Krugman on China’s dollar trap
Most commentators have either gloated over or bleated at the paper that the governor of the People’s Bank of China posted on the central bank’s web site, calling for a super-sovereign reserve currency. The truth, as always, is duller. I shall refrain from saying more here as I intend to develop my arguments fully for the forthcoming MINT column on April 7th. In any case, I had commented on this development last week.
Prof. Krugman, in his latest NYT Op-Ed. gets it right.
The bottom line is that China hasn’t yet faced up to the wrenching changes that will be needed to deal with this global crisis. The same could, of course, be said of the Japanese, the Europeans — and us.
On his last sentence (below), I suspect that he read my last column in MINT 
… failure to face up to new realities is the main reason that, despite some glimmers of good news — the G-20 summit accomplished more than I thought it would — this crisis probably still has years to run.
This is what I had written at the beginning of my last column, ‘Ponzimonium prevails’
There is no evidence yet that humility has arrived, despite the mayhem. Hence, I find it difficult to believe that we have solved or brought the crisis under control. [More here]
Goldy,
Krugman has his own reasons for cockily asserting that China is stuck in America’s clutches whether it likes it or not. As you know, Krugman’s been calling for massive spending, across-the-board nationalization, massive state controls, etc, etc. Any moves by China to balk at this rampant monetarily expansionist policy then immediately motivates Krugman to quickly nip fears of it in the bud. Sorry, but his self-assured cockiness sounds like famous last words. The idea that China is completely at the USA’s mercy is Krugman’s overconfident presumption.
For one thing, the T-Bill Republic of China is quickly moving away from purchasing long-term T-bills to shorter term ones. Uh-oh. This means that the US will then be increasingly living hand-to-mouth from day-to-day, having to pay back these mounting short-term debts. This is called being caught by the short-and-curlies, because even the slightest/briefest twitch by China could then send ripple effects through the US economy, affecting its stability. If Krugman’s hoping to play a game of chicken, his cocksure advice is going to earn Americans a rude awakening.
Krugman also keeps warning darkly of some horrendous unending deflationary cycle, which I don’t see happening yet. If the US is buying most of everything from an outside world that is predatorily underpricing it, as he claims, then how would the deflation of such trade deficits hurt the US?
It wouldn’t. The US would gain at the world’s expense.
@Sanjay
While no one really questions that China as the largest creditor to the US, can destabilize the latter if it chooses to, the point really is that China would really have to pay a very heavy price for it too. If demand from US weakens dramatically (as it would, if China tries to destabilize the US), it would really break the back of chinese manufacturing, which has built up huge capacities across industries to cater to export demand, primarily the US. And an economic destability in China would have much larger costs than in the US, given its severely imprefect political system (you would heard of the 8% growth threshold for maintaining social stability).
the other interesting point is, the US consumer appears to have learnt the lesson reagridng savings. If I have the numbers right, the Q1 09 estimate for consumer savings is about 5% and some expect it to move to 10% by the end of the year. A 10% run rate means about a trillion dollars of savings – which to some extent would tend to reduce the dependence on China.
To my mind, it appears that China is barking only because it cannot bite. the only way China can overcome its perverse dependence on US is to boost domestic consumption – and there are no straightforward solutions to that in the long term. OTOH, the US consumer has already learnt his lesson about the pitfalls of overspending – and while there is going to be a painful period of readjustment, hopefully that lesson is well-learnt and he would not repaet it.
China could conceivably use its monetary muscle to buy more US assets. It only needs to be able to strongarm the US Congress into allowing it. If I were them, I would also try to make ingress into neighbors Canada and Mexico.
The fact is that the ability to manufacture outweighs the ability to consume, and so the US and China are by no means on equal footing in this standoff. China could in the long run follow Japan by transitioning into capital-intensive industries to outclass the US in these areas, creating deep dependencies that the US would not be able to rebound from, were the pertinent Chinese goods and services to be cut off.
