Re: More on the economics of China and the U.S.-- pretty deep

[David Farber <dave () farber net>]

Begin forwarded message:

From: "Ted Nelson" <tandm () xanadu net>
Date: January 24, 2008 5:15:28 AM EST
To: "David Farber" <dave () farber net>
Cc: "Ted Nelson" <tandm () xanadu net>
Subject: More on the economics of China and the U.S.-- pretty deep
Reply-To: tandm () xanadu net

Hi Dave-- for IP, if you wish.

From the below:
"Without China¹s billion dollars a day, the United States could not
keep its economy stable or spare the dollar from collapse."


---------- Forwarded message ----------
From: stuart silverstone <ss () graphics org>
Date: Jan 24, 2008 6:19 AM
Subject: Fallows: Chinese dollars: The $1.4 Trillion Question (Atlantic)
To: goldWar () graphics org


The Chinese are subsidizing the American way of life. Are we playing  
them
for suckers‹or are they playing us?
BY JAMES FALLOWS



Stephen Schwarzman may think he has image problems in America. He is the
co-founder and CEO of the Blackstone Group, and he threw himself a $3
million party for his 60th birthday last spring, shortly before making  
many
hundreds of millions of dollars in his company¹s IPO and finding  
clever ways
to avoid paying taxes. That¹s nothing compared with the way he looks in
China. Here, he and his company are surprisingly well known, thanks to
blogs, newspapers, and talk-show references. In America, Schwarzman¹s
perceived offense is greed‹a sin we readily forgive and forget. In  
China,
the suspicion is that he has somehow hoodwinked ordinary Chinese  
people out
of their hard-earned cash.

Last June, China¹s Blackstone investment was hailed in the American  
press as
a sign of canny sophistication. It seemed just the kind of thing the  
U.S.
government had in mind when it hammered China to use its new wealth as a
³responsible stakeholder² among nations. By putting $3 billion of  
China¹s
national savings into the initial public offering of America¹s best- 
known
private-equity firm, the Chinese government allied itself with a big- 
time
Western firm without raising political fears by trying to buy operating
control (it bought only 8 percent of Blackstone¹s shares, and nonvoting
shares at that). The contrast with the Japanese and Saudis, who in their
nouveau-riche phase roused irritation and envy with their showy  
purchases of
Western brand names and landmark properties, was plain.

Six months later, it didn¹t look so canny, at least not financially.  
China¹s
Blackstone holdings lost, on paper, about $1 billion, during a time  
when the
composite index of the Shanghai Stock Exchange was soaring. At two  
different
universities where I¹ve spoken recently, students have pointed out that
Schwarzman was a major Republican donor. A student at Fudan University  
knew
a detail I didn¹t: that in 2007 President Bush attended a Republican
National Committee fund-raiser at Schwarzman¹s apartment in Manhattan  
(think
what he would have made of the fact that Schwarzman, who was one year  
behind
Bush at Yale, had been a fellow member of Skull and Bones). Wasn¹t the  
whole
scheme a way to take money from the Chinese people and give it to the
president¹s crony?

The Blackstone case is titillating in its personal detail, but it is  
also an
unusually clear and personalized symptom of a deeper, less publicized,  
and
potentially much more destructive tension in U.S. China relations.  
It¹s not
just Stephen Schwarzman¹s company that the laobaixing, the ordinary  
Chinese
masses, have been subsidizing. It¹s everyone in the United States.

Through the quarter-century in which China has been opening to world  
trade,
Chinese leaders have deliberately held down living standards for their  
own
people and propped them up in the United States. This is the real  
meaning of
the vast trade surplus‹$1.4 trillion and counting, going up by about $1
billion per day‹that the Chinese government has mostly parked in U.S.
Treasury notes. In effect, every person in the (rich) United States  
has over
the past 10 years or so borrowed about $4,000 from someone in the (poor)
People¹s Republic of China. Like so many imbalances in economics, this  
one
can¹t go on indefinitely, and therefore won¹t. But the way it  
ends‹suddenly
versus gradually, for predictable reasons versus during a panic‹will  
make an
enormous difference to the U.S. and Chinese economies over the next few
years, to say nothing of bystanders in Europe and elsewhere.

Any economist will say that Americans have been living better than they
should‹which is by definition the case when a nation¹s total  
consumption is
greater than its total production, as America¹s now is. Economists  
will also
point out that, despite the glitter of China¹s big cities and the rise  
of
its billionaire class, China¹s people have been living far worse than  
they
could. That¹s what it means when a nation consumes only half of what it
produces, as China does.

