China. China. China. And the US dollar.
I wish the US government, along with all its subsidiaries and pro-government idealists would calm down about China. As long as China continues down the path of government-mandated loans, non-market based supply manipulation, and all the other games and number fudging it plays, we need to worry more about the political and military threat it poses rather than the financial. Instead, we should worry about our own internal policies that are moving in the wrong direction – namely, away from market-based practices and an increase in government debt that is unsustainable. That’s our own fault, not the Chinese government’s fault. Now, many readers have gone ga-ga for China, so I wanted to share some history. I took an article (see link at the end) from a few years ago, and replaced China wherever it mentioned the other country’s name. My reaction is at the end. Here are a few highlights:
Containing [China]
[China]‘s one-sided trading will make the U.S.-[Chinese] partnership impossible to sustain—unless we impose limits on its economy.
…[China] is more important to the United States, in more ways, than Saudi Arabia or most other countries will ever be. Yet [Chinese]-American relationships have a fragile, walking-on-eggs quality, which makes people think that it’s dangerous to talk frankly in public. Many other international relationships are robust enough to survive open discussions of disagreements; during the nasty little “beef hormone” war early this year, for example, no one imagined that the United States and the European Community were about to turn their backs on each other. But the American fraternity of [China]-handlers, which includes most diplomats and a number of businessmen, scholars, and journalists, instinctively stifles outright complaints about [China].
…Now, however, [China] has become too important to be treated with such delicacy. Excessive politeness prevents [China] and the United States from facing the conflict that in the long run endangers their relations much more than the comments of any bigoted [China]-bashers could.
For the foreseeable future [China] will be America’s single most valuable partner, because of what it can do in three areas. First is the U.S.-[China] military understanding…Second is finance: [China] has become America’s financier, providing investment capital and covering much of the U.S. government’s debt. Third is business: [Chinese]-American business relations provide technology, markets, talent, supplies, and other essential elements to both nations’ companies.
These three realities tempt many people, especially American diplomats, to assume a fourth: that [Chinese] and American interests do not clash in any fundamental way. This assumption is wrong. There is a basic conflict between [Chinese] and American interests—notwithstanding that the two countries need each other as friends—and it would be better to face it directly than to pretend that it doesn’t exist.
That conflict arises from [China]‘s inability or unwillingness to restrain the one-sided and destructive expansion of its economic power. The expansion is one-sided because [Chinese] business does to other countries what [China] will not permit to be done to itself. It is destructive because it will lead to exactly the international ostracism that [China] most fears, because it will wreck the postwar system of free trade that has made [China] and many other nations prosperous, and because it will ultimately make the U.S.-[Chinese] partnership impossible to sustain.
The [Chinese] do not desire any of these results, or the erosion of American power that would go along with them. Despite their pride, veering toward arrogance, about what [Chinese] business has achieved, most [Chinese] would feel more comfortable with a United States that is strong, stable, and rich enough to remain the No. 1 of the non-communist world. (Much more frequently than Americans, [Chinese] talk about nations holding No. 1 and No. 2 positions.) [China]‘s twentieth-century history in Asia implies that it will be much better accepted as an economic power and cultural force than as a major military power. As a diplomatic leader, [China] is still reluctant and inexperienced. It has given the world an example of what hard work can do, but in general [China] prefers to focus on its own affairs and let other countries proselytize for democracy, capitalism, communism, or whatever else they believe in. Most [Chinese] politicians say that they would like to leave non economic initiatives to the United States—if the United States can afford them. Unfortunately, the major external threat to America’s ability to pay the costs of leadership is [China]‘s uncontrolled, unbalanced economic growth. To keep a world trade system going, the strongest powers must be willing to make certain sacrifices—for example, keeping their own markets open, despite domestic political objections, as the British did during their free-trade heyday and as the United States has on the whole done since the end of the Second World War. ([Chinese] and Korean politicians now complain about American “protectionism,” but how protectionist can a country with a $10 billion monthly trade deficit really be? [ It’s much higher now!!]) [China] shows very little inclination to make these sacrifices itself, and its continued expansion will in time weaken the ability of the United States to do so.
Friends must sometimes help friends break destructive habits. [China] is in a good position to lecture the United States about its destructive business and financial habits, and more and more [Chinese] officials have been doing just that. But [China]‘s destructive habits are potentially more harmful to the rest of the world than America’s are. If [China] cannot restrain the excesses of its own economy, then the United States, to save its partnership with [China], should impose limits from outside.
