Here Comes the Chinese Yuan

What evidence have I got that the United States has mis-used its responsibility as the provider of the reserve currency of the world?

Look at the morning papers.

“Singapore Aims to be Renminbi Trade Hub,” in the Financial Times (http://www.ft.com/cms/s/0/64bac520-6a4f-11e0-a464-00144feab49a.html#axzz1JsjXsOj5).

“China Speeds Yuan Push,” in the Wall Street Journal (http://professional.wsj.com/article/SB10001424052748704740204576272802457892870.html?mod=ITP_pageone_0&mg=reno-wsj)

In the first article we learn that Singapore has moved to become the first overseas center for trading the renminbi.  It was learned that Beijing will designate a Chinese bank to clear renminbi trades thereby allowing banks in Singapore direct access to the Chinese currency. 

In the second article we learn that China’s central bank is changing its rules so as to make it easier to bring funds raised offshore back onto the Chinese mainland.  This would mean that companies and governments could fund bonds and the purchase of goods in Hong Kong and the Chinese could move those monies around both into China and out to the rest of the world.

Although there seems to be no rush to make the Chinese currency fully convertible into other currencies, most analysts see this as just another step toward the Chinese currency playing a larger and larger role in world trade and finance. 

In the Financial Times article the authors claim that “The People’s Bank of China is pushing for a greater role for the renminbi in global trade and investment to reduce China’s almost total reliance on the US dollar.”

As is typical of Chinese strategy, there is no real hurry to achieve full convertibility and global position for their currency.  The move is slow and steady, building toward inevitability.  We need to remember this as the slow, patient, ascension of China proceeds in the twenty-first century.

No other country has really threatened the position of the United States dollar as a reserve currency since World War II.  This has been of great benefit to the United States and has allowed the US government to get away with a lot of things in international financial markets that it could not have done if it had not had the world’s reserve currency. 

Still, the failure of the United States to act in a fully responsible way relative to its providing the world’s reserve currency seems to finally be catching up with it. 

Beginning in the 1960s, the United States government began fifty years of credit inflation.  The first victim of this prolificacy was the international gold standard, which ended on August 15, 1971 when president Richard Nixon announced that the value of the dollar would now be floated in the foreign exchange markets. 

The second victim was the purchasing power of the United States dollar.  A dollar that could purchase a dollar’s worth of goods and services in 1960 could only purchase about fifteen cents worth of goods and services in 2011.  That is, the purchasing power of the dollar declined by 85 percent during this fifty year time period!

The third victim was the value of the United States dollar in the foreign exchange markets.  Since the United States dollar was floated, the value of the dollar against the currencies of other major trading partners has declined by about 35 percent.  It has declined by even more against the currencies of other countries the US trades with. 

The United States has profited greatly over the past fifty years or so by having its currency serve as the reserve currency of the world.  Treasury Secretary Geithner drew on this fact the other day when he claimed that the world was still very comfortable buying US Treasury securities. 

Yet the confidence of the world Geithner claimed for the purchase of US Treasury securities is sadly tarnished by the performance of the United States dollar in world foreign exchange markets.  The United States has benefitted from its position as the supplier of the reserve currency, but it has abused its responsibility of being the supplier of this reserve currency by following a path for fifty years of fiscal and monetary policy that undermined the value of the currency.

Now, there is a rising star in the world that threatens the position of the United States dollar.  As I remarked above, the Chinese currency still has a long way to go to dethrone the United States dollar.  What we must notice, however, is that the fault lines seem to be forming.

It will be interesting to see what the leaders of the United States government do as this situation becomes clearer. 

The Bear and the United States Dollar

I continue to be a long-term bear on the United States Dollar.

The credit inflation that is looming on the horizon in the United States over the next decade is daunting. Financial leverage is going to increase once again and financial innovation, spurred on by advances in information technology, is going to this future.

This is what people do in a period of strong credit inflation.