Neither government likes to draw attention to this arrangement,  
because it
has been so convenient on both sides. For China, it has helped the  
regime
guide development in the way it would like‹and keep the domestic  
economy¹s
growth rate from crossing the thin line that separates ³unbelievably  
fast²
from ³uncontrollably inflationary.² For America, it has meant cheaper  
iPods,
lower interest rates, reduced mortgage payments, a lighter tax burden.  
But
because of political tensions in both countries, and because of the  
huge and
growing size of the imbalance, the arrangement now shows signs of  
cracking
apart.

In an article two and a half years ago (³Countdown to a Meltdown,²
July/August 2005), I described an imagined future in which a real-estate
crash and shakiness in the U.S. credit markets led to panic by Chinese  
and
other foreign investors, with unpleasant effects for years to come.  
The real
world has recently had inklings of similar concerns. In the past six  
months,
relative nobodies in China¹s establishment were able to cause brief  
panics
in the foreign-exchange markets merely by hinting that China might stop
supplying so much money to the United States. In August, an economic
researcher named He Fan, who works at the Chinese Academy of Social  
Sciences
and did part of his doctoral research at Harvard, suggested in an op-ed
piece in China Daily that if the U.S. dollar kept collapsing in value,  
China
might move some of its holdings into stronger currencies. This was  
presented
not as a threat but as a statement of the obvious, like saying that  
during a
market panic, lots of people sell. The column quickly provoked alarmist
stories in Europe and America suggesting that China was considering the
³nuclear option²‹unloading its dollars.

A few months later, a veteran Communist Party politician named Cheng  
Siwei
suggested essentially the same thing He Fan had. Cheng, in his  
mid-70s, was
trained as a chemical engineer and has no official role in setting  
Chinese
economic policy. But within hours of his speech, a flurry of trading  
forced
the dollar to what was then its lowest level against the euro and other
currencies. The headline in the South China Morning Post the next day  
was:
³Officials¹ Words Shrivel U.S. Dollar.² Expressing amazement at the  
markets¹
response, Carl Weinberg, chief economist at the High Frequency Economics
advisory group, said, ³This would be kind of like Congressman Charlie  
Rangel
giving a speech telling the Fed to hike or cut interest rates.²  
(Cheng, like
Rangel, is known for colorful comments‹but he is less powerful, since  
Rangel
after all chairs the House Ways and Means Committee.) In the following
weeks, phrases like ³run on the dollar² and ³collapse of confidence²  
showed
up more and more frequently in financial newsletters. The nervousness  
only
increased when someone who does have influence, Chinese Premier Wen  
Jiabao,
said last November, ³We are worried about how to preserve the value² of
China¹s dollar holdings.

When the dollar is strong, the following (good) things happen: the  
price of
food, fuel, imports, manufactured goods, and just about everything else
(vacations in Europe!) goes down. The value of the stock market, real
estate, and just about all other American assets goes up. Interest  
rates go
down‹for mortgage loans, credit-card debt, and commercial borrowing. Tax
rates can be lower, since foreign lenders hold down the cost of  
financing
the national debt. The only problem is that American-made goods become  
more
expensive for foreigners, so the country¹s exports are hurt.

When the dollar is weak, the following (bad) things happen: the price of
food, fuel, imports, and so on (no more vacations in Europe) goes up.  
The
value of the stock market, real estate, and just about all other  
American
assets goes down. Interest rates are higher. Tax rates can be higher, to
cover the increased cost of financing the national debt. The only  
benefit is
that American-made goods become cheaper for foreigners, which helps  
create
new jobs and can raise the value of export-oriented American firms
(winemakers in California, producers of medical devices in New England).

The dollar¹s value has been high for many years‹unnaturally high, in  
large
part because of the implicit bargain with the Chinese. Living  
standards in
China, while rising rapidly, have by the same logic been unnaturally  
low. To
understand why this situation probably can¹t go on, and what might  
replace
it‹via a dollar crash or some other event‹let¹s consider how this  
curious
balance of power arose and how it works.

