Wise Words from Peter Thiel

He says (via Marginal Revolution):

...there is no good scenario for the world in which China fails.

The Ignored Emerging Economic Power

Brazil is now the world's largest "emerging economy," pushing past China, as measured by Morgan Stanley's country index of equity markets.

First Strike Capabilities

I agree with Matthew Yglesias' general tenor here, but I find this part strange:

Simply put, a scenario in which the United States possesses an effective ability to shoot down a Russian or Chinese ICBM threat would be completely intolerable in Moscow or Beijing. It would, in effect, give the United States a viable a threat of a nuclear first strike. Neither Russia nor China is going to let that happen. Instead, they'll spend money on building up their nuclear arsenals in order to maintain their deterrent capacity. Thus, at great cost to the Unites States, to Russia, and to China we'll be back at the status quo. But beyond the monetary cost, the large buildup in Chinese nuclear capabilities that would result from this situation would force India to engage in a nuclear build-up of its own. And that, in turn, would force Pakistan to follow suit. This large increase in the global stock of nuclear weapons would, of course, imply an increase in the odds of a nuclear accident or the loss or theft of nuclear material. At the same time, a nuclear buildup of this sort might create incentives for Iran to reinitiate its nuclear weapons research program.

In truth, the U.S. already has massive first strike capabilities against China or Russia (or anybody else), and the U.S. already has started building up and modernizing its nuclear arsenal. Neither Russia nor China responded to this by starting a news arms race; those countries still have too many domestic problems which take priority to spend untold billions on weaponry which would still be decades behind the U.S.

Second, India and Pakistan have their own reasons for building and maintaining a nuclear arsenal which have nothing to do with the U.S. or China, and they will continue to stand-off against each other no matter what we do.

Third, N. Korea and Iran weren't persuaded by calls to nonproliferation in the past, nor were they encouraged to pursue nuclear weaponry because of American expansion of arms. Indeed, their programs were begun and expanded during the period of time when the U.S. was dis-arming.

The Nonproliferation Treaty is essentially dead in the water, and that's a shame. Resuscitating it is possible, with the U.S. and Russia on board, but there's no guarantee that the NPT will have any serious deterrent effect in any case. McCain's policy is overly simplistic and uninspired -- as usual -- but it's not as disastrous as Yglesias is claiming it is.

Economics: No Longer the 'Dismal Science'

Alex Tabarrok is optimistic about the future:

People used to think that more population was bad for growth. In this view, people are stomachs--they eat, leaving less for everyone else. But once we realize the importance of ideas in the economy, people become brains--they innovate, creating more for everyone else.

New ideas mean more growth, and even small changes in economic growth rates produce large economic and social benefits. At current income levels, with an inflation-adjusted growth rate of 3% per year, America's real per capita gross domestic product would exceed $1 million per year in just over 100 years, more than 22 times higher than it is today. Growth like that could solve many problems.

In the 20th century, two world wars diverted the energy of two generations from production to destruction. When the horrors ended, the world was left hobbled and split. Communism isolated much of the world, reducing trade in goods and ideas--to everyone's detriment. World poverty meant that the U.S. and a few other countries shouldered the burdens of advancing knowledge nearly alone.

The battles of the 20th century were not fought in vain. Trade, development and the free flow of people and ideas are uniting all of humanity, maximizing the incentives and the means to produce new ideas. This gives us reason to be highly optimistic about the future.

Of course, Tabarrok is a libertarian, and libertarians are born optimists w/r/t the potential of mankind. It is still true that we don't understand very well how development occurs, or how to maximize growth across the board. China and India are growing very fast, but it isn't without side effects. Still, the overall trajectory of the world in the 21st century is better -- so far -- than the trajectory of the 20th. There are good reasons for optimism.

Bad News from Beijing

Apparently, inflation in China has become such a concern that the government is ready to take drastic measures:

Prime Minister Wen Jiabao responded Wednesday to growing public anxiety about inflation by announcing that China would freeze energy prices in the near term, even as international crude oil futures have continued to surge.

The new effort to fight rising prices comes with inflation hitting an 11-year high in China. A recent nationwide public opinion survey found that “rising prices of consumer goods” ranked as the top public concern, followed by income inequality and corruption.