Chairman Bernanke says he doesn’t see any signs of a buildup of inflationary expectations.

This analysis comes from a man who has been late for every economic event during his ten-years of leadership in Washington, D. C.

Inflationary expectations may not be showing up significantly in bond yields, but inflationary expectations continue to dominate the markets for the U. S. Dollar.

Inflationary expectations are not showing up to any extent in the government bond market because of the pressure kept on this market by the Fed’s quantitative easing efforts. The Fed, given the magnitude of its actions, can keep even long term interest rates lower than they would be otherwise.

The Federal Reserve cannot achieve the same success in the foreign exchange market, especially if it is flooding the financial markets with liquidity.

Foreign exchange markets look for governments that are “out of control” in terms of their fiscal affairs. Large deficits and growing levels of debt contribute to an environment of credit inflation. That is, not only does the government debt increase in such an environment, but the incentives are established by the government so that private debt levels also increase. If such credit inflations are observed by foreign exchange markets to be excessive relative to what is occurring in other countries, the value of the currency in the country that is least disciplined will decline relative to these other countries.

The last time the foreign exchange markets appeared to believe that the United States government was managing its budget in a relatively prudent way was in the late 1990s. Beginning in early 1995 when the Clinton administration began bringing the fiscal deficits of the country under control, the value of the dollar against major currencies (Federal Reserve series) rose by almost a third until January 2001 when Bush 43 took over as President.

The value of the dollar reached its near term peak in February 2002, just after 9/11, after the “flight –to-quality bid up the currency during this uncertain time. However, the budget policies of the Bush 43 administration became clearer to foreign exchange markets as the spring of 2002 progressed and the value of the dollar began to decline.

The credit inflation begun during the Bush 43 presidency continued into the Obama administration. From February 2002 through February 2011, the value of the dollar declined by almost 36%!

Some recovery took place in the value of the dollar last year as a result of the turmoil in the sovereign debt markets in Europe. However, to me, when United States credit inflation surfaced again in the late summer of 2010, it was very obvious that the focus of foreign exchange markets turned almost immediately toward selling the dollar.

The event of the late summer was the speech by Chairman Bernanke which introduced the forthcoming QE2, the second round of quantitative easing. The value of the dollar has fallen since then, indicating that the attention of foreign exchange markets was still on the lack of fiscal and monetary discipline in the United States government.

Since the summer of 2010, the value of the dollar against major currencies has declined by about 9%.

Furthermore, foreign exchange markets are showing no confidence in the fights now taking place in the United States Congress concerning the “battle-over-the-budget.”

To me, foreign exchange markets are saying that there is no leadership on fiscal matters (or monetary matters) in the United States government. Everything is the same as it has been for the last fifty years. And, we see no evidence that anything will be changed in the foreseeable future.

In addition, the rise in the price of oil due to the turmoil in the Middle East seems to raise further questions about the United States economy and this is adding to the downward pressure on the value of the dollar.

How much more will the dollar have to fall?

Barry Eichengreen, an expert of the international monetary system, gives us his estimate in the Wall Street Journal this morning. He argues that “the dollar will have to fall by roughly 20%.” The time frame seems to be over the next five years or so. (See http://professional.wsj.com/article/SB10001424052748703313304576132170181013248.html?mod=ITP_thejournalreport_0&mg=reno-wsj.)

Given this scenario, Eichengreen also sees the role of the United States dollar as the world’s primary reserve currency declining. Besides the lack of fiscal discipline in the United States and the proliferation of financial innovation in the world, he argues that there are now some legitimate alternatives to the dollar in global trade. The euro and the Chinese yuan are being used more and more in world trade and given the further decline in the value of the dollar this trend for the euro and the yuan will continue.

This outlines the picture that I am working with when I take my bearish position with respect to the long-run value of the United States dollar. In a world where capital flows very fluidly throughout the world, even a country as powerful as the United States, a country that possesses the globe’s reserve currency, cannot operate as if the rest of the world doesn’t exist.