       Why a poor country has so much money

By 1996, China amassed its first $100 billion in foreign assets,  
mainly held
in U.S. dollars. (China considers these holdings a state secret, so all
numbers come from analyses by outside experts.) By 2001, that sum  
doubled to
about $200 billion, according to Edwin Truman of the Peterson  
Institute for
International Economics in Washington. Since then, it has increased more
than sixfold, by well over a trillion dollars, and China¹s foreign  
reserves
are now the largest in the world. (In second place is Japan, whose  
economy
is, at official exchange rates, nearly twice as large as China¹s but  
which
has only two-thirds the foreign assets; the next-largest after that  
are the
United Arab Emirates and Russia.) China¹s U.S. dollar assets probably
account for about 70 percent of its foreign holdings, according to the
latest analyses by Brad Setser, a former Treasury Department economist  
now
with the Council on Foreign Relations; the rest are mainly in euros,  
plus
some yen. Most of China¹s U.S. investments are in conservative, low- 
yield
instruments like Treasury notes and federal-agency bonds, rather than
showier Blackstone-style bets. Because notes and bonds backed by the  
U.S.
government are considered the safest investments in the world, they pay
lower interest than corporate bonds, and for the past two years their  
annual
interest payments of 4 to 5 percent have barely matched the 5-to-6- 
percent
decline in the U.S. dollar¹s value versus the RMB.

Americans sometimes debate (though not often) whether in principle it is
good to rely so heavily on money controlled by a foreign government. The
debate has never been more relevant, because America has never before  
been
so deeply in debt to one country. Meanwhile, the Chinese are having a  
debate
of their own‹about whether the deal makes sense for them. Certainly  
China¹s
officials are aware that their stock purchases prop up 401(k) values,  
their
money-market holdings keep down American interest rates, and their bond
purchases do the same thing‹plus allow our government to spend money  
without
raising taxes.

³From a distance, this, to say the least, is strange,² Lawrence  
Summers, the
former treasury secretary and president of Harvard, told me last year in
Shanghai. He was referring to the oddity that a country with so many  
of its
own needs still unmet would let ³this $1 trillion go to a mature, old,  
rich
place from a young, dynamic place.²

It¹s more than strange. Some Chinese people are rich, but China as a  
whole
is unbelievably short on many of the things that qualify countries as  
fully
developed. Shanghai has about the same climate as Washington, D.C.‹and  
its
public schools have no heating. (Go to a classroom when it¹s cold, and
you¹ll see 40 children, all in their winter jackets, their breath  
forming
clouds in the air.) Beijing is more like Boston. On winter nights,  
thousands
of people mass along the curbsides of major thoroughfares, enduring long
waits and fighting their way onto hopelessly overcrowded public buses  
that
then spend hours stuck on jammed roads. And these are the showcase  
cities!
In rural Gansu province, I have seen schools where 18 junior-high-school
girls share a single dormitory room, sleeping shoulder to shoulder,
sardine-style.

Better schools, more-abundant parks, better health care, cleaner air and
water, better sewers in the cities‹you name it, and if it isn¹t in  
some way
connected to the factory-export economy, China hasn¹t got it, or not  
enough.
This is true at the personal level, too. The average cash income for  
workers
in a big factory is about $160 per month. On the farm, it¹s a small  
fraction
of that. Most people in China feel they are moving up, but from a very  
low
starting point.

So why is China shipping its money to America? An economist would  
describe
the oddity by saying that China has by far the highest national  
savings in
the world. This sounds admirable, but when taken to an extreme‹as in
China‹it indicates an economy out of sync with the rest of the world,  
and
one that is deliberately keeping its own people¹s living standards lower
than they could be. For comparison, India¹s savings rate is about 25
percent, which in effect means that India¹s people consume 75 percent of
what they collectively produce. (Reminder from Ec 101: The savings  
rate is
the net share of national output either exported or saved and invested  
for
consumption in the future. Effectively, it¹s what your own people  
produce
but don¹t use.) For Korea and Japan, the savings rate is typically  
from the
high 20s to the mid-30s. Recently, America¹s has at times been below  
zero,
which means that it consumes, via imports, more than it makes.

China¹s savings rate is a staggering 50 percent, which is probably
unprecedented in any country in peacetime. This doesn¹t mean that the
average family is saving half of its earnings‹though the personal  
savings
rate in China is also very high. Much of China¹s national income is  
³saved²
almost invisibly and kept in the form of foreign assets. Until now, most
Chinese have willingly put up with this, because the economy has been
growing so fast that even a suppressed level of consumption makes most
people richer year by year.

