The $1.4 Trillion Question

September 30, 2008 12:30 PM

"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) People’s Republic of China." James Fallows on how the trade deficit between China and America works and what it means for the future.
posted by afu (41 comments total)

Why exactly is China continuing to invest in American T-bills when even my goats outside would agree that the US is nearly insolvent? Yeah, there's the yarn that they lose their biggest trading partner, but surely there's not Big Chinese Man Buying All The T-Bills Not Wanting America To Collapse but rather individual humans wanting to shelter against risk, and I don't understand why they aren't flocking to European investments. I guess I've got to read the article, but it's the middle of my workday. But I'm darn sure going to read it... the Atlantic is awesome.
posted by crapmatic at 12:45 PM on September 30, 2008

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.)

Key economic figures being state secrets troubles me greatly.
posted by infinitewindow at 12:46 PM on September 30, 2008 [3 favorites has favorites]

Why exactly is China continuing to invest in American T-bills when even my goats outside would agree that the US is nearly insolvent?

The US economy is still 4 to 5 times the size of China's, even with our banking/credit fuckup.
posted by Pollomacho at 12:52 PM on September 30, 2008

The US economy is still 4 to 5 times the size of China's, even with our banking/credit fuckup.

True, but why aren't they investing in Europe?
EU GDP - $16.6 trillion
US GDP - $13.8 trillion
posted by crapmatic at 12:54 PM on September 30, 2008

Honestly, it's hard for me to feel bad for the Chinese government. Their purchase of U.S. bonds insures that a great many Chinese will continue having jobs (with all this implies for the government's unchallenged retention of power). And besides, it's not like the Chinese aren't willing to pressure the U.S. to protect the value of their investment.
posted by longdaysjourney at 12:56 PM on September 30, 2008 [1 favorite has favorites]

I also suspect that the powers that be in the PRC have an interest in ensuring that Chinese affluence among ordinary folk does not increase at too threatening a rate. Threatening to the hegemony of the government, that is.

I don't understand why they aren't flocking to European investments

Europe has done a far better job managing trade issues, but they have some longer term fundamental problems on the horizon. They have population pyramid inversion issues, a decreasing revenue pool to pay for services for aging populations, immigration issues that have never effectively been dealt with and financial system problems of their own.
posted by psmealey at 12:59 PM on September 30, 2008

True, but why aren't they investing in Europe?

1: Who says they weren't?
2: European bonds are divided by nation still (please correct me if I'm worng) and aren't unified.
3: The EU market's investment banks are in the same credit shithole as the US's. For example: BeNeLux just dumped 11.2 billion Euro into Fortis to shore them up similar to the US bailout of AIG.
posted by Pollomacho at 1:09 PM on September 30, 2008

True, but why aren't they investing more in Europe?

One sentence in the article nets out the answer quite succinctly: "China can’t afford to stop feeding dollars to Americans, because China’s own dollar holdings would be devastated if it did. As long as that logic holds, the system works. As soon as it doesn’t, we have a big problem." And they go on to talk a little bit about various things that could lead to "a big problem."
posted by brandman at 1:20 PM on September 30, 2008 [2 favorites has favorites]

True, but why aren't they investing in Europe?

They've invested a ton of money in Africa...
posted by fearfulsymmetry at 1:27 PM on September 30, 2008 [1 favorite has favorites]

crapmatic: but surely there's not Big Chinese Man Buying All The T-Bills Not Wanting America To Collapse but rather individual humans wanting to shelter against risk

From the article:
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 China’s “surrender requirements,” Chinese banks can’t 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 China’s equivalent of the Federal Reserve Bank, the People’s Bank of China, for RMB at whatever is the official rate of exchange.
...
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 SAFE’s 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.
posted by Gyan at 1:28 PM on September 30, 2008

Yes. I was just going to say: crapmatic: RTFA.

Nice post afu. Well written article.
posted by beelzbubba at 1:35 PM on September 30, 2008

Also, keep in mind the article was written in January 2008. Taking into account the financial events of the past 2 months in the US, I wonder how much of what this article posits as theory accelerates or changes.
Will China now start aggressively investing elsewhere? Could that, in turn, push oil to be set in Euros? Or could China now start using that enormous wealth to purchase floundering US manufacturing companies that they couldn't before because of political pressure?
posted by seldom seen cid at 2:13 PM on September 30, 2008

I assume that they aren't interested in Europe because their resources are already sunk into the US and Africa, and trying to horn in on Europe would stretch them too thin, and the point of exporting all of this money is to have and maintain a controlling interest. China wants the US to have an insurmountable debt to China that they can use as leverage lest they call it in. As for Africa, I'd think it's the resources they're after, probably by a similar mechanism.