Yet, that seems to be the view of the leaders of the United States and I don’t see that attitude changing anytime soon. Thus, the value of the dollar will continue to decline.

China Plays the Game

The Chinese central bank has announced that it will raise the one year lending and deposit rates by 25 basis points. This has been a major surprise to international financial markets.

One can assume that this move was done very deliberately and very intentionally. The Chinese do not make policy decisions unless they are well thought-out.

The immediate reason for the move at this time: later this week there will be a meeting of the G-20 finance ministers. Next month in Seoul, South Korea there will be a meeting of the G-20 leaders.

The move is not an accident!

The International Monetary Fund just completed meetings earlier this month in Washington, D. C. Before that meeting, the United States took a strong stand on the value of the Chinese currency and the behavior of the Chinese government with respect to this value. The United States made an effort to get other nations to criticize the Chinese position.

The result of the IMF meeting? Little to no pressure was put on the Chinese giving indication that the United States was having no luck in its campaign to bring the Chinese “into line” on the value of their currency. The United States looked weak. (See my post on this: http://seekingalpha.com/article/229388-the-imf-meetings-you-can-t-lead-out-of-weakness.)

If China’s action on interest rates is followed up by China allowing for a faster climb in its currency, the yuan, the Chinese will strengthen the position of their government within the G-20. It would also strengthen the role of other Asian nations as well as other BRIC nations in negotiations concerning the future of the dollar as a reserve currency.

Thus, the Chinese would build on the exhibited weakness of the United States at the meetings of the IMF in Washington and help to consolidate other nations around its leadership in world economic affairs.

Is the United States and China at war?

In one sense they are. Martin Wolf at the Financial Times of London has written, “In effect, the US is seeking to inflate China, and China to deflate the US. Both sides are convinced they are right…” (See http://seekingalpha.com/article/227632-monetary-warfare-u-s-vs-china.)

How has this situation developed? Well, in a real sense, the world has bifurcated. Part of the world, generally the developed countries, are struggling to restart their economies from the Great Recession, while many of the emerging countries are doing just fine, thank you.

The Federal Reserve System in the United States and the European Central Bank seem intent upon buying massive amounts of bonds to carry out a “Quantitative Easing” in an attempt to “jump-start” their economies. The prospect of this has resulted in a weakening of the dollar. This has not been looked on favorably by the emerging nations who are experiencing economic growth and even a potential threat of inflation.

As a consequence, several of the emerging nations have already taken actions to protect the value of their currency from the weaknesses seen in the American position. These nations have already considered control techniques to protect themselves from the fall in the dollar exchange rate. They are considering the possibility having dual exchange rates, one for trade payments and one for non-trade payments.

The threat here is that world will break into two currency areas, one that is dollar/euro dominated and one that is dominated by China and the other emerging nations. And, certainly, the possibility of some kind of financial controls on foreign exchange is not a settling thought.

The reigning problem to me is the failure of leaders, especially leaders in the United States and in other developed countries, to appreciate the changes that have taken place in the world. The continued focus of the leadership in the United States on stimulating internal demand so as to achieve something, full employment of resources, that they really can’t achieve, is leading them down the path of isolation. By continuing to follow an economic philosophy that has proven itself to be ineffective (if it ever was effective) is only creating a fissure within the world.

In effect, the United States, by pursuing the same type of policy it has followed for the last 50 years, is not only weakening itself but is providing the stage for the Chinese to exert its own leadership to those the United States policy is hurting.

The Chinese are moving to achieve a position of prominence in the world of the 21st century. What they are doing is very intentional and when they do things, they do them in their own time and for their own reasons. They are not always right, but that is not the point.

The point is that the Chinese are very deliberate in promoting themselves and their country. The United States, however, seems to be helping them achieve what they want to achieve. This cannot continue.