But saying that China has a high savings rate describes the situation
without explaining it. Why should the Communist Party of China  
countenance a
policy that takes so much wealth from the world¹s poor, in their own
country, and gives it to the United States? To add to the mystery, why
should China be content to put so many of its holdings into dollars,  
knowing
that the dollar is virtually guaranteed to keep losing value against the
RMB? And how long can its people tolerate being denied so much of their
earnings, when they and their country need so much? The Chinese  
government
did not explicitly set out to tighten the belt on its population while
offering cheap money to American homeowners. But the fact that it does
results directly from explicit choices it has made‹two in particular.  
Both
arise from crucial controls the government maintains over an economy  
that in
many other ways has become wide open. The situation may be easiest to
explain by following a U.S. dollar on its journey from a customer¹s  
hand in
America to a factory in China and back again to the T-note auction in  
the
United States.

       The voyage of a dollar

Let¹s say you buy an Oral-B electric toothbrush for $30 at a CVS in the
United States. I choose this example because I¹ve seen a factory in  
China
that probably made the toothbrush. Most of that $30 stays in America,  
with
CVS, the distributors, and Oral-B itself. Eventually $3 or so‹an average
percentage for small consumer goods‹makes its way back to southern  
China.

When the factory originally placed its bid for Oral-B¹s business, it  
stated
the price in dollars: X million toothbrushes for Y dollars each. But the
Chinese manufacturer can¹t use the dollars directly. It needs RMB‹to  
pay the
workers their 1,200-RMB ($160) monthly salary, to buy supplies from  
other
factories in China, to pay its taxes. So it takes the dollars to the  
local
commercial bank‹let¹s say the Shenzhen Development Bank. After showing
receipts or waybills to prove that it earned the dollars in genuine  
trade,
not as speculative inflow, the factory trades them for RMB.

This is where the first controls kick in. In other major countries, the
counterparts to the Shenzhen Development Bank can decide for  
themselves what
to do with the dollars they take in. Trade them for euros or yen on the
foreign-exchange market? Invest them directly in America? Issue dollar
loans? Whatever they think will bring the highest return. But under  
China¹s
³surrender requirements,² Chinese banks can¹t do those things. They must
treat the dollars, in effect, as contraband, and turn most or all of  
them
(instructions vary from time to time) over to China¹s equivalent of the
Federal Reserve Bank, the People¹s Bank of China, for RMB at whatever  
is the
official rate of exchange.

With thousands of transactions per day, the dollars pile up like crazy  
at
the PBOC. More precisely, by more than a billion dollars per day. They  
pile
up even faster than the trade surplus with America would indicate,  
because
customers in many other countries settle their accounts in dollars, too.

The PBOC must do something with that money, and current Chinese doctrine
allows it only one option: to give the dollars to another arm of the  
central
government, the State Administration for Foreign Exchange. It is then  
SAFE¹s
job to figure out where to park the dollars for the best return: so  
much in
U.S. stocks, so much shifted to euros, and the great majority left in  
the
boring safety of U.S. Treasury notes.

And thus our dollar comes back home. Spent at CVS, passed to Oral-B,  
paid to
the factory in southern China, traded for RMB at the Shenzhen bank,
³surrendered² to the PBOC, passed to SAFE for investment, and then bid  
at
auction for Treasury notes, it is ready to be reinjected into the  
U.S . money
supply and spent again‹ideally on Chinese-made goods.

At no point did an ordinary Chinese person decide to send so much  
money to
America. In fact, at no point was most of this money at his or her  
disposal
at all. These are in effect enforced savings, which are the result of  
the
two huge and fundamental choices made by the central government.

One is to dictate the RMB¹s value relative to other currencies, rather  
than
allow it to be set by forces of supply and demand, as are the values  
of the
dollar, euro, pound, etc. The obvious reason for doing this is to keep
Chinese-made products cheap, so Chinese factories will stay busy. This  
is
what Americans have in mind when they complain that the Chinese  
government
is rigging the world currency markets. And there are numerous less  
obvious
reasons. The very act of managing a currency¹s value may be a more  
important
distorting factor than the exact rate at which it is set. As for the
rate‹the subject of much U.S. lecturing‹given the huge difference in  
living
standards between China and the United States, even a big rise in the  
RMB¹s
value would leave China with a price advantage over manufacturers  
elsewhere.
(If the RMB doubled against the dollar, a factory worker might go from
earning $160 per month to $320‹not enough to send many jobs back to  
America,
though enough to hurt China¹s export economy.) Once a government  
decides to
thwart the market-driven exchange rate of its currency, it must control
countless other aspects of its financial system, through instruments  
like
surrender requirements and the equally ominous-sounding ³sterilization
bonds² (a way of keeping foreign-currency swaps from creating  
inflation, as
they otherwise could).

