Streetwise Professor

October 26, 2010

We Have the Stuff: They Have the Benjamins. Who Has More Power?

Filed under: Economics,Financial crisis,Politics — The Professor @ 11:57 am

I exchanged IMs with Renee yesterday, in which she was describing the attitudes of virtually all of the students in her economic development class towards US debt with China.  She wrote: “people are crazy paranoid about the chinese taking over the US with our dollars. . . . they are all asking, what happens when they call in our debt.”  To which I responded: “They gave us stuff.  We gave them paper.  Pretty good deal.”

Lo and behold, what should I read in today’s WSJ, but an excellent oped by John Cochrane, from my alma mater, the Booth School at the University of Chicago, saying the same thing:

What’s the right policy toward China? They put a few trillion dollars worth of stuff [same word, even] on boats and sent it to us in exchange for U.S. government bonds. Those bonds lost a lot of value when the dollar fell relative to the euro and other currencies. Then they put more stuff on boats and took in ever more dubious debt in exchange. We’re in the process of devaluing again. The Chinese government’s accumulation of U.S. debt represents a tragic investment decision, not a currency-manipulation effort. The right policy is flowers and chocolates, or at least a polite thank-you note.

Yet Mr. Geithner thinks that the Chinese somehow hurt us. There is at work here a strange marriage of Keynesianism and mercantilism—the view that U.S. consumers supported the world economy by spending beyond our means, so that other people could have the pleasure of sending things in exchange for pieces of paper [again–same word choice].

Cochrane is also spot on in skewering the policy Goldilocks who claim to be able to discern what level of trade, investment, and saving is “just right”:

This is all as fuzzy as it seems. Markets and exchange rates are not always right. But it is a pipe dream that busybodies at the IMF can find “imbalances,” properly diagnose “overvalued” exchange rates, then “coordinate” structural, fiscal and exchange rate policies to “facilitate an orderly rebalancing of global demand,” especially using “medium-term targets” rather than concrete actions. The German economics minister, Rainer Brüderle, called this “planned economy thinking.” He was being generous. Planners have a clearer idea of what they are doing.

He also makes a point that I’ve belabored over the past two years, but which I’ve seldom seen in print:

So Mr. Geithner knows that trade surpluses in the end come down to saving and investment. And he knows that in the U.S. people are trying to save right now. Our government is undoing their efforts with massive fiscal deficits. Mr. Geithner recognizes that most of the trade “imbalance” comes down to a big fat fiscal imbalance centered in Washington, D.C.

Abso-effing-lutely.  It drives me crazy (short trip, I know) to hear “analyses” of Keynesian-style stimulus policies that are predicated on the belief that Americans are programmed automatons, rather than deciding, active, acting, and reacting, agents.  They want to restore their ravaged balance sheets, and do so by saving.  They understand, perhaps not intellectually, quoting Ricardo, but certainly intuitively, that expanded government spending today is nothing but tomorrow’s tax bill.  So they react to stimulus, and threats of more stimulus (and “threat” not “promise” is the right word), by making decisions that largely reverse government actions.  Maybe not 100 percent, but substantially.  Which means that the fact that stimulus has not stimulated shouldn’t be surprising to anybody who understands that American households are not inert blobs that can be manipulated at will by Washington mandarins.  (I understand that excludes a good fraction of the 202 area code and vast swathes of the commentariat.)

No, talk of governments or the IMF correctly discerning “imbalances” and crafting appropriate policies in response is like Cochrane says: a pipedream (if not worse).  The main thing that is unbalanced in the American economy right now is the administration’s economic policy, and those responsible for it.  And Timmy! is at the top of the list.

One more thing about the Chinese and debt.  The implicit presumption underlying the fear of Renee’s classmates is that the creditor has the power and calls the tune.  But as far too many of Donald Trump’s bankers have found out to their dismay over the years, if you lend somebody enough, he has tremendous power over you.