The IMF Bowl: the United States versus China

With the IMF annual meeting taking place this weekend in Washington, D. C., it is hard to pick on any other topic than what is happening in economics and finance in the world.

The underlying story: the United States has not been challenged, financially as well as economically, in many years and has grown comfortable with its position as the Number One Player (NOP) in the World.

Plot line: the United States will not fall from its position as NOP but other countries are becoming relatively stronger, especially China.

Scenario: China smells weakness in the United States position. When an “opponent” smells weakness, that “opponent” steps up its game. Most experts expected China to “step up its game” at some time in the future, but they did not expect this behavior to happen so soon.

Response: the NOP calls “foul”! The first reaction of the NOP is to claim that the “opponent” is cheating or playing dirty. The NOP tries to get those on the sideline into the game in order to overcome the pressure that the “opponent” is applying to the NOP. China bashing has become de rigueur in the United States, especially for those running for office in this fall’s elections. (“China-Bashing Gains Bipartisan Support,” http://professional.wsj.com/article/SB10001424052748704689804575536283175049718.html?mod=ITP_pageone_2&mg=reno-wsj.)

Script: the battle goes on. This conflict is not going to be resolved this weekend. Nor is the conflict going to be resolved at the G-20 meetings in November. The conflict, for the time being, is going to be played out on the playing fields. The “opponent” is going to push the NOP and is going to hit the NOP on many different fronts.

For example, another move by the “opponent’ is the effort by the Chinese to make its currency, the yuan, more global. Last week, electronic trading of the yuan began. Further efforts are underway to expand this trading to banks in the United States and in Europe. (“Yuan Goes Electronic in Global Market Bid,” http://professional.wsj.com/article/SB10001424052748704011904575537754269611906.html?mod=ITP_moneyandinvesting_0&mg=reno-wsj.)

“China’s government has made a series of moves in the past year to encourage the yuan’s use outside China, an effort to become less dependent on the dollar for trade and investment. The moves are allowing pools of yuan to accumulate in bank accounts outside of China, particularly in Hong Kong.

Hong Kong banks have been trading the currency among themselves, but through over-the-counter trades where the banks contact each other directly or through brokers.”

This new move will mean that prices and trading amounts will be posted for all to see.

The effort to improve its relative position in the world is not going to stop. China is making efforts on many fronts to strengthen its position in the world. The contest is on.

Leaders in the Obama administration, from the President to the Secretary of the Treasury on down, are speaking out more forcefully against the actions of the Chinese.

World leaders are observing this conflict and are trying to keep the discussions civil and “in bounds”. This is why someone like the managing director of the IMF, Dominique Strauss-Kahn, as well as others, are attempting to temper the rhetoric and bring things into the existing organizations that deal with trade and international finance. (“IMF Chief Steps into Dispute over China’s Currency Policy,” http://www.nytimes.com/2010/10/08/business/global/08currency.html?ref=business.)

Players crying “foul” can only achieve so much. Sooner or later the NOP will have to modify its game plan and raise its play to another level. The “opponent” is not going to lessen its pressure as long as weakness in perceived in the NOP.

And, where does this weakness show? One very prominent place this weakness shows is in the value of the dollar. Since the early 1970s when the dollar was taken off the gold standard, the value of the dollar has declined by about 40%. Except for the “flight to quality” periods experienced during the financial unpleasantness of the 2008-2009 period, the dollar has continued to be in decline from the level it reached during the Clinton years. The international investment community is not “in love” with the fiscal and monetary policy of the United States government.

This contest between China and the United States is for real. The pressure from the Chinese is not going to abate anytime soon. The “rest-of-the-world” is not in any position to contain this conflict unless it shuts down world trade, something it will not do.

This means that the United States must get its act in order. The United States cannot compete with 20% to 25% of its industrial capacity not being used. The United States cannot compete with 20% to 25% of its labor force under-employed and not trained sufficiently to work in the modern economy. The United States cannot compete when its government creates incentives for people to protect themselves from credit inflation rather than engage in productive pursuits.
And, fiscal stimulus by the government and quantitative easing on the part of the monetary authorities will not correct these problems. They will only indicate to the Chinese how weak the United States has become.