These and similar tools are the way China¹s government imposes an
unbelievably high savings rate on its people. The result, while very
complicated, is to keep the buying power earned through China¹s  
exports out
of the hands of Chinese consumers as a whole. Individual Chinese  
people have
certainly gotten their hands on a lot of buying power, notably the
billionaire entrepreneurs who have attracted the world¹s attention  
(see ³Mr.
Zhang Builds His Dream Town,² March 2007). But when it comes to amassing
international reserves, what matters is that China as a whole spends so
little of what it earns, even as some Chinese people spend a lot.

The other major decision is not to use more money to address China¹s  
needs
directly‹by building schools and agricultural research labs, cleaning up
toxic waste, what have you. Both decisions stem from the central
government¹s vision of what is necessary to keep China on its  
unprecedented
path of growth. The government doesn¹t want to let the market set the  
value
of the RMB, because it thinks that would disrupt the constant growth  
and the
course it has carefully and expensively set for the factory-export  
economy.
In the short run, it worries that the RMB¹s value against the dollar  
and the
euro would soar, pricing some factories in ³expensive² places such as
Shanghai out of business. In the long run, it views an unstable  
currency as
a nuisance in itself, since currency fluctuation makes everything about
business with the outside world more complicated. Companies have a  
harder
time predicting overseas revenues, negotiating contracts, luring foreign
investors, or predicting the costs of fuel, component parts, and other
imported goods.

And the government doesn¹t want to increase domestic spending  
dramatically,
because it fears that improving average living conditions could
paradoxically intensify the rich-poor tensions that are China¹s major  
social
problem. The country is already covered with bulldozers, wrecking  
balls, and
construction cranes, all to keep the manufacturing machine steaming  
ahead.
Trying to build anything more at the moment‹sewage-treatment plants,  
for a
start, which would mean a better life for its own people, or smokestack
scrubbers and related ³clean² technology, which would start to address  
the
world pollution for which China is increasingly held responsible‹would
likely just drive prices up, intensifying inflation and thus reducing  
the
already minimal purchasing power of most workers. Food prices have been
rising so fast that they have led to riots. In November, a large Carre  
four
grocery in Chong qing offered a limited-time sale of vegetable oil, at  
20
percent (11 RMB, or $1.48) off the normal price per bottle. Three people
were killed and 31 injured in a stampede toward the shelves.

This is the bargain China has made‹rather, the one its leaders have  
imposed
on its people. They¹ll keep creating new factory jobs, and thus reduce
China¹s own social tensions and create opportunities for its rural  
poor. The
Chinese will live better year by year, though not as well as they  
could. And
they¹ll be protected from the risk of potentially catastrophic
hyperinflation, which might undo what the nation¹s decades of growth  
have
built. In exchange, the government will hold much of the nation¹s  
wealth in
paper assets in the United States, thereby preventing a run on the  
dollar,
shoring up relations between China and America, and sluicing enough cash
back into Americans¹ hands to let the spending go on.

       What the Chinese hope will happen

The Chinese public is beginning to be aware that its government is  
sitting
on a lot of money‹money not being spent to help China directly, money  
not
doing so well in Blackstone-style foreign investments, money invested  
in the
ever-falling U.S. dollar. Chinese bloggers and press commentators have  
begun
making a connection between the billions of dollars the country is  
sending
away and the domestic needs the country has not addressed. There is  
more and
more pressure to show that the return on foreign investments is worth
China¹s sacrifice‹and more and more potential backlash against bets that
don¹t pay off. (While the Chinese government need not stand for popular
election, it generally tries to reduce sources of popular discontent  
when it
can.) The public is beginning to behave like the demanding client of an
investment adviser: it wants better returns, with fewer risks.

This is the challenge facing Lou Jiwei and Gao Xiqing, who will play a
larger role in the U.S. economy than Americans are accustomed to from
foreigners. Lou, a longtime Communist Party official in his late 50s,  
is the
chairman of the new China Investment Corporation, which is supposed to  
find
creative ways to increase returns on at least $200 billion of China¹s
foreign assets. He is influential within the party but has little
international experience. Thus the financial world¹s attention has  
turned to
Gao Xiqing, who is the CIC¹s general manager.

Twenty years ago, after graduating from Duke Law School, Gao was the  
first
Chinese citizen to pass the New York State Bar Exam. He returned to  
China in
1988, after several years as an associate at the New York law firm  
Mudge,
Rose (Richard Nixon¹s old firm) to teach securities law and help develop
China¹s newly established stock markets. By local standards, he is  
hip. At
an economics conference in Beijing in December, other Chinese speakers  
wore
boxy dark suits. Gao, looking fit in his mid-50s, wore a tweed jacket  
and
black turtleneck, an Ironman-style multifunction sports watch on his  
wrist.

