China Drivin’ Me Crazy!

There has been a lot of noise coming from China over the last week or so coming out of their People’s Congresses on many issues of global economic importance. I feel like a lot of the conversation has essentially amounted to the pot calling the kettle black except that the kettle is on the stove, while the pot is hidden away in the cupboard. I’ll expand on that in a bit.

From the NYT:

The Chinese premier Wen Jiabao expressed concern on Friday about the safety of China’s $1 trillion investment in American government debt, the world’s largest such holding, and urged the Obama administration to provide assurances that its investment would keep its value in the face of a global financial crisis.

So ok…I can understand a lot of what is going on here. The world is in a financial crisis and no one really knows how we are going to get out of it. It is precisely this insecurity which is driving down the values of EVERYTHING! First, what kind of assurances would be satisfactory? Sure, Obama can stand up and