China's Global Ambitions

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For China, Will Money Bring Power?


By PIERS BRENDON

Published: August 21, 2010

This article captures in a nutshell many of the important themes of the course!!
 
Brendon reports that:

As the media have breathlessly reported, China has just overtaken Japan as the world’s second largest economy, and bids fair to knock the United States from the top spot within 20 years. Ever since Deng Xiaoping embarked on his “second revolution” in 1978, introducing free market reforms and opening up to the outside world, China’s economy has grown by almost 10 percent a year — one of the most sustained expansions in history.  ...

The crucial question is: how will China use its new-found wealth?

The traditional answer is that rich countries tend to equip themselves with the sinews of war in order to enhance their position at the expense of rivals. According to the dominant economic philosophy of the 18th century — mercantilism — wealth and power are interchangeable, each helping in the acquisition of the other.

Thus Britain used its economic predominance after the Industrial Revolution to establish global hegemony. Protected by the fleet, its multiplying colonies supplied the mother country with raw materials and bought her manufactured goods. But by 1914 Germany was easily out-producing Britain, and Kaiser Wilhelm’s challenge to the Royal Navy’s supremacy did much to precipitate the First World War.

However, history does offer alternative answers — and the case of America is particularly pertinent. The economy of the United States overtook that of Britain in the 1870s, and by 1914 it was nearly three times as large. A small island making steam engines by hand inevitably fell behind a bountiful continent that mass-produced motor cars on assembly lines.

Brendon's expertise on the British Empire. The major question is whether China's rise will be more like Germany's or the United States' challenge to Great Britain.

It also seemed inevitable that the United States, particularly under the internationalist leadership of Presidents William McKinley and Theodore Roosevelt, would mount its own challenge to the British Empire by translating its economic strength into military might. Uncle Sam did arm, of course, during the conflict with Spain and World War I, creating an outstanding Navy.

But for the most part, the nation’s business was business. In the 1890s it was suggested that the State Department should close down because it had so little to do. And during the isolationist period between the two world wars, when at its peak America was responsible for nearly 40 percent of the world’s manufacturing output, the United States Army was around the 17th-largest on the planet.

In other words, the military of the world’s richest nation amounted to hardly more than a border constabulary armed with obsolete equipment like 1903 Springfield rifles. During the Depression, cash was so tight that its best officer, a bald-headed major named Dwight D. Eisenhower, had to make a requisition for his streetcar fare between the War Department building and the Capitol.

Needless to say, Axis aggression transformed the United States into a military-industrial colossus. It so galvanized a depressed economy that the historian Niall Ferguson of Harvard has been moved to dwell on “the benefits of militarism.”

Brendon then canvasses the liberal view that peace promotes prosperity and vice versa - opposed to the realist (mercantilist) idea about power and plenty.

Market forces act in the moral world, said the 19th-century British politician Richard Cobden, like “the principle of gravitation in the universe — drawing men together and thrusting aside the antagonism of race, and creed, and language.” Certainly this is an ideal to which China has at least paid lip service since the end of the cold war, asserting that globalization fosters international cooperation.

Recall that at the start of the new millennium, a consensus existed among China-watchers that the Red Menace was as much of a mare’s-nest as the Yellow Peril. Like the United States before Pearl Harbor, China would concentrate on butter not guns, harmonizing its interests with those of its competitors through the peaceful mechanism of the open market. There was much talk of an entente between China and Japan, even of a Chinese-American alliance to maintain stability, fight poverty, tackle global warming and so on.

No doubt much of this was wishful thinking. Indeed, such soft soap may well have been part of a charm offensive by China, culminating in the Beijing Olympics of 2008, designed to mask the true character of a monstrous tyranny that was made manifest on Tiananmen Square in 1989.

Whatever the truth, informed opinion is now divided about Chinese intentions. Some pundits maintain that the fundamental assumption of China’s leaders is that conflict is part of the human condition, the only way of resolving differences in a perilous world. A recent comprehensive survey of Chinese authors revealed that most anticipate a repeat of the “warring states era in Chinese history.” Is not hostility toward “foreign barbarians” China’s default state?

