Chinese Control over US Economy

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China's Foreign Currency Reserves

In 1994, China had less than $25 billion of foreign currency reserves.[1] Since then, China’s enormous trade surplus and the inflow of foreign investment have helped boost its foreign exchange reserves to U.S. $1.76 trillion by the end of April 2008 with reserves said to be growing by U.S. $100 million per hour. Whereas many economists tend to think that a country’s foreign reserves should be sufficient to pay for 3-6 months of imports, China’s reserves can pay for a year and half of imports – leading many to conclude that China’s foreign reserves are unnecessarily large.[2] Critics point to these astounding figures as a further example of how out of balance China’s trade with the rest of the world is.


How China’s Foreign Exchange Reserves Got So Large

Increased Exports: The reserves started growing when China pegged its currency (the renminbi or yuan) to the U.S. dollar in 1994, with the intention of keeping the yuan’s value low and steady, thereby allowing Chinese products to remain low cost and affordable to overseas buyers. This in turn boosted exports, which allowed the Chinese economy to grow at the torrid rate of around 9%-10% it has in the last decade or so (with some exceptions during a regional-wide Asian Financial Crisis in the late 1990s). As China’s economy surged ahead in the last 5-10 years, but the exchange rate remained pegged to the dollar, dollars have stacked up in the Chinese banking system as the government has withdrawn the foreign currency from circulation.

“Sterilization”: When foreigners buy products made in China, they pay in foreign currency – usually the U.S. dollar – which Chinese manufacturers take to the bank to exchange for RMB to pay their workers and other costs. Whereas banks in many countries can decide what to do with the dollars to achieve the highest return, Chinese banks cannot and must send the dollars to the People’s Bank of China (PBoC - China’s version of the Federal Reserve) to be “sterilized” for yuan. The PBoC in turn reverts the dollars to the State Administration for Foreign Exchange (SAFE), which decides what to do with the huge, ever expanding foreign exchange reserves.[3]

Overexpansion: China’s inflexible and undervalued currency regime has locked the country into a situation whereby the large trade surpluses and capital inflows have led and continue to lead to domestic monetary expansion as the excess capital is reinvested in industrial production; this creates over-expansion and over-investment. Since production outpaces consumption, the trade surplus naturally increases, which feeds monetary expansion, starting the cycle all over again.

Greater Productivity: Besides the growth in exports, China has also seen a burst of manufacturing productivity (from the restructuring and privatization of a number of China’s inefficient state enterprises), investment and credit, which have all contributed to the excess liquidity in the economy.


Impact of large foreign exchange reserves on China

Inflation: In China, all the dollars from exports that need to be converted to RMB is causing inflation: as demand for the yuan increases, rather than let the value of the yuan rise too quickly, Beijing is printing up new money instead. Even with bonds, China’s monetary system cannot absorb all the extra cash, so prices have risen as a result and the stock and real estate markets have become inflated. China has tried to slow its accumulation of reserves by cutting export subsidies so as to decrease its trade surplus, by letting the yuan appreciate against the U.S. dollar (by 20%), and by encouraging domestic firms to invest abroad, but all to no avail[4] so far as the reserves keep increasing.


What does China do with all of its foreign exchange reserves?

For many years, SAFE has parked about 70% of its reserves in government-backed securities – primarily U.S. Treasury bills – with the rest in Euros and Japanese Yen. In the last several years, though, as the dollar has declined in value relative to the yuan, the Chinese government has indicated a desire to diversify its investments in order to get a better return. In recent years, however, with a host of other domestic problems besetting the country, the Chinese people are starting to question why their government is financing another country’s spending spree instead of using some of the large reserves to address the country’s domestic needs.


Impact of China’s foreign exchange reserves on America

The United States has welcomed China’s investment of its excess foreign reserves in U.S. Treasury bills, which has effectively helped to finance the U.S. current account deficit – the result of a low savings rate and government spending that far exceeds its income. This massive “loan” from China has effectively helped the U.S. government to do everything from waging wars in Iraq and Afghanistan, to paying Congressional salaries (including those of politicians criticizing China), to rebuilding roads in New Orleans, and writing Social Security and Medicare checks. In turn, China has had a safe place to park its excess dollars.