This contest between China and the United States is for real. The only way the United States can “raise its game” is by focusing on what can make it more competitive. I don’t believe that the United States will ever again get the “free ride” it benefitted from over the past thirty years or so. So, the United States government must change the way it does business.

The Chinese are only the first in line to “take us on”. Right behind them are the Brazilians, the Indians, and, of course, the Russians, again. And, right behind them is a whole host of other nations.

The Problem is "Out There"! It's China!

The quote of Stephen Covey that continues to resonate with me is "As long as you think the problem is out there, that very thought is the problem."

With all the fuss over the movement by the Chinese to allow the value of their currency to rise we hear, once again in the background, that the real problem is that the imbalances in the world are really a consequence of “an entrenched savings excess” in China. (See the article by George Magnus, “We Need More from China than a Flexible Renminbi,” http://www.ft.com/cms/s/0/4f19ced4-7d4a-11df-a0f5-00144feabdc0.html.)

There we have it!

And, the support for this theory goes as far as Ben Bernanke, Chairman of the Board of Governors of the Federal Reserve System, who came up with this idea to provide Alan Greenspan with an excuse to keep interest rates excessively low in the earlier years of the 2000s.

The problem is “Out There”!

Those Chinese just save too much! Let them be like the Americans who reduced their savings to close to around one percent of disposable income earlier this decade. The Chinese bought a large proportion of the bonds going to finance the huge deficits of the United States government and this kept interest rates so low that the Federal Reserve could reduce their target interest rates to levels that created a bubble in the United States housing market.

As Magnus writes, the Chinese do have an unreformed rural sector, an immature social security and financial system and a one-child policy. But, China is transforming. It is just not doing it at the pace that the Western world would like it to in order to reduce or eliminate the imbalances that exist internationally.

The Chinese, however, are not going to change their social policy overnight. This is one of their “no-no’s”! They saw what happened in Russia and Eastern Europe as the social order unraveled when the Communist governments in these areas fell. They vowed to keep a lid on things, culturally, as China modernized. They will not back off this controlled approach as they move toward a state capitalism and a society that is more open to the world.

But, this is not what created the huge government budget deficits in the United States. The total amount of United States debt outstanding rose at a compound rate of over 7% from early in the 1960s through the end of 2008. This was not the fault of the Chinese!

Nor is it the solution to the low personal savings rates in the United States and the huge government budget deficits going forward. The personal savings rate in the United States stayed above 7% for most of the period between the late 1950s into the late 1980s. It exceeded 10% at times!

What eventually got to the American saver was the steady erosion of the real value of the savings put aside during this time. And, as the American saver moved into the 1990s, the personal savings rate began to fall and continued to fall into the 2000s. Consumer prices in the United States rose at a compound rate of around 4% from January 1961 through the summer of 2008. The purchasing power of a 1961 dollar dropped during this time to about $0.15.

If anything may accelerate the decline in the personal savings rate in China it may be the rising rate of inflation that is being experienced there. If the real value of savings takes a precipitous drop, even the rural Chinese may begin to adjust their behavior.

The real problem in this picture is the massive amount of United States debt that is outstanding. And, the amount of debt that is outstanding is the fault of no one but the United States. But, this problem puts a lot of pressure on other countries, especially on China.

China holds about 70 percent of its foreign exchange reserves in dollars, mostly in United States Treasury securities. This accumulation began in the 1990s and accelerated into the 2000s. The United States dollar was the reserve currency of the world and United States Treasury securities were the most secure investment around in terms of risk.

I remember working with a group from China in the early 1990s that represented Chinese pension funds. This discussion took place at the University of Pennsylvania. I was not teaching at the time, I was the president and CEO of a bank.

