Submitted by Edward Harrison of Credit Writedowns
In 2002, the global economy was weak and equity markets around the world were at multi-year lows following the greatest equity bubble and bust in world history. Many policy makers including Alan Greenspan, chairman of the U.S. Federal Reserve, feared a deflationary spiral of Great Depression proportions resulting from the stock market collapse.
To prevent such an outcome, the United States embarked on an historic monetary experiment to reflate a post-bubble economy by lowering interest rates to 1%, the lowest in 50 years. The result was a huge global economic boom which benefitted nearly every economy and every asset class on the planet. But the boom has turned to bust. In its wake, the cozy relationship between China and the United States that developed during boom time is unravelling.
Just Friday, Barack Obama slapped Chinese tire imports into the United States with tariffs of up to thirty-five percent. China was outraged and immediately threatened to retaliate. I now see a trade war between China and the United States as the biggest threat to global economic recovery.
With this trade war looming, one must wonder if Chimerica, the marriage of China and America as one economic entity, will end in murder-suicide, taking the global economy down with it.
Chimerica’s origins
Niall Ferguson and Moritz Schularick invented the term “Chimerica” in 2006 to describe the underpinnings of the 2000s boom. In their view, this economic upswing resulted from an America and China joined at the hip in a state of economic interdependence. Americans were the spenders and the Chinese were the savers and producers. The United States spent far in excess of what it saved. Meanwhile China ran a huge current account surplus, accumulating a $2 trillion stash of largely U.S. dollar-denominated international reserves, effectively funnelling America’s borrowed money back into the U.S. economy.
This state of affairs was always unsustainable – more so after the collapse of the associated credit and asset bubble exposed fissures in the global financial system in 2007. However, the flashpoint came in 2008 when the U.S. dollar plummeted to record or multi-decade lows against a host of other major currencies, leaving China’s reserves diminished in value. For the months since, the Chinese have expressed growing concern that they could get the short end of the stick if the marriage which created Chimerica dissolves.
Chimerica’s unravelling disturbs China
If one looks at any one incident involving China and the United States during the global economic crisis in isolation, it is easy to lose sight of the big picture. However, threading the events of 2008 and 2009 together makes a compelling case that the Chinese – U.S. marriage is coming apart.
The first indication of Chinese concern which I detailed came as the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac collapsed last August. The Chinese had put much of their reserve money into GSE debt, believing it as safe as U.S. government debt. It was evident that the GSEs were not a safe investment except through an implicit government guarantee (as I said in May 2008). But when the GSEs collapsed, the Chinese were caught out and warned they could dump dollar-denominated assets unless they were made whole. Subsequently, Fannie Mae and Freddie Mac were nationalized and creditors were made whole.
The next flashpoint was created by comments by incoming Treasury Secretary Tim Geithner at his confirmation hearings before Congress. Geithner charged China with ‘manipulating’ its currency in an environment in which many western policy makers were openly blaming Asia’s mercantilism for the economic crisis. The Chinese retaliated, with Chairman Wen slamming the U.S. as a profligate nation in unusually stark terms that raised quite a few eyebrows.
At just about this time, the first hints of real American protectionism came into being in the form of the Buy America provision attached to the stimulus bill. There was quite an uproar from America’s major trading partners like Canada and China – and I saw this as a 21st Smoot-Hawley at the time, a view I still hold. (To make matters worse, the provision has had perverse consequences.)
By this point – early 2009, the Chinese were done. They had suffered the potential for massive losses through the dollar’s weakness and the failure of the GSEs. Now, they were being blamed for a crisis which began in the west. It was at this time that I noticed a steady drumbeat of ditch-the-dollar talk coming out of China. By the G-20 meeting in April, the Chinese central bank head Zhou outright called for a new international reserve currency.
The drumbeat of anti-Dollar news coming from China got louder and louder during the spring. The Chinese started settling trade in Yuan (Apr. 9) instead of dollars. The Chinese were discovered to be stocking up on gold supplies (Apr. 24). The Chinese central bank attacked the policy of quantitative easing in its quarterly report (May 9). The Chinese positioned themselves as the champion of emerging market nations and assembled support from Russia, Brazil and India for reforms in the international reserve system (Jun. 12).