There are, at any rate, obvious signs that the awakened dragon is flexing its muscles. China’s defense budget rose to be the second highest in the world in 2008, and its naval (particularly submarine) buildup has, in the opinion of the American journalist Robert D. Kaplan, caused “the loss of the Pacific Ocean as an American lake.” In search of markets and natural resources, China is expanding its influence aggressively in Asia, the Middle East, Africa and South America.

On the other hand, China’s 6.6 percent share of global expenditure on arms is dwarfed by America’s 46.5 percent. And, like the United States during and after the reconstruction era, modern China is preoccupied by the problems associated with rapid growth: pollution, corruption, rural poverty, urban overcrowding and troubled labor relations.Above all, its leaders have to keep the lid on the simmering political and ethnic cauldron, while at the same time preventing the economic bubble from bursting — as Japan’s did.

China may well keep its promise, for the moment at least, to follow the path of peaceful development. We can’t know, of course. But doom-merchants predicting that China will topple America from its pre-eminence should recognize that history is not necessarily on their side.

 

Global Imbalances

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Michael Pettis has written an interesting article on the significance of the global imbalances between US and Chinese economies: "The last chance to avoid a global trade war".

I've recently constructed graphs on global current account deficits and surpluses to show just how important the US deficit is in counterbalancing the surpluses of China, Germany and Japan. The graphs show the percentage each of the top 11 countries have of total world deficits and surpluses.

The data is from the IMF WEO Database for April 2010.

Pettis argues expanding US trade deficits (the US current account deficit is mainly a trade deficit, unlike Australia which is mainly an income deficit) could lead to a global trade war:

The world seems to be marching inexorably towards trade war. The US trade deficit is surging, for reasons that have nothing to do with domestic consumption and everything to do with policies and events abroad. In the months ahead, the US will be forced to choose either protection or soaring trade deficits with rising unemployment. It will almost certainly choose the former but if it overreacts, which is likely, it could unleash another round of global protectionism – which will especially hurt trade-surplus countries.

He says arguments that the currently growing US deficit is the result of unbridled consumerism are wrong:

As it continues rising there will be renewed criticism about US consumers embarking on another ill-judged buying spree, but this time the finger-waggers will be wrong. The surge in the trade deficit is the automatic consequence of a shift in global trade imbalances.

Five countries or regions have largely driven these imbalances in the past decade. Three of them – China, Germany and Japan – run huge trade surpluses on which they are dependent for domestic employment growth.

Counterbalancing them have been the two trade-deficit champions – the US and trade-deficit Europe, dominated by Spain, Italy and Greece

The problem is that deficit countries are generally lowering their debt levels, which makes them less able to maintain "the excess demand they provide to the rest of the world". But trade surplus countries have resisted making appropriate adjustments and have instead pushed to increase their surpluses.

The combination of a collapsing euro and German fiscal constraint will raise Germany’s trade surplus sharply and generate rapid growth. Any rise in the value of the renminbi has been more than offset by a surge in cheap credit to Chinese manufacturers, increasing their competitiveness, so China’s surplus is also rising. Recent strength in the yen has set off alarm bells and Tokyo, too, will do what it can to maintain its trade surplus.

But rising surpluses require rising deficits elsewhere, and here the situation is dire. The crisis has made it all but impossible for most of the trade-deficit countries in Europe to raise new financing – Spain, Italy, Greece and many of the other trade-deficit countries of Europe will see their capital account surpluses contract rapidly. Since current account deficits are the obverse of capital account surpluses, their current account deficits will automatically contract too.

The obvious dilemma here is the obvious fact that global trade must balance:

The rest of the world will have to absorb, with rising trade deficits, the combination of rising surpluses among surplus champions and declining deficits in trade-deficit Europe. Given its openness and financial flexibility, the US will, in practice, absorb most of the adjustment, its trade deficit rising inexorably – until Congress implements vigorous anti-trade policies. The US lacks the industrial, currency intervention and interest-rate management policies available to the main trade-surplus countries, and so will be forced to use other forms of trade protection – tariffs and import quotas.

