Tuesday, August 26, 2008

China Propping up the $US

I have discussed the position of China in the world currency system previously. I have made the point that China needs to be challenged to open up the RMB to be being a completely free currency, as this is one of the absolute necessities for rebalancing the world economy. The simple fact of the matter is that, as long as the RMB does not trade freely, the Chinese economy can use the currency to subsidise exports. I do not believe in any forms of currency controls, but even for apologists for such a system I can see little justification on the RMB.

Bearing all of this in mind, I was fascinated to read an article in the Telegraph newspaper, which had the following to say:
'China has resorted to stealth intervention in the currency markets to amass US dollars, using indirect means to hold down the yuan and ease the pain for its struggling exporters as the global slowdown engulfs the economy...'
'Beijing has raised the reserve requirement for banks five times since March, quickening the pace with two half-point rises in late June.This is having major spill-over effects into the currency markets because banks in China have been required over the last year to hold extra reserves in dollars rather than yuan. The latest moves have lifted the mandatory deposit from 15pc to 17.5pc of total lending since March'
There are many motivations that could be given to justify this action, some of which are more forgiving than others. It might be argued by apologists for China that they are doing this to protect the value of the $trillion+ reserves of $US. However, such a move can only delay the day of reckoning for the $US, so I do not believe that this would be why the policy is being enacted. Furthermore, it is just multiplying the problem of increasing the holdings of a currency that is structurally weak, meaning that the problem that it is trying to solve would just be getting more acute. However, I agree with the article that China is using unfair means to subsidise exports.

I have also pointed out in previous posts that China has sustained an implicit policy of allowing wholesale intellectual property theft (a generous interpretation of China's policy can be found in an article here). However, there is more to the story of Chinese economic aggression than currency manipulation and intellectual property theft. Last year, whilst living in China, I came up with a rather startling thought about China and the way in which it is managing trade and the economy. It occurred to me that China was waging and economic war against the US, Japan and Europe. Having come up with the idea, I explained this to some friends who lived in China. As you would expect, they were initially aghast at the idea and were disbelieving. However, after I showed them some recent articles, added to the RMB policy and intellectual property policy, they agreed that there was merit in what I had to say.

At the time I had read several articles in the Economist magazine that, in isolation, were not too worrying. However, taken together they showed a pattern of Chinese government anti-foreign business policy. For example one article showed how the Chinese press were campaigning against Western companies through the use of slanderous stories about Western companies. Such campaigns could only be undertaken in China with at least tacit support of the Chinese government, and they appeared to be coordinated. The campaigns were clearly intended to undermine the perception that Western brands provided quality and safety. In other words, they sought to undermine the potential for foreign economic success within China. In another article it was demonstrated that there were counterfeits being made of cars in China. The extraordinary thing is that the cars were being sold below any reasonable cost of manufacture. This is what the Economist had to say:
'The great mystery about these copycat cars is their price. Chinese counterfeiters obviously save on research and development costs, but they still have to buy steel and other materials at market prices. Most of them make cars in very small volumes, so there are no economies of scale. That they can sell these cars for half the price of the originals suggests that something odd is going on. They either do not know their own costs (a distinct possibility), have revolutionised carmaking (highly unlikely) or are being subsidised in some way. For the time being, no one knows.'
The only conclusion that can be drawn here is that the government has been subsidising the manufacture of these cars. They are actively trying to destroy the foreign car business in China.

Such articles were just a couple of examples from a brief period when the idea of Chinese economic war was dawning upon me. There have been many more since. We can add to these examples the widespread use of commercial espionage, such as an article here which shows conventional industrial espionage, an article here which shows commercial espionage against the US government and here for commercial espionage in Europe.

As for the attacks on foreign owned businesses in China, these are still ongoing. For example, China has introduced new labour laws and, no surprise, they have actively targeted the laws at foreign multi-nationals, despite the fact that foreign companies are generally much better employers in every respect. An article on this can be found here. Another recent example of unfair trade (restricting car imports, and car part imports) can be found here.

On a related subject, in an article a while ago the Telegraph, it was reported that senior Chinese officials were willing to use dollar sales as a way of exerting power over the US. In short, the Chinese have the power to destroy the $US by selling the currency, and therefore have huge economic power over the US. The Chinese government later denied the policy, but those familiar with Chinese culture will know that using such methods of presenting a threat is not unusual.

Each of the stories above, taken in isolation, would not cause undue alarm. However, when considering them all together, then there is a worrying pattern emerging. It should also be remembered that all of the above are just examples. What is very clear is that China, and the Chinese government, are actively pursuing a policy of unfair trade at home and abroad. Quite simply, they are using economics as a tool of power rather than just enrichment.

I have suggested in a previous post that the world trading system needs to get tough with China. I did not have the time to dig up the articles that I had read, which caused me so much concern, so have previously not outlined this point of view. However, on reading the latest attempt by the Chinese government to manipulate trade, it seemed a good point in time to outline this problem. I am at heart a free trade advocate, but I also believe that trade should be free and use reciprocal rules should be binding and enforced. It is very clear that China intends to rise economically by any means, fair or foul. The crazy part is that the foul is unnecessary, and one then becomes very suspicious of the underlying motives for such methods.