And then came the retaliation.
Protectionism rises
On June 16, I wrote a post “Beijing starts a ‘Buy China’ policy” which clearly demonstrated that the Chinese were incensed by the Buy America provision in America’s stimulus bill. The trade war was on.
The ‘Buy America” and the “Buy China” provisions were nationalistic and prevented goods from other countries being bought. However, they were merely passive protectionism i.e. legislative exclusion of foreign goods and services. No tariffs were assessed.
But when Barack Obama chose to slap 35% tariffs on Chinese tire imports, this was an unmistakable act of active protectionism. This was the proverbial serving of divorce papers.
Expect prices to rise as a result:
Marguerite Trossevin, who represents a coalition of U.S. tire companies that import Chinese tires, said the tariff decision is "very disappointing." She predicted price increases for U.S. consumers and losses for U.S. tire importers.
The Chinese have now said they will look to retaliate on U.S. poultry and auto products:
China announced dumping and subsidy probes of chicken and auto products from the U.S., two days after President Barack Obama imposed tariffs on tires from the Asian nation.
Chinese industries complain that they’re being hurt by “unfair trade practices,” the nation’s Ministry of Commerce said on its Web site yesterday. The dumping investigation relates to poultry alone, a spokesman said in Beijing today. The ministry didn’t specify the value of imports of the products.
To be honest, the protectionism should not be a surprise. Obama is no free-trader. And I certainly foresaw a rise in protectionism and indicated in December 2008 the United States was the likely first mover:
Tariffs, export subsidies and currency devaluations will roil the desire for free trade. Initially, countries will seek relief at the WTO (World Trade Organization) but later they will begin to act unilaterally. The U.S. will be the first to unilaterally retaliate.
Even the resistance to unwinding excess capacity and global rebalancing are all very predictable as nations retreat into nationalistic thinking when the chips are down. As far back as March 2008, I warned of a likely multi-cycle W-recession predicated on resistance to unwinding the status quo:
The global economy, now supported in the main only by the overextended U.S. consumer, finds itself at stall speed, susceptible to any number of potential exogenous shocks. Ultimately, the economic malaise created by this confluence of events will take years to unwind. A positive outcome to this process is dependent wholly on liquidation of excess credit and consumption.
This process will be extremely painful in the short term, but will lead to a healthy economy long-term. Unfortunately, experience shows that these painful steps will only be taken as a last resort. Moreover, geopolitical events become volatile in a world of economic insecurity, leading to political upheaval and protectionism. Protectionism is a natural outgrowth of nationalist economic policy as it transfers wealth from foreign producers to domestic producers by cutting off access to lower cost excess capacity in the goods in service sectors. However, this also serves to transfer wealth from domestic consumers to domestic producers by increasing the price of goods in the protected sectors, ultimately reducing consumption demand.
For these reasons, I am cautious about the long-term outlook for the global economy and the U.S. economy in particular. The likely outcome for the next decade is one of sub-par global growth with short business cycles punctuated by fits of recession.
Yes, trade and dumping are difficult issues. But, protectionism makes most everyone a loser. In June, I wondered should we expect a protectionist China. But I ended saying it was how the Obama administration responded to the green light given by the WTO to impose sanctions which would be most instructive. Obama has gone protectionist.
Chimerica marriage is ending in divorce
All need not be lost. Global re-balancing, where the American partner in this marriage does a little bit more of the saving and a little less of the spending and the Chinese partner does just the opposite, is what most economic counsellors suggest. This could save a strained relationship and put the partners on a sustainable path. This does seem to be happening.
Nevertheless, could this relationship between China and America be coming to an end?
I say emphatically yes. 100%. There is no going back now. Each partner in this marriage, China and the United States, has a bevy of domestic constituencies which are forcing a dissolution of the relationship. Hardliners in China want to move away from the dollar. And populists in America want to punish the Chinese for allegedly manipulating their currency and dumping goods below cost in America.
