DeLong Smackdown Watch: Brad Setser
Brad Setser agrees with Jeff Faux that China's exports to the United States must be cut--but for very different reasons:
Brad Setser: DeLong’s position – that the US needs to position itself as a friend of China’s economic development -- is an appealing one. But it is also one that I suspect glosses over some big issues. Both the US and Europe... have done their part to support China’s development over the past few years. US imports from China have increased from $100 b in 2001 to $280b in 2006.... Eurozone imports from China have gone from 62b euros in 2002 to something like 130b euros, maybe a bit more, in 2006.... Both the US and Europe have supplied a lot of demand for Chinese goods over the past few years. The risk of a protectionist backlash is no doubt rising. But so far, the US hasn’t taken any policy actions that have really crimped the expansion of China’s exports – which is what I think worries DeLong.
Nor for that matter has the US government done much – if anything -- to help in the US whose living standards have been adversely affected by China’s export success. DeLong and Jeff Faux would both agree that tax cuts for the have-mores whose assets are worth even-more thanks to large financial inflows from China doesn’t count....
Since 2001, China’s exports have basically quadrupled, Chinese productivity has shot up, the set of products that China produces has expanded dramatically and the external purchasing power of the RMB has fallen. If China’s government stopped intervening and allowed the RMB to rise, the ratio between China’s market GDP and its PPP GDP to rise to a level more typical of other emerging economies with comparable levels of development. China’s government has had a policy of, in effect, subsidizing the use of Chinese labor for the production of goods for export.... China subsidizes – through its exchange rate intervention – the global consumption of Chinese goods, which leaves producers in other poor countries whose governments don’t offer a comparable subsidy at something of a disadvantage.
Chinese exports have increased from about around $265b in 2001 to about $1,000b in 2006 – and are poised to rise to $1,250b in 2007. Now you can argue that this policy of holding down the external purchasing power of China’s workers has worked. Real living standards in China are growing strongly.... China is a far richer place today than it was a few years ago....
But China’s policy of buying dollars (and to a smaller degree euros) also means that China is sinking a growing share of its national wealth into a set of assets that are almost certain to depreciate over time.... The sums involved are not trivial. China is now running a current account surplus of around 10% of its GDP. That implies that about 20% of China’s annual savings... is being invested in assets that are likely to depreciate.... China’s government effectively now has a policy of both holding China’s current living standards down and sinking a fairly large share of China’s savings into assets that are sure to lose value.... The capital losses could destroy the PBoC’s formal capital: borrowing in RMB, even at an artificially low rate, to buy depreciating dollars isn’t a winning financial strategy....
When the time comes for China to realize the losses that are now accumulating quietly on the PBoC’s balance sheet (and soon on the balance sheet of the state foreign investment company), I doubt China’s leaders will say, “you know, these losses were really incurred years ago, when we decided to sink a lot of Chinese savings into depreciating dollars in order to encourage our export sector and make it attractive for foreign firms to locate investment in China. We shouldn’t blame the US for the fact that China’s investments in the US haven’t done well. We were the ones who over-paid for US assets.”
I suspect China’s leaders will be somewhat less magnanimous. They will argue that the losses... [stem] from the failure of the US to adopt the policies needed to maintain the value of Chinese investment in the US....
I worry that at some point, China will conclude that investing so much of its savings in the non-tradable part of the US economy isn’t the best way of building Chinese wealth, and the flow of funds will stop. If that process is gradual, it will be for the best--but it if it is sudden, well ... a lot of US workers now employed in the non-tradables sector will need to shift into tradables production, pronto. DeLong:
In this alternative scenario, the U.S. has to move about ten million workers out of currently-favored sectors--construction, home-equity-credit financed consumer expenditures, and so on--into export and import-competing manufactures. How much structural unemployment does such a sectoral shift require, and how long does the structural unemployment last? Other countries have to shift up to forty million workers out of export manufactures into other industries, and to generate demand for the products of those industries...
If that process isn’t smooth, I rather suspect the US won’t say, “You know, we got an awful good deal from China for all these years. Rather than complaint about the costs of the transition that followed the end of Chinese financing, we should thank China for selling us so many goods at such generous prices, lending us so much on such generous terms, and for helping keep the profits of US firms up for so long by underpricing its labor.”...
DeLong has in the past argued that the US should aim to try to replicate its post-war success at creating a liberal international economic order. The new liberal international economic order though would extend beyond the US, Europe and a few islands in East Asia. It would in effect, draw in the big population centers of the Asian land mass as well. That is a very appealing vision--one that I think is very widely shared. By the party of Davos. But not just by the party of Davos.
I worry, though, that the conditions that allowed the US to construct a liberal international order after World War 2 no longer exist.... In a sense right now, rather than having a Marshall plan, where the US--at the time the US public sector--financed the reconstruction of Europe on very generous terms while opening its markets to European goods (creating the conditions that allowed Europe to repay the US loan), we have something that looks like a Marshall plan in reverse. Or maybe half the Marshall plan--China doesn't seem to have given much thought to how the US will pay it back.
China’s public sector is, as a matter of policy, providing subsidized financing to the US. The reverse comes because China, still a very poor country, is financing the still very rich US. Bretton Woods 2 is very, very different from Bretton Woods 1.
I am convinced the post-war analogy doesn’t quite fit. But I also don’t have a better one to suggest.