Under Lou and Gao, the CIC started with a bang with Blackstone‹the wrong
kind of bang. Now, many people suggest, it may be chastened enough to  
take a
more careful approach. Indeed, that was the message it sent late last  
year,
with news that its next round of investments would be in China¹s own  
banks,
to shore up some with credit problems. And it looks to be studying
aggressive but careful ways to manage huge sums. About the time the  
CIC was
making the Blackstone deal, its leadership and staff undertook a crash
course in modern financial markets. They hired the international  
consulting
firm McKinsey to prepare confidential reports about the way they should
organize themselves and the investment principles they should apply.  
They
hired Booz Allen Hamilton to prepare similar reports, so they could  
compare
the two. Yet another consulting firm, Towers Perrin, provided advice,
especially about staffing and pay. The CIC leaders commissioned  
studies of
other large state-run investment funds‹in Norway, Singapore, the Gulf
States, Alaska‹to see which approaches worked and which didn¹t. They  
were
fascinated by the way America¹s richest universities managed their
endowments, and ordered multiple copies of Pioneering Portfolio  
Management,
by David Swensen, who as Yale¹s chief investment officer has guided its
endowment to sustained and rapid growth. Last summer, teams from the CIC
made long study visits to Yale and Duke universities, among others.

Gao Xiqing and other CIC officials have avoided discussing their plans
publicly. ³If you tell people ahead of time what you¹re going to  
do‹well,
you just can¹t operate that way in a market system,² he said at his  
Beijing
appearance. ³What I can say is, we¹ll play by the international rules,  
and
we¹ll be responsible investors.² Gao emphasized several times how much  
the
CIC had to learn: ³We¹re the new kids on the block. Because of media
attention, there is huge pressure on us‹we¹re already under water  
now.² The
words ³under water² were in natural-sounding English, and clearly  
referred
to Blackstone.

Others familiar with the CIC say that its officials are coming to  
appreciate
the unusual problems they will face. For instance: any investment group
needs to be responsible to outside supervisors, and the trick for the  
CIC
will be to make itself accountable to Communist Party leadership without
becoming a mere conduit for favored investment choices by party  
bosses. How
can it attract the best talent? Does it want to staff up quickly, to  
match
its quickly mounting assets, by bidding for financial managers on the  
world
market‹where many of the candidates are high-priced, not fluent in  
Chinese,
and reluctant to move to Beijing? Or can it afford to take the time to
home-grow its own staff?

While the CIC is figuring out its own future, outsiders are trying to  
figure
out the CIC‹and also SAFE, which will continue handling many of China¹s
assets. As far as anyone can tell, the starting point for both is risk
avoidance. No more Blackstones. No more CNOOC-Unocals. (In 2005, the  
Chinese
state oil firm CNOOC attempted to buy U.S. based Unocal. It withdrew the
offer in the face of intense political opposition to the deal in  
America.)
One person involved with the CIC said that its officials had seen  
recent Lou
Dobbs broadcasts criticizing ³Communist China² and were ³shellshocked²  
about
the political resentment their investments might encounter in the United
States. For all these reasons the Chinese leadership, as another  
person put
it, ³has a strong preference to follow someone else¹s lead, not in an
imitative way² but as an unobtrusive minority partner wherever  
possible. It
will follow the lead of others for now, that is, while the CIC takes its
first steps as a gigantic international financial investor.

The latest analyses by Brad Setser suggest that despite all the talk  
about
abandoning the dollar, China is still putting about as large a share  
of its
money into dollars as ever, somewhere between 65 and 70 percent of its
foreign earnings. ³Politically, the last thing they want is to signal  
a loss
of faith in the dollar,² Andy Rothman, of the financial firm CLSA,  
told me;
that would lead to a surge in the RMB, which would hurt Chinese  
exporters,
not to mention the damage it would cause to China¹s vast existing dollar
assets.

The problem is that these and other foreign observers must guess at  
China¹s
aims, rather than knowing for sure. As Rothman put it, ³The opaqueness  
about
intentions and goals is always the issue.² The mini-panics last year  
took
hold precisely because no one could be sure that SAFE was not about to
change course.

