Tuesday, September 4, 2012

You Have No Power Here, China Investment Corp

I realize I'm a bit late to the game on this (real life intervened, as it so often does), but in his speech at the Tampa convention last week, Rob Portman threw out a doozy of a line:
"Take trade with China. China manipulates its currency, giving it an unfair trade advantage. So why doesn't the President do something about it? I'll tell you one reason, President Obama could not run up his record trillion dollar deficits if the Chinese did not buy our bonds to finance them."
Let's take this claim from the top. First of all, let's look at U.S. borrowing from abroad over  the past several years. As Paul Krugman notes, it is, in fact, way down:



You'll note that the scale on the y-axis is negative. In any case, the reason borrowing from abroad is way down is because the private sector in the U.S. is paying down the massive amounts of debt it accrued in the 2000s. What do people do when they save more and spend less? Well, they buy assets with their savings. Assets like United States Treasury Bills. So most of our debt right now is being financed not by China, but by U.S. citizens saving more of their money.

Now then, back to the whole "currency manipulation" business. Rob Portman is right about one thing: we should have done something about China's currency manipulation. It is, however, a bit late for that, since China hasn't manipulated its currency in over a year. But humor me for a few minutes and assume that they'll start doing it again. I suppose we'd need to actually know what currency manipulation entails first, before going into more detail, so here we go. Exchange rates are determined on the foreign exchange markets. Basically, what China does to keep its currency cheaper in terms of U.S. dollars is that it buys lots and lots of dollar-denominated assets. As such, demand for these assets, and thus the currency they are denominated in, rises, which drives the value of that currency upwards. As a result of this, the Chinese Renminbi drops in value, while the U.S. dollar strengthens, comparatively.

All of this brings me back to the oft-uttered conventional wisdom that "China lending trillions to the U.S. gives them power over us!!" No, not right now it doesn't. First of all, they're parking tons of their money in assets that give them virtually nothing back. Kind of a poor decision on their part, but there it is. Anyways, the bigger reason is this: all that would happen if China stopped buying our treasury bills and instead bought other currencies is that the dollar would become weaker. And that would be a good thing. 

Think of it this way: if the dollar is weaker on the world stage, American-made goods (which are bought in dollars!) are relatively cheaper than, say, Chinese goods (or European, or whatever). So the end result would be that, in having a weaker dollar, we'd sell more goods overseas via trade. Thus, firms in the U.S. would see increased demand for their goods and would produce more, hire more, etc, etc. In effect, this would be a form of economic stimulus.

Basically where the conventional wisdom sort of goes off the rails is the part where people fear what will happen if we get "tough on China" for manipulating their currency. Most people think that we need the Chinese to finance our deficits, and by getting tough on them, they'll cut us off, making it that much more difficult for us to borrow money. But the fact is that if China dumped all of their U.S. Treasury holdings right now, they'd be doing us a huge favor. Not to mention the fact that they'd be shooting themselves in the foot.

So, in the words of Clint "Argues-With-Chairs" Eastwood, go ahead, China, make my day.