Is this a tenable situation for America?

Although both the United States and China have benefited from this arrangement, many experts and observers believe this is not a tenable situation in the long run. According to economists at the Petersen Institute of International Economics, in early 2008, the U.S. government was running a global current account deficit of almost $800 billion, the largest it has ever been. In order to finance this deficit and its own foreign investments, the U.S. must import about $1 trillion of foreign capital every year or more than $4 billion every working day, which is simply unsustainable in the long run.[5] After all, at some point, foreign appetite for dollar assets will wane.

As average Americans become more aware of the reality that they are relying on money controlled by a foreign government and that never in America’s history has she been so deeply in debt to another country (as of early 2008, foreigners now control over 40% of the U.S. national debt[6]), especially one with whom America shares an ambivalent relationship, and who America has at times blamed for taking away job, fear is setting in about how long this imbalance will continue and about what might happen should China decide to pull its massive reserves out of the U.S. economy. Moreover, long-term U.S. interest rates are driven by the buying and selling of bonds, making these interest rates effectively at the control of foreign central banks, especially those of China and Japan.[7] In short, China’s excessive foreign exchange reserves are causing some Americans to fear that control of their economy is increasingly at the mercy of China.


What would happen if China switched from dollar assets to other assets?

Moving from dollar assets to other assets will cause the dollar to depreciate, as the dollar will be worth less. At the same time, the bulk sale of U.S. treasury bills (short term bonds) could cause U.S. bond prices to drop and therefore yields to increase. Since government bond yields determine mortgage rates, this will result in higher long-term interest rates, which could make borrowing for a home more difficult, which would in turn further decrease already-dampened demand for housing and cause even more of a decline in the value of American real estate.[8]


How likely is China to exercise this economic “nuclear option” of withdrawing its reserves?

While China has in fact been looking to diversify its forex reserves by investing abroad, it will likely do so very gradually and in relatively small amounts, for otherwise they would stand to lose a lot with a bulk sale of U.S. treasuries as the value of the government bonds they don’t sell would decline. Hence, any moves toward diversification should have minimal impact on the value of the dollar. And although the value of the dollar is weak, there is no more stable alternative right now for China’s vast sums. Most economists agree that barring any unforeseen or major incident between the two countries, China will not exercise this economic “nuclear option” as China already has its own set of domestic problems to contend with at home as a result of its enormous forex reserves.


Looking Ahead

China: The yuan’s slow appreciation does not seem to have had much of an impact in reducing China’s reserves, hence some economists believe China will have to allow for an even faster appreciation, though that may hurt exporters. China will also likely face higher inflation, which the government may try to offset by using some of the reserves to give subsidies to the poor, though it has to be careful not to exacerbate inflation in the process.[9] Some experts think China’s foreign exchange reserves will not continue to grow “exponentially” as some have feared because there is pressure to use some of it on China’s infrastructure needs and on education and health for the poor.
United States: Many economists, such as those at the Petersen Institute of International Economics, think that correcting the U.S.’ global current account deficit is the highest priority for U.S. foreign economic policy. Proposals for the useful short-term remedy include sizably reducing the U.S. budget deficit; generating greater domestic savings than greater output, thus expanding U.S. net exports; expanding domestic demand in other major economies such as China, Japan, and Europe to absorb U.S. exports; and the continuing gradual realignment of exchange rates.[10] While the U.S. can continue to pressure foreign economies to shoulder more responsibility for global consumption (China has a savings rate of about 50%[11]), these autonomous sovereign nations in the end will act in their own self-interest. The only part that the U.S. has any real control over is in regards to its own spending habits. Unfortunately, the likelihood of the U.S. reducing its budget deficit in lean times and during an election year is not very high. Expect American politicians unwilling to get their own house in order (undoubtedly at some cost to the American public) to continue to put the blame and responsibility on foreign countries and to threaten protectionist responses.

http://www.aasc.ucla.edu/uschina/trade_currency.shtml

U.S.-China Media Brief

 

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U.S.-China Media Brief

Growing dependence of US economy over China is a cause of worry. United States, which has already been entered in a slow pace of recession, needs a good support of other democratic countries to help them to face the challenges of slowing economy and wars in Afghanistan and Iraq.

