The casual joke turns on China knocking on our door in the middle of the night on a repo call. Like a lot of jokes it’s a way of laughing off a genuine fear – that they US is slowly being owned by a nation that isn’t exactly friendly and we have no reason to trust. Paranoia sometimes sets in when people wonder why China would loan us all this money in the first place – has this been a plot all along?
A hard look at the Chinese Dragon shows that not only is there little to fear from them, they have far more reason to be afraid of us. And they’re pretty open about it, too.
China’s interest in the US is not what they sell us. The total value of the goods and services in the US that are made in China is 2.7% of our economy, or a bit over 5% of their economy. They would certainly miss the income if we crashed, but since China has been growing at over 9% a year for a long time they’d make it up quickly.
What has driven their appetite for US Treasury Bills is instead their entire strategy for growth, which is to export like crazy. About 30% of the Chinese economy, or $1.8T in 2010, is exported – quite a bit higher than the worldwide average of 21%. In order to do this they keep reserves in US Dollars because that is the global currency. Around the world, everything is priced in US Dollars, and everyone trading has to keep reserves of US Dollars. When possible, nations prefer T-Bills over Dollars – they are same thing, except T-Bills pay interest.
The exact figure of Chinese exports is important compared to the value of T-Bills that they hold. As of June it stood under $1.2T, or about 10% of all our debt. More to the point, it’s running about 6-8 months of total Chinese trade. Global appetite for our debt is always similar, which is to say that our debt of $14T has to be compared with global trade figures of about $16T total. If anything, China is running pretty lean.
Our ability to finance 30 years of nearly constant deficits has everything to do with the increase in global trade rather than our own economy. As long as trade increased, the global hunger for T-Bills increased right along with it. What has happened recently is that we got ahead of that curve during the 2008 slowdown and sent out more paper than we ever have before. As long as worldwide investors see this as a risk-free investment they can absorb it – but there are limits. That’s the bind we are in.
Meanwhile, China knows that they cannot keep up their growth forever. An export based strategy is the flipside of a borrowing base strategy, which is to say that China and the US have grown to be dependant on each other in ways that neither is comfortable with. The problem for China is that insanely high growth has to be met with infrastructure improvements, which is to say investment in their own nation. But exports require an investment in the US because the Dollar is the reserve currency around the world. That’s the balance they’ve had to strike to move up as rapidly as they have, and it’s precarious. It can’t hold forever.
That’s why China is pretty vocal about US borrowing – and has called for international supervision of the US Dollar. It’s not just that they are the largest holder of our debt. China is counting on a worldwide system, based on US Dollars and a careful balance, to lift them rapidly.
So what do we have to fear from the Chinese holding our debt? A lot less than they have to fear from us. There is no Chinese Dragon plotting to loan us into slavery or any other complicated scheme. Instead, we have a nation playing by the rules but pushing things as hard and fast as they possibly can in order to rapidly assume their place among developed nations.
What we do have to fear is a push to remove the US Dollar as the reserve currency, making all those T-Bills far less valuable. That can come from other nations as growth continues throughout the developing world despite the Depression in the developed world. We can reasonably expect there will be a push from developing nations once their economies are half of the world’s GDP. And yes, we can expect China to lead the push to either ditch or seriously reform the US Dollar Standard. That’s when it all gets very interesting.
This piece contains a large number of external links with some very interesting observations, data, and commentary. There are also several past Barataria essays linked. If you wish to know more about the topics please follow the links. Thank you!
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This is what we were talking about on the twitter #EconChat. I have to think about this a lot more but if the value of the dollar and our ability to borrow depends more on global trade then our own economy it explains a lot. What makes me stop & think is that this has never been explained like this before and though it seems right it has been like a secret.
What I think is scary in all this is that if we stop running the world we stand to lose a lot more than even you have let on before. I can see why it has been so important for us to keep doing it.
Anna: What this means is that we have not had full control over our own domestic economy for a long time, preferring instead to run the rest of the world. I’m having trouble piecing together the argument, but it seems to me that what we have been doing has benefited the upper class greatly at the expense of working people who need jobs that allow them to develop skills gradually (like manufacturing) and thus move up in income. We have traded cheap gizmos for the security of our own people, and I think that’s been a crappy deal.
Yes, there will be pain when the US Dollar standard finally ends. But we can manage our way past it – and take advantage of the freedom we will have to benefit a forgotten class of people. As long as there is not hyperinflation induced by a rapid change we’ll be OK, I think. I certainly think the policies we’ve had are exhausted and have run their course.
This is the first intelligent thing I’ve read on China & the economy. It makes a lot of sense but I agree with Annalise that it’s a bit “out there”. I will think about this some.
The idea of us “accepting international supervision” is bizarre. What do they mean? Lose complete control over the Dollar to some kind of UN operation? There’s no way that would ever happen. If that’s what China wants they are going to be disappointed.
Jim: Thanks. It’s worth thinking about, and strangely very few people understand this. The system as we know it clearly benefits people with money (ie, people who think of shopping as entertainment) at the expense of those who need jobs, so it’s important to think about.
Dale: Think about this from China’s perspective – they’ve been sucked into this mess doing nothing more than playing by the rules. And now they have a lot on the line. They can ask for “international supervision”, but we all know that they won’t get it – we’d never give up sovereignty over our own currency. But … at some point they will insist on doing something. That’s when the Dollar Standard comes to a crashing halt – unless we can ease our way out of it.