The flipside of this - suppressing their own economy - keeps the cost of labor insanely low. It's literally more cost effective to hire 15 guys with scissors to cut grass than to buy a lawnmower and hire one guy. Essentially free labor is what's made China's incredible growth possible. Another example: where else in the world can cities afford to let architects take risk after risk? Shanghai is a city of cranes erecting hundreds of buildings, all crazier than the next. Could they afford that without a suppressed economy and a massive class divide?

When they're ready, they'll call in their debts, already having taken control of the densest resources in the world, boosting their own economy and suppressing ours. Good plan, I'd say.

I didn't read the article, so sorry if they either said this or refuted it completely.
posted by cmoj at 2:21 PM on September 30, 2008 [1 favorite has favorites]

Why exactly are trade deficits a big deal? I've never really gotten why people are so hung up on them, I mean if The U.S. buys crap from China, and China buys Oil from Saudi Arabia, and the Saudis buy oil services from companies like Halliburton, that's not really a trade deficit, although it looks like we have a deficit with China.

Of course, as far as I know the U.S. does have a net trade deficit, but I still don't see why that's a problem. After all, if U.S. workers are more productive then the rest of the world, then we will be producing more wealth per capita. That wealth has to go somewhere, right?

Also, the idea that we are 'borrowing' money in a trade deficit is absurd. Every month I pay my landlord. Does that mean he owes me that money back? Or that I somehow owe him an amount equal to my rent? After all, there is a 'trade deficit' between the two of us.
posted by delmoi at 2:24 PM on September 30, 2008 [1 favorite has favorites]

Warren Buffet CNBC Interview

Mr. BUFFETT: Well, it won't continue if over the next five or 10 years we
run very large current account deficits. Now, exports have been doing well
lately. I mean, the country is remarkably innovative and resilient. I mean,
we are going to export 12 percent of our GDP this year, and in 1970 it was 5
percent.

QUICK: Mm-hmm.

Mr. BUFFETT: So people who think that America is not in the game are totally
wrong. But we have been importing like 17 percent of GDP. If we have that
gap and it continues, the dollar over time will get weaker. Not necessarily
next week or next month or next year, but it will get weaker over time. You
can't run persistent, huge current account deficits for decades and not have
consequences.
posted by Comrade_robot at 2:28 PM on September 30, 2008

China wants the US to have an insurmountable debt to China that they can use as leverage lest they call it in

How exactly do you think china would "call in" Their debt? I mean, they could chose not to renew their treasury notes as they expire, which would cause the interest rates to go up, making interest on the debt a higher portion of the annual budget, but beyond that what exactly do you think would happen? Americans are perfectly happy loaning money to the government, and I think they will be able to to pick up the slack if the Chinese stop doing so.
posted by delmoi at 2:29 PM on September 30, 2008

"Key economic figures being state secrets troubles me greatly."

I'm sure it disturbs you greatly that the M3 is no longer published. Hell, I'm a lot more worried about that than how many dollars the Chinese have tucked away.
posted by Sukiari at 2:40 PM on September 30, 2008

Actually, yes, the loss of M3 publishing—an economic indicator that was covered in high school!—is also troubling. However, to me "not publishing the M3" doesn't have the national security implications for the U.S. that "foreign currency holdings are state secrets" does.
posted by infinitewindow at 2:50 PM on September 30, 2008

But we have been importing like 17 percent of GDP. If we have that
gap...

It disturbs me greatly that Warren Buffett used a superfluous 'like.'
posted by nosila at 2:51 PM on September 30, 2008

If Germany had that kind of stake in the U.S. economy, we would never have entered in WWII.
posted by StickyCarpet at 2:51 PM on September 30, 2008 [1 favorite has favorites]

The US can default on its debt to China if it got really desperate.

The Chinese government can't really afford to put much of their workforce out of work otherwise it will be time for Revolution #2 (#3?).
posted by GuyZero at 2:58 PM on September 30, 2008

Europe has done a far better job managing trade issues, but they have some longer term fundamental problems on the horizon. They have population pyramid inversion issues, a decreasing revenue pool to pay for services for aging populations, immigration issues that have never effectively been dealt with and financial system problems of their own.

Though it is worth remembering that the European Union is an alliance of individual states and member states, for example the UK (itself, essentially, a political union), can be members of more than one alliance. Also the EU's constituent members have many different financial systems and a wide range of economic bases, from countries that still have a manufacturing base to countries that are completely service-led.