So, as surely as day turns to night, this arrangement between China and the United States will end. This marriage is over. The question is whether it will end gradually and peacefully in divorce or violently in murder-suicide. Right now, it’s looking like the latter.
32 comments
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I understand why the Chinese are upset – but we have legitimate reasons for increasing tariffs.
Too bad product quality isn’t one of them (from Angry Bear):
http://www.nytimes.com/2007/06/26/business/worldbusiness/26tire.html?_r=1
What is happening to China because of substandard drywall or adulterated consumer products or flawed pharmaceuticals?
I know the banking industry is returning to the 1920’s, but does the world really need to go back to the manufacturing standards of the Upton Sinclair era?
I know quality isn’t the reason for the tariffs – perhaps Obama is sending a message that the era of reducing US worker income is coming to an end – otherwise even more of that Freddie and Fannie paper is going to be worthless.
Ed, you write, “And populists in America want to punish the Chinese for allegedly manipulating their currency and dumping goods below cost in America.”
What is ‘alleged’ about Chinese currency management and selling goods below cost? They pursue their perceived domestic social, economic and political interests.
And is it ‘populists’ alone in America who think the current Sino-American trade regime cannot go on forever without more and more harm to US citizens and national interests?
Respectfully, these rising trade frictions are not driven only by hardliners on either side. People on both sides of the Pacific want to work, and the competitive and cooperative fumbling and groping towards that goal is entering a new phase. No need for dramatic flourishes.
Your ad homimen attack on Obama is just off putting and juvenile; not to mention lacking in any substantive background data or arguements.
If a ‘free-trader’ is one who gives his trading partner a competitive advantage, such as pegging the exchange rate, it is better not to be a free-trader.
There is much amiss in the so-called ‘free-trade’ doctrine such as oversight and corporations gaming their domiciled nation’s taxes.
Really, I’m quickly coming to the conclusion that many otherwise fine websites, such as this and Cafe Americain, are starting to slide into hysterionics and hyperbole. I know some poeple have alot on their plates, but pull back from the darkside and return to substantive issues with logical arguments, conclusions and data context. gl
If you asked anyone who reads this blog regularly, you would know that I was a supporter of Obama and do voice favorable opinions of his policy when merited: for example on his health care speech and I certainly got stick for that as pro-Obama.
There are no ad-hominem attacks. I am not concerned about Obama here, but rather the likelihood that a trade war could develop. A more convincing criticism would be on the merits of the case for protectionism. After all, the WTO did rule against the Chinese. And some commenters have tried to make that case.
Your argument that I am merely tearing down the President is simply false.
While I usually enjoy Mr. Harrison’s columns, there is only so much free trade bootlicking I can take at a stretch.
Seriously, is there a single shred of evidence (not just Freshwater Econ ideology) that unbridled trade such as we have with China is anything more than a race to the bottom?
Why is protectionism always bad? (like “populism” I guess). How is hemorrhaging jobs to some other country solely because their workers are so starved, or so tyrannized that they’ll work for a dollar cheaper a good thing?
Fluffy, you’ll see I have sympathy for the protectionist argument from my comment above. And I voice some of this in a post from last year:
Free trade – as practiced – has hurt middle class Americans through global labor arbitrage and has led to a widening inequality in the U.S. as the owners of capital benefit disproportionately. This is a real problem and why protectionism occurs.
But, history shows slapping tariffs on goods is a poor way to resolve a trade dispute. It usually escalates and most lose – not least the consumer. This is a very difficult issue because China is clearly keeping its currency down and trying to keep costs artificially low in order to employ its tens of millions. Meanwhile this is having a serious impact on America’s workers – minorities disproportionately.
My hope is that we can find a way forward without escalation, but it looks now like this is where we are headed.
Nice reply and I agree with it completely.
I’m not real comfortable with the tariff approach, but I agree wholeheartedly that globalism and free trade have helped Capital while gutting the middle class. If we have to reduce our standard of living until China’s standard of living comes up to meet us in an equilibrium (which free trade would seem to suggest is unavoidable) we are going to end up with a destitute a miserable middle class… I’m not seeing the benefit here.
Most trade disputes such as this one on tires don’t amount to much in the long run.
