China's Lifeline to the US (Fareed Zakaria):
For weeks the world has eagerly awaited word from the Obama transition team about the people who will head up the next administration -- the new secretaries of state and treasury, the attorney general. But one of the more crucial positions in the Obama administration probably isn't going to be filled for months and is likely to get little attention when it is -- the post of U.S. ambassador to China.
China has become the key to America getting through the worsening economic crisis. The American ambassador in Beijing (okay, this is a metaphor for all those officials who will be managing this relationship) will need to make sure that China sees its interests as aligned with America's. Or else things could get very, very ugly.
Everyone agrees now that Washington needs to spend its way out of this recession, to ensure that it doesn't turn into a depression. Economists on both the left and right agree that a massive fiscal stimulus is needed and that for now, we shouldn't be worrying about deficits.
Why do we need to spend our way out of recession? What's the logic here? There are at least two other options: (a) tax cuts, and (b) monetary policy. Of course, if we cut taxes that also increases the deficit.
But to run up these deficits -- which could total somewhere between $1 trillion and $1.5 trillion, or between 7 and 11 percent of gross domestic product -- America has to get someone to buy its debt. And the only country with the cash to do so is China.
America isn't having any trouble selling its debt right now. Interest rates on US Treasuries are at about 0%.
In September, Beijing became America's largest foreign creditor, surpassing Japan, which no longer buys large amounts of Treasury notes. In fact, though the Treasury Department does not keep records of American bondholders, it is virtually certain that, holding 10 percent of all U.S. public debt, the government of the People's Republic of China has become Washington's largest creditor, foreign or domestic. It is America's banker.
But will the Chinese continue to play this role? They have the means to do so. China's foreign exchange reserves stand at about $2 trillion (compared with America's relatively puny $73 billion). But the Chinese government is worried that its own economy is slowing down sharply, as Americans and Europeans stop buying Chinese exports. It hopes to revive growth in China (to levels around 6 or 7 percent rather than last year's 12 percent) with a massive stimulus program of its own.
The spending initiatives that Beijing announced a few weeks ago would total almost $600 billion (some of which include existing projects), a staggering 15 percent of China's GDP. Given its focus on keeping people employed and minimizing strikes and protests, Beijing will not hesitate to add tens of billions more to that package if need be.
At the same time, Washington desperately needs Beijing to keep buying American bonds, so that the U.S. government can run up a deficit and launch its own fiscal stimulus. In effect, we're asking China to finance simultaneously the two largest fiscal expansions in human history -- theirs and ours. Naturally China's priority is likely to be its own citizens.
Of all the causes for "desperation," this does not seem to be one of them. Everybody wants Treasury bonds right now. And, if China stops buying American bonds, the result should be to weaken the dollar. Which is good for us because it makes our exports more competitive.
"People often say that China and America are equally dependent on each other," says Joseph Stiglitz, winner of the 2001 Nobel Prize in Economics. "But that's no longer true. China has two ways to keep its economy growing. One way is to finance the American consumer. But another way is to finance its own citizens, who are increasingly able to consume in large enough quantities to stimulate economic growth in China. They have options, we don't. There isn't really any other country that could finance the American deficit."
What is Stiglitz talking about? Sure people will buy Treasuries, if the interest rates are right. Right now they're too eager to buy them. If Stiglitz means the government deficit, Americans can finance it. If he means the trade deficit, that will resolve itself of its own accord if foreigners cease to be willing to send capital to the US. If the Chinese were to stop buying Treasuries and dedicate themselves to fiscal stimulus at home instead, that would fuel Chinese demand for exports, including US exports.