October 1, 2008
The Panic of '08 -- Blame China?
A good friend of ThreeSources sends a link to this commentary in Commentary by Gordon Chang. It's a good piece and I find much to agree with. But his central tenant is that China holds a lot of culpability for our current woes and that changes in Sino-US economic relations are required to get us past it. It's a good and very short piece worth reading in full.
American lenders have had too much money at their disposal in recent years because China has lent staggering sums to America, especially the U.S. Treasury, Fannie, and Freddie. Beijing has done that because the United States is the place where most excess cash in the world goes. The Chinese have excess cash because they have excess savings. They have excess savings because the government depresses internal consumption and creates massive trade surpluses-like last year’s US$262.2 billion (all of which but $5.9 billion related to sales to the United States). Beijing runs up massive trade surpluses because it manipulates the value of its currency to provide a cost advantage, provides below-market credit to producers, depresses the cost of labor, and subsidizes crucial manufacturing inputs like energy and water. When a country engineers excess savings, it has no choice but to lend funds abroad.
My emailer asks "Is it bunk?"
I would not call it is bunk, but I would not give some elements the same stress that he does.
Excess liquidity is a good backdrop to any bubble. ThreeSources folk bitterly cling to their Austrian Economics and the Austrian Business Cycle Theorem (ABCT) lays much of the blame for bubbles on monetary policy. I am not nearly as ready to blame China (on a few fronts) as is Mr. Chang. Excess liquidity comes from the Greenspan Fed’s “accommodative” monetary policies. The Fed Funds rate was kept at 1% for years. That is virtually daring people to borrow. So I’ll join Chang in citing excess liquidity as an important cause, but I’ll give China a free pass. How dare they buy our bonds! “Dad, if you continue to give me this extravagant allowance, you’ll be to blame if I become a slacker!”
I have a running debate with two of my economic betters about the extent to which new derivatives allow money to be created outside of Central Banks. I hold that they do to a greater extent than Perry or The Everyday Economist will allow. But even I hold the FOMC ultimately responsible if an over-abundance of dollars are printed.
Nor do I share Chang’s concern for Chinese currency valuation. What they really did was to outsource their central banking to the US with a dollar peg and I would say that it served them pretty well. As bad as their bubble was, I think the dollar peg ameliorated it. I heard a lot of protectionists worry about the “artificially low Yuan.” If you want to sell me stuff too cheap, I’m not one to complain.
Chang then gives the US Government a free pass. I’ll say plenty of nasty things about authoritarian China’s fear society, but I will not blame them for buying too many of our bonds or selling us goods too cheaply. If you get the time machine and can go back, Terminator style, to fix our current problems, I would suggest:
1. Rein in Fannie Mae and Freddie Mac. Set the way-back machine far enough to prevent their birth if you can, but at the very least pass the reforms that President Bush and (some) GOP legislators proposed in 2004 and 2005. Cut their leverage in half and you cut the current mess to a fourth.
2. Get Andrea Mitchell to dope Greenspan’s tea and get him to raise rates to at least 2% before handing the reins over to Princeton Boy.
3. Strangle mark-to-market accounting in the crib. Bank regulation makes accounting a legal endeavor. These rules are too harsh and give short sellers too powerful a tool to take a bank down.
4. Laugh the Community Reinvestment Act out of Congress. Do not require banks to make bad loans, they seem to do pretty well on their own.
Get halfway there on all of those and there’s no panic. I don’t fault China, but I do agree with Chang that both politicians have completely whiffed on this one.
Just a few brief points for now. Dollars that the Chinese lend to us is not "excess liquidity," for the simple reason that they come from our own money supply. And it certainly is dollars that they lend right back to us, because it makes no sense to turn their huge trade surplus of dollars into euros or whatever, when they need dollars to buy U.S. dollar-denominated securities. So you're absolutely correct to say that it comes down to the Fed. For the same reason, Chinese lending is not inflationary, because the Chinese aren't creating the dollars in the first place (aside from counterfeiting, whose effect is minimal).
Also, blaming China for lending us is the same BS as accusing mortgage lenders and credit card providers of "predatory lending."
"If you want to sell me stuff too cheap, I'm not one to complain."
Remember what Bastiat said: if someone's selling you something at a cheaper price than you'd otherwise buy, it's a *gift* to you. It can also backfire against attempted "dumping," as Herbert Dow showed the German bromide manufacturers. I've had the privilege of Burt Folsom telling me that story in person.
Posted by: Perry Eidelbus at October 1, 2008 9:51 PMGreat post, JK. Agree with PE that China cannot increase our money supply even when considering M2 and M3; only the Fed can do that.
Posted by: Boulder Refugee at October 2, 2008 11:01 AM | What do you think? [2]