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Oct 12 2011

The Myth of the Chinese Loan Shark

Every time I hear a politician from either party blather on about how we have to “borrow money from China” for any deficit spending, or suggest that we are somehow at the mercy of the Chinese because they own so much American debt, I cringe. I cringe both because it isn’t true and because it is classic fear-mongering (precisely because it isn’t true). Daniel Blumenthal debunks this claim in Foreign Policy:

In fact, China is more like a depositor. It deposits money in U.S. Treasurys because its economy does not allow investors to put money elsewhere. There is nothing else it can do with its surpluses unless it changes its financial system radically (see above). It makes a pittance on its deposits. If the United States starts to bring down its debts and deficits, China will have even fewer options. China is desperate for U.S. investment, U.S. Treasurys, and the U.S. market. The balance of leverage leans toward the United States.

China owns 8% of American debt (treasury bills). They can’t “call it in” as I’ve heard suggested by some terribly ignorant people; those instruments have fixed payback schedules. The most they could do is sell them off to other investors, but A) they have very good reasons not to do so; and B) that would only temporarily and marginally depress the value of those bonds. It is China’s manipulation of its currency to keep it artificially low and therefore keep their products artificially cheap that is a problem for us, not the fact that they buy up a small percentage of our debt on the open markets.

Blumenthal is also correct when he points out that we have far more to fear from a China in decline than a China that is growing richer.

20 comments

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  1. 1
    Randomfactor

    You mean there’s nuance in international relations? However will we put THAT on a bumper sticker?

  2. 2
    Marcus Ranum

    we have far more to fear from a China in decline than a China that is growing richer.

    And China has far more to fear from a US in decline…

  3. 3
    Ben P

    The only point I’d quibble with is the “temporarily and marginally” as it pertains to the effect on US Debt if the government of China were to put its holdings of US Currency on the market all at once.

    Putting 8% of the US’s $14 trillion public debt (about $1.12T) on the market all at once would significantly affect the US treasury prices in the short term.

    But that’s exactly why China can’t do it in a short period of time. They might get market rates for the first $300B or so in currency, but they’d have to take steeper and steeper discounts to unload the rest of it. They’d get killed on the deal, and their counterparties would gladly snap up billions in US Treasuries at a discount.

    The real risk is more going forward that if China does change its system and moves to another reserve currency, it becomes harder for the US to borrow additional money and the interest on treasuries goes up, which causes inflation.

  4. 4
    Deen

    The most they could do is sell them off to other investors

    Well, they could also decide not to buy new ones when the old ones are repaid. But they wouldn’t really have a reason to do that either, for the same reasons you list.

  5. 5
    dochopper

    Its not the Debt as much as it is our manufacturing that we sent over there that is causing the problem.

  6. 6
    jameshanley

    Agreed with all of the post except this:

    It is China’s manipulation of its currency to keep it artificially low and therefore keep their products artificially cheap that is a problem for us,

    That’s not a problem for us at all. It means we can afford more goods, which is what the real definition of wealth is.

    Does it destroy American jobs? Well, they may outcompete us for certain specific jobs, but they don’t affect the overall number of jobs. And if we didn’t buy those certain goods from China, we might buy them from South Korea, or Vietnam, or Maylasia, or Canada, etc.

    Also, a lot of those “artificially cheap” products are inputs for products that are completed in the U.S. Forcing the price up hurts those U.S. manufacturers.

    Ultimately, lower prices are what we want. China is effectively subsidizing, at its own cost, our purchases. That’s good for us, not bad.

    And while it’s hard to see from our current employment trough, over the long run importing goods has no meaningful effect on the employment rate. Through the ’90s and mid 200s, as imports zoomed, the unemployment rate remained very low. And that was true even though we had very high immigration growth, meaning we were creating new jobs faster than the population was growing, even though we were importing record amounts.

    In fact the evidence shows that in the U.S. strong economic growth has been associated with high trade deficits, and weaker growth has been associated with lower trade deficits. So, no, China keeping the price of its goods low doesn’t harm us at all.

