First, and following up on my post from Monday, comes the news that China's currency hit a record high against the US Dollar over the last day, and that bigger and faster appreciation is now expected due to concerns about inflation and weak foreign demand (and not political threats):
China's currency jumped to a fresh high against the dollar as authorities announced the country's biggest trade surplus in over two and a half years and amid speculation that Beijing might tolerate more currency appreciation to offset inflation.If all of this sounds familiar to you, it should: it's pretty much exactly what I said two days ago and many times before that. And it's definitely something to remember the next time some smarmy politician tries to convince you that pernicious Chinese currency manipulation is crushing the US economy and can be easily solved by aggressive American unilateralism. (Don't fret: I promise not to tear a rotator cuff patting myself on the back.)
The relatively sharp rise in the tightly controlled yuan currency comes amid a backdrop of rising domestic inflation and speculation of new external inflationary pressures if the U.S. Federal Reserve turns to a third round of what's known as quantitative easing to stimulate the flagging U.S. economy.
Some economists have been suggesting that current global market turmoil means that Beijing may be reluctant to use interest rates to counter its problems with inflation, which jumped to 6.5% in July, a three-year high. Strong trade surpluses are setting the stage for China to let the yuan rise faster to take on some of that inflation-fighting role.
"The central bank may speed up the rise in the yuan to alleviate domestic inflationary pressures in the near future, and we maintain our forecasts of a 6% full-year rise in the yuan," said ANZ Bank economist Liu Ligang.
The yuan hit 6.4170 to the dollar compared with 6.4404 on Friday before global markets were thrown into turmoil on the downgrading of the U.S. credit rating by ratings firm Standard and Poor's. The yuan has strengthened every day this week....
China has been concerned that a fresh round of quantitative easing—or massive bond buying by the U.S. Fed—could export inflation to emerging nations such as China, adding to its current price woes....
China is under pressure from the U.S., Europe and other trade partners to let its currency appreciate to help reduce hefty trade surpluses. It has generally chosen a go-slow approach but analysts suggest that inflationary pressure from China's huge pile of foreign exchange reserves is also prodding Beijing.
China has foreign exchange reserves of nearly $3.2 trillion and the nation's rigid foreign exchange regime means much of the nation's foreign currency earnings are added to the money supply, in turn creating inflationary pressure.
Speaking of the effects of Chinese imports on the economy, next up is a WSJ write-up of a fantastic new study from the San Francisco Fed which analyzes just that very thing. The results may surprise you (unless you've been reading my blog religiously, of course):
According to San Francisco Fed senior economist Galina Hale and research advisor Bart Hobijn, the share of Chinese produced goods in U.S. consumption is not nearly as high as is widely believed.Great stuff, although one glaringly obvious point remains unsaid: if American workers reap more than half of the benefits of Chinese imports into the United States, then protectionist US policies designed to limit those imports or raise their prices hurt not only the American consumers of those imports, but also the workers whose jobs depend on them. In fact, even leaving aside their clear consumer harms, anti-China import policies hurt American companies and workers more than they hurt Chinese companies and workers.
Surveying data from the Commerce Department, Bureau of Labor Statistics and the Census Bureau, the pair finds that a full 88.5% of goods and services consumed by U.S. households is produced domestically. Of the 11.5% that is imported, goods made in China account for barely more than a quarter — or 2.7% of total U.S. consumption spending.
Even that overstates the true share of China’s imports. The reason? Almost all consumer goods are the product of many hands, and properly accounting for what is made where further reduces the share of “made in China.”
Hale and Hobijn explain:
Obviously, if a pair of sneakers made in China costs $70 in the U.S., not all of that retail price goes to the Chinese manufacturer. In fact, the bulk of the retail price pays for the transportation of the sneakers to the U.S, rent for the store where they are sold, profits for shareholders of the U.S. retailer, and the cost of marketing the sneakers. These costs include the salaries, wages and benefits paid to U.S. workers and managers who staff these operations.
The San Francisco Fed’s calculations show that on average 36% of the price of imported goods goes to U.S. companies and workers, and for goods imported from China that number is even higher:
“On average, of every dollar spent on an item labeled ‘Made in China,’ 55 cents go for services produced in the U.S.,” Ms. Hale and Mr. Hobijn write. “In other words, the U.S. content of ‘Made in China’ is about 55%. The fact that the U.S. content of Chinese goods is much higher than for imports as a whole is mainly due to higher retail and wholesale margins on consumer electronics and clothing than on most other goods and services.”
It gets more complicated. Chinese made parts also go into the 88.5% of U.S. consumption spending devoted to goods made in the U.S. Adding it all up, the researchers conclude that the total share of “made in China” goods in U.S. household consumption is just 1.9%.