 

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U.S.-China Media Brief

Billionaires say US debts need attention


OMAHA : Two billionaires used the screening of a documentary in theaters across the United States on Thursday to urge the country to come to grips with its staggering debt load.

Warren Buffett and Pete Peterson were at the premiere of the movie ``I.O.U.S.A.'' to add their views to the film's message: An economic disaster will befall the nation if the federal government's $53 trillion in debts continue to grow.

But Buffett said at a news conference before the movie's showing that he doesn't think the country's financial picture is quite as dire as the filmmakers portray.

``I do not regard our national debt as unduly alarming,'' said Buffett, who is chairman and chief executive of Berkshire Hathaway Inc., and is listed by Forbes magazine as the world's richest man.

Buffett said he's confident the country will be able to address its debts and remain prosperous, but he doesn't want to see the share of the U.S. gross domestic product devoted to debt continue to grow.

``We've overcome things far worse than what is going on right now,'' Buffett said, who was interviewed in the movie but is not backing it financially.

The film that was shown Thursday in 358 theaters nationwide details the federal government's debts. The movie is backed by Peterson _ who co-founded the Blackstone Group LP private equity firm and served as commerce secretary under President Nixon _ and is part of his foundation's campaign to give the ballooning debt a central role in the presidential campaign.

``What concerns me more than anything is our savings rate,'' Peterson said.

Peterson said the meager U.S. rate of savings today means that roughly 70 percent of the nation's debts are being bought by foreign investors, and that could create geopolitical and economic problems for the country.

A panel discussion in Omaha followed the movie and was broadcast live to the other theaters, except on the West Coast where it was shown tape-delayed. Thursday's panel discussion featured Buffett, Peterson, AARP Chief Executive Bill Novelli and William Niskanen, chairman of the libertarian-leaning CATO Institute.

Niskanen said the nation has to increase the retirement age in Social Security to at least 70 from the current range of 65 to 67. He also backed adding an income test to Medicare so those with more money pay a larger share of their health costs.

Peterson said he hopes the movie will help explain the problems debt can bring, so politicians will feel more pressure to act.

``The problem is getting the public understanding and the political will to do something about it,'' he said.

The ``I.O.U.S.A.'' filmmakers followed former U.S. Comptroller David Walker as he toured the country, speaking to college groups, newspaper editorial boards and community groups about the nation's financial problems.

Most of the talks in the movie took place while Walker still ran the Government Accountability Office, an investigative arm of Congress that audits and evaluates the performance of the federal government.

Walker and the movie cite GAO figures that show the U.S. government owed roughly $53 trillion more than it had at the end of the 2007 fiscal year, the most recent figure available.

About $11 trillion of that covers publicly traded government debt, the amount the federal government owes to employee pensions and the cost of environmental cleanup of federal land. The rest of the $53 trillion figure accounts for projected shortfalls in Medicare and Social Security.

The cost of covering those obligations is expected to soar as more baby boomers become eligible for the two programs.

Buffett said he doesn't believe those programs that help provide for the elderly will consume the bulk of the government's resources in the future because America will be wealthier.

``The important thing to remember is that the pie gets larger over time, and there's more to divide up,'' Buffett said.

But Walker, who also took part in the panel discussion, said he disagrees with Buffett's assessment because the predictions the movie highlights about the country's debt already assume the nation will be wealthier.

Walker said he hopes both the Democratic and Republican candidates for president will acknowledge the staggering amount of debt the nation carries, and pledge to appoint a bipartisan coalition next year to look for solutions.

The film also featured interviews with prominent businessmen and officials from both major political parties, such as former Federal Reserve chairmen Alan Greenspan and Paul Volcker and former U.S. Treasury secretaries Paul O'Neill and Robert Rubin.