  7. 7
    jameshanley

    dochopper,

    Before the current recession, U.S. manufacturing output was at record highs. Employment in manufacturing had dropped, but the value of our manufacturing output continued to climb, because of productivity.

    The manufacturing jobs that were outsourced (and everyone who talks about outsourcing predictably fails to take a look at how much work is ins-sourced to the U.S.) were the low-value ones. Bringing them back in would increase the prices of those goods, meaning consumers would either choose to do without them, or in order to buy them would have to choose to do without something else. That ultimately doesn’t help the economy at all.

  8. 8
    Stevarious, Public Health Problem

    Also it’s important to note how much of this ‘good’ or ‘bad’ for America is at the expense of other peoples. We benefit, sure, but some Chinese people suffer in conditions that we wouldn’t allow our dogs to suffer so that Chinese industry can undersell the competition.

    Which is bad.

  9. 9
    addiepray

    Also, Chinese loan sharks are rare because of soup.

  10. 10
    gingerbaker

    james hanley:

    “…The manufacturing jobs that were outsourced (and everyone who talks about outsourcing predictably fails to take a look at how much work is ins-sourced to the U.S.) were the low-value ones. Bringing them back in would increase the prices of those goods, meaning consumers would either choose to do without them, or in order to buy them would have to choose to do without something else. That ultimately doesn’t help the economy at all.”

    ???

    But those consumers would have more money to buy those goods, because millions more of them would be working.

    Reclaiming lost jobs would be bad for the economy? Really? Your argument sounds like it leapt from the mouth of a WalMart spokesman.

  11. 11
    harold

    James Hanley –

    I’m inclined to take a position intermediate between yours and the one you are disputing.

    I’d also like to add a point that neither you nor Ed has made.

    Chinese manufacture isn’t competitive merely because of currency manipulation, container ship transportation, etc. It’s also able to offer low cost goods because Chinese people receive relatively poor compensation*, China has poor workplace safety regulations, and China has mixed but overall not very good environmental regulations (despite some programs for show and overall very high cultural support for environmental preservation).

    *I had better address the “cost of living” argument before it comes up. Cost of living is high in fully developed countries because it’s more or less impossible for most people to opt out of public health regulations, housing standards, electricity and plumbing, workplace safety standards, etc. People don’t live on $1 a day or $1 an hour in the developing world because everything where they live is magically cheap. They live on those amounts mainly because they have a much lower standard of living and lack much that we take so for granted that we forget to count it.

    Most of what you say is pretty mainstream, and I probably would have agreed with all of it ten years ago.

    In fact the evidence shows that in the U.S. strong economic growth has been associated with high trade deficits, and weaker growth has been associated with lower trade deficits.

    The economic growth could be causing more indulgence in imported goods.

    So, no, China keeping the price of its goods low doesn’t harm us at all.

    I think the US has bigger problems than Chinese imports.

    However, for both ethical and strategic reasons, I think that Chinese imports present some problems.

    On an ethical level, I oppose completely free trade with nations that don’t have acceptable labor standards and environmental regulations. It isn’t really free trade. They’re manufacturing in a way that would be illegal in the US.

    On a strategic level, there doesn’t seem to be a “post-industrial” model that works well for society.

    One science fiction scenario which seems guaranteed not to come true is the scenario of humans not needing to work, or not work much, yet living comfortably.

    It doesn’t happen, because societies resolutely refuse to distribute wealth except by payment for work, inheritance, investment/speculation gain (much of which is zero sum and by definition, while beneficially creating liquidity, merely redistributes from loser to winner), or through very low subsistence payments to some needy people.

    American society requires, unless something strange happens, that Americans have jobs, because a job is the only way a typical American has access to a significant income. Only a small proportion inherit enough to live comfortably on, you can’t invest or speculate unless you already have money (and can’t base an economy on zero sum speculation), and welfare is neither adequate nor available for most people.

    So rising productivity can actually pose a major problem.

    I realize that you said that imports don’t reduce local jobs. I don’t think that’s always true, but I won’t argue that general principle (here).