The latest freezes, announced on the government’s main Web site, came after Mr. Wen presided over a Wednesday meeting of the State Council to revise policies on price controls.

Prices of oil products, natural gas and electricity will be frozen in the near term. Rates for public water bills will also be frozen, as will the price of public transportation tickets.

The edict also called for stabilizing prices on medical services and for certain agricultural fertilizers. It ordered local governments to monitor prices closely and warned that punishments would be strengthened for those who violate government price-control policies.

To some extent, inflation is a by-product of an economy that is growing too big, too fast. But the fact that the government is resorting to price controls is a bad sign. Either the Chinese government can't control its monetary base, or else it is pursuing a bad policy out of desperation. The Chinese may believe that price controls are a lesser evil than intentionally slowing the rate of economic growth while so many of its citizens still live in abject poverty. But price controls are unsustainable even in the medium-run. At some point something will have to give: either inflation will return, or the economy must slow.

China Yields

From the WSJ:

WASHINGTON -- China moved to address a flash point in economic relations with the U.S., agreeing to end trade-distorting subsidies to Chinese manufacturers, a senior Bush administration official said.

"This outcome represents a victory for U.S. manufacturers and their workers," U.S. Trade Representative Susan Schwab said in a statement Thursday. She added that the settlement "also demonstrates that two great trading nations can work together to settle disputes to their mutual benefit."

Quite right. But there has got to be some sort of quid pro quo for this. Perhaps, in exchange, the U.S. will lessen pressure on China to let the RMB appreciate. Or, perhaps the U.S. has agreed to lower agriculture subsidies (I doubt it). Perhaps China is just looking for some positive P.R., but I kind of doubt they'll get it. Perhaps China is looking for some leverage in future negotiations. I'm not sure, but something is coming out of it.

But no matter what it is, it's a good thing. China's manufacturing industry is pretty well established at this point. Continuing to distort the markets through subsidies doesn't make long-term political sense, nor does it make economic sense.

A Minor Mistake

China's economic rise has surely been impressive. The stats have shown remarkable growth over the past few decades. This growth was considered to be so exceptional as to be unsustainable. Now, it turns out, it might not have been true:

I recently doubted that the Chinese economy lives up to its reputation. Now the Financial Times says that the Asian Development Bank is backing me up:

In a little-noticed mid-summer announcement, the Asian Development Bank presented official survey results indicating China’s economy is smaller and poorer than established estimates say. The announcement cited the first authoritative measure of China’s size using purchasing power parity methods. The results tell us that when the World Bank announces its expected PPP data revisions later this year, China’s economy will turn out to be 40 per cent smaller than previously stated.

This more accurate picture of China clarifies why Beijing concentrates so heavily on domestic priorities such as growth, public investment, pollution control and poverty reduction. The number of people in China living below the World Bank’s dollar-a-day poverty line is 300m – three times larger than currently estimated.

How could an error of this magnitude happen?

Until recently, China had never participated in the careful price surveys needed to convert accurately its gross domestic product into PPP dollars.

The World Bank’s estimates based on summary data from the late 1980s probably overstated China’s PPP gross domestic product even then. Up to now, the bank has revised its estimate very little. In the meantime, China has repeatedly raised the prices of food, housing, healthcare and a range of other non-traded goods and services. These reforms should have lowered the PPP adjustment, but the bank left it basically unchanged.

The lesson: Steve Levitt's quip that "People lie, numbers don't" is once again way off - because all numbers are made by people.

The Return of Price Controls

Daniel Gross notices that price controls have gotten more popular recently, even in non "anti-market" states like Russia, China, and Argentina. Gross' conclusion:

Price controls, food subsidies, greater state control of the economy, a governor named Romney running for president. It seems like 1967, not 2007. And of course, price controls create powerful disincentives for people and companies to invest in the sort of production capacity that could, in time, create the sort of competition that would help bring prices under control. This isn't a good time to invest in a cattle farm in Argentina, a cheese plant in Russia, or a gasoline refinery in China. If the price controls continue much longer, these economies could see the revival of another distressing factor that defined socialist economies in the 20^th century: rationing.

Price controls are always enacted by desperate politicians trying to save their own skin. They are never enacted for economic reasons. For very short periods of time, they can (sort of) work, but this success is always very short-lived. Politicians don't care, because they are usually out of office by the time things get really screwed up. But citizens should care very much, because they always have to live with the aftermath.