@Sanjay
Sure, it looks plausible that China could have a better grip on the US if they do succeed in the kind of stratgeis that you had mentioned above, but these are fairly long term processes. However, that does not address your initial point that China could use its CURRENT position to control/harm the US which I disagreed with in my earlier post. And your statement that Chinese manufacturing outweighs US consumption needs to substantiated further before you can claim it to be a fact.
sai,
Anybody can consume. It takes no special talent for that. Manufacturing, as we in the underdeveloped world know, takes expertise and capital. If the Chinese shift towards ever more capital-intensive means of production to achieve further gains in cost competitiveness, then any subsequent collapse of the US dollar would not only make it harder for Americans to buy those goods, but also leave Americans without the capital to shift into producing those goods themselves.
If financial giants like AIG or Citigroup can default and go bankrupt, what is actually preventing whole big countries from going bankrupt ?
Once the monopoly of US dollar is broken on international trade, USA will be going down the drain. The Americans should pay double attention to the state of their economy, because they will probably not get a second chance of repeating this financial misbehavior. The next economic recession may very much break out in a world war, if American people are stupid enough to donate their country to the whims of the Federal Reserve.
What China mostly buy in the present time is short term T-bonds, the maturity of three months, six months and one year only.
Assume a person is US and he wants to borrow money by mortgaging his house which in this case is the US Dollar…do you think US can make independent policy with every three months, you have to report to the bank what you do in daily life…and if you don’t response properly, the bank will bring heavy equipment to your house and threatened to smash your house with you inside the house until you response properly. And if you not able to pay, either you surrender your house voluntary for the bank to control(the bank might let you live in it by paying rent) or the bank will smash the house…even if the bank lose by smashing the big mortgaged house, the bank does not care because it does not live in that house, the bank got its own house(Renminbi) and because of the incident the bank can even expand its own house to your complex…you think who will suffer in the long term if the mortgaged house is smashed…the bank or the occupier of the house which in this case is US? Unless if person decides to make a second house or new house, which mean new currency besides the US dollar.
You owe a bank a million, the bank owns you…..you owe the bank 100 million…the bank is afraid of you….if the proverb applies to countries…then why don’t country like US try to default? It is easier to default and start a brand new chapter, right? Why cares what happen to US dollar….like Russia ruble did….
So the US government and its people, for their own interest(not because they want to help the Chinese), will do as much as possible to keep the value of dollar in good shape. Maybe by raising tax or cut infrastructures /social/military spending, who cares? Its not other countries problem if US becoming a third world country and as long as the country can consume like the others third world countries, that’s good enough for China and other exporting countries. If dollar collapse too fast, other countries will start to unpeg and float their currencies more freely…By the way that’s what US always advocate right? All countries have a higher currency compared with dollar, but meanwhile US is a major oil and finished goods importing country, not exporting one….
“First world countries” = US population 300 million, EU 500 million, “Third world countries” = India 1.1 billion, Africa 950 Million, South East Asia 570 million, China 1.3 billion, and South America 382 million and so on.. I don’t think, if the first world countries going down, there aren’t customers left for China or other countries to do business with. They are not the only population in this earth. No wonder China do not want to join the G8.
US government can print the US dollar as much as it wants, China actually does not really care because it is not their currency. If there is inflation in US, its not Chinese people that suffers, so China does not care because it is not China or other countries’ problem. Other governments such as China, can also print their own currency as much as needed, in order to exchange/get US dollar from its own population. As long as its local economy can afford to absorb its own printed currency, government can print it without inflation. Can the US with its 300 million populations able to do that without big inflation? If the demand of US treasury bonds is so liquid and deep, in other word: big demand for US dollars….then why don’t the US government just print more dollars without need to worry about inflation, instead of borrowing money by selling more treasury bonds ? With borrowing, comes responsibility and loss of authority, why the US government want to do that?
US citizen thinks their nation is the most powerful because they can print US dollar and everyone wants US dollar. Well, citizens of China or India need to be worry if US government is the one that has the right to print Chinese Yuan/Renminbi or Rupee, but US government does not has that right!!! Indians or Chinese in their own countries do not use US dollar for their daily payment. So why people need to be anxious if US print too much of its own currency, it is US and its citizens problem, not other countries’ problem.