Chinese pension funds had a very large amount of money, yet because they could only invest on Mainland China they had limited capabilities of earning a decent return on their monies and were very limited in terms of their ability to diversify their investment holdings. This group was investigating investing pension fund monies “off-shore” and they were interested in foreign exchange risk and how this risk could be hedged. And, these discussions were a part of the general discussion going on in China at the time about investing more and more of their monies and international reserves in the rest of the world.

The point is that the early 1990s represented a time in which China was opening up and investigating how it could participate in global financial markets. Being very cautious, the Chinese were learning about how to diversify into the world but keep its risk exposure low both in term of credit risk and foreign exchange risk. I don’t see much of a change in this attitude at the present time.

Magnus mentions, in his article, that because of China’s creditor status it must play a role in helping to fix the global financial imbalances. Specifically, he argues that China cannot “back away” from these world imbalances—as the United States did in the 1920s and the Japanese did in the 1980s—because, in the end, backing away will neither help the world, or themselves.

My guess is that the Chinese will not “back away” and “dump” United States Treasury securities. This is one of the reasons why the Chinese do not want to see the value of the Yuan rise too rapidly. A “quicker revaluation would act as a stealth monetary tightening not only in China but also the US.” This is because it would have a negative effect on US equity prices and also result in higher US interest rates. (See the Lex column in the Financial Times: http://www.ft.com/cms/s/3/9db857ea-7d45-11df-a0f5-00144feabdc0.html.)

However, President Obama’s administration and the United States Congress continues to press for China to change the behavior of its government and the savings habits of its people. Yet, many of the major imbalances in the world today result from the undisciplined behavior of the United States over the past fifty years or so. The huge amounts of United States government debt outstanding are not the result of the government of China or the Chinese people. Why, then, should the Chinese bear the brunt of any adjustment that is to take place?

As long as the United States government and the people of the United States think the problem is out there, the problems and imbalances will not be resolved. The only one we can control is ourselves, so if anything is going to be accomplished, we are going to have to do it…not the Chinese.

China Is In The Game

China wants to play in the game. Yes, it would like to dominate the game, but that is for another time. For the present, China wants to be a player. I have written this constantly throughout my blogging career and I see no reason to change my opinion at this point.

China wants to play in the game and to do so its leaders realize that it must be a part of the game and not absent from it. But, remember two things: first, China will not do anything that it thinks might be harmful to itself in the long run; and second, China will always move in a way that “saves face.” Given these two conditions, China will be “in the game.”

The weekend news about China’s move on its currency is a case in point. The move was taken at China’s initiative. It seemed to catch the rest of the world by surprise. The move followed weeks of discussion about the possibility that China would not change the value of its currency in the near term.

China timed its move according to its dictates and not those of other nations.

Furthermore, the move pre-empts any discussion or actions by members of the G-20 at its June 26-27 meeting to highlight China’s unwillingness to play ball with the other major nations that will be in attendance. Now, the rest of the G-20 must re-boot their strategies relative to the agenda of the upcoming meeting.

China must see this as beneficial to itself and believe that moving at this time “saves face” because the news was done on its terms and not those of other countries in the world. It is keeping itself in the game.

However, China does not want events to get ahead of its plans. Although the announcement came on Saturday, when the market opened on Monday the value of the yuan was approximately 6.83 yuan to the dollar, roughly the same as it closed on Friday. By Monday afternoon, however, the yuan was trading around 6.8015 to the dollar, the highest level it has been in the modern era.

The point here is that China wants any appreciation in the value of the yuan to be incremental and not discrete. That is, movements in the yuan will tend to be more like a slow crawl and not like a discrete jump or leap. The leaders in China do not want to encourage speculators or huge currency inflows.

The signal to investors is that the value of the yuan may change but don’t expect wide swings. This is just not the way the Chinese do business.