It's a shame that these lessons will have to be re-learned. But it appears that that's what's going to happen.

Multilateralism? What Multilateralism?

Dani Rodrik calls the efficacy and legitimacy of the IMF into question, calling it a tool of the U.S.:

Mark Thoma brings up IMF' new policy of surveillance on exchange-rate policies and quotes from a piece by IMF Managing Director Rodrigo de Rato on the subject. He refers to an earlier post of mine and encourages me to return to the topic as I had promised.

I will do that at some point, but for the moment let me just point to the obvious hypocrisy at work here. Rato writes:

This reform represents a victory for multilateralism that demonstrates ownership of how Fund surveillance will be strengthened and members' willingness to live up to their responsibilities in the process.

A victory for multilateralism? He has got to be kidding. The new policy was instituted at the behest of the United States, with the express purpose of bringing pressure on the Chinese.

And when the IMF staff took "multilateralism" seriously and reported its view that the dollar was overvalued, they were told to mind their own business and not to meddle with U.S. policies. So while we shall see plenty of reports coming out of the IMF on the undervalued Remninbi, don't expect anything on the dollar soon.

This in the face of the Obama/Clinton legislation to put tariffs on China unless they allow the value of the RMB to rise. The logical shortcomings of U.S. policy is astounding. After all, imagine the U.S. reaction is the E.U. threatened sanctions unless we allowed the value of the dollar to further depreciate. The difference, of course, is that the dollar is a major international reserve currency, so depreciation could more severely hurt holders of dollars, and those are not limited to citizens of the U.S. (tho they certainly include citizens of the U.S., particularly those who get more value from imports than exports). But it's even worse for us, because the Chinese hold a lot of U.S. debt. If the value of the RMB rises relative to the dollar, then servicing that debt becomes more expensive for us. So Obama and Clinton are essentially begging China to increase our debt burden and increase our costs of living, or else they are threatening to do it for them. Remarkably stupid.

The IMF needs independence to be productive and credible. The U.S. needs a consistent policy to maintain credibility. The Chinese are looking at us and wondering what the hell we're thinking.

Thomas Barnett Blogging

Barnett begins his column this week by citing Krueger's study "What Makes a Terrorist," ties that to the idea that the way to fight global terrorism is to foster the growth and strengthening of the middle classes in developing countries, esp. those with authoritarian governments (i.e. almost all of the MidEast). The upshot:

In the end, it’s true that politics explains terrorism, but likewise that economics explains politics.

This long war requires long efforts, not seductive shortcuts.

The United States should be in the business of applying both its hard and soft power assets toward the same end: defending and extending globalization’s spread. Feed stomachs and wallets first, and then hearts and minds will follow.

Elsewhere, Barnett is interviewed at Time's China blog. Nothing especially revelatory, but still interesting.

The Inanity of the U.S./China Trade Debate

Philip Levy hits the nail on the head. The upshot:

Congress is demanding the right policy for the wrong reasons and warning that they’ll hurt American consumers unless they get their way. Regular Americans are scared of the Sino-shrimp. And the Chinese are threatening to do what Congress wants, unless Congress relents. This has all the makings of a classic summer farce. If only global macroeconomic stability didn’t depend on it.

arg.

(ht: Greg Mankiw)

China's Environmental Problem

Marginal Revolution points us to a great article in the Washington Monthly about China's environmental problem. Pollution has been rampant, and the government can't control it on its own. So what is it doing? Empowering NGOs and individuals to do a lot of the work for them. It's a strategy that must work, or else China is in trouble.

P.S. On bad days, 25% of smog in L.A. originates from China. Didn't know that.

More on the HRC/Obama China Tariff...

... which I first blogged about here. Matthew Yglesias reads Brad DeLong and wonders:

Now where I tend to lose the plot is this. If mainstream economists like Brad think it's a bad idea to use threats of tariffs to push China into changing its exchange-rate policies, how come the economics mainstream seems to have so few complaints about the fact that it's completely normal for US trade negotiators to use exactly this sort of leverage to try to get other countries to change the intellectual properties policies or to privatize their water systems or what have you? Why is the threat to shoot ourselves in the foot okay when made on behalf of pharmaceutical companies and movie studios, but not when made on behalf of import-competing manufacturers? Often when I see this argument made, I feel like the point is -- aha! hypocrites! you should support our China bill after all! -- but I really do think Brad's right, this is a bad bill. But by the same token, the people who complain about this sort of thing ought to complain about the other sort of thing as well.