With respect to China, we already have the stuff, thank you.  We’ve promised to give you stuff in return in the future.  Just what is the mechanism for enforcing that promise?  This has been the conundrum in sovereign debt markets from time immemorial.  Just look at how the Greeks can tie the Euros in knots.  I’m not saying it will come to this, but insofar as debt is concerned, China is more vulnerable in many ways than the US.  They have the Benjamins, yes, but (a) the amount of stuff the Benjamins can buy is outside of their control (and in the control of another Ben, ironically), and (b) there is always the risk that we tell them that their Benjamins are no longer exchangeable for stuff.

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  1. Problem with this picture of paper-for-junk picture you draw is it neglects three major factors:
    (1) It allowed China to acquire foreign currency with which to pay for resource imports, build up its heavy industrial base at a historically unprecedented tempo, and acquire advanced technologies. (In some of the latter sectors – e.g. renewable energy – it is now outstripping the US and Europe). The US just got a lot of cheap goods that only served to temporarily cushion rising inequality and conceal industrial stagnation.
    (2) China doesn’t much need the US market anymore, as can be seen in it starting to gobble up energy and mineral sources directly, establish bilateral trade deals, and the increasingly dominant role its own domestic market serves to power growth.
    (3) The US derives a lot of advantages from the $’s status as a world reserve currency. Defaulting, as you suggest, would end this. And the US will never manage to get easy foreign credit again.
    I agree with you that China in no way “owns” or threatens to own the US, but that in no way means that the US in the better position in this relationship. If Washington were to approach this as cavalierly as you suggest, it would probably collapse the current international order, and hurt the US far more than China (which would probably just experience a temporary spike in unemployment).

    Comment by Sublime Oblivion — October 26, 2010 @ 12:44 pm

  2. SO, where is he suggesting the US default? He’s stating the obvious, as the trade imbalance grows, the dollar devalues, further increasing the trade imbalance. China is essentially giving the US a dollar today for 50 cents in 20 years. Not to mention, China’s trade and currency policies are having the direct effect of keeping inflation (and thus, the real interest rate) low in the US. Defaulting would also hurt domestic interests more than foreign (Bill Gross/PIMCO and the Fed combine to hold more US debt than any sovereign nation).

    Your foreign currency hoarding point is a myth as well. China has entered into deals in Greece (loan to purchase chinese ships) and Angola (loan to use chinese engineers, steel, etc, in exchange for oil) that are a modern barter system, yes, they are ‘loans’ on paper, but no FX is actually changing hands.

    Comment by Jack — October 26, 2010 @ 1:22 pm

  3. According to the latest stats, China holds $868B of the $4.2T in the hands of foreign entities. Japan holds $836B. A year ago at this time, China held $936B, so (according to U.S. Treasury figures) in the past year, China has been selling U.S. debt, not buying. The Brits quadrupled their holdings of U.S. debt in the past year and the Japanese increased their holdings by more than $100B during the same time period. China bought high and sold low while the Brits and the Japs are buying U.S. debt at relatively cheap prices. If the Chinese are holding less debt this year as compared to last and the overall debt is increasing, the Chinese are less in a position to “take over the US with our dollars” than the have been.

    Everybody settle down and quit panicking about the influence of the Chinese with respect to our economic affairs. The Chinese have their own problems and I wouldn’t trade our problems for theirs. Our external debt per capita ranks well below that of Switzerland, the U.K., the Netherlands, Germany, Belgium, France and others. We need to get our spending under control moving forward, but as it stands today, I don’t think the Chinese are going to dump their debt holdings on the market. If they did, it would cause FAR more economic pain for them than it would for us.

    Comment by Charles — October 26, 2010 @ 4:04 pm

  4. But I do have to ask here: how will the Professor react if the Chinese start desperately shifting those Benjamins that Timmy and Co are – ha ha ha, all your base are belong to us – into physical assets? And companies? Here in the U.S.? Is he gonna freak out like the Kremlins buying up chunks in his back yard? Certain sock puppets have suggested um, no we have the rule of law. But what happens when they get a piece of a tollway? If you object to insane fines for missed tolls, does that become an act of anti-colonialism?

    Comment by Mr. X — October 26, 2010 @ 8:18 pm

  5. Mr. X, your rant against direct foreign investment makes no sense. When was the last time a foreign owner of a tollway sought to remove the tollway from its location and move it to a foreign country? Also, a fine for a missed toll isn’t issued by the owner of the tollway, just as owners of tollways don’t receive revenue from speeding violations on their tollways. My guess is that, if the Chinese wish to move from financial assets and into physical assets, the Professor would be largely indifferent.