I am stunned because no one ever explained this before. Thank you.
Thanks, Sheryl. In case you didn’t notice, I’m backing up a bit from last week’s post on the Death of the Dollar because it dawned on me that people weren’t “getting it” quite like I thought. China is a good example to use.
Thanks Erik. I now get it better than before, though it is still a fuzzy understanding at best. For others like me trying to grasp the basics of economics David Frum has written a pretty comprehensible history of the gold standard.
http://www.frumforum.com/what-really-went-wrong-with-the-nixon-shock#more-101446
Laurie: The Dollar Standard has not been written about very extensively in terms that most people can understand. It’s not really that complicated in how it works, but the implications are. China, for its part, has been playing by the rules – and winning – but they are now starting to question the rules for some pretty good reasons that include the fact that they are likely to hit the wall shortly.
Gold? Hard to say what its future really is. In inflation adjusted terms we’re not at an all-time high. I do think that it makes sense to price commodities worldwide as a ration to some other random commodity, and gold is as good as anything for that. So between the tradition and the need for something truly distributed we could see it again – but outside of the Gold Dinar there is no serious proposal yet.
Agreed with other readers that this is the most cogent explanation I’ve read regarding the economic relationship between China and the U.S.
I am not afraid, yet, about the end of the dollar standard. It must end at some point, and we would be arrogant and dense to think otherwise. Change happens. This is one reason why I highly recommend reading Harry Dent’s most recent book: the 2008 published “The Great Depression Ahead.” (Erik admits he wasn’t the first to call this a depression, but Erik is also one of the few among us willing to call it like it is.) Dent’s book reads a bit like a textbook (he should probably hire Erik to ghostwrite his next book!) but it makes use of visuals and history to demonstrate the nature of economic cycles. According to Dent, we just happen to be at the low point of several intersecting cycles–hence our current depression.
Anyway, I digress. The key point Erik makes here is that neither the U.S. nor China have need to panic at present. That said, change is afoot folks, and this world will never again be either what it was or what we thought it would be. See the change around you and plan accordingly so you can be proactive rather than reactive.
I think that the powers that be want us to panic about the wrong things so that they can control us and keep us diverted from how bad they are screwing up. I can see the dangers in the future in this article but they are different than I thought and much deeper. There has to be a reason that no one else explains this. I don’t doubt you are right because this makes a lot more sense than all the other crap I hear. But why are you the only one who is doing this? That bothers me & would like your opinion. Thanks.
Kevin: Thanks very much. No, I am not the first to call “Depression!”, but I am the most obnoxious. 🙂 This is hard stuff to explain, and I think about it often. I corner people in bars and practice my schtick before I write it here. It’s not easy to do, but I enjoy it. Call it a very strange hobby.
Oh, and I am indeed available for ghostwriting and related services!
Kevin: There are many reasons why this isn’t explained, and most of them are pure laziness. The biggest issue is that the “experts” who learn this stuff often learn it along with a ton of jargon and forget plain English. I refuse to do that, and I work at it constantly – a very minority preference. I really appreciate that you said the Powers that Be(tm) are covering up their incompetence – I believe that is very true. However, in their defense this is an unusual situation that requires deep thinking “outside the box”, so people like Larry Summers were easily caught trying the same, old same-old and it didn’t work.
Never explain with malice what can be explained by laziness or incompetence, I always say. And I don’t think malice is necessary to explain a thing here. And thank you very much for your kind words of support!
In effect, when the USD is no longer the standard for international trade, we give up control. It makes me wonder what Ron Paul and his supporters are thinking in trying to foster its demise as an international trading currency. Perhaps they havent put 2+2 together?
Ron: I don’t think they understand the implications completely, but I do agree with them that abandoning this standard has some major benefits for us. Right now, we have little control over our own currency, directing our economy in a direction that does not favor the working middle class. Naturally, it is possible to lose this standard AND ignore the policies necessary to support a middle class nation of citizens, but I do think that the standard we have now has horrible tilted things for far too long.
If nothing else, I think the loss of the Dollar Standard is inevitable and should be prepared for. This can’t hold forever.
Maybe we can’t be the sole standard forever but it looks as though from what you said before that we might be part of it for a long time. It seems to me that half measures with a lot of different currencies might be the way it goes in the near future and that would be very good for everyone.
Sheryl: That’s what probably will happen. The current plan is a weighted basket of US Dollars, UK Pounds, Japanese Yen, and Euros. I would add some gold in there and call it a party. It would ease us out. I think the Dollar weighting is 50% at the IMF right now.
The US gave the Chinese access to our internal markets, leading to the liquidation of US manufacturing, and didn’t ask a lot in return. I suppose China needed this access to jump-start it’s economy but with their domestic consumption on a steep upward trend, this must be a lot less important now. So US leverage on China, to the extent we still have it, must be of a different nature–one in which we can’t hurt them without hurting ourselves more…..
We tend to forget that for much of recorded human history, China has been the richest and most advanced–in many respects–country in the world. The Chinese difficulties of the last couple of hundred years are something of an aberration, and things are trending back towards historical norms.
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