Dr. Harrison says:
“I now see a trade war between China and the United States as the biggest threat to global economic recovery.”
In contrast, with great respect, I instead see the continued dominance of the Merchants of Debt (and derivatives etc.) in Big Finance as the most obvious risk to a healthy global economy. Now, if the whole world gets into a serious trade war, that’s another story.
And let us remember the known unknowns and the unknown unknowns.
I’ve always read the Chinese noise about “dropping the dollar” and the Obama administration’s subsequent bootlicking as Obama being bad at Poker. The beef the US has with China is that China is artificially holding down the value of its currency by buying US Bonds. The Chinese then threaten to stop buying US Bonds (and thus let their currency appreciate). Rather than saying “please don’t throw me in that briar patch” the Obama administration begs and grovels China to keep behaving badly. A rather sad performance for someone from the Chicago machine.
Both governments represent corrupt centrally planned economies most of whose politicians are simply padding their own nests and looking to maintain power. The paper triangle of Fed, Treasury and Wall Street are America’s central planners. The scam is a game of musical chairs to exchange paper for slave labor and commodities where the general population is entranced either by the force of impoverished circumstances (China) or the magic of the market media (America and China) run as fast as they can to move one rung up an endless ladder. Both China and America know the game. When the scam works the picking are so easy that the “upper crust” is too busy enriching themselves to worry about the other side of the transaction and indeed both are benefiting by stripping commodities from impoverished asset stripping nations, again for paper. Then when the shit hits the fan everyone notices not only that it is just paper (and not even a real promise) and that the neocapitalist wizards have no way to continue to indenture citizens further to keep the paper/goods exchange flowing, well then, the real fight begins. Where all boats were rising, at least somewhat, all was ok. But when all boats are sinking, granted at different rates, and the paper triangle has run out of incantations, look out, the big boys start playing hard ball.
This is a really interesting post and I recommend everyone to consider the issues raised by Ed. I agree the presentation of some facts but I disagree on the, causes and effects. I will focus on a couple of issues.
To begin with, I was not aware that there was a marriage between the US and China and, to boot, that this marriage is falling apart. There is a relation which seems beneficial to both parties (“seem” being a key word) and this relation has its ups and downs. I believe that, human nature being what it is, we all enter into relations for our own selfish reasons but we do not always get what we want. China is pursuing a fast growth policy (“boom” strategy) and the US is taking advantage China’s desire to grow at all costs.
However, these strategies have their downside for both parties. China has to subside quite heavily its exports, both directly and indirectly. The indirect part is by buying US assets to support the dollar. So, I will have to disagree with Ed who says that “The Chinese had put much of their reserve money into GSE debt, believing it as safe as U.S. government debt.” No Sir-ee, Bob! The Chinese put their reserve money into US assets with the full understanding that they would lose much of it. Of course, what politicians do and what they say are not necessarily the same thing. So, of course there is complaining when assets lose value…
As for the US, it benefits in the short term by having a strong dollar that allows us to spend more on defense that the next four or five countries put together and also to import everything at a fraction of what it would cost to produce here. But to a cynic, this looks like a hedonistic “eat, drink, and be merry, for tomorrow we die” strategy (or lack thereof). The private economy in the US is in really bad shape as households progressively realize that they are not as rich as they thought. Cheap imports are good but is cold comfort for someone without a job.
So, let us say that the US and China have the potential to develop a really good economic relation, much better than the one we had in the last ten years. There are fights even in the best of marriages.
The U.S. is one of the most productive countries in the world but it has brought our workers very little. Wages are stagnant or falling and jobs are being eliminated through technology or being sent offshore to serf laborers. We manufacture almost nothing and that is our undoing. I remember going into Wal-Mart years ago when they used to have a big sign in the front featuring an American product. The product featured was a glass measuring cup! After a while, even that sign disappeared. If we don’t institute protectionism, there will be nothing left to protect.
I hope so. I’m tired of reading on the back of my iPhone “Designed in California, assembled in China”, as if Steve Jobs needs to apologize for manufacturing his otherwise fine piece of equipment in China. I want to see “Made in U.S.A.” on my iPhone. Anybody at Apple reading this?
