It is tempting to see the world through ones own domestic situation, but in a globalized world this is wrong, and dangerous. Globalization, like it or not, has made nations more interconnected and more interdependent than ever. When a large nation "abuses" this relationship it impacts everyone.
I have written that this recovery is not "real", and I still believe that. It is not real because the conditions that caused the "recession" have not been fixed, so as it stands I think we will see another leg down and a drawn out and very slow climb back.
An article by Michael Pettis (an American, who formerly worked for Bear Sterns and now lives and teaches in China) clearly shows how bumpy the road ahead is for the US and China.
This diary will look at, in simple terms, the key roadblocks ahead with China and a prescription or two for what the US should do.
The Problem: This crisis has a number of causes that are ultimately interlinked. Any discussion usually ends up in a chicken-egg loop. So for a moment let's suspend a discussion of which caused what. Here are the key points.
a) The Chinese government has pursued an economic policy focused on exports. To this end it has manipulated its currency, kept worker labor labor rates low, maintained incentives for manufacturers, and worked to keep imports down.
The Chinese government has done this for 2 important reasons. First as it modernizes it needs to find jobs for the 10's of millions of peasants leaving the countryside in search of a higher standard of living. Second it needs to "get rich" before it gets old as it faces the prospect of a rapidly aging society caused by its one-child policy (a policy ironically enough that was essential for building the platform for current growth). So, the Chinese government has very valid reasons for pursuing this path of development. It is clearly in their short term national best interest.
b) The US, in the aftermath of the tech bubble and 9/11, kept interest rates artificially low to try to "pump up" the economy. Low interest rates meant people (and the government) could afford, at least temporarily, to buy things that they would not have otherwise purchased. This led to record car sales, record housing construction, and a flood of imported goods, much of it purchased on the buy now pay later plan.
Of course to buy on credit someone has to provide the credit. Here the Chinese were also obliging, willing to take very low interest rates on their money in exchange for the US continuing to spend on its (China's) manufactured goods. So here is the chicken-egg issue. Did China's economic policies including lending the money cause the problem, or did the US's low interest rates cause the problem.
Either way a circle was built that kept everyone happy until it collapsed, and its collapse was inevitable because it was built on ever and ever bigger imbalances. Picture a scale that at the beginning has weights on both sides. Now picture a person shifting the weights slowly from the right side to the left side, while holding the left side of the scale up with their other hand. If you don't see the hand you would assume everything is balanced (the 2 sides of the scale are level), but if the hand is taken away, "bang", the left side goes down, the right side goes up. The only way to "fix" the situation is to move the weights back from the left to the right. Trying to again "hold up" the left side will not work in the long term - and unfortunately that is all that has happened so far during this recession.
Issues: For the purpose of this diary I have kept the explanations below quite simple. If there is interest I can expand with more examples or detail.
1. Foreign exchange manipulation. By pegging their currency to the US dollar China is able to avoid all the negative issues of a floating currency and is able therefore to keep prices lower than they should be and by so doing can outcompete other nations. Although there was once an argument for a developing country to have a fixed rate, China is now the world's second biggest economy (and has 2 trillion in FX reserves). The time has come for it to "grow-up" and stop cheating.
2. Chinese government squeezing the workers. China makes sure that its worker income does not go very far. There is lax enforcement of labor laws, imported good prices are kept high, and interest rates for savings are kept low. This is all to maintain competitiveness. Companies prosper, workers suffer.
3. Chinese banking bubble. If you think US banks are in trouble. Take a look at Chinese ones. The government policy of flooding the market (banks) with liquidity and basically forcing them to lend has meant capital has been misallocated (vacant shopping malls, empty cities, real estate speculation). So far the non-performing loans don't look bad ... but just wait. There is bubble that is ripe for popping.
4. Investment in infrastructure gone mad. Usually we think of infrastructure investment as a good thing. And it usually is ... BUT. It is possible to so flood the market that projects are undertaken that make no economic sense. So building a high speed rail system that charges a day's wages for a trip to save an hour in travel time is unlikely to make sense ... but that is what is happening.
5. Liquidity. Right now things are starting to look better ... but unfortunately it is all a short term illusion made possible by massive liquidity and new debt. Chinese bank debt has exploded as the financial system literally rammed money into the system (and not really caring where it went). The US system too has been kept afloat by massive government deficits (as has Europe's). Unfortunately most people have no concept as to how much money has literally been thrown at the problem and what the long term cost will ultimately be. Everyone instead is fixated on stopping the short term pain. However, only when the stimulus is reduced (let alone withdrawn) will we start to feel how weak the underlying economy actually is.
6. 1929 revisited: There have been many comparisons to 1929 during the current recession. Unfortunately most of the comparisons have been wrong. In fact if you want to make comparisons, the US of today would be the UK of 1929 and China would be the US. In 1929 the US was the major exporter and manufacturer. It ran a large trade surplus just as China does today. It was the imposition of tariffs that caused much of the problem (which was shall be say, unwise, as the US was a net exporter and so would lose the most in a trade war). China too is now vulnerable to a slowdown in world trade as its economy is built on exports. This is where the rest of the world has leverage to confront the Chinese currency position.
7. NOTHING has been fixed: In the end this is the most important point. Nothing has been done to fix what caused the crisis. China is still controlling its currency and encouraging exports. It's stimulus plan has been aimed at encouraging "investment", not consumption. The US still using low interest rates and massive liquidity to try to re inflate the bubble. Private debt has been taken on by the public sector, but the debt still exists.
A REAL solution requires that China starts spending more (and exporting less) and the US starts saving more and importing less. That is the ONLY way that the world can be rebalanced. To do this China must free up its exchange rate and the US needs to lift taxes (reduce the deficit) and interest rates (to reduce consumption).
So far this rebalancing remain a long way off and likely will not happen until push comes to shove comes to all out brawl.
Extra bit:
China of late has started to flex its political muscles. At Copenhagen and with the execution of the British man China has ignored world opinion. However in a globalized world, what the rest of the world thinks can and should matter. To this end, although the US government can not come out and urge a "do not buy" China plan, US consumers can! It's called pocketbook politics and in a capitalist society it is very powerful. Although it is difficult (everything seems to be made in China) try to not buy Chinese products. Talk to your neighbors. Talk to the store where you shop. Make it apparent that you want non-Chinese goods.
The short term goal must be a move by China to a flexible exchange rate. Until that happens China is winning by cheating ... case closed.