    However, I will note that industrial economies created a spectrum of jobs, with low barriers to entry into the middle class. Jobs tended to pay decently and be quite secure. This carried over from industrial settings, and was the case for white collar jobs as well.

    “Post-industrial” economies, even while demanding more education, tend to create an unevenly dichotomous situation, with a small layer of elite “management” jobs paying a great deal, and a vast majority of jobs being insecure and poorly paid. A few professions like medicine, dentistry, engineering and accounting, occupying a small percentage of the work force, remain comically “in the middle”, better off than most but very poorly paid, given years of education and training, relative to the executive class. Members of these remaining “middle class” professions often try, with varying degrees of success, to join the executive class. (Please note that by “executive class” I am not referring to shareholders; in fact, grotesque executive pay essentially comes out of the pockets of shareholders, unless a “bailout” takes it out of the pockets of the general taxpayer.)

    Executive class membership is not defined by hard skills. Most Americans have a fair idea of what they would have to do to become a neurosurgeon, or could easily learn. The barriers are almost exclusively ability, willingness to sacrifice, and to a lesser extent, age (due to the length and physical rigor of training). A neurosurgeon earns about as much as a low paid CEO at a fairly small company. You can try to start your own company, but for an average person, the path to becoming a member of the executive aristocracy is most unclear, and the requirements are vague enough to assure that outsiders can be kept out. Certain educational institutions are associated with the executive class, but they are arbitrarily competitive (i.e. even after achieving highest academic record you may be turned down), overtly favor “legacy” admissions, and even then, many people who attend these institutions don’t make it into the executive elite.

    The executive class is said to “create jobs” and “create wealth”, but except for a few highly inventive entrepreneurs like the late Steve Jobs, the mechanisms for this are very unclear.

    German or Dutch executives earn far less, yet it is unclear why American corporate executives should be considered to “manage” five, ten, or more times better.

    What point am I making? The ability to “offshore” work to nations with poor labor conditions has increased the power of management at the expense of the rest of society.

    It’s interesting to note that one might have expected it to increase the power of shareholders (owners); however, in fact, it has been the executive management class, whose roles are neve offshored, who have benefited.

  12. 12
    jameshanley

    gingerbaker,

    But those consumers would have more money to buy those goods, because millions more of them would be working.

    But all those who currently have jobs, with is over 90% of them, would be forced to spend more on those items, meaning less spending elsewhere, and more jobs lost in other areas because of it.

    You want to know whose my authority on this? Paul Krugman, who, writing about NAFTA, said (slightly paraphrased as I don’t have the book with me right now), “Here’s my prediction for what the unemployment rate will be after NAFTA passes–whatever Alan Greenspan wants it to be, plus or minus a a few tenths of a percent to account for the fact that he’s not quite God.” So, okay, replace Greenspan with Bernanke, and there you go.

    Reclaiming lost jobs would be bad for the economy?
    Yes, if they drive up consumers’ expenses so that they have to cut back somewhere else. Take any product you personally desire, and assume there’s a price increase. That may be great for those who produce that product, but where does it leave you? Your choices are 1) to not buy the product at the higher price, in which case you’re not supporting those jobs; 2) to buy the product at a higher price and not buy something else, in which case you’re not supporting the jobs of those who produce the something else; or 3) buy the product, but the something else, and reduce your savings, in which case you’re reducing your future spending power (and possibly not supporting jobs in whatever sector of the economy your saving would have been borrowed to invest in).

    The jobs we’ve lost will be replaced. It has always happened when any given set of jobs disappear, and as gloomy as things look now, there’s no reason to think it won’t happen again. It just sucks for those who are caught in that transition, and assistance to help tide them over is justified. But protecting them from competition by telling consumers how much they have to pay for products is not justified, either ethically or economically. If it is, I’m going to start lobbying my state legislature to require that all Michigan college students must buy their education in state, to help ensure that my employer always needs my services.