***

China has it's own issues of course. There's an interesting little article here [blog overview] by Orville Schell [video, mp3, vorbis of full talk]
posted by mandal at 3:01 PM on September 30, 2008 [1 favorite has favorites]

P.S. The blog overview is a quick read, the video...well, get some popcorn, maybe a drink.
posted by mandal at 3:09 PM on September 30, 2008

The one things this article doesn't seem to address is China's population problem. Despite what you may be thinking China won't have a problem with over population in the near future. What it will have a problem with is an aging population that won't be replaced by its children. The one child per family policy is setting up China for an inverted pyramid in the age of its population like some countries in Europe are beginning to see today, except in a much more extreme manner.

In the future china won't have enough workers to support its aging population and its economy will contract as its overall population goes down. So what's China doing with all those T-bills? Perhaps it's saving for its retirement.
posted by 517 at 3:10 PM on September 30, 2008

In the 70's it was the Arabs that were going to own it all, in the 80's, Japan. Now it's China...or the EU or Russia.

One U.S. asset that seems to trump resources and cheap labor is a stable and predictable political structure. One can't calculate the value of the governmental stability that is rooted in the U. S. Constitution, but it seems to have helped us weather the storms of the 70's and 80's. I expect it will get us through these times as well.
posted by mygoditsbob at 3:32 PM on September 30, 2008

If they have to protect their investment then maybe China will offer to bail the US out. They could give the US Treasury some money in exchange for limits on compensation and equity in the nation. It would be silly to forget oversight too. They could just "nationalize" the debt.

Who's in?
posted by polyhedron at 3:37 PM on September 30, 2008

“Chinese leaders have deliberately held down living standards for their own people and propped them up in the United States.”

Hey, thanks for that. You’re beautiful. *tips*
posted by Smedleyman at 4:00 PM on September 30, 2008

I, for one, welcome our new Chinese overlords.
posted by nvly at 4:21 PM on September 30, 2008

We (America) are now just a rounding error.
posted by webhund at 4:28 PM on September 30, 2008 [2 favorites has favorites]

517, of course China has changing demographics. However, unless you believe in an infinite planet (i.e. you're an economist or a madman), this is a good thing not a bad thing. Very soon the discourse in America will be “oh fuck we’ve got way too many people”, rather than “gee I’m glad we’re not like those sclerotic Europeans and chinese.”
posted by wilful at 5:24 PM on September 30, 2008

Very soon the discourse in America will be “oh fuck we’ve got way too many people”

That's basically the discourse now if you're discussing immigration. Except it starts "fuck you" as opposed to "oh fuck".
posted by GuyZero at 5:33 PM on September 30, 2008 [1 favorite has favorites]

wilful, from a multi-generational perspective it is a good thing. But within the course of one human life time, China's consumer base is going to get cut in half. That will be horrendously economically devastating. Add to that the fact that in the decade leading up to that loss of consumers, China will be supporting something on the order of 2 pensioners for every one worker and it's not hard to see the "oh fuck" that a decreasing population causes to an economy.

I understand the concept of unsustainable growth but what China is looking at right now is unsustainable decay.

("...sclerotic Europeans and chinese." I don't know how old you are but I am in my late 20s. If you are too we'll both get to experience the fun of trying to grow our 401(k)s as the baby boomers try to sell off theirs. Deflation in action at a much lower rate.)
posted by 517 at 7:27 PM on September 30, 2008

In the future china won't have enough workers to support its aging population

China is used to mass starvations. They've lost hundreds of millions of peasants to starvation over the past few generations. More people have starved to death or died of plague in China this past two hundred years than have ever lived in the USA.

Being a senior in crisis China could really suck.

517, at the same time the consumer base is cut in half, it inherits the wealth of its parents. It will be like Europe post-plague: everyone who survives becomes considerably wealthier through multiple inheritances.
posted by five fresh fish at 7:52 PM on September 30, 2008

So, the loop goes like this: The US pays for cheap goods in China, US dollars end up in SAFE, and the Chinese government invests those dollars in T-bills. Is the idea that if China stopped buying so many T-bills, the US would have to raise taxes to fund the government, which in turn would lower US consumption? I'm missing the "mutually assured financial destruction" angle. Is it all just because the US government spends more than it takes in?
posted by Nquire at 8:51 PM on September 30, 2008

China is used to mass starvations.

Yeah, but a lot of the popular legitimacy the Communist Party has, to the extent it has it, is theat they are percieved as being better that the old Imperial and warlord governments; allowing mass starvation would pretty much strip them of that.
posted by rodgerd at 9:21 PM on September 30, 2008

Wait, wait, wait.

