Monday, August 08, 2011

When China wises up, what then?

The issues of our time are becoming more acute. Of course we watch with alarm the affairs in Libya, Syria, and now Britain. But also, over the long term there is the changing attitude of the Chinese toward the United States, whose wealth, along with that of the Japanese, has been holding up the profligacy of the Americans. An article on this by Stephen S. Roach puts it together for us. Below are some quotes from his article. [Click on the title for a link to the whole article.] RLC

Read China's lips: China may soon be fed up with US fiscal intransigence and show it by halting the purchase of the dollar.
Stephen S Roach: 07 Aug 2011 07:53

The Chinese have long admired the economic dynamism of the US. But they have lost confidence in America's government and its dysfunctional economic stewardship.

… ….Senior Chinese officials are appalled at how the United States allows politics to trump financial stability. One high-ranking policymaker noted in mid-July: "This is truly shocking … we understand politics, but your government's continued recklessness is astonishing."

….China recognises that it no longer makes sense to stay with its current growth strategy - one that relies heavily on a combination of exports and a massive buffer of dollar-denominated foreign-exchange reserves. Three key developments led the Chinese leadership to this conclusion:

First, the crisis and Great Recession of 2008-2009 were a wake-up call. ….Second, the costs of the insurance premium - the outsize, largely dollar-denominated reservoir of China's foreign-exchange reserves - have been magnified by political risk. …. Finally, China's leadership is mindful of the risks implied by its own macroeconomic imbalances - and of the role that its export-led growth and dollar-based foreign-exchange accumulation plays in perpetuating those imbalances. Moreover, the Chinese understand the political pressure that a growth-starved developed world is putting on its tight management of the renminbi's exchange rate relative to the dollar - pressure that is strikingly reminiscent of a similar campaign directed at Japan in the mid-1980s.

…With these considerations in mind, China has adopted a very transparent response. Its new, 12th, Five-Year Plan says it all - a pro-consumption shift in China's economic structure that addresses head-on China's unsustainable imbalances. By focusing on job creation in services, massive urbanisation, and the broadening of its social safety net, there will be a large boost to labour income and consumer purchasing power.

…. It moves economic growth away from a dangerous over reliance on external demand, while shifting support to untapped internal demand. In addition, it takes the heat off an undervalued currency as a prop to export growth, giving China considerable leeway to step up the pace of currency reforms.

But, by raising the consumption share of its GDP, China will also absorb much of its surplus saving.

… So China, the largest foreign buyer of US government paper, will soon say, "enough". Yet another vacuous budget deal, in conjunction with weaker-than-expected growth for the US economy for years to come, spells a protracted period of outsize government deficits. That raises the biggest question of all: lacking in Chinese demand for Treasuries, how will a savings-strapped US economy fund itself without suffering a sharp decline in the dollar and/or a major increase in real long-term interest rates?

The cavalier response heard from Washington insiders is that the Chinese wouldn't dare spark such an endgame. After all, where else would they place their asset bets? Why would they risk losses in their massive portfolio of dollar-based assets?

China's answers to those questions are clear: it is no longer willing to risk financial and economic stability on the basis of Washington's hollow promises and tarnished economic stewardship. The Chinese are finally saying no. Read their lips.

Stephen S. Roach, a member of the faculty at Yale University, is Non-Executive Chairman of Morgan Stanley Asia and the author of The Next Asia.

A version of this article first appeared on Project Syndicate.

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