December 06, 2004

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Facts and myths in China's economy

I mentioned whenChina raised interest rates that at the same time they liberalised they also abolished the ceiling on lending rates. This allows proper credit charges to be factored into loans, a major step in improving China's banking system and moving towards a more normal market economy. Now the China head of the IMF looks at the same issue in greater depth and notes the same: this is a far more important (micro)-economic step than China's (macro)-economic raising of rates.

While on things economic, the White House has declared that China abides by its law against currency manipulation.

In its report, the department said that "no major trading partner of the United States met the technical requirements" laid out in the 1988 law. China's decision to keep its currency, the yuan, tightly linked to the U.S. dollar and not allow it to rise in value did not meet the law's requirement's concerning problematic currency manipulations for unfair trade advantages.
China cops a lot of flak in talk of the US dollar and its decline. In fact it is not clear that China's currency is under-valued. China runs at best a balanced trade account. What it does is process raw materials and runs a massive deficit with countries that provide those, and turns them into manufactured goods it then exports primarily to America. A float of the yuan might even see its value fall if the massive pent-up demand from Chinese citizens to diversify their (large) yuan currency holdings into other currencies. The previous quid pro quo has been for Asian countries, predominately China and Japan, to export goods to America and buy back US dollars and Treasuries in return. This supported the US dollar and has kept US interest rates low, despite huge budget deficits. In turn that combined with huge amounts of liquidity have spurred asset market rallies (bubbles), the latest being in the property market. This merry dance is now reaching its inevitable conclusion. The US is quite content, official speeches not withstanding, to allow its currency to depreciate and thus devalue its way of its current account problem. No other country could get away with running a deficit as high as 6% of GDP without facing a massive run and financial chaos. But markets appear sanguine when it comes to the US, perhaps because of the dollar's role as the historic reserve currency. But if I'm Japan or China, owning a shedload of Treasuries, and I am about to see their value fall another 30% or more from a dollar depreciation, I'm going to be mighty p!ssed. I can't keep doubling up without causing domestic economic chaos, especially as both ecnomies are growing and inflation is looming as a problem. But I also can't sell or even stop because that just makes the problem worse. The only real alternative is the Euro, but buying those assets doesn't make much sense when most of my trade is denominated in US dollars. Brad, I'm damned if I do, but far more damned if I don't continue holding and buying US dollars and Treasuries. China and the BoJ are many things, but they are not fools. They are not going to shoot their biggest asset holdings in the foot.

What's the solution? It's actually basic economics. The US needs to save more and stop relying on the rest of the world to pay its credit card bill each month. A good way to start? Cut the budget deficit, quickly. It will mean both spending cuts and tax rises. It won't be easy. But considering the alternatives, it is the least bad option and it is about time America did something to get itself out of its own mess. Otherwise the US will find foreigners are going to have enough of owning US assets and are no longer going to want to use the US dollar as the basis of their trade. The dollar will keep losing value and potentially stoke domestic US inflation. If followed to its logical conclusion, the world needs to get ready for a Mexico-style bail-out...for the USA. It would be ironic if China, bastion of Communism, ends up giving the US a helping hand out of its economic mess.

In other words: the party's over. It's payback time.

posted by Simon on 12.06.04 at 10:49 AM in the


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The US needs to save more and stop relying on the rest of the world to pay its credit card bill each month. A good way to start? Cut the budget deficit, quickly.

Hear, hear. Now if we could just do something about the pesky rules about who's allowed to be President, we in the U.S. could look forward to voting Simon in 2008.

The deficit issue was used against Republicans in 1992 by Perot and it's always nice to see how much they've learned from it--nothing.

posted by: ilyka on 12.06.04 at 11:05 AM [permalink]

are trying to avoid another Great Depression. At the same time they . There are two main camps as represented by Jimmy Carter and George W. Bush (the first President Bush is closer to former President Carter politically than to his son). But on some issues all must give way. No one wants another Great Depression.

posted by: Ju on 12.07.04 at 11:26 PM [permalink]

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