This should not be allowed to happen. Instead of supporting policies that shift the adjustment elsewhere, the other main economies must agree to absorb a large share of the European shock. If they do not, they will force the US to retaliate. It is up to the surplus countries to ensure their urgent dependence on foreign demand does not result in a collapse in the willingness of deficit countries to continue providing that demand.

Perhaps it is already too late. Trade-deficit Europe has no choice but to adjust quickly. Opposition from uncomprehending domestic constituencies in the trade-surplus champions will prevent them from taking steps to adjust. Meanwhile, US anger over trade is rising quickly and has made bashing foreigners an easy and obvious vote-getter.

Responsible leaders must nonetheless make every effort to rebalance trade in a less disruptive way. Trying to avoid sharing the cost of the necessary global adjustment is how the major economies reacted in the 1930s, and those policies are widely and correctly referred to as beggar-thy-neighbour. We know how that game ends.

To make the matter potentially worse is the growing possibility of a double-dip recession in the US will make it even more difficult for the Obama administration to resist protectionist pressures.

Demography

Some interesting statistics on the ageing of populations in various countries over the next 20 years ...

It's important to think about what implications these projections will have on growth and the need for immigration.

Counties like Australia which have integrated diverse peoples since WWII are probably better set up for increases in immigration than countries like Japan, for example.

India is demographically advantaged for growth over the next 20 years ...

Americans increasingly spurn stocks ...

In my last post I talked about how Americans were increasingly funding their own govt debt and relying less on foreigners to purchase their bonds. One consequence of this is that Americans are getting out of the stock market in droves turning to US govt bonds instead. This is good news for the US govt who needs to fund its debt, but bad news for those still in the stock market. Graham Bowley from the NY Times points out that:

Investors withdrew a staggering $33.12 billion from domestic stock market mutual funds in the first seven months of this year, according to the Investment Company Institute, the mutual fund industry trade group. Now many are choosing investments they deem safer, like bonds.

If that pace continues, more money will be pulled out of these mutual funds in 2010 than in any year since the 1980s, with the exception of 2008, when the global financial crisis peaked. ...

One of the phenomena of the last several decades has been the rise of the individual investor. As Americans have become more responsible for their own retirement, they have poured money into stocks with such faith that half of the country’s households now own shares directly or through mutual funds, which are by far the most popular way Americans invest in stocks. So the turnabout is striking.

So is the timing. After past recessions, ordinary investors have typically regained their enthusiasm for stocks, hoping to profit as the economy recovered. This time, even as corporate earnings have improved, Americans have become more guarded with their investments.

Bowley points out that the effect on the stock market on uncertainty is similar to the effect on the housing market. Losses on property are likely to make investors wary of housing in the US for some time. Americans are also increasingly wary of investing in the stock market for their pension savings (401(k)s in the US or super in Australia)

Until two years ago, 70 percent of the money in 401(k) accounts it tracks was invested in stock funds; that proportion fell to 49 percent by the start of 2009 as people rebalanced their portfolios toward bond investments following the financial crisis in the fall of 2008. It is now back at 57 percent, but almost all of that can be attributed to the rising price of stocks in recent years. People are still staying with bonds.

United States Debt: Who Buys It?

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US debt purchases have become an important story in the world political economy and a symbol of supposed US powerlessness in the face of a relentless Chinese ascendancy. I think this equation is overdone and instead think that the fact that the Chinese feel obliged to buy US debt as a sign of continued Chinese weakness in their economic structure rather than strength. But it undoubtedly is a complicated debate.

But let us at least get a few facts on the table.

The first is to look at figures for the purchases of US Treasury Securities from an article by Floyd Norris of the NY Times: "For a Change, U.S. Debt Is Staying in the U.S."

The most interesting fact is that Americans themselves are now buying most of this debt. This is not unusual. Most of Japan's debt for example is bought by the Japanese themselves. This amounts to what Hugh Stretton calls "borrowing from ourselves" and therefore removes foreign risk. It also helps to keep interest rates lower.