I want to see retailers go back to selling products made right here in America, putting some good Americans (and a few illegal Mexican immigrants) to work. Stay tuned… I think it’s coming to a Walmart near you…
Besides, I would never put Chinese-made tires on my Lexus, anyways. My family’s safety is more important than saving a few bucks…
Vinny G.
Is the anything on your Lexus about being ““Designed, Assembled or Made in U.S.A.”?
May be you could afford made in USA but many other Americans could not.
We’ve lost so much manufacturing that I suspect that the appearance of more American made goods in WalMart would be positive for consumer confidence.
Good post, Ed. But like most here, I too am lost as to why is China being wronged in all this? They sold us cheap plastic trash that fell apart as soon as we took it out of Walmart, and we gave them Dollars that lost their value before they got to buy gold with it. I think that’s a fair transaction…LOL
Besides, I am sure protectionism will benefit the Chinese people. Doesn’t every Chinese mother prefer to feed her baby Chinese-made contaminated baby formula? And she probably also prefers to have her now brain-damaged child play with Chinese-made deadly or lead-contaminated toys. And, surely enough, the average Chinese yuppie loves to eat lead-contaminated Chicken Cho Mein made out of truly home-grown/home-contaminated artificially-inseminated hens. Not to mention the toxic toothpaste, poisonous pet food, and the list goes on and on. So obviously, there are no benefits to China’s importing safe, healthy, uncontaminated products from America…LOL
Long live protectionism! One year of that, and the Chinese Communist Party will likely decree (in the most undemocratic fashion) to confiscate most of the new Beijing skyscrapers and turn them into elegant, asbestos-insulated chicken coops…LOL
I kindly suggest we ditch concepts such as “free trade” and “globalism” and simply return to the economics of “common sense”.
Vinny G.
Those Chinese manufacturing jobs are never coming back to the U.S. , even Alabama’s wages are too high. They will just go to another Asian rival – an up and comer like Indonesia. Vietnam is very well positioned as well.
I hate to say there is no hope, but there is little future for working class Americans – short of some insurrectionary political movement. The threat of expropriation is the only thing that will sway the ruling class as they smash through the world economy.
I’m not so pessimistic. Actually, nowadays jobs move from China to Viet Nam typically only when the process is low-tech, equipment can be readily shipped or economically abandoned, and labor is therefore a large component of the cost of production. Think clothing, with employees living in dormitories, which has definitely led the migration into and out of China.
Lots of manufacturing jobs can come back onshore provided the playing field is leveled a bit. It is a wide spectrum between BMW making cars in Germany and Delphi buying crappy hardparts in China — lots of room for decent American jobs somewhere there in the middle, and great American jobs somewhere nearer the BMW side of the field.
A number of manufacturing operations that have closed under relentless Chinese competition could have stayed open, “high American wages” and all, absent the ridiculously cheap Yuan policy that compels American CEOs and CFOs to feel obliged to buy Chinese. Think Johnson Controls in Dixon, Illinois.
But you are definitely correct that Humpty Dumpty cannot be put back together just the way he was.
I’ll believe it when I can find something made in USA in Wal-Mart or Kmart.Other than food.
Your right Ed, the relationship is busting up probably for more reasons then you have identified but a good start.
If the great global economy is on its death bed then on to other possibilities which is why we have invested so much time and money educating the current crop of economists to think outside the box. Hopefully then can deliver and soon!
Some good stuff, especially about the economic prognosis going forward. However, a few stumbles. As pointed out above, what we now have is certainly not ‘free trade’ as determined by comparative advantage. And I think a strong case can be made that Asian currency policies have artificially spurred borrowing in its trade partners (unless you believe that China’s official currency purchases were entirely undone by private capital flows, despite China’s capital contols). China’s $2 trillion is only part of that story. Blame U.S. regulation and banking practices? But the U.S. housing boom was no worse than those in Spain, Ireland, the U.K., or Australia, to name a few.
China has not suffered a real loss in the value of its reserves. The dollars they took in lieu of goods can still buy the same amount of U.S. goods (the loss to inflation covered by interest).
