Wednesday, September 22, 2010

The Long View of China

“Spend enough time with Chinese officials and economists, and you will hear a story about the Japanese yen in the 1980s.” So writes David Leonhardt in “The Long View of China’s Currency” (

A few years ago, I heard something similar, only it went like this, “Spend enough time with Chinese officials and economists and you will hear a story about Russia opening up its economy and suffering large bouts of social chaos.” Here the fear on the part of the Chinese was that opening the economy up too quickly could bring on social unrest similar to that observed in Russia, when Russia began to open up its economy.

One of the best insights given to me has been the one a friend of mine gave about the future of China. He said, “The Chinese believes that they need to move in the direction of a more capitalistic society. They also believe that moving too quickly in this direction could result in societal disruption that could derail their efforts. Furthermore, the Chinese think in decades whereas Americans think within a two- to four-year horizon. Consequently, Americans will become very impatient with what the Chinese are doing.”

Just a side note: Martin Wolf, in explaining how China is achieving its remarkable growth, makes the statement that, China “is, in a sense, the most ‘capitalist’ economy ever.” This is because it is putting so much emphasis upon investment to achieve a 8-10 percent a year growth rate. However, this is a pretty dramatic generalization. (See Wolf’s column, “How china must change if it is to sustain its ascent,”

Leonhardt makes two important points I would like to give my on. First, he writes that China and the United States aren’t the only two countries in the world producing products. But, “The entire value of the product counts toward the trade deficit between the United States and China.”

China is making itself felt in many, many parts of the world. Again, we see the article this morning, “Chinese Business Gains Foothold in Eastern Europe,” ( And, we are constantly hearing about the initiatives of China in South America, and Africa, and the Middle East. And, this doesn’t fully capture the advances of the Chinese Sovereign Wealth Fund that is even buying physical assets in the United States.

China has a long term plan to obtain supply sources and build influence throughout the world. They are doing this quietly, peacefully, and continuously.

The United States is mired in the current value of the renminbi and the current trade deficit. In the meantime, the strength of the United States economy continues to slide. There have been numerous assessments recently about where the United States stands in the world economy and they have not been very favorable to the relative strength of America’s economic performance.

One of the standard arguments for a rise in the value of a nation’s currency, or, a decline in the value of a nation’s currency is that such movement will correct trade imbalances. This is only true if the relative quality of the goods produced by the countries remains the same.
The international investment community has been especially concerned about the performance of the United States economy and the economic philosophy of the United States government since the 1980s. This concern has been reflected in the continued secular weakness of the United States dollar (see my post “The Dollar and the Fed,”

The decline in the value of the United States dollar will not automatically correct America’s trade balance problems. The problems go much deeper.

And, this gets me to Leonhardt’s second point: we should not “view the exchange rate as a cure-all” because “economies, like battleships tend to turn slowly.”

China will continue to maintain a long-term view of where it is going. The United States will continue to focus on the short-term. As a consequence, the specifics of United States policy will vary this way and then it will vary that way, attempting to maintain high levels of economic growth and high levels of employment. The thing we have learned over the past fifty years is that such a short-run focus eventually fails to achieve either higher levels of economic growth or high levels of employment. Such policies have led to one out of every four individuals of employment age being under-employed, the capacity utilization of American industry hovering under 80%, and continued growth in income inequality.

Business is in a “funk” right now concerning the future. Uncertainty about future economic policy is high. Few people place much confidence in where the Obama administration is going policy-wise and even more people have much confidence that the Federal Reserve knows what it is doing.

The Chinese have taken the road to economic power that Germany, Japan, and the United States have taken in the past. This path relies upon becoming an exporter and reaping the advancements that come from successfully becoming an important part of world trade. Now comes the hard part, building up “a thriving domestic economy. Leonhardt argues that China is now moving slowly to achieve this.

My belief is that the Chinese will continue to travel along this path. Some of the bumps along the road, however, are going to come from sources like the United States that have created their own problems and now want others, like the Chinese, to bail them out from the weaknesses they have created for themselves. This situation will not change until the United States stops pointing fingers at others and takes a very hard look at itself.

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