What does it all mean? There’s good news and there’s bad news. The good news is that the China threat that looms so large in U.S. political debate is overstated. China’s exports as a share of U.S. consumption might have grown quickly, but they are still a small fraction of the total. U.S. workers and companies are also taking a fair chunk of change from the process.
The bad news is that hopes of a stronger yuan creating more space for U.S. manufacturers to sell to the domestic market – already overplayed – appear even less credible. If most of the cost of “made in China” imports actually accrues to U.S. workers and companies, yuan appreciation will have only a limited impact on competitiveness.
Stop for a moment and wrap your heads around that one. Got it? Ok, good. Now let's move on.
Finally comes an eye-opening op-ed in today's WSJ from China economy guru Michael Pettis on China's supposedly inevitable global dominance. It turns out that - and stop me if you've also heard this one before - such dominance has been completely oversold. In fact, China's very likely heading for a pretty rough patch due to its longtime adherence to an export-driven economic growth model (including its currency policy):
As China fitfully tries to rebalance its economy, a small but rising number of Chinese economists are beginning to predict sharply lower annual growth rates of 6% to 7% over the next few years. But the arithmetic of adjustment suggests growth is likely to be even lower, perhaps half that level.What a mess. Maybe China will emerge from it unscathed, and some day sit atop the global economy. But after reading this piece, can we at least all agree that such a fate is far from inevitable? And can we also agree that we'd be absolutely insane (and, considering the pain intentionally inflicted on households, immoral) to pursue a similar course of action here in the United States?
China's growth over the past couple of decades was based on large increases in government-directed investment. As a consequence, it had to run large trade surpluses to absorb the resulting excess capacity in manufacturing.
This can't continue. Investment, especially in infrastructure and real estate, is increasingly wasteful. With Europe in crisis, and Japan and the U.S. struggling with their debt, demand for China's exports will stagnate.
Can China rebalance away from investment and toward domestic consumption as the main engine of growth? Yes, but with great difficulty. Chinese households consume only about 35% of gross domestic product (GDP), far less than any other country. Such a large domestic imbalance has no historical precedent.
Some in Beijing understand how lopsided their development has been. So over the next 10 years, policy makers have said they will try to raise consumption to 50% of GDP. Even that is a low number; it would put China at the bottom of the group of low-consuming East Asian countries.
But achieving this goal is problematic, since it requires that household consumption grow four percentage points faster than GDP. In the past decade, Chinese household consumption has grown by 7% to 8% annually, while GDP has grown at 10% to 11%. If one expects Chinese GDP to grow by 6% to 7%, Chinese household consumption would have to surge by 10% to 11%.
Such consumption growth is unlikely because powerful structural factors work against it. The Chinese growth model transfers income from households to the corporate sector, mainly in the form of artificially low interest rates. These sharply reduce borrowing costs for the state-owned companies that funnel this easy money into mega-investments. The easy financing also gooses banks' profit margins and allows them to resolve bad loans with ease.
This cheap borrowing comes at the expense of depositors. Low yields on deposits force them to sacrifice consumption, to save more. This results in a sharp decline in consumption's share of GDP. If China is to replace investment with consumption as the engine of growth, this process of financial repression has to be reversed. Households must get a rising share of overall growth.
This reversal is inevitable, but it will not come easily. Wasted investment and excess capacity translate into growing amounts of bank debt, meaning continued wealth transfers are necessary to keep the banking system viable. But if households continue to pay over the next few years, as they have in the past, China will be stuck in the same model.
The historical precedents of the debt buildup are worrying. Every country in modern history that has achieved many years of "miracle" growth has run into the problem of over-investment and then excessive debt. Just look at Japan. The need to resolve the debt has itself made domestic rebalancing difficult, and it has always taken far longer than even the most pessimistic forecasts.
Still, consider the price of delaying this reversal. Even if consumption manages to keep growing at the same rate it has during the past decade (when Chinese and global conditions were buoyant and debt levels much lower), China's growth must slow to 3%-4% to achieve rebalancing. This is the impact, in other words, of the required reduction in investment, which will have to be sudden and sharp.
In the worst-case scenario, consumption growth slows down to less than what it was in the last decade—perhaps because of slower GDP growth—making rebalancing even harder.
There is very little question that certain policies by the Chinese government, such as IPR enforcement and market access, are causing real problems for American businesses. But, as these three articles make abundantly clear, China's currency policies and export-driven growth model are simply not destroying America via cheap imports and thereby ensuring China's future global dominance. By focusing on these non-issues, we risk missing the the real threats to US-China trade relations and messing things up even more than they already are.
UPDATE: And right on cue, we get this ridiculous headline today (8/11): "Wider US trade gap could propel China currency bill." You have got to be kidding me.