Greenspan warned that the nation cannot continue consuming more than it produces indefinitely.

``Without savings, there is no future,'' Greenspan said in the movie.

Thursday's screenings and panel discussion will be followed by a 12-city theatrical run beginning Friday. Peterson says he wants to have the movie shown on TV next year.


Billionaires say US debts need attention- International Business-News-The Economic Times

 

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Will China bail out the West?


With nearly $2 trillion (£1.2 trillion) worth of foreign currency reserves, China is being touted by some as the potential saviour of the Western banking system.

In order to bail out ailing financial firms, Western governments need money - and China seems a good place to get that much-needed cash.

But Chinese economists say that while Beijing is ready to play its part in the rescue efforts, it will not be writing any blank cheques.

Senior Chinese officials say they are more focused on their own, internal problems, such as avoiding a domestic economic slowdown.

And any help offered by the Chinese government to solve the current financial crisis is likely to come with strings attached.


Gigantic loan?

China's burgeoning exports over recent years have helped the country build up the world's largest foreign exchange reserves.

Figures released this week show these reserves now total $1.9 trillion.

Writing in the Financial Times, US-based economist Arvind Subramanian suggests the US could borrow some of this money.

"The Chinese government could offer to lend up to $500bn to the US government for the rescue of its financial sector," wrote Mr Subramanian, of the Peterson Institute for International Economics.

In fact the Chinese have already been doing something similar for a number of years. Beijing has been buying up US government debt, which has allowed the US to spend beyond its means.

"China is already helping the US economy and, if possible, it will continue to do this," said Zhao Xijun, of Beijing's Remin University of China.


Shared burden

But Mr Zhao, deputy dean of his university's school of finance, made it clear that China alone could not solve all the world's financial problems.
Other emerging economies, such as Russia, India and Brazil, will also have to help, he said.

"It's not sufficient for emerging economies or developed countries to do this on their own. They must get together," added Mr Zhao.

And even though China might have the money to help out, it is not certain that there is the political will to put the world's financial crisis at the top of the agenda.

Chinese leaders have already indicated that they believe Western governments should clean up their own financial problems.


Domestic priority

Yi Gang, vice-governor of the People's Bank of China, made this point at a meeting of world financial leaders in Washington last week.

"The World Bank should urge the developed countries to shoulder their due responsibilities in stabilising the global economy," he said.

Chinese Premier Wen Jiabao has added his comments to the debate. He said his country would do its bit to help stabilise world financial markets.

But in a telephone conversation with Britain's Prime Minister Gordon Brown, he also made it clear where China's priority lay.

"The most important thing for China now is to handle its own affairs well," China's state-run Xinhua news agency reported him as saying.

And for all its foreign exchange reserves, China is still a developing country with its own problems that will require lots of money to fix.

Just a few days ago, the Chinese leadership promised to double incomes in rural areas - where most of its people live - over the next 12 years.

The government will have to try to meet these promises despite what independent Chinese economist Andy Xie believes will be an economic slowdown in China.

He said the country had largely escaped financial problems affecting others, but would have to look to other areas of the world to generate future growth.

"China needs to play a bigger role in circulating money among emerging economies," he said.


Political strings

Even if China does agree to help with the global financial crisis, there will almost certainly be conditions attached to any help the Chinese government offers the West.

"The Chinese are definitely looking for some give and take," said Willy Lam, of the Chinese University of Hong Kong.

Specifically, Beijing will want guarantees that it will be able to buy US assets without the opposition that this has generated in the past, he said.

Its new-found leverage over the US could also lead to the Chinese making political demands on its counterparts in Washington DC, added Mr Lam.

China has just registered its opposition to the US sale of $6.5bn-worth of arms to Taiwan, a self-governing island that China considers its own.

"The power equation is changing and the Chinese are pleased with this, although they do not want to gloat too much," said Mr Lam.

"In their eyes, this also proves that the Chinese model is working."


BBC NEWS | Asia-Pacific | Will China bail out the West?