…There is one further indication of economic imbalance: the continuing pattern of one-sidedness in many [Chinese] transactions. A few years ago the management expert Peter Drucker introduced the term “adversarial trade” to describe [China]‘s approach to commerce, which is characterized by resistance to high-value imports and by targeted attacks on established foreign industries. The contrast with Germany is instructive. Like [China], Germany chronically runs a large trade surplus; exports actually represent a higher proportion of its GNP. The reason there are fewer complaints about Germany, however, is not simply that it imports much more than [China] (20 percent of its GNP, versus [China]‘s six percent) but also that it imports more valuable things. Three fourths of the goods that Germans (and Americans and most Western Europeans) import are manufactured products; less than half of [China]‘s imports are. Germany’s trading patterns are similar to those of most other developed countries—Germany is simply more successful at carrying them out. [China]‘s are the exception. [China] is now starting to import more manufactured goods, but from a very low base.
Money Politics
IF NORMAL MARKET FORCES WON’T MODERATE [CHINA]‘S expansion, what about outright political control? For more than five years [Chinese] leaders have said, with seeming sincerity, that they want to reduce their nation’s trade surplus sharply, since it is the source of 90 percent of the ill will that [China] encounters in the world. So far their efforts have made little or no difference, because the basic elements of [Chinese] politics—the flow of money, the balance of power, and the underlying structure of ideas—all push the economy ahead on its unbalanced course.
…Capitalistic trade is not supposed to be reciprocal on the small scale. I buy from the local grocery store, and it doesn’t buy anything back from me. But capitalist theory assumes that life will be reciprocal in a larger sense. Each of us specializes in certain functions, and we use our earnings to buy from those who specialize in something else. This model, more or less unchanged since Adam Smith set it out in the Wealth of Nations, stands in contrast to several other ideas of how economic systems should work. One is the primitive-village model, in which small groups of people produce everything they want to use. Another is the mercantilist system that Adam Smith was directly attacking, in which the Spanish and Portuguese empires tried to store up as much gold as they could, rather than frittering any of it away in trade. And the latest and most relevant is what Chalmers Johnson calls the “capitalist developmental state,” whose prime example is [China]. Here the government uses a number of strategies to suppress consumption, channel personal savings to industrial investment, and convert industrial competition into a ratchet-like process. In the industries where the country has a lead-in [China]‘s case, consumer electronics and autos—it holds on to the lead, and in areas where it lags, it discourages imports until its own industries can grow. [Chinese] corporations typically compete with each other in every product line—each beer maker produces a draft beer, a “dry” beer, a lager, and so on; each electronics company tries to produce a full range of radios, TVs, and fax machines. Successful [Chinese] students are expected to get top marks in every subject; star pitchers in [Chinese] baseball often burn out early because they are expected to pitch in practically every game. Trying to be on top in every field, rather than specializing in some and leaving the rest to competitors, is a stronger impulse in [Chinese] society than in most others, and is the rule that [China]‘s trade policy appears to follow.
Americans may complain about the decline of their steel and semiconductor industries—that is, areas where the United States once enjoyed a lead and has had to watch factories shut their doors. But few Americans really think it is a problem if we have to buy our entire supply of CD players from overseas. The United States has no government project under way to create a domestic fax industry, and when government guidance is proposed—for semiconductors, high-definition TVs, and superconductors—it is always controversial. [China] acts differently.
What Will Change
WHAT PRECISELY IS THE DANGER FROM CONTINUED [Chinese] expansion? Some people say there is no danger at all. Three lines of reasoning lead to such a conclusion.
The first is that whether or not the expansion can be controlled, it is about to end. Many [Chinese] people, temperamentally pessimistic even though their country has repeatedly surmounted prophecies of doom, fall into this camp. So do some outside observers… The population will soon have the world’s highest proportion of retirees and will be using up some of the savings it is amassing now; Korea and Taiwan will exert unrelenting pressure; at some point the [yuan] may rise so far that it actually does price [Chinese] exporters out of the world market. And let’s not forget the next big [natural disaster]. In addition, certain divisions are opening within [Chinese] society, which could eventually impair the country’s ability to sacrifice, invest, and grow. Besides cynicism about [China]‘s money-politics system and the rise of an affluent and perhaps less self-sacrificing yuppie generation, a noticeable gap is opening up between [Chinese] haves and have-nots. This class divide has to do mainly with land ownership-land has become so expensive that people who do not inherit it from their parents can probably never afford their own house—but also with education, which is becoming stratified. In theory, such developments could limit [China]‘s growth quite soon. However, the limits are still purely theoretical; no symptom of slowdown can yet be observed. By every measurable indication—corporate profit, personal savings, industrial productivity—[China] is distinctly on the rise.
According to the second line of reasoning, [China]‘s expansion cannot, by definition, be threatening to anyone else, since it merely increases the wealth and welfare of customers in the rest of the world. This is the classic free-trade view, which often guides U.S. government policy toward [China] and which dominates the view of the American media. On its own narrow terms, it is obviously correct: consumers are always better off with fewer restrictions on trade. Indeed, the main reason American consumers now live so much better than those in [China] is that U.S. policy has hewed closer to free trade.