The uncertainty arises in part from the limited track record of  
China¹s new
financial leadership. As one American financier pointed out to me:  
³The man
in charge of the whole thing²‹Lou Jiwei‹³has never bought a share of  
stock,
never bought a car, never bought a house.² Another foreign financier  
said,
after meeting some CIC staffers, ³By Chinese terms, these are very
sophisticated people.² But, he went on to say, in a professional sense  
none
of them had lived through the financial crises of the last generation:  
the
U.S. market crash of 1987, the ³Asian flu² of the late 1990s, the  
collapse
of the Internet bubble soon afterward. The Chinese economy was  
affected by
all these upheavals, but the likes of Gao Xiqing were not fully  
exposed to
their lessons, sheltered as they were within Chinese institutions.

Foreign observers also suggest that, even after exposure to the Lou  
Dobbs
clips, the Chinese financial leadership may not yet fully grasp how
suspicious other countries are likely to be of China¹s financial  
intentions,
for reasons both fair and unfair. The unfair reason is all-purpose
nervousness about any new rising power. ³They need to understand, and  
they
don¹t, that everything they do will be seen as political,² a financier  
with
extensive experience in both China and America told me. ³Whatever they  
buy,
whatever they say, whatever they do will be seen as China Inc.²

The fair reason for concern is, again, the transparency problem. Twice  
in
the past year, China has in nonfinancial ways demonstrated the ripples  
that
a nontransparent policy creates. Last January, its military  
intentionally
shot down one of its own satellites, filling orbital paths with  
debris. The
exercise greatly alarmed the U.S. military, because of what seemed to  
be an
implied threat to America¹s crucial space sensors. For several days, the
Chinese government said nothing at all about the test, and nearly a year
later, foreign analysts still debate whether it was a deliberate
provocation, the result of a misunderstanding, or a freelance effort  
by the
military. In November, China denied a U.S. Navy aircraft carrier, the  
Kitty
Hawk, routine permission to dock in Hong Kong for Thanksgiving, even  
though
many Navy families had gone there for a reunion. In each case, the most
ominous aspect is that outsiders could not really be sure what the  
Chinese
leadership had in mind. Were these deliberate taunts or shows of  
strength?
The results of factional feuding within the leadership? Simple
miscalculations? In the absence of clear official explanations no one  
really
knew, and many assumed the worst.

So it could be with finance, unless China becomes as transparent as it  
is
rich. Chinese officials say they will move in that direction, but  
they¹re in
no hurry. Last fall, Edwin Truman prepared a good-governance scorecard  
for
dozens of ³sovereign wealth² funds‹government-run investment funds  
like SAFE
and the CIC. He compared funds from Singapore, Korea, Norway, and  
elsewhere,
ranking them on governing structure, openness, and similar qualities.
China¹s funds ended up in the lower third of his list‹better-run than
Iran¹s, Sudan¹s, or Algeria¹s, but worse than Mexico¹s, Russia¹s, or
Kuwait¹s. China received no points in the ³governance² category and  
half a
point out of a possible 12 for ³transparency and accountability.²

Foreigners (ordinary Chinese too, for that matter) can¹t be sure about  
the
mixture of political and strictly economic motives behind future  
investment
decisions the Chinese might make. When China¹s president, Hu Jintao,  
visited
Seattle two years ago, he announced a large purchase of Boeing aircraft.
When France¹s new president, Nicolas Sarkozy, visited China late last  
year,
Hu announced an even larger purchase of Airbuses. Every Chinese order  
for an
airplane is a political as well as commercial decision. Brad Setser says
that the Chinese government probably believed that it would get  
³credit² for
the Blackstone purchase in whatever negotiations came up next with the
United States, in the same way it would get credit for choosing  
Boeing. This
is another twist to the Kremlinology of trying to discern China¹s  
investment
strategy.

Where the money goes, other kinds of power follow. Just ask Mikhail
Gorbachev, as he reflects on the role bankruptcy played in bringing  
down the
Soviet empire. While Japan¹s great wealth has not yet made it a major
diplomatic actor, and China has so far shied from, rather than seized,
opportunities to influence events outside its immediate realm, time and
money could change that. China¹s military is too weak to challenge the  
U.S.
directly even in the Taiwan Straits, let alone anyplace else. That, too,
could change.

       A Balance of Terror

Let¹s take these fears about a rich, strong China to their logical  
extreme.
The U.S. and Chinese governments are always disagreeing‹about trade,  
foreign
policy, the environment. Someday the disagreement could be severe.  
Taiwan,
Tibet, North Korea, Iran‹the possibilities are many, though Taiwan  
always
heads the list. Perhaps a crackdown within China. Perhaps another  
accident,
like the U.S. bombing of China¹s embassy in Belgrade nine years ago,  
which
everyone in China still believes was intentional and which no prudent
American ever mentions here.