But, I think, there is a bigger story going on here. The bigger story includes Russia and India…so we have three of the four BRIC nations as a part of what is going on. President Obama and his administration are making a concerted effort to be a part of the trajectory taking these countries into a prominent position in the world. All three of these countries are engaging each other, and talking with each other, visiting each other, and doing things with each other.

Chinese leaders have come to America and American leaders have gone to China.

New contacts with Russia show promise. Last year, President Obama called for a reset in relations with Russia. The countries have now signed a nuclear arms reduction treaty, agreed to increase cooperation in Afghanistan, and Russia has supported United States sanctions against Iran. This week President Medvedev comes to Washington to discuss business and then will visit Silicon Valley to meet with leaders in the technology field. Medvedev would like to encourage technology areas similar to Silicon Valley in Russia.

Leaders in India also are responding to invitations from the Obama administration to engage in dialogue and improved communications between India and the United States. Of these three BRIC nations, India has the longest solid ties with the United States and the greatest personal bond to see that these ties become stronger.

Not only are these three countries becoming relatively stronger in the world pecking order, but are the important reason why discussions about world business and foreign trade need to work in the larger Group of 20 nations rather than in the smaller groups that have been so prominent in the past.

Add on top of this the economic weaknesses experienced in the United States and Europe which have allowed these three, China, Russia, and India, to gain relative to “the West” faster than they would have if the financial collapse in these former areas had not occurred. These three nations are not going to back off their ascent in the world power scramble just because the United States and Europe are facing some “uncomfortable” economic weaknesses.

Furthermore, Europe has its own internal contradictions to deal with. Leadership in Europe is close to zero and the political problems that must be resolved there are almost overwhelming. And, while Europe attempts to get its house in order…the rest of the world moves on.

Brazil, the other BRIC, seems to be laying bricks lately. The current president, Luiz Inảcio Lula da Silva seems more interested in playing around with the leaders of countries at odds with the United States rather than entering into more mature relationships with the rest of the emerging world. Enough said.

What is vitally important for world trade and finance is to have these major countries talking with one another and learning about how they can work together to create a world in which all can prosper. World trade will not exist if it just benefits one or two countries.

The emerging nations are doing just that…emerging. These countries must be an important part of the world of the future. Keeping these nations down and causing resentments in a world where there are no channels for communication is not the way to build a richer and more vibrant world to live in.

The crucial thing is learning how to deal with each other. As I mentioned above, the Chinese will not make moves that will harm themselves in the long run and when they move they will do so in a way that does not make them look bad. Can we in the United States accept these two behavioral traits that seem so important to the Chinese or will we become so impatient and try and impose our self-importance on them?

Certainly, leaders in the United States cannot become “doormats” that others can just walk over. But, the time seems right for talking, for keeping channels open, for cooperation within the competitive framework, and for learning how to work with each other, accepting the quirks and psychological needs of others.

China will not always internally do the things we in the United States think that they should do…especially in some areas like human rights. We should not be silent on these things. But, I believe the world still has more to gain by building cooperation over the longer run than it does by breaking off ties. I believe that the recent economic moves by China confirm this. I believe that the leaders of China truly want to be in the game and will act accordingly.

China is Changing the World

Earlier, on March 25, I raised the question “Why Should China Change?” in my post, “Why Should China Change?” (http://seekingalpha.com/article/193689-why-should-china-change)
The thrust of the post was captured in the following:

“The world has changed and we in the United States have not accepted the fact.

Why should China change direction at this time?

China is growing stronger and stronger. The United States, and most of the rest of the west, is in a weakened state. The United States, and most of the rest of the west, has gone through a very severe financial crisis and the worst recession since the 1930s.”

The United States is still the number one power in the world, both economically and politically, but its relative position has changed. And we continue to see that in our relationship with China (and India and Brazil and Russia).