There are a couple answers to this:

1. Most in the "economics mainstream" -- i.e. the orthodox theories and those who espouse them -- do oppose using these tactics in bilateral or multilateral trade negotiations. It's "normal" for US trade negotiators to use these tactics, but not because economists approve of it. It's common for US trade negotiators to use these tactics because their job isn't to enact good economic policies; it is to extract concessions from other countries so that trade agreements will be more politically feasible. But usually, we would never put tariffs on another country unless they are violation of WTO rules.

2. The US trade negotiators have different rule sets when negotiating with, say, Chile than they do when negotiating with China. We can easily do without having Chile as a trading partner, and we have the upper-hand in any negotiations with them because they need access to our markets much more than we need access to theirs. So we can browbeat them into doing just about whatever we want them to do by threatening tariffs or other punitive punishments. With China it's not so easy. We do rely on China much more than other countries. Not only do they provide a lot of our consumption, but they also hold a lot of our debt. Because of that, and past military tensions, we view them as a threat to our hegemony (or, at least, some people do). So, threats of tariffs are made, despite the fact that it would hurt us more than China (but they still will hurt China). And, unlike Chile, China isn't going to do whatever we want whenever we want it, so we've got to act like we've got a big stick. We don't have the same sort of leverage against China that we have with Chile.

Also, we do threaten tariffs and other punitive punishments against China for violating intellectual property laws (e.g. pirated software and movies). And part of the reason why Doha has failed so far is because of the US's insistence on the inclusion of intellectual property reform in the developing world. Most economists disagree with that line of logic, although the patent system and intellectual property laws are a wholly separate beast from import-competing manufacturing. After all, in the former cases, Chinese producers aren't producing a product at lower cost than American producers can; they're just free-riding on American innovation without paying anything at all for it. In some cases, they are stealing our products outright. It's a difficult and complex issue, and not easily comparable to standard international trade logic.

HRC & Obama: Death to China!

No, no, no! Please, no more of this!

Hillary Clinton and Barack Obama, the frontrunners for the Democratic presidential nomination, have agreed to co-sponsor legislation that would levy punitive duties on Chinese goods to cajole Beijing into revaluing its currency, according to aides.

Okay, the economic logic of this is absurd. Presumably, Sens Clinton and Obama are concerned about job loss in American industrial sectors, and China makes an easy political target. It makes political sense to express concern: Pennsylvania and Ohio are swing states, and Michigan is also up for grabs. Some good ole' fashioned populism could help their campaigns, especially in a general election.

But the economics is just silly. First of all, unemployment levels have remained very low in the U.S. In fact, they've been surprisingly low. Our median wages continue to increase, while consumption inequality has remained mostly constant. The things we mainly import from China are products of unskilled labor industries which don't exist in America any more (e.g. shoes, clothes, toys), so any significant employment gains are unlikely.

Not only that, but the U.S. has a pretty severe trade deficit with China. Which means that we import more from them than we export. If China raises the value of its currency, then our imports become more expensive. So... our trade deficit will increase, or else our imports will go down. If our imports from China go down, then our standards of living go down. In either case, inflation increases with the price level, and the FED has to further raise interest rates (or, at least not lower them) to keep inflation in check. This causes business investment to decrease, which causes future economic growth to recede, and also lowers domestic employment. Meanwhile, the incidence of the tariff tax would be regressive, as low-income people are the ones most reliant on cheap imports. The poor Walmart shopper would be hurt the most.

If China is devaluing their currency, then they are effectively subsidizing American consumption of the goods they produce. In other words, China is transferring money from themselves to us. They are giving us money for nothing. We should be thanking them... not threatening them.

So what would these tariffs accomplish? They would raise the costs of living of American consumers, eliminate the surplus gains we are getting from trade with China, and eliminate the surplus gains we are getting from China's devalued currency. Not only that, but it would jeopardize political relations with China, which will become more and more important over the coming years. It's a bad policy, in every way.