Whatever the provocation, China would consider its levers and weapons  
and
find one stronger than all the rest‹one no other country in the world  
can
wield. Without China¹s billion dollars a day, the United States could  
not
keep its economy stable or spare the dollar from collapse.

Would the Chinese use that weapon? The reasonable answer is no,  
because they
would wound themselves grievously, too. Their years of national  
savings are
held in the same dollars that would be ruined; in a panic, they¹d get  
only a
small share out before the value fell. Besides, their factories depend  
on
customers with dollars to spend.

But that ³reassuring² answer is actually frightening. Lawrence Summers  
calls
today¹s arrangement ³the balance of financial terror,² and says that  
it is
flawed in the same way that the ³mutually assured destruction² of the  
Cold
War era was. That doctrine held that neither the United States nor the
Soviet Union would dare use its nuclear weapons against the other,  
since it
would be destroyed in return. With allowances for hyperbole, something
similar applies to the dollar standoff. China can¹t afford to stop  
feeding
dollars to Americans, because China¹s own dollar holdings would be
devastated if it did. As long as that logic holds, the system works.  
As soon
as it doesn¹t, we have a big problem.

What might poke a giant hole in that logic? Not necessarily a titanic
struggle over the future of Taiwan. A simple mistake, for one thing.  
Another
speech by Cheng Siwei‹perhaps in response to a provocation by Lou  
Dobbs. A
rumor that the oil economies are moving out of dollars for good, setting
their prices in euros. Leaked suggestions that the Chinese government is
hoping to buy Intel, leading to angry denunciations on the Capitol  
floor,
leading to news that the Chinese will sit out the next Treasury  
auction. As
many world tragedies have been caused by miscalculation as by malice.

Or pent-up political tensions, on all sides. China¹s lopsided  
growth‹ahead
in exports, behind in schooling, the environment, and everything  
else‹makes
the country socially less stable as it grows richer. Meanwhile, its
expansion disrupts industries and provokes tensions in the rest of the
world. The billions of dollars China pumps into the United States each  
week
strangely seem to make it harder rather than easier for Americans to  
face
their own structural problems. One day, something snaps. Suppose the CIC
makes another bad bet‹not another Blackstone but another WorldCom, with
billions of dollars of Chinese people¹s assets irretrievably wiped  
out. They
will need someone to blame, and Americans, for their part, are already
primed to blame China back.

So, the shock comes. Does it inevitably cause a cataclysm? No one can  
know
until it¹s too late. The important question to ask about the U.S. China
relationship, the economist Eswar Prasad, of Cornell, recently wrote  
in a
paper about financial imbalances, is whether it has ³enough  
flexibility to
withstand and recover from large shocks, either internal or external.²  
He
suggested that the contained tensions were so great that the answer  
could be
no.

Today¹s American system values upheaval; it¹s been a while since we¹ve  
seen
too much of it. But Americans who lived through the Depression knew  
the pain
real disruption can bring. Today¹s Chinese, looking back on their  
country¹s
last century, know, too. With a lack of tragic imagination, Americans  
have
drifted into an arrangement that is comfortable while it lasts, and  
could
last for a while more. But not much longer.

Years ago, the Chinese might have averted today¹s pressures by  
choosing a
slower and more balanced approach to growth. If they had it to do over
again, I suspect they would in fact choose just the same path‹they have
gained so much, including the assets they can use to do what they have  
left
undone, whenever the government chooses to spend them. The same is not  
true,
I suspect, for the United States, which might have chosen a very  
different
path: less reliance on China¹s subsidies, more reliance on paying as  
we go.
But it¹s a little late for those thoughts now. What¹s left is to  
prepare for
what we find at the end of the path we have taken.



JANUARY/FEBRUARY 2008 ATLANTIC MONTHLY
All material copyright The Atlantic Monthly Group
http://www.theatlantic.com/doc/200801/fallows-chinese-dollars





--
- FIRST ROCK MUSICAL RECALLED-- See
http://hyperland.com/A&E.AnnivBlurb-D10.txt
- NEW XANADU SOFTWARE-- See xanarama.net
- MY SPECIAL LECTURE on 14 non-computer topics--
http://www.ecs.soton.ac.uk/podcasts/seminars.php

Theodor Holm Nelson
 Founder, Project Xanadu
 Visiting Fellow, Oxford Internet Institute
 Visiting Professor, University of Southampton

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