The current ‘high-level’ meeting in Beijing of representatives from China and the United States highlights the changing relations between the governments of China and the United States. As reported in the New York Times, “the opening session laid bare a recurring theme…the United States came with a long wish list for China…while China mostly wants to be left along…” (http://www.nytimes.com/2010/05/25/world/asia/25diplo.html?ref=business)

China is “turning into an economic superpower” according to the Times article and wants to continue along on its merry way. The United States, other than initiating an all out trade war, seems incapable of slowing down the Chinese economic machine or even getting the attention of the Chinese leaders.

Chinese President Hu Jintao did pledge to continue reform of China’s currency, but then repeated the standard operating response: “China will continue to steadily push forward reform of the renminbi exchange-rate formation mechanism in a self-initiated, controllable and gradual manner.” That is, we will change things when we want to change things and no sooner.

Secretary of the Treasury Geithner graciously replied: “We welcome the fact that China’s leaders have recognized that reform of the exchange rate is an important part of their broader reform agenda.” What else could he say?

The United States, and most of the rest of the west, is in a weakened state. But, this weakened state goes beyond the short-run. The United States is facing longer run, structural problems it must deal with. Economic growth and financial strength are important factors in world economic power. However, when a nation extends itself and stretches itself too far due to over-commitment and over-leverage, thinking it can do too much, it exposes itself to other nations that are not in a similar position.

It is the United States, the number one world power that is asking China to change. China is in a position where it does not feel the need to cave into the American requests. China is strong and disciplined. The United States is strong, but undisciplined. Therein lies the difference.

And, the (supposed) allies of the United States are little or no help. Europe is attempting to resolve the problems it created for itself. As a consequence it is slowly fading into the background. The G-7 group of nations, the United States, Canada, France, Germany, Italy, Japan, and England, is losing relevance in the world. The G-20 includes the seven, but more importantly includes several emerging nations that are more strategic to the future than is the “old boyz club” from Europe.

De-emphasize the G-7 and raise up the G-20!

The ultimate problem of the United States is its lack of discipline. For the past fifty years or so, the United States has lived for “the short-run” because, we have been told, that “in the long-run we are all dead.” The economic policy of the United States has been designed to combat short-run increases in unemployment with a constant pressure to achieve high rates of economic growth. But, this creates an inflationary bias in economic policy. Because of this the United States has seen the purchasing power of its dollar drop 85% from January 1961 until the present time, underemployment has grown to about 20% of the working age population and the capacity utilization of its industrial base has declined to less than 75% at present (but rose to only slightly more than 80% in its most recent cyclical peak).

These are not signs of economic strength. Furthermore, the value of the dollar over the past forty years has dropped by approximately 35%. Huge amounts of United States debt, both public and private, have been financed “off shore”. These developments do not put America in a very strong bargaining position.

China thinks in decades. The United States thinks in terms of the next election. Discipline does matter.

There are still many economists in the United States who argue that the government must spend more and create more debt to get the country going once again. Their fundamentalist view of how the world works blinds them to the fact that it was the loss of fiscal discipline, the exorbitant creation of huge amounts of government debt and the subsequent credit inflation that this encouraged, that put the United States into the position it now finds itself.

More spending and more debt are not going to make the situation any better. I examined this issue in my May 13 post “Government Deficits and Economic Activity”: http://seekingalpha.com/article/204948-government-deficits-and-economic-activity. My basic conclusion was that in the present situation where the Federal Reserve has pumped so much liquidity into the banks that big banks and big companies can play games in world financial markets and cause major problems for areas like the euro-zone. The continued creation of deficits and more government debt is not going to solve this problem for Europe…or the United States.

Until it gets it act under control and in order, the United States will be the one asking China to change the way it does things. China, given the present circumstances, will continue to do things in their own interest and at their own speed. In addition, it is my guess that other, emerging nations will begin to exert themselves in similar ways. And, the United States will not be in a position to resist their efforts.

As I said earlier, “The world has changed and we in the United States have not accepted that fact.”

All we can really control is ourselves and if we fail to do that we give up the chance to influence others.