According to Norris:

Before the financial crisis struck in 2008, neither Americans nor private foreign investors showed much eagerness to finance Washington’s deficits.

In calendar year 2007, the Treasury borrowed a net $237 billion. Of that, 81 percent came from foreign governments, mostly from central banks. Private foreign investors took up the rest, as American companies, banks and individuals reduced their combined Treasury holdings by $13 billion.

In the first six months of this year, the Treasury numbers indicate that foreign governments reduced their holdings of Treasury securities by $10 billion. Not since 2000 — when the United States government was running a surplus and did not need additional funds — have foreign governments been net sellers for a full calendar year.

But then again in a globalising financial world, Norris notes also that often it is not exactly clear who the buyers may be:

The figures are estimates by the Treasury and are subject to substantial revision. And they need to be interpreted with caution, because they do not necessarily reflect the ultimate ownership of securities. Holdings of a London-based money manager are attributed to Britain, even though that manager’s clients could live in New York, Hong Kong or Paris.

The trend, however, is clear:

Over all, domestic investors purchased more Treasuries than did overseas ones — including foreign governments — in 2009 and again in the first half of this year. Those purchases came as government borrowing rose to pay for bailouts and recession-related spending.

By contrast, during the six years from 2002 — the first year that the United States ran a significant deficit after the years of surpluses — through 2007, three-quarters of the $1.7 trillion in new borrowing came from abroad, with $1 trillion of that coming from foreign governments.

In the two and a half years since the end of 2007, the Treasury has raised twice that amount in new money, $3.5 trillion. More than half of that came from American companies and individuals, double the proportion they contributed in the earlier period.

Still more than 46 per cent of debt is held by foreigners, down from 46 per cent in 2008:

Even with those increased domestic purchases, 46 percent of the publicly issued Treasury debt is held overseas. That is down from 49 percent in early 2008, just before the financial crisis began, but it is way above the 31 percent proportion at the end of 2001.

The figures also don't include debt bought by the Federal Reserve itself, which involves a notion called quantitative easing, colloquially known as "printing money"

The figures exclude Treasury securities owned by the Federal Reserve or other United States government agencies. As a result, Fed purchases and sales are not counted.

Fiscal Stimulus

A whole bunch of economists have signed a letter arguing for the need for fiscal stimulus. I fully agree with their argument.

An Open Letter


We the undersigned economists are convinced by the evidence that the coordinated policies of the Australian Labor Government have prevented the Australian economy from a deep recession and prevented a massive increase in unemployment. Unlike most OECD economies we have come out of the Global Financial Crisis and the subsequent world recession with only one quarter of negative GDP growth and a smaller increase in unemployment.



We note that during a recession automatic stabilizers (increase in total unemployment benefit payments and decreased tax revenues) lead to an increased government budget deficit. In almost all the OECD countries there has been a massive increase in unemployment and in budget deficits. In Australia both have been trivial by comparison. The Government Fiscal Stimulus package that was introduced was carefully crafted and implemented in a clever sequence. The first stage, the payment of $900 to most households, helped to boost confidence in the retail industry.



The second stage of the stimulus package (the Building Education Revolution, and the First Home Owners Grant) boosted the construction industry and created thousands of new jobs. Besides the employment effect, it also provided a much needed increase in the stock of public capital (better and greener homes, better schools) and prevented a sudden fall in house prices. The last stage of the fiscal stimulus package (as it takes time to prepare plans etc.) was the infrastructure program that increased employment as well as increasing the stock of public capital and helping to overcome the significant short fall in Australian public infrastructure, and hence would increase future productivity, taxable capacity and the ability to repay public debt.



Just as a major corporation goes into debt to invest in its stock of capital, so does a government. Just as many householders have a debt to a bank or mortgage company, so does a government. A government has a budget deficit and a government debt, but it also has capital assets (roads, ports, better equipped schools, Broadband, etc.). The performance of the Australian economy has been outstanding: the International Monetary Fund (IMF) and the Organisation for the Economic Cooperation and Development (OECD) have show-cased Australia as a model economy.



We hope that the economic achievements of the Australian Labor Government will be recognized by the population.