Harry Swain is a former federal deputy minister of Industry Canada and Indian and Northern Affairs Canada
Old friend John Nellis, late of the World Bank, posed the following conundrum last week: Suppose you are an official in the Chinese Ministry of Finance managing that government's portfolio of U.S. debt instruments. (You are a figure of some importance; China currently holds somewhere between $750-billion and $1-trillion of the $2.4-trillion of U.S. Treasury debt held by "foreign official" entities - and that doesn’t count another trillion of dodgy but fully guaranteed Fannie and Freddy debt.)
You are a worried man. You see that the recommendations of the various recent U.S. commissions proposing fiscal restraint - based on a combination of revenue increases and expenditure reductions - have been rejected by both right and left. And you see that the tax deal engineered by Mr. Obama will add, if it passes, from $700- to $900-billion to the already massive deficit for the next few years at least. The explanatory justification, to the extent there is one, is that this will engender growth; that this growth will produce increased future revenues to government; and that these, in combination with unspecified expenditure reductions that will take place, will reduce, if not eliminate, the deficit.
To put it charitably, you have some doubts as to the likelihood of this scenario unfolding in the hoped for manner. The U.S. political system seems perfectly designed to prevent solutions to the deficit problem.
You know that Chinese prosperity is intricately linked to U.S. consumption; even a modest decline in continued Chinese purchase of U.S. Treasuries -- much less a halt or a partial sale of existing holdings -- could precipitate a crisis and a recurrence of recession that would harm the Chinese almost as much as the U.S. But you also know that the value of the holdings in your care is highly likely to decline, perhaps greatly, though not for a year or so.
Where do you draw the line in the sand? What is the point at which dumping the Treasuries becomes preferable to keeping the credit line open? I think many in the U.S. are banking (forgive the pun) on the hope that there is no such point; that the Chinese fear unemployment worse than we fear the discipline of capital markets; that they will never stop buying (or at least holding their existing stock) of Treasuries. But what will happen if they are wrong?
Bottom line, oh senior Chinese official: what do you now recommend that China do?
I would start with the objective of the Chinese state, or the (formerly) Communist Party: stability and control, reinforced by gerontocracy. They are (a) immensely pleased by the economic growth of the last 30 years; (b) uncomprehending, in some measure, about where it came from; (c) therefore anxious not to disturb the magical Dengian conditions that brought such expansion; and (d) all too aware of the domestic sources of instability.
These latter include large interregional differences in incomes, which have stimulated the most monumental rural-to-urban migration in human history. Under its calm surface is the most angst-ridden and fearful politburo imaginable. This is the most conservative, cautious and important government in the world. Even when provoked by dangerous goofs like North Korea's Kim they stick their heads in the sand and hope it will all go away.
Their model of domestic development has drawn them, unwittingly but to their increasing horror, into a sick symbiosis with the United States. All that stuff flows east across the Pacific, replaced only with paper. Actually, only with entries in electronic accounts, nothing “real” at all. And they are now, as you say, John, prisoners in the cage they built. They are bankers to a trillion-dollar debtor, poor darlings. And the debtor is about to default, through devaluation and inflation.
The only way out, imperfect as it is, is to pursue three grand courses of action simultaneously. One, trade as much of that about-to-shrink hoard as they can for real resources in the ground, and secondarily for intellectual property, anywhere in the world, but preferably in the currently politically stable ones. So watch for huge flows of Chinese investment: into resources, infrastructure (whose user prices will keep pace with inflation), into companies and countries that produce what the Chinese machine needs: resources, food, fuel...
The second and third courses of action are entirely domestic, and for that reason have not gathered as much media attention as international trade and investment. One is climbing the value chain. China has become the manufacturing master of the world but has few brands, intelletual property or pricing power. China recognizes this and will soon start to buy and develop brands. In the process they will strike at the heart of the American development model.
The third great imperative is liberating the vast quantities of MUM (Money Under Mattresses) sloshing through the Chinese economy. In a country with no social security/old age/health systems to speak of, reliance on the traditional Chinese family is very high, hence lots of MUM. If those unproductive savings could be mobilized for domestic consumption (not necessarily red-hot growth, but a tangibly better life for zillions of Chinese), the stability of the regime would be markedly enhanced -- objective number one. This requires the invention of social security systems, and of course being smart they are already engaged on that long march.
Of course it may even be healthy from a Chinese perspective that they can’t spend the hoard all at once, and that the old mercantilist model keeps spinning off so much. This will keep the U.S. -- the west in general -- depressed and in thrall to Chinese bankers. Tant pis! It’s not so much that China wants to control the world as it is that China doesn’t want pesky foreigners with enough clout to lecture and intervene. Sell Google, buy Potash.