So no surprise that a few presidential hopefuls would be proposing it.

UPDATE: Brad DeLong, former Deputy Assistant Secretary of the Treasury under Pres. Clinton, and strong Democratic supporter, doesn't like the policy proposal either:

Of course, then the candidates will be attacking US consumers (who will pay higher prices for imports), workers in the construction industry, US borrowers (who will then pay higher interest rates to domestic and foreign creditors), and US homeowners (who will see the higher interest rates push down housing prices and reduce their equity). The net short-run effect is surely a minus--it's not as though we desperately need to swap construction jobs for manufacturing jobs right now, and we surely don't need a more-rapid decline in housing prices right now.

But then he says something interesting:

In the long run of three to five years, yes: The renminbi needs to become worth a lot more (primarily for China's sake). Pressure on China to adopt better policies is helpful (provided we don't shoot ourselves in the foot). But this strikes me as a classic threat to shoot ourselves in the foot: it is not a good policy move on either Obama's or Rodham Clinton's part.

If the RMB needs to appreciate for China's sake, then that supports my original point: a rise in the value of the yuan will be detrimental for American consumer in the short or long run. If you want to make the case that appreciation of the yuan would benefit Chinese, then be my guest. But if you want to argue that appreciation of the yuan would benefit Americans... then you've got a lot of evidence and theory to overcome.

Brad DeLong Doesn't Agree with Krugman Either

Brad DeLong, who very rarely disagrees with Paul Krugman on anything, disagrees with Paul Krugman on his latest inequality column:

Paul Krugman writes about the link between expanding trade--especially between the U.S. and China--and rising income and wealth inequality within the United States. I find myself skeptical. Yes, China is exporting a lot of goods that it produces using low-skill labor. But if those goods were to be produced here in the United States, they would be produced with higher-skil labor and with lots of capital. The key question is how has the shift in economic activity created by expanding trade affected the demand for different kinds of labor and capital here in the United States. We have had:

• A shrinkage in export and import-competing manufacturing.
• A tremendous expansion in construction.
• An expansion in consumer services.

I don't see how those shifts significantly reduce the demand for factor of production "labor" and enhance the demand for factor of production "capital." Construction employs lots of capital--but so does tradeable manufacturing. I want to see Leontief input-output matrices for the U.S. before I upweight trade and downweight education, collapsing unions, migration, changing norms, monetary policy, and other factors as more likely to be responsible for the lion's share of the increase in U.S. inequality over the past generation and a half.

And "outsourcing": outsourcing seems at least as likely to me to equalize the U.S. income distribution as to give it a further inequality boost. Consider what kinds of jobs are likely to be outsourced.

Right. Plus, as I mentioned before, this goes against the changes in inequality that shows up in the Piketty-Saez data: namely, that nearly all the increased inequality is benefiting the top 1% of the population; they aren't really affected by a loss of American manufacturing jobs (unless they are all CEOs of corporations with subsidiaries in China, I guess).

Paul Krugman Says Globalization Leads to Higher Income Inequality After All

This is a big difference from the mantra in the 1990s and early-00s. And he blames China:

At the same time, the rise of China has prevented, for the time being, a development that I and others expected to mitigate the effects of trade on income distribution: up-skilling by the developing country exporters. “As newly industrializing countries grow,” I wrote in 1995, “their comparative advantage may shift away from products of very low skill intensity.” And that’s exactly what happened – for the countries that were the major exporters of manufactured goods to the OECD then. As John Romalis has shown, the exports of the original group of Asian newly-industrialising economies have shifted dramatically away from labour-intensive toward skill-intensive products.

But along has come China, which is far more labour-abundant now than the NIEs were then. A simple indicator is relative wage rates: in 1990, according to the US Bureau of Labor Statistics, the original four Asian NIEs had hourly compensation costs that were 25% of the US level. Now the BLS estimates that China’s labour costs are only 3% of US levels.

In 1995 I also believed that the effects of trade on inequality would eventually hit a limit, because at a certain point advanced economies would run out of labour-intensive industries to lose – more formally, that we’d reach a point of complete specialisation, beyond which further growth in trade would have no further effects on wages. What has happened instead is that the limit keeps being pushed out, as trade creates “new” labour-intensive industries through the fragmentation of production.