Goats?
posted by milquetoast at 9:51 PM on September 30, 2008 [1 favorite has favorites]

Why exactly is China continuing to invest in American T-bills when even my goats outside would agree that the US is nearly insolvent?

The article explicitly talks about what would happen if China tried to stop buying American T-bills. I'm sure China would theoretically like to diversify what they were doing with their rapidly accumulating foreign reserves, but as the article mentioned, even some middling professor with no connection to the government mildly suggesting that it would be a good idea to diversify caused a huge eruption in the foreign exchange market. If the Chinese government actually announced "Starting from today, we're not going to buy any more T-bills"...my goodness.

So, the loop goes like this: The US pays for cheap goods in China, US dollars end up in SAFE, and the Chinese government invests those dollars in T-bills. Is the idea that if China stopped buying so many T-bills, the US would have to raise taxes to fund the government, which in turn would lower US consumption?

If the Chinese stopped buying so many T-bills, the US would have to raise the amount that they pay on interest to their debt in order to attract other investors to T-bills. Paying more interest to foreigners implies either raising taxes, reduce federal spending, or combination of the two.

What's the downside for China? First of all, if the dollar collapses, their trillion dollars in foreign exchange which they already have is worth less. Second, a slow-down in the US economy would hit Chinese exports, which has been the main driver of Chinese growth.
posted by alidarbac at 9:53 PM on September 30, 2008

"...everyone who survives becomes considerably wealthier through multiple inheritances."

That's a good point but I don't know that it would work the same for the Chinese as it did for the Europeans. The farmers would get to inherit the means of production like the post-plague Europeans did. But the middle class would get to inherit things like houses, cars and consumer goods. Things that are mostly liabilities and would have to be sold onto a market that would be awash in similar stuff. (These are guesses, I have no idea how Chinese property law works.)
posted by 517 at 10:04 PM on September 30, 2008

The tenor of the article (and of several comments here) could be taken to imply that this strategy is in some way aimed at the U.S., but I don't see it. It's mere coincidence that at the relevant point in China's post-liberation development the U.S. was the largest economy.
The strategy of deliberately suppressing the earnings of part of the population has a precedent in the "price scissors" used during the early days of the socialist economy, where excess value was creamed off the poor peasantry and used to build the industrial economy. As a resource-scarce nation with no overseas colonies, exploitation of population was China's only option for capital accumulation.
The habits of control and a desire to direct the overall direction of the economy remain in the post-reform era. Fallows is correct that there are a plethora of public goods, particularly education and health, which are crying out for investment but then he doesn't seem to mention the enormous infrastructure investment that has occurred - for example, one figure that struck me was along the lines that investment in Chongqing municipality alone in the first five years on the 21st century exceeded the post-war Marshall Plan in parity dollars. But that investment strategy was regularly identified as being one of the reasons for periodic overheating scares for the economy as a whole.
It's China's domestic development strategy that is ultimately determining this policy. Yes, the idea of the nation as "rich and strong" and taking its rightful place in the world counts (also the chance to out-bid Taiwan in diplomatic tussles in Central America), but more important would be that perceived need to manage the pace of growth, keep Chinese labour "disciplined" and competitive and have the reins of the economy firmly in central government hands despite ongoing market reforms.
posted by Abiezer at 11:08 PM on September 30, 2008

If the Chinese stopped buying so many T-bills, the US would have to raise the amount that they pay on interest to their debt in order to attract other investors to T-bills. Paying more interest to foreigners implies either raising taxes, reduce federal spending, or combination of the two.


That's the rub. The article took it as a given - and this is apparently common sense among economists - that this would hurt the US economy, without explaining to laypersons like myself, exactly how. Taken another way, this implies that if the US doesn't run a federal budget deficit, the economy will tank. But in the late '90s, we had a budget surplus, we were paying down the national deficit, and the economy was still growing.

Considering how much the federal budget and national debt fluctuates, there's a disconnect as to how the US not being able to sell loans to China would catastrophically nuke the economy. Wouldn't WalMart still buy cheap goods from overseas? Time to Google and Wiki for answers, I guess...
posted by Nquire at 11:41 PM on September 30, 2008

If Germany had that kind of stake in the U.S. economy, we would never have entered in WWII.

Nor would we if they had nuclear weapons.

Yeah, but a lot of the popular legitimacy the Communist Party has, to the extent it has it, is theat they are percieved as being better that the old Imperial and warlord governments; allowing mass starvation would pretty much strip them of that.

So? The Chinese government doesn't have to worry about Florida's electoral college votes. Old people are not going to be staging a revolution any time soon. As long as young people are happy enough not to overthrow the government by force, the government will be able to stay in power.
posted by delmoi at 9:30 AM on October 1, 2008