    Comment by Charles — October 27, 2010 @ 9:46 am

  6. It’s not a rant against FDI. It’s a rant against the cognitive dissonance between having previously encouraged an aggressive foreign policy towards Moscow if not Beijing and then having a hand out for their investment, ala Hank Paulson and the Bush Administration in mid-2008.

    No one can move a tollway. But Matt Taibbi makes a point that offering 50-75 year leases to foreigners for roads that were once financed with taxpayer revenue just to balance the budget for a few years could end up being a raw deal and lead to higher costs for every trip long term. Even Governor Perry had to back off privatizing roadways that the taxpayers paid for in full in Texas. ‘Privatize the profits, socialize the losses’ – a scheme as old as the pyramids (Wall Street 2)

    Charles, you’ve obviously never been hit with several hundred dollars in fines for tolls you were not allowed to pay before the deadline by a corrupt tollway authority. So don’t talk about it as if you’re a tolling expert. In California an elderly man was fined $75,000 for his scofflaw nephew who had been driving his car without his knowledge.

    If I had been that septugenarian I would have left California and told them to f— off. At a certain point without some defiance the corporatists are going to squeeze Americans to death.

    Comment by Mr. X — October 27, 2010 @ 10:10 am

  7. Mr X, WOW! Where do I begin? “…having previously encouraged an aggressive foreign policy towards Moscow if not Beijing.” Um…so you see the U.S. as an aggressor nation and both Russia and China as being unduly thretened by the big, bad, mean Americans? An interesting view of 20th century geopolitical history, to say the least.

    As for the U.S. “having its hand out for investment” China invests in U.S. Treasury debt for one reason – because China believes it is in China’s best interests to do so (Russia is a third world naton with an economy slightly smaller than that of the State of Texas. Russia is a non-entity when it comes to global economic matters). China doesn’t invest in U.S. debt to reward the U.S. for any foreign policy stance or for any reason other than it is in their interests to make such investments. Private roadways are no different that private railways or private pipelines. We have no problem regulating railway tolls and pipeline tarriffs. We will have no problem regulating highway tolls. And Rick Perry backed off the privitized highway plan because the Trans Texas Corridor plan got shot down by the legislature, not because there was oppositon to privitized transportation infrastructure.

    For the record, I have never been hit with a fine for not paying a highway toll. Private entities do not have police powers, so privately owned tollways cannot enforce fines issued on their tollways. Police powers are explicitly governmental powers, so that old man in California wasn’t being abused by any corporate entity. It was, as usual, the government that was supposedly abusing him.

    Finally, call me when the day comes that “the corporatists squeeze Americans to death.” The defiance you speak of should be directed at the government, not the corporations.

    Comment by Charles — October 27, 2010 @ 11:24 am

  8. The US just got a lot of cheap goods that only served to temporarily cushion rising inequality and conceal industrial stagnation.

    The US getting a load of cheap goods made them an awful lot more wealthy. The benefit of trade comes from the imports, not the exports.

    Comment by Tim Newman — October 27, 2010 @ 3:10 pm


    GE pays paltry amount of corporate tax — I guess those adverts for Obama, er, the MSNBC network, has started to pay off. But seriously, this did start years before Obama and PMSNBC’s lurch to the Left.