Strangely, however, this contradicts some of his earlier premises. Namely, that increased income inequality is almost all concentrated in the top 1% of of Americans, and the further up the ladder you go, the further the gains in income shares are held. So, if China has increased the college wage premium at the expense of lower-skilled workers, we should expect the income gains to be spread more broadly across those in the distribution who have attained higher levels of education. But they haven't been; the gains in wage shares have gone almost entirely to the very top of the income distribution.

The data, especially the Piketty-Saez data that Krugman loves to cite, is more consistent with Rosen's "superstar" theories, or (especially) with the the "income shifting" arguments of Slemrod and others, or with the data that shows that changes in the tax code led wealthy Americans to work more, or that changes in the tax code changed the predominant method of CEO compensation from wages to stock options. If China is truly significant, it's importance is seemingly being crowded out by other factors. Either that, or the Piketty-Saez data isn't providing a true representation of inequality.

How China Benefits the U.S.

That topic is the cover story in this month's issue of The Atlantic (subscribers, go here; i haven't found a non-gated copy yet, but there is an accompanying web-only slide show, with sound, here). James Fallows, who has been embedded in China for a good few months now, does us the honor. I haven't read it yet, but Fallows is a savvy observer of globalization, international markets, and interconnectedness. He discusses the article a bit on his blog. I'm looking forward to getting around to the article itself. I'll probably discuss it more later. Almost everything Fallows writes is dead-on; I expect that this will be a great piece.

Elsewhere, Tyler Cowen points us to the Washington Post, which disputes the notion that China's rising production is to blame for our increased oil prices. Well, not exactly, but kinda:

China's oil imports have increased dramatically during the past five years; the country now imports 3.5 million barrels a day, compared with U.S. daily imports of 12.2 million barrels. But it's far less obvious that Americans are really paying a price for this.

If you've been to the mall lately, you've probably noticed that China is making scads of plastic. As the world's second-largest plastic producer, it is furiously turning oil and petrochemicals into everything from lobster souvenirs to sneaker soles. By embedding oil in products, China is, in effect, importing oil on behalf of U.S. consumers -- as much as 1 million barrels per day.

While China's demand for energy is driving up oil prices worldwide, its cheap goods are having the opposite effect on the cost of living in the United States. A recent analysis by the U.N. World Economic and Social Survey suggests that Chinese pressure on oil imports may have raised U.S. inflation by 0.23 percent from 2001 to 2005, but cheap imports of Chinese goods decreased U.S. inflation over that same period by 0.28 percent. For the moment, the net winners are U.S. consumers.

The importance of China -- as an ally, not an enemy -- is a common theme among geopolitical strategists like Thomas Barnett. The emergence from the Gap to the Core of China (and India) is going to be the story of the 21st century, and that is a good thing.

Why Debts to China Are Good for America

The re-emergence of populist politics in the U.S. since the last election has had one strange side-effect: the demonization of China. Presumably, China is a bad guy because they buy U.S. government bonds, and peg the yuan's value to the dollar. But these policies actually work in the U.S.'s favor. I've written about this a few times, but Greg Mankiw and Thomas P.M. Barnett both have short, succinct, illustrative posts about why this illogic is so frustrating. First, Mankiw:

Suppose the U.S. President were to propose the following policy: "My fellow Americans, I have just asked the Congress to increase taxes on all of us. After they pass my tax increase, I will instruct the Treasury to lend the additional tax revenue to the government of China."

Most Americans would, I suspect, be opposed to this proposal. They would see it as beneficial to China but without much benefit to the United States. With America eager to lend, China would enjoy lower interest rates. Why should Americans pay higher taxes to finance Chinese borrowing and spending?

I agree that this would be a strange and not very sensible policy for the U.S. government to pursue. But isn't it a bit odd that many Americans today are objecting to precisely the opposite of this policy. China is not borrowing from the U.S. government but is instead lending to the U.S. government by buying large quantities of Treasury bonds. The money used to buy these bonds could be returned to Chinese citizens in lower taxes. In other words, Chinese taxpayers are financing American spending and keeping our interest rates lower than they otherwise would be. And many Americans, including the President and Treasury Secretary, are complaining.