  13. 13
    jameshanley

    Harold,

    On an ethical level, I oppose completely free trade with nations that don’t have acceptable labor standards and environmental regulations. It isn’t really free trade. They’re manufacturing in a way that would be illegal in the US.

    I agree that they’re manufacturing in a way that would be illegal in the U.S. Whether that means it’s not free trade is really a definitional issue, so I’ll set that aside. Where I disagree is with your ethical position. The only thing that’s ever led to better quality labor standards and environmental regulations is a relatively wealthy population. Cutting off trade with China helps keep them poor, and helps prevent the development of higher labor and environmental standards. I think that would be unethical.

    “Post-industrial” economies
    Since, barring the recession, the U.S.’s industrial output has continued to rise, I will take on the definitional issue here. The U.S. is not post-industrial. We just use a smaller proportion of our labor supply to produce that output, meaning we have more labor available to do other things. Sure, we could go back to using more labor to produce our industrial output–that would mean a) there’d be less labor to fill other jobs; and b) our products would not be competitive on the world market.

    The only way societies have ever produced more wealth is through increasing productivity. Asking for lower productivity is asking for reduced wealth.

  14. 14
    bexley

    It is China’s manipulation of its currency to keep it artificially low and therefore keep their products artificially cheap that is a problem for us, not the fact that they buy up a small percentage of our debt on the open markets.

    Err Ed, China keeps its currency artificially low by buying foreign denominated (including US) debt and building up hige foreign currency reserves. So China buying up lots of US debt is indeed a problem, just not for the reasons the nutbags claim.

    @ 12,
    James, Krugman disagrees with you:

    http://krugman.blogs.nytimes.com/2011/10/02/the-renminbi-and-us-manufacturing/

  15. 15
    harold

    James Hanley –

    If you’re reading something in a way that makes the writer seem very stupid, please stop, and ask yourself “Am I interpreting this correctly?”. I did not say the very stupid things that you accuse me of saying.

    Cutting off trade with China helps keep them poor, and helps prevent the development of higher labor and environmental standards. I think that would be unethical.

    I did not suggest that I adhere to a false dichotomy of “unrestricted trade” versus “cutting off trade”, so why do you put the words “cutting off trade” in my mouth?

    However, I think we do need to take labor conditions into account (*this is not the equivalent of saying that we should “cut off trade”*). Here is why – when labor in developed countries successfully achieved better conditions, the people who provided the labor were also frequently the market for the goods. Also, despite the brutal treatment of early labor activists, China may well be more authoritarian even than the nineteenth century US.

    Chinese workers don’t necessarily have that advantage. No-one ever needs to care, in terms of a short export efficiency, whether significant numbers of Chinese can afford the goods they produce, or would buy them.

    Ideally, China should develop that way (albeit, of necessity, in a more environmentally sustainable way than the US developed). However, since Chinese workers don’t have the advantage of also being the major consumers of their goods, we, who do consume them, might consider conditioning some of our consumption on improved conditions.

    As for the ethics of hypothetically cutting off trade, we’ll have to disagree – I don’t recommend it, but the US does have the right to trade with whoever we want.

    The only way societies have ever produced more wealth is through increasing productivity. Asking for lower productivity is asking for reduced wealth.

    This is flat out insulting. You seem to suffer from a self-serving bias that causes you to misread what others say, in a way that allows you to perceive them as substantially stupider than you.

    No reasonable reader could conclude that I advocated lower productivity.

    I made a very important, if subtle point – one that you ignored. I pointed out that, unless there are substantial unexpected social and cultural changes, for the time being, the vast majority of Americans of working age need full time jobs. This is because American society distributes wealth only as a reward for work, on in other ways that are not accessible to or adequate for most people (inheritance, successful speculation, welfare).

    Of course we want productivity to increase, but we have to remember that with increased productivity, we still need to maintain high employment, and/or (far less likely) redefine full time employment. Otherwise, increased productivity, although a good thing in isolation, and although decreased productivity is always bad, could lead to social chaos.

    Sorry if I seem mildly irritated. It’s one thing to be misunderstood, and another thing to be misunderstood in a way that is insulting.