    And Charles, you didn’t quite get what I was saying. Certain corporations DO enjoy a preferential status with our Natural State in Washington D.C. — think Google (Uncle Sam start up funding for the world’s largest data mining operation…cough cough), GE (MIC), ADM (stuffs corn starch/syrup in damn near everything and then pretends that people objecting to this and ballooning obesity rates the last thirty years are weirdos – ) and of course, the cherry on top, Gubm’t Sachs. If the Tea Party movement had been smart, it would have picketed these companies HQs and highlighted their privileged relationships with Uncle Sam rather than pretend that the government restricts the American people’s freedoms all by itself. I do not think all corporations are bad not even all large ones, simply that corporatism – the unaccountable merger of state and corporate power – can be very harmful to freedom. And that as you and the Professor and anyone not sticking their head in the sand have noticed, a big chunk of corporate America is just FINE with bailouts and Big Government, it restricts their competitors who don’t have the pockets to hire armies of lobbyists to buy off the regulators. By corporatists squeezing Americans to death, this is exactly what I am talking about. Even the health care monstrosity would not have passed without at least some of the industry deciding that they wanted to lock in their customers for life with the threat of U.S. government fines (which will probably be struck down as unconstitutional, granted). Why do you NEVER hear about ending the Embargo against Cuba and opening up that country to medical tourism? Answer: Big Health Care and Big Pharma don’t want to be undercut by a competitor for senior care dollars 90 miles away. All the other explanations – Big Sugar, continuing resentment against Castro for placing Soviet missiles against Cuba and his human rights violations — pale in comparison.

    “Um…so you see the U.S. as an aggressor nation and both Russia and China as being unduly thretened by the big, bad, mean Americans?” Not really what I said, no, but I do see some serious tit for tat and perhaps very soon a permanent Chinese military presence in the Western Hemisphere, probably in Venezuela, even if it’s out of uniform PLA (how about Dragonwater instead of Blackwater?). Which the Professor will deny from here to eternity (along with most mainstream non Ron Paul conservatives) that it has absolutely nothing to do with our presence in Afghanistan, Kyrgizistan, or anywhere else. Because our motives are always good and their motives are bad, and the rest of the world would see it that way if it wasn’t for the weak-kneed paintywaist crypto-commie community organizer in the White House. Now I have no use for Obama apart from the ‘reset’ and a few other foreign policy moves. But in Professorland, nations don’t engage in tit for tat, like, ever. America is not just exceptionalist but permanently exceptional. Chickens never come home to roost, and blowback, etc they don’t exist. We have never created a single new terrorist by dropping a bomb on the wrong house. Defense spending shouldn’t be cut one iota and if those Tea Baggers insist the whole budget has to be on the table for Washington to be serious on deficit reduction they too should be mercilessly flogged as wanting to cut off the troops, etc.

    When even Walter Russell Mead, one of the thinkers the Professor likes to cite, is scratching his head wondering why the Georgians created visa free travel with Chechnya, well…maybe someone should show Walter ‘Plan Kavkaz’ or at least introduce him to the concept of ‘Prometheanism’ and the set in D.C. that promotes it. There’s our government which supposedly warned Saakashvili and duly follows the Commander in Chief’s priority of ‘reset’ with Russia — then there’s this weird quasi-governmental foreign policy making gang that hangs out in front groups like the ‘American Committee for Peace in the Caucases’ (what’s next, a Chinese Committee for a Free Texas?), never seems short on cash either taxpayer provided or from defense contractors (Frank Gaffney), and seems hellbent on turning back the clock with provocations (who told the Georgians to do that? You really want to convince me no one in Tblisi whispered in their ear?).

    It’s not so much Jamestown — they may be but one small fish, paymasters of Kim Zigfeld or not — as who’s stirring the soup in which they swim, and what’s the connection between ZBig and Daddy Warbucks Soros.

    Say what you will about ‘the Natural State’ in Russia versus Corporatist America, but at least Gazprom provides heat and power to millions of people in return for being a national champion — and managed to be the most profitable natural resource firm in the world in 2009, according to Fortune magazine. What the hell has Goldman Sachs done for anyone but itself? Even their BRIC fund has been a net money loser since it started.

    Comment by Mr. X — October 29, 2010 @ 12:47 pm

  10. “The implicit presumption underlying the fear of Renee’s classmates is that the creditor has the power and calls the tune.” And this is really the heart of the matter and of the Professor’s post. The overall claim is, “Don’t worry about how much debt we owe them, it’s a bigger problem for them for us, and least of all, that this debt will force any changes in American foreign/defense policy.” That’s the subtext here and it’s not one I buy into. Yes economic chaos in the U.S. could also hurt China badly, but as everyone knows they’re much more willing to use force to keep order than our own government (yet!).

    Comment by Mr. X — October 29, 2010 @ 1:03 pm

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