Unlike Matthew Slaughter, I would not argue that Chinese policy is incapable of affecting the real exchange rate. In a world of imperfect capital mobility, Chinese policy can affect international capital flows and thus the real exchange rate that equilibrates trade in goods and capital. But I am skeptical that their policy intervention is adverse to broad American interests. What the Chinese are doing, to boil it down to its essence, is buying U.S. government bonds (and some other American assets). The U.S. government is in the business of selling these bonds. There is no good reason to object when a willing buyer steps into the market.

These purchases most likely affect the exchange rate to some extent--and indeed the effect on the exchange rate could well be motiviating the purchases. It is crucial to keep in mind, however, that the exchange rate is a price, and a change in a price has opposite effects on different sides of the market. Cheap Chinese goods are bad news for U.S. producers that compete with those goods, but they are good news for U.S. consumers who buy these goods.

The more difficult question is whether the Chinese are acting against their own self-interest by saving so much and investing in foreign assets. Perhaps they are worried about potential future crises and want a large reserve fund for such a contingency. One can argue that the fund is now excessive. But it harder to argue that their saving and investing in our economy is a problem for us.

Before you say, "They are stealing our jobs," let me point out two things. First, while some jobs are lost to import competition, other jobs are gained because of lower interest rates and greater investment spending that capital inflows finance. Second, the U.S. unemployment rate is now low by historical standards. Based on either theory or evidence, the canonical political refrain of "jobs, jobs, jobs" makes little sense in this debate.

and now Barnett, who isn't an economist, but has good enough sense:

Bunch of these articles lately, pointing out what a lot of people have been saying for a while: pegging the yuan to the dollar has been great for America. We get deflationary pressure, plus our remains cheap from the recycling.

It’s really Europe that gets screwed in the process.

If China revalues, then what? It won’t cure the fact that Americans spend too much and save too little. It won’t reduce our imports, because restricting Chinese imports will lead to Americans simply importing the same products from other nations, not in our building such products ourselves. There is no substitution effect here.

And cheap Chinese imports don’t cause unemployment here, unless you think 4.5% is a lot of unemployment (actually, it’s close to our lowest number in decades).

China would actually benefit more than we would from such a revaluation, because it would help them shift money from investment to consumption, which would allow them to moderate the growth of the economy better and help avoid bubbles and crashes caused by excess liquidity (there is such a thing as having too much money in the system).

And yet watch Congress pursue all sorts of tariff threats, making you wonder if there’s one decent economist out of the 535.

China know that the only way for their economy to continue to grow at such rates is to ensure that the U.S. continues to buy their exports. They know that the only way to ensure that happens is to help keep the U.S. economy in good shape. China is acting in their interest by helping us fulfill our interests. We should be thanking them... not railing against them.

I'm Becoming a Disciple of T.P.M. Barnett

Two great posts from one of our best strategic thinkers:

There are always intell reports that explore all potential downsides. Their existence proves nothing, because that's intell's job: list me the bad things that can happen if I do this, or if I don't do this.

It's like the surgeon telling you before the op about all possible complications. Their potentiality is but one element to be calculated in your decision.

That's why this notion of "faulty intell" is all wrong. It's not how intell works. You get a range of potential outcomes (inevitably, all worst case) and then you make your call.

The presumption of "good" or "bad" intell can't really be proven per se. Some always ends up being "amazingly prescient," the rest is a load of hyperbolic crap.

When things work out, no one cares about all the "bad" intell. But when it goes badly (always for a host of reasons and decisions, or simply because the decisionmakers prefer the sub-optimal outcome to no action at all), then the "amazingly prescient" intell is inevitably touted as "proof" of the intell "failure" (I made this argument first in PNM).

Also inevitably, there will be calls for "reform," none of which can possibly overcome this essentially political decisionmaking process, nor will it stop the very same politicians from declaring their pet defense programs "crucial" because "we live in a world of COMPLETE UNCERTAINTY!"

In short, no president can be "controlled" or "corrected" by perfect intelligence--a useless concept if ever there was one.

Bush and Cheney made their decisions. Until the casualties began piling up ("high" by today's standards, marginal by yesterday's), their decisionmaking was supported--in poll after poll and congressional vote after vote--by the clear majority of Americans and their leaders. Once the bodies piled up and a sense of non-progress ensued, a clear majority turned against those decisions--and those decisionmakers.

That's just how it works in our political system.

So the real correction is--duh!--get the casualties down, not "fix intell."

Iraq stopped being a binary outcome a long time ago. Kurdistan is where we've won, and Kurdistan is where we'll manage to define a partial victory, reduce our exposure and casualties by concentrating the bulk of our troops there, and continue to sequence the rest of Iraq toward something better over time (back to Hoagland and Friedman--and me for two-plus years now--on engaging Iran and keeping this Big Bang strategy alive).

For some, it will always be solely about kinetics and the intell that justifies it.

To others, it'll always be a mix, a sequence, a balance.

The former is a strategy all right, just not a grand one.

And no amount of good intell will overcome that mindset.

And:

An overwrought argument from Mann, who specializes in them.

China is no "new" model or threat. It follows the model of Singapore, and before that South Korea, and before that Japan: a single-party state that bases almost all of its legitimacy on rising income and development through export-driven growth. It is a self-liquidating model: eventually the society wants more political freedom to go with that wealth. China's just so fricking huge and so poor that this process isn't going fast enough for Mann--hence the inevitable "threat."

Mann recognizes neither those past examples nor the significant economic and personal freedoms unleashed inside China over the past quarter century. His Z not having been reached fast enough, he discounts all movement from A since the bizarre depths of Mao's cultural revolution, which is no more distant politically than our Vietnam.

While China's "new" model, such as it is, appeals greatly to many authoritarian regimes in the Gap, there are scant few there that can possibly replicate it (yeah, size matters)..

I mean, name one Gap regime to date that has successfully emerged using China's model? Just interacting with China economically hardly connotes successful subversion to its model. It simply indicates recognition that external economic connectivity is a prerequisite for raising incomes at home, and yeah, if you're an authoritarian leader ruling over a stagnate economy, that's attractive.

As for our take on it, we should logically welcome any so-called model that promotes external economic connectivity, because we know where that goes historically (i.e., where Japan and South Korea finally ended up: creating political freedoms that match their system's potential--something that took us a while to achieve as well).

In short, China carries our economic model's water for us, pushing us to marry up our political model with it over time (what we seek to encourage in China, we logically seek to encourage in similar situations across the Gap). Hardly an alternative model, China's path is but a steppingstone to outcomes we naturally seek. I mean, crawling might be described as an alternative to walking, but only until you're able to walk, then it suddenly seems like a passing phase.

China's "model" will never move beyond crawling, because it's about transforming a hugely rural, impoverished, disconnected society (one-sixth of humanity) into an urban, consumeristic, connected one. Once achieved, and China is nowhere near that at this time, with well over half its population still living in very Gap-like conditions, then its model self-liquidates that all before it.

China's future leaders know this, so do our smart observers. Mann ain't one of the them. He knows his China from a long way back now, and he'll never recognize another.

Confusing China's influence-peddling with model propagation is a new academic fad in search of actual data to prove its distinctiveness, but there is none. China's model is not unique, but a copycat of something we've seen before in "rising Asia," just not on this scale. Prior to that, the USSR had its own bankrupt version. China's model will extend itself only where China extends itself, and since China's economic ties remain exceedingly mercantilistic, that won't be far.

In short, the academic tomes touting China's "victory" are arriving just as the Gap is beginning to turn on China, and just as China's starts feeling the scary blowback from its extension of trade nets deep into the Gap. As always, the academics are right on time.

Hardly a great threat, this "model," but merely a tool to be manipulated by leaders more strategically imaginative than our current crew--or the ideologically-myopic Mann.

The first is funnier. The second is more substantive. I think I'm becoming a disciple of T.P.M. Barnett.

About Time

China has decided to reform their currency controls, fight excessive liquidity, moderate their balance of payments imbalances, and temper their blistering growth - currently at nearly 12% - to prevent a debt crisis or excessive inflation.

There are several good things about this. First, it will help create a policy framework for China to continue growing at sustainable rates. Second, it will help Western countries - like the U.S. - narrow their current account deficits, which might help bring a successful conclusion to Doha. Third, it lowers the potential for China's bubble to burst, or for inflation to run roughshod over the economy, killing that country's poor. Fourth, it removes one of the last American excuses for liberalizing trade further, as China can now band together with the G-20 to force America to practice what it preaches. I think I like everything about this.