It is very worrying indeed.

Note: At the end of this post there is an always appreciated comment from a regular commentator on the blog, 'Lemming'. I just thought I would respond. He correctly identifies that I have said that there is no 'conspiracy' in a previous post, but the following post suggests otherwise. However, as Lemming correctly identifies, what I am referring to is that there is no conspiracy amongst bankers and the government of the UK, and Western governments. The point of this post is that China may actually really be conspiring. I hope that the intended meaning is clear in the first post, and believe that there is therefore no inherent conflict of opinion / contradiction in the two posts.
It is nice to know that people are paying such close attention to what I have written, which is very heartening, in particular as I had forgotten the details of the original post myself.

Note 2: A quick response to an anonymous comment (see below). If the Chinese government were to seek to destroy the US currency, it is difficult to guess where the US dollar would land. Let's just say at 50% of today's value against a basket of the major currencies, for the sake of argument. Some of the consequences would be as follows:

1. In so doing, the US currency would cease to have reserve status (loss of economic power)
2. There would be hyper inflation in the U.S.
3. The U.S, would not be able to borrow any more money (maybe a good thing)
4. The U.S. economy would collapse
5. The U.S. would be a much poorer country

In reality, the collapse of the U.S. currency would cause chaos, and it is difficult to predict the precise consequences. In a state of chaos it is impossible to say what situation would emerge. However, the one certainty is that the U.S. would be destroyed economically and would emerge from the chaos fatally weakened.

The revaluation would make the adjustment that I have talked about elsewhere in the blog, such that the U.S. would be a much poorer country. This is, in any event, going to happen. However, in this scenario, it would happen in a way in which it would be a dramatic shock. Instead of a gradual adjustment to a new equilibrium, the U.S. economy would plunge. As an analogy think of a person climbing down a ladder compared with falling from a height.

Yes, it would hurt China's exports, and throw the world economy into a tail spin. It would hurt China as well as the U.S. Eventually, the U.S. would recover with export growth, but it would almost certainly never regain the pre-eminent position in the world economy, which would go to China. China would risk social unrest during the adjustment that followed. However, the reward if they were to pull it off would be status as the new economic power.

As for the cost, $600 billion in devaluation of reserves would be a small price to destroy your greatest rival, and assure a pre-eminent position. The foundation of power is economics. If China destroys the U.S. economy, they destroy the power of the U.S.

The threat to sell the dollar I refer to in the blog, is an expression of China's new found power. Whether they are willing to take a gamble on the consequences of use of such power is a point of question. There are major risks to China if they were to carry it out. However, as things stand, the threat has rebalanced world power.


  1. Could I dredge up a quote from one of your earlier posts Mark? In July a reader asked:

    'Reading your essays one can't help but wonder at the enormity and depth of the government cock-ups that have made us the country we are today.

    Looking at the exquisite perfection of the US and UK's problems, do you ever, just for a fleeting moment, wonder whether any of this might have been deliberate?'

    You said:

    I hope that I have not misunderstood the intent of meaning of this poster. It appears that there is a suggestion of conspiracy, that there is some malign purpose in what is occurring in the UK/world economy. I am not sure I have it right, but I will answer on that basis.

    The short answer to this question is 'no', there is no conspiracy.

    My own view is that the current situation stems from group think, vanity, pettiness, personal ambition and sometimes (good, old fashioned) stupidity.

    It sounds as though you might be changing your opinion? Admittedly the question suggested deliberate policy on behalf of the West's governments, and your latest article attributes sinister motives to the Chinese, but either way, the current situation would not just be accidental.

    (Dons tinfoil hat) If the Chinese were 'up to something' is it likely that the West's governments would not have suspected it? And yet they implemented policies which played right into Chinese hands... Is such a suggestion that much more fanciful than that the Chinese are waging an economic war on the West?

  2. I would dearly like to know more about cars and China.

    China is usually presented as an unqualified success story. I have never been there, or had any contact with Chinese businesses, but I suspect there are troubles behind the facade.
    As we have been reminded by the Olympics: for over a decade the Chinese Government has overseen a material boom as a substitute for the poitical change that went throught the rest of the Communist World in the early 1990s.
    The weakness of the US$ presents them with conflicting difficulties. A weak RMB keeps their exports competitive, but makes their imports more expensive and heats up the already high rate of inflation.
    The import this most applies to is oil which is imported for petrol to feed the growth of car ownership, and is sold on to the Chinese consumer at a subsidised price.
    They may be selling copies of foreign cars at a loss to meet the expectations of car ownership they have created.

  3. "the Chinese have the power to destroy the $US by selling the currency" But surely, such an act would be one of self-destruction, since it would result in the obliteration of Chinese export industries by raising the cost to America of imports of Chinese goods,a huge resurgence of American exports (food anyone?) and vast losses in money since the act of selling would debase their own currency holdings.

    I know they are said to be inscrutable, but I just don't buy this!


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