  16. 16
    jameshanley

    Bexley,

    I was quoting Krugman, so, no, he doesn’t disagree with me, he disagrees with himself. And his professional reputation has suffered as a result.

    Harold,
    I sincerely did not mean to misinterpret you. We can, indeed, try to pressure China to do better, but I don’t think that has anywhere near the power of internal pressure. I think U.S. pressure would ultimately be nothing substantive, just political posturing. Let China grow wealthy; the Chinese will make their own demands on the government.

    As to productivity, no, you didn’t argue for lower productivity, but you expressed concerns about higher productivity. Yes, some people won’t do well, and for most of them it’s because in a more highly productive economy they will lack the skills. There are Americans whose skill levels are about the equivalent of a new immigrant without an education or English language skills. They need to stop fucking around and start getting serious about improving their skills, instead of expecting that politics is going to hand them a solution to the challenge of competition.

    And in fact, contra your concern, we have maintained high employment with increasing productivity, all through the ’80s, 90s, and ’00s. The current recession is not the long-term outlook, despite what the pessimists say.

    American society distributes wealth only as a reward for work,
    And a good thing, too. I believe in taking care of the poor who are unable to take care of themselves, but it’s a hell of a lot better to get the poor into work whenever possible. If America did distribute its wealth primarily in any way other than as a reward for work, we’d decline rapidly. So of course people need jobs, but except for recessions, Americans do have jobs. Productivity has not reduced the number of jobs. Productivity cannot reduce the number of jobs, because it creates more wealth, which is going to get fed back into the system, where it is ultimately going to create more jobs.

    So, while I did not mean to misinterpret or insult you, I remain strongly opposed to your argument.

  17. 17
    bexley

    Bexley,

    I was quoting Krugman, so, no, he doesn’t disagree with me, he disagrees with himself. And his professional reputation has suffered as a result.

    Well either Krugman is an expert in which case you should note that his most recent position disagrees with yours or he isn’t in which case you don’t get to quote him backing your position on 12. What you don’t get to do is claim that Krugman’s opinion should be trusted when he agrees with you and then to claim he’s a poopyhead to be ignored when he disagrees.

    Second I suggest you actually read the article because:

    1. He argues that “there are real effects on the US if production moves, say, from China to Mexico. To an important extent, global manufacturing is carried out by regional complexes — an Asian complex centered on Japan and China in effect competes with a North American complex in which labor-intensive stuff is done in Mexico or Central America.”

    Therefore the NAFTA argument is far less analagous to the Chinese argument.

    2. Krugman is arguing that things are different because the US is in a liquidity trap. See this article making this more explicit:

    http://krugman.blogs.nytimes.com/2011/10/03/more-on-china-and-jobs/

  18. 18
    jameshanley

    Bexley,

    Well either Krugman is an expert in which case you should note that his most recent position disagrees with yours or he isn’t in which case you don’t get to quote him backing your position on 12.

    Krugman is an expert. He was also an expert when he wrote what I quoted. His current analysis is supported by some other experts, and his former analysis is supported by many other experts. So I disagree with expert Krugman now, and agree not only with expert Krugman then, but with lots of other economics experts now.

    If you read your linked blog post carefully, you’ll see that that Krugman notes that he still is a free trader, he just thinks, as you note, that a liquidity trap is one of those rare occurrences when things are different and the normal rules of economics don’t apply. On the other hand, if you start poking around the econ blogs, you’ll see not everyone agrees (either about the U.S. being in a liquidity trap, his argument that monetary policy doesn’t work in a liquidity trap, or that other normal laws of economics are suspended in a liquidity trap; there’s also reason to think Krugman has inappropriately redefined the term).

    But set others’ disagreement aside. Let’s say the government took Krugman’s advice and engaged in a $1 trillion fiscal stimulus policy, and let’s say further that this policy worked as Krugman argues it would work. What would be the result? Liquidity trap gone, normal economic rules back in place, and Krugman arguing for free trade with China again. That is, Krugman’s advice is that we move as quickly as possible back to the position where the normal rules once again apply and there’s no reason to worry about what China’s doing with his money.

