Sunday, November 23, 2008

China as America’s Banker

This whole shtick that China is America’s only savior has gone too far. Fareed Zakaria and Niall Fergusson are the prominent advocates of this theory. The argument goes something like this – America’s trillion dollar stimulus package will be financed by Treasury bonds & bills and China is the only country with surplus to buy the coming flood of American debt (well, good debt unlike the earlier toxic CDOs). In this world view, if China refuses to buy new American ‘stimulus’ debt; the interest rates America will have to pay will be killing and America will be essentially trapped in stagflation since to combat high interest rates Fed will have to inevitably increase the interest rates. That will be the end game and it will be essentially ‘over’ for American Economy.

Zakaria argues that China has the option in increasing their internal consumption / demand and that is where China can use it’s surplus instead of buying America’s stimulus program. Granted that, Zakaria accepts it is in China’s interest to increase consumption in USA since that will continue their ‘export driven’ miracle economy.

So there are number of questions here:

1. What is the composition of trade between China and America such that whose economy is more ‘hooked’ to this trade? The one who is more dependent on this trade continuing will bend backwards to sustain it. It also depends on political economy of ‘export driven’ businesses in China. One can very well understand how ‘Chabols’ in South Korea and Toyota, Honda and Sony of Japan would wield disproportionate political influence to continue their export markets. In China, if export businesses are deeply entrenched economically and from employment perspective; political price to pay to let die these industries will be quite high. In other words, to increase ‘internal demand / consumption’ is all about ability of the State to take on entrenched ‘vested interests’ within in the country. To think off, it is the country party ‘trade’ of GM bailout in USA. The heartening sign there is starting from NYT Editorial board, to Lefty Lawmakers to, dethroning of Dingell; all those sign point encouraging developments in USA. The question is - do we see similar encouraging signs in Asian economies (Japan, South Korea, China and India) to take on vested interests of those countries in increasing their internal consumption / demand? My two cents – that is where the vitality of political system and acuteness of political antennas of leaders come into the picture. With Barack Obama’s election, America has at least started off well out of the gate.

2. As last few weeks of capital markets show, investors are today accepting literally zero interests (2 year bonds and so on) for the safety of Treasury bonds and bill. Equities are performing too badly so that Americans are buying Fed debt. So much cash is on sideline in America itself and in Western World that to assume these native investors do not have any ability to finance American stimulus package is to ignore completely basics of markets in Western World. Besides, do we remember ‘war bonds’ which FDR touted for quite some time? Are we to assume that Americans will be dumb so much that they can borrow ideas of New Deal but not the native financing of the same if need arises?

3. Another way to say that China is the last purchaser of America, is to imply collapse of Dollar. Okay, raise your hands who think that is going to happen. American bombs, nukes, tanks and air craft carriers are not the only ones which are holding the value of Dollar. It is the basic ‘openness’ of American Economy, open Capital Markets and freedom to start, own and close businesses; that is the key to Dollar’s role in the world. Dollar will be eclipsed when rest of the world can very easily ‘move in and move out’ their capital in other currencies. Can some one educate us how much ‘Capital Freedom’ is offered to native Chinese; leave aside foreigners?

4. One more missing point is, as China and rest of the world increases their consumption; are we aware how many more Intel Chips, Boeing aircrafts and Microsoft Windows copies will be sold? Add to this if Dollar weakens. Meaning American Exports will increase. Germany makes her living off of export; despite being high cost economy. Americans do that to a certain extent already and will be able to ante if forced.

5. Also what about ‘disruptive technology’ breakthroughs altering balance of the global trade? How hard it is to imagine that alternative energy solutions have made substantial inroads and oil has climbed down from its stratospheric price? Suddenly if T Bone Pickens’ America gets realized; we are talking about Terra Watts of Energy being exported to Western Hemisphere in addition to satiating voracious energy demand of American economy. Point is, ‘substitution of oil’ will be of far more impact than falling apart of Chinmerica were to happen.

So in nutshell, being circumspect in speculating China as the sole savior of American Economy will be much more prudent. America will get out of this morass based on how it conducts its internal affairs, how it structures the stimulation, how pro-innovation it remains, how well policies are executed, how systematically it throws away it’s oil addition as well as debt dependence in personal consumption. In other words, it is much more than how it conducts its China relations.

No comments: