"Smoot Hawley" redux

Last week, Paul Krugman chided the Chinese for not allowing its currency, the RMB, to rise against the dollar, despite a huge trade surplus. This will end badly, warned Krugman,

James Fallows put this in historical perspective for non-economists.

The heart of Pettis's argument was that China's economy in this past year was like America's in the early 1930s. Each had been the workshop of the world in the preceding decade; each had piled up huge trade surpluses and financial reserves; and -- the underappreciated part -- each suffered big job losses when its foreign customers could no longer buy its excess production. Having had more than "its fair share" of the world's manufacturing jobs in the 1920s, the US had more of them to lose in the 1930s. So too with China as demand fell around the world last year. Relatively more of China's people had depended on foreign customers for their jobs, thus relatively more of them were at risk than in Europe or the US. And indeed, tens of millions of Chinese factory jobs disappeared last year, especially in the southern part of the country.

The crucial part of Pettis' analysis was the next step: whether China would respond to this loss the way the U.S. had in the 1930s. Back then, desperate to protect American factory jobs, the U.S. Congress passed the Smoot-Hawley tariff, with levies on thousands of product categories. In itself, that tariff was not the cause of the world Depression (contrary to the implications of "Smoot Hawley" in the standard political speech or op-ed column). But as other countries retaliated, the cascading failure of demand intensified the hard times worldwide.

To bring this back to Krugman and China: Pettis concluded that the natural result of last year's economic slowdown would be the shrinkage of China's export economy and global trade surplus. Anything else would delay the "rebalancing" of economies that was necessary worldwide. If China tried too hard to prevent this, then that step would be the modern Smoot Hawley equivalent. As I put it in the article:

"The real damage of Smoot-Hawley, [Pettis] says, was less economic than political. Other countries understood that the United States was trying to protect its trade surplus and therefore its workforce. They didn't like it as a political matter, and they struck back.

"If that were to happen again... the real counterpart to Smoot-Hawley would be Chinese protectionism--or rather, any effort by China to defend its huge trade surpluses, as the U.S. once did. China's government is unlikely to rely on outright Smoot-Hawley-style tariffs. Instead it could increase subsidies to exporters; it could try to push the RMB's value back down, after three years of letting the currency rise; it could encourage manufacturers to restrain wages; it could impose indirect barriers to imports, as with its recent pressure on China's airlines to cancel outstanding orders for Boeing and Airbus airplanes. By early this year, China's government was in fact doing every one of these things."

Trade Wars for the Teens?

Red scare

Dean Baker disagrees with Paul Krugman, noting that the Chinese can't suddenly have been "surprised" that they could lose money on the US dollar investments. Baker argues that China saw the value of the dollar plunge a year ago and did nothing to hedge their bets; in fact, the Chinese have long used the dollar to keep their own currency value low and hence keep the prices of Chinese goods for US consumers quite low.

Most importantly, Baker argues that China's "threats" about the US getting its finances in order is being used as the latest cudgel over "entitlements."

Anyhow, the reason why the distinction between the China surprise versus strategy view is important is that the bad guys are already using the China threat as an argument to cut Social Security and Medicare. The argument goes that if we don't get our budget in order (i.e. cut Social Security and Medicare) then the Chinese will pull the plug on us. The Peter Peterson crew have already been vigorously pushing this line.

China floods

I am not the first to point this out, but could the difference between the reaction of Chinese authorities' -- at all levels -- to the earthquake and the potential flood and our government's reaction to Katrina be any starker?

The earthquake

A heartbreaking slideshow.

Peter Hessler writes about Sichuan Province -- a place where bad things happen with depressing regularity.

In China, when bad things happen, they happen in places like Sichuan. The province is landlocked, remote, and rugged; it’s always been heavily populated, and it’s always been poor. When I was in the Peace Corps, Sichuan was home to a hundred and ten million people, a staggering figure: roughly one of every fifty human beings on earth was Sichuanese. Since then, the central government has divided the region into two parts, Sichuan province and Chongqing municipality, but that has done nothing to change the sheer sense of massed humanity. And the recent earthquake is by no means unusual. If you’ve lived in Sichuan, and continue to follow it in the news, you become accustomed to terrible stories—floods and landslides and collapsed bridges. Periodically, I’ll receive an e-mail that stops me cold, such as the one that Kevin sent last May:


I am sorry to tell a bad news. My town is called Yihe in Kaixian County in Chongqing. Two days ago, a big thunder hit my wife’s village school. It killed 7 students and wounded 44 students. It was not my wife’s class. But when the tragedy happened, my wife was teaching her students. . . . I am sorry to tell you about the bad news. These days my wife and I are both sad and scared at home.

The Chinese often believe that human beings are shaped by the land around them. After my time in Sichuan, I came to agree; I had never lived among people who were so tough. The Sichuanese are natural workers, and they dominate construction crews in many parts of China. They are patient and tireless and determined, and they’re famous for pragmatism—Deng Xiaoping came from Sichuan. The people are also surprisingly good-natured and optimistic. Maybe that’s what happens when you’re a survivor, and maybe that also accounts for their sense of humor. On Tuesday, I received another e-mail from Willy:

…a minor quake measure 6.1 occurred again in Chengdu at around 3:00 and I called my friend there, they said when it happened yesterday, the whole house was like a swing. But this afternoon, when I called him, he said many of his colleagues (some teachers) were playing mahjong happily in the wake of the terrible quake.…
Do you still remember my uncle, who went to Gansu as the early migrant worker? His son survived the quake. . . . He was a college student in Aba Teachers’ College, which happens to be located in the epicenter. He is going to graduate in July, but he found a job for Yanjing Beer Company, the company asked them to go to Guangxi to get training instead of going back to school to study, so when the quake happened he was on the train to Guangxi not knowing that Yanjing Beer Company had saved his life.

Meanwhile, NPR has been doing a tremendous job of reporting this story with immediacy and sensitivity.

Steven Mosher

I heard this guy speak tonight. Never have I sat through a more smug, disingenuous mix of naive idealism and obsessive fear that "we" will change in the face of growing Chinese economic and military power.

His lecture was titled, "China, the Olympics, & the War Against People" [sic].

Early on he mentioned he had been a member, in the 1980s, of "Team B," which he pointed out, without a trace of irony, acted as a policy counterpoint to CIA analysts who consistently "under estimated the power of the Soviet Union."

He is part of the reason McCain must not be president. Remember that, oh Democratic voters, feeling what ever you're feeling tonight. Mosher left unsaid what it is we are supposed to do about China's "war on people," other than to boycott the opening of the Olympic Games. I think he and his ilk are less reticent about what they advise neoconophiles on Capitol Hill.

The China bargain

Probably better not to read James Fallows' analysis of our trade deficit with China and what it really means when you are considering how to finance a home remodeling project.

And the government doesn’t want to increase domestic spending dramatically, because it fears that improving average living conditions could paradoxically intensify the rich-poor tensions that are China’s major social problem. The country is already covered with bulldozers, wrecking balls, and construction cranes, all to keep the manufacturing machine steaming ahead. Trying to build anything more at the moment—sewage-treatment plants, for a start, which would mean a better life for its own people, or smokestack scrubbers and related “clean” technology, which would start to address the world pollution for which China is increasingly held responsible—would likely just drive prices up, intensifying inflation and thus reducing the already minimal purchasing power of most workers. Food prices have been rising so fast that they have led to riots. In November, a large Carre­four grocery in Chong­qing offered a limited-time sale of vegetable oil, at 20 percent (11 RMB, or $1.48) off the normal price per bottle. Three people were killed and 31 injured in a stampede toward the shelves.

This is the bargain China has made—rather, the one its leaders have imposed on its people. They’ll keep creating new factory jobs, and thus reduce China’s own social tensions and create opportunities for its rural poor. The Chinese will live better year by year, though not as well as they could. And they’ll be protected from the risk of potentially catastrophic hyperinflation, which might undo what the nation’s decades of growth have built. In exchange, the government will hold much of the nation’s wealth in paper assets in the United States, thereby preventing a run on the dollar, shoring up relations between China and America, and sluicing enough cash back into Americans’ hands to let the spending go on.

The Chinese public is beginning to be aware that its government is sitting on a lot of money—money not being spent to help China directly, money not doing so well in Blackstone-style foreign investments, money invested in the ever-falling U.S. dollar. Chinese bloggers and press commentators have begun making a connection between the billions of dollars the country is sending away and the domestic needs the country has not addressed. There is more and more pressure to show that the return on foreign investments is worth China’s sacrifice—and more and more potential backlash against bets that don’t pay off. (While the Chinese government need not stand for popular election, it generally tries to reduce sources of popular discontent when it can.) The public is beginning to behave like the demanding client of an investment adviser: it wants better returns, with fewer risks.

But if you're not thinking about taking on lots of shiny new debt, I highly recommend reading the whole thing.