Finally, China would suffer much, much more than the U.S. from a trade war. For example, the upshot of a short-term dollar collapse would be a rather minor inconvenience to U.S. consumers, balanced by a large increase in aggregate demand for U.S. made goods.
This appears to have been pure politics, as I suspected, according to this report. I really wouldn’t get worked up over this.
http://acrossthecurve.com/?p=8631
“In addition, the articles suggest the White House may have negotiated the tire tax in advance with the Chinese, telling them the President needed to throw a sop to the unions to win support for health care reform.”
There is no murder-suicide. There is cooperation.
I’m afraid John Jansen is mistaken. Xinhua, which is considered a government mouthpiece says no deal was reached:
http://news.xinhuanet.com/english/2009-09/13/content_12043010.htm
There are other stories of a similar variety in the Chinese press, many at Xinhua.I suggest you read them. Moreover, independent of this incident, the pattern of behavior suggests an escalation, as I have said in this post.
I hope an agreement can be reached and I do think much of this is for domestic consumption on both sides. But, this is not just posturing.
Ed,
I’m still not convinced, I’m afraid. More recent Xinhua stories(one, two) devote extensive portions of the column to extensive pressures on President Obama by labor groups to impose tariffs and suggest that it’s all just political. Analysts in the domestic AP suggest that taking the case to the WTO takes it off the agenda of the G-20, meaning China — and possibly America — think China will prevail.
The active attempts to downplay the angst and noise in both countries following the initial splash demonstrates to me an even greater likelihood that the media just ran further with this in both countries than either government expected.
We’ll see what happens next, but put me on record as saying this is all a bunch of posturing for domestic consumption.
we shall see where this leads. a trade war is the last thing chimerica needs at this time. is this truly a race to the bottom?
Two places to blame:
1. Greenspan’s low interest rates, making capital far too cheap (and US labor too expensive)
2. China’s currency manipulation eliminating the safety valve on trade deficits/surpluses of currency rebalancing.
There really is no easy way out, whatever you may say about China or the US. Two leaders with the best of intentions would be unlikely to agree on the required actions simply because they would be so painful. They will have to be FORCED to take the actions, and that will be doubly painful, because the pressures will eventually come from the overshooting marketplace.
Neh, this is just a Chimerican show and one of the tools to cool the markets in case they become overheated overtime.
“…By the G-20 meeting in April, the Chinese central bank head Zhou outright called for a new international reserve currency…”
Don’t forget Geithner, IMF and UN also think a new global reserve currency is desirable. US dollar is a defacto global currency but it is still a national currency encumbered by US national considerations. The UN is needed as a global organisation for the same reason that US is not UN.
Dean Baker has some information that I found interesting. Here is the quote:
“Tire Tariffs are WTO Legal
It would be good if at least some of the news stories on the tire tariffs gave a bit of background. When China was admitted to the WTO it agreed to allow the United States to impose tariffs to temporarily counteract the disruptive effects of an import surge. The agreement did not require the United States to show that China had in any way acted unfairly, simply that the growth of imports had seriously disrupted the domestic market.
This clause was an important factor in selling China’s entry to the WTO to interest groups in the United States. Therefore, it should not be surprising that the government would occasionally take advantage of a clause that it had demanded. –Dean Baker”
http://www.prospect.org/csnc/blogs/beat_the_press_archive?month=09&year=2009&base_name=tire_tariffs_are_wto_legal
Most here seem to think that China will be worse off for a split in the relationship, that they need us more than we need them. I disagree. China has the raw human and natural resources to advance their society and economy in real terms. They will get ever better a manufacturing, and even become a world class innovator. There’s nothing missing in the heads of bright young chinese college grads that we miraculously have here and they don’t. So the US stops buying their products to some extent. There will be pain in China, but they will get used to it and adjust, and they will go one improving and growing. A nationalist might even consider this the ideal scenario, that their growth and advances will truly be home grown. And what is it that we can continue to sell? Worthless financial paper and high end “services”. Ha, the “services” economy paradigm might prove to be an all time great fallacy.