    You may also notice that Krugman’s argument in that post is a bit vague. Is he actually claiming that multiplier effects only come into effect during a liquidity trap? He can’t be–and I mean I would wager heavily that if someone suggested he was, he would call them an idiot for thinking so–and yet that’s how his post is written. If all he really wants to say is that replacement jobs are going to appear more slowly during a serious recession, well, then he’s just saying something really bland and obvious.

    For an alternative take, that provides a much deeper argument that really takes Krugman to task on his yuan comments, see this Scott Sumner post.

    Overall, the point is that Krugman now is contradicting Krugman then, but the Krugman of then has much more support among economists. Sure, he’s damned intelligent, and maybe he’s seen some new information. But there are plenty of other economists who are just as smart (just not as well known) and who aren’t at all persuaded by him. In fact one Chicago economist argues that Krugman is simply unfamiliar with the last several decades of macro economic research. I can’t give any more links, but google John Cochrane. And I’ll give you a couple of his quotes about Krugman here.

    Keynesian ISLM models have not been taught in any serious graduate school since at least 1980, except as interesting fallacies or history of thought… Not a single policy simulation from a Keynesian model has appeared in any respectable academic journal since 1980. Not one. The whole business was simply discredited as being logically incoherent 30 years ago. </blockquote

    Most of all, it’s sad. Imagine this weren’t economics for a moment. Imagine this were a respected scientist turned popular writer, who says, most basically, that everything everyone has done in his field since the mid 1960s is a complete waste of time. Everything that fills its academic journals, is taught in its PhD programs, presented at its conferences, summarized in its graduate textbooks, and rewarded with the accolades a profession can bestow, including multiple Nobel prizes, is totally wrong. Instead, he calls for a return to the eternal verities of a rather convoluted book written in the 1930s, as taught to our author in his undergraduate introductory courses. If a scientist, he might be an AIDS-HIV disbeliever, a creationist, a stalwart that maybe continents don’t move after all.

    Even Krugman has admitted that his strength is not really in macro (notably his Nobel was in trade theory, not macro), but that he’s particularly adept with making good political arguments. (This quote can easily be googled.)

    although I kept up with macro research, I avoided getting into the frontline theoretical and empirical disputes. By contrast I probably do have a better sense than most technically competent economists of the arguments that actually drive political discourse and policy

    So why do I quote Krugman from more than a decade ago? Because that’s before he started getting actively involved in political debates, when he was still more analytical and less ideological.

  19. 19
    gingerbaker

    James:

    “…But all those who currently have jobs, with is over 90% of them,…”

    Not that it matters much to the argument, but you do realize that there are a heck of a lot more unemployed than the ‘official’ numbers indicate?

    James:

    “…You want to know whose my authority on this? Paul Krugman, who, writing about NAFTA, said…”

    I am certainly no expert, but I don’t think that Krugman’s quote directly addresses your point.

    James:

    “…Reclaiming lost jobs would be bad for the economy?
    Yes, if they drive up consumers’ expenses so that they have to cut back somewhere else…”

    Sure, there is a marginal increase in cost to the consumer. The question is whether this is more than offset by the compounding effect of millions of new jobs injecting capital locally, where it changes hands frequently, instead of shipping those dollars offshore. I don’t think it is even close.

    A substantial portion of our workers are un- or under- employed. If the ‘official’ unemployment rate is 10%, I would wager that the true rate is at least 20%. That represents an enormous amount of people who could potentially inject a titanic amount of new capital and increase demand for products.

    By your argument, this would be bad for the economy or the consumer, because that would increase prices further? Yet that makes no sense whatsoever. More people working spending money is good for the economy. You seem to be defending the dodgy downpricing aspect of supply-side Reaganomics to the exclusion of the proven benefits of demand-side.

  20. 20
    bexley

    Stepping back, you think the models Krugman uses aren’t much cop. So what are the better models telling us to do to get out of the doldrums?

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