on since ... the 80s ... Clinton introduced PNTR with China in 1999 ... the tech boom crashed ... OK, there are many starting points. The reporting here is decent, though it's more like a synposis than anything indicative of the scope of the subject. But, significantly, I hope it's a first step to understanding in much greater detail the root of a collapsing American -- and global -- economy. There were many factors that went into the housing -- and general consumer -- bubble that continues today, and from which we'll still be seeing much worse effects for another year or more. The mess was caused by banks pushing up profits via off-balance sheet credit default swaps and sketchy investments; homeowners and consumers who forgot that they need to have money to finance exorbitant purchases; a weak Congress totally ignorant of what was going on; and Alan Greenspan.

You boys BOTH deserve a medal for that one!

But the overvalued dollar and macroeconomic factors allowing Americans to obtain credit without any connection to their income didn't come from banks or consumers themselves. And Greenspan couldn't just keep rates suppressed at 1% from June 03 to June 04 when the US was at war without fearing major repercussions for the dollar and investment if he didn't know there was a major, major buyer out there ready to purchase US bonds and T-notes no matter the interest rates.

For years, the Chinese government has carried out a carefully calibrated policy to essentially appropriate from exporters $.50 on every dollar entering China from export purchases. The Chinese government invested the majority of the unprecedented amount of money that accumulated in US treasury notes and other bonds, including US mortgage bonds. That was intentionally done to keep the yuan/renminbi low, the dollar strong (if they held those reserves in yuan, the opposite effect would have been achieved, e.g.), and interest rates low in the US. That fueled the credit binge that allowed homeowners and consumers to seemingly defy economic law (until they no longer did) and banks to have 35-to-1 leverage rates (i.e., for every dollar of capital a bank actually had, it controlled $35 in assets, many of them tied to mortgages and consumer debt, bought with borrowed money).

Keep interest rates low so we can sell our products and be employed and not demand our rights, all of which serves the good of lucky scientifically harmonious society

While American society and the media have rightfully chewed out the US government and banks for being complicit in the credit fiasco, the larger, underlying problem remains China -- and for reasons I do not understand (is it fear of retribution, that China will dump its dollars and create a run on the US dollar? is it unwilingness to open this Pandora's Box and see how bad things really are? is it lobbying pressure applied by US businesses invested in China or Chinese state/economic interest lobbies?) we still have not addressed the structural problems stemming from our addiction to Chinese government investment and cheap Chinese goods -- or China's addiction to the US consumer.

This is a slow economic bleed for the US, and if we don't address this, we'll be absolutely toast in the long term. We need to use some teeth to get China to adhere to the WTO rules it's agreed to follow and "normalize" its trade regime. Given that China is a leading economic heavyweight, it needs to stop being classified as a "poor" country not subject to everyone else's rules in the WTO. It needs to abandon protectionism, end its illegal subsidies and VAT rebates to exporters, float the yuan on world markets to end its long period of undervaluation, and allow foreign companies to operate normally (without 100%-Chinese incorporated JVs with local state companies) on its territory. Failing all of these things, the US government needs to finally stick up for the interests of the US with coordinated action with Japan and the EU including WTO lawsuits and potential tariffs. Yet guess what? US Treasury Secretary Henry Paulson continues to play the fool, calling the biggest problem of the day "hopelessly academic" and glibly saying that it takes a "crisis" to bring about change. Mr Secretary, you've got your crisis, now when are you reversing gear on the policy you yourself admit is a dud?

You're a hell of a guy, Phil Knight

But more importantly, US executives, consumers and government officials need to recognize the importance of investing in competitiveness in the domestic market to ensure their long-term success. That means doing what the Germans, Japanese, Finns, Koreans and French do: investing in advanced manufacturing techniques to make production cost- and quality-efficient at home, rather than investing in new facilities in China to exploit cheap labor. The latter route may be good in the short run, but long term it will do nothing but hollow out the US operations of a company: Like telecoms company 3Com, when your production is all in China and most other US companies also have their production there, soon your operations are all their as are your customers. At that point, there's no reason to continue as a US company, while it makes more sense to sell to a Chinese competitor. And those competitors come about via local workers leaving your factories to take government offers to create Chinese-owned competitors. So you sell for cheap to a competitor who beats you on cost and connections in China that never would've existed had you and your fellows not gone for the cheap-labor move. In short, exploiting cheap labor is long-term bad for your company, destroys shareholder value -- and it screws over your kids' economic future.

I have lived in the former Soviet Union. It's ugly. And I can see the US heading in that direction if we too allow our economy and production base to be hollowed out -- as the USSR did by growing dependent on oil, gas and a generally BS castle-in-the-sky economic system. I increasingly am inclined to describe our economy as just that -- a castle in the sky, built on Chinese government investments fueled by Chinese government-subsidized production of goods to Americans living and losing their jobs amid decaying, unused old factories and who wouldn't be able to afford the goods were it not for the Chinese government investments fueled by ... (it's the song that doesn't end -- till it does!).

What you really don't want. Trust me

Thanks to the Times for finally opening up this issue -- but what the hell took you people so long? Three WTFs to Congress for still refusing to address this, the biggest systemic threat to the country at a time when it's proved insane not to address our systemic failures in time.

(Side note: Try using your post-Christmas sale shopping to buy exclusively non-Chinese things. It's really, really hard -- and leaves you feeling satisfied when you can find a non-Chinese product. Moreover, it gives you an appreciation for how addicted to Chinese goods we are. And, if any other overly robust market -- tech stocks, houses -- must come down, then it seems there's something akin to a bubble in Chinese products. They're inescapable, omnipresent, and seem too good to be true. And, given our dependence on them, they probably are. I have no idea how this bubble could fall apart, but they always do, and this one will too. What happens if Taiwan declares independence and the US supports it? We'd be without boots, shower curtains, mops, TVs, computers, sunglasses, watches, auto parts and -- increasingly -- certain food and medicine until we gave in to China's demands. Reliance on one trade partner -- no matter how closely geopolitically aligned your interests are -- and they aren't here -- is dangerous. Chinese goods could well be the next great bubble.)

Ah, symbolism

1 comment:

  1. Good piece! For a TV discussion of just the same thing, see