Inconveniently, offering consumers the best price is not the only thing involved in building a good society. Permitting children to work in garment factories, for instance, would lower the price of shirts and help the American consumer, but it is against the broader national interest. In the case of [China]‘s expansion, the harm comes from the erosion of numerous elements of American strength, especially those being left to erode because of a sense that the United States is so deep in debt that it can’t afford to do many of the things a leading power should do—explore space, improve its schools, maintain its military bases in [China] so that [China] doesn’t build its own army, and so on.
From the strict free-trade perspective, not even the accumulation of debt is necessarily a cause for worry. The borders between [China] and the United States are increasingly artificial to corporate managers and to consumers, who buy Sony Walkmen in Chicago and McDonald’s hamburgers in Tokyo. Perhaps the borders should be ignored in observing capital flows as well. No one cares about the Texas state “deficit” relative to Illinois; we concentrate on how individual firms are doing. Some [Chinese] internationalists suggest that the overall U.S.-[China] balances should also be overlooked. This is noble-sounding and forward-looking, but the fact is that [China] and the United States still are two separate nations, and America’s ability to pay its own way still is the basis of its strength. The United States can’t tax the [Chinese] to pay for its military—it can only borrow. Until national borders really don’t matter, America’s ability to meet its commitments will depend on its own solvency, not on the size of the combined U.S.-[Chinese] capital pool.
This is related to the third line of reasoning: that reasonably soon the borders between [China] and the United States will for all practical purposes disappear. [China] and the United States, which already interact closely in business and the military, will integrate themselves in other ways and, despite remaining separate countries, will function essentially as one unit.
Anyone who has spent time in [China] will recognize how attractive such a merger would be. These two countries, with their respective economic strengths, technical skills, political ideologies, and sources of social resilience, make up two complementary halves of the mightiest possible superstate. I would be delighted by the creation of a hybrid U.S.-[Chinese] state. For all its difficulties, [Beijing] is a more stimulating place to live than almost any city in America. I would rather work with my best [Chinese] friends than for most companies in the United States, and would rather bind [China]‘s strengths to America’s than view [China] as a threat. But like most other foreigners who have lived in [China], I consider such a de facto merger impossible, because of social resistance on the [Chinese] side.
…I admire the idealists and hope they turn out to be right, but nothing I have seen so far makes me believe that they will.
…Unless [China] is contained, therefore, several things that matter to America will be jeopardized: America’s own authority to carry out its foreign policy and advance its ideals, American citizens’ future prospects within the world’s most powerful business firms, and also the very system of free trade that America has helped sustain since the Second World War. The major threat to the free-trade system does not come from American protectionism. It comes from the example set by [China]. [China] and its acolytes, such as Taiwan and Korea, have demonstrated that in head-on industrial competition between free-trading societies and capitalist developmental states,” the free traders will eventually lose. The drive to break up the world into trading blocs—united Europe, North America, East Asia—is largely fueled by other countries’ desire to protect themselves against [China]. Even in their own inroads into the [Chinese] market, foreigners are tempted to settle for a small place [role]…rather than pushing for truly open competition in [China]. The ideal of free trade retreats, as the states that don’t really believe in it expand.
THE PURPOSE OF THIS ARTICLE IS TO MAKE THE CASE for containing [China]‘s expansion, rather than to discuss specific means of containment. The specifics will be the subject of a future article. But merely recognizing that American and [Chinese] interests do conflict is in itself an essential step. It frees us of the delusion that normal business competition will balance out whatever is unbalanced now.
Of course America needs to reform its own corporate practices, improve its schools, and reduce its debt. Of course our economic goal should be an open free-trading system around the world, not escalating trade barriers. Of course we have no business telling the [Chinese] how to run their own subtle, sophisticated society. But we do have the right to defend our interests and our values, and they are not identical to [China]‘s.
The article is much longer and I cut out as much as I could. I did my best to maintain the flow of the article with the changes in [] for clarity. Please click here for the full article. It was written by James Fallows in The Atlantic Monthly in 1989…about Japan! The fear of Japanese expansion was palpable. In the article, Fallows talks about the trend in trade and the continued dependence of the US government on Japanese financing. And of course, the final paragraphs encouraging active retribution, protectionist measures, and even military options is not surprising.
We all know how this ended. The Japanese miracle was ending, and Japanese economic expansion was halted. Japanese purchases of US assets with overvalued currency ended up being incredible burdens on Japanese firms, especially banks, for decades, in fact, they continue to this day.
What should have been the course of action: continued open markets, low tarrifs, encouragement of free trade, and an investment in US infrastructure and education. What should be our policy now towards a seemingly unstoppable economic superpower?
So I might be early in saying that Chinese economic might will be waning, but it will come. And I anticipate that it will come soon.
Charts, Connect The Dots, General, Strategy/Allocation | Yaron Sadan | 
October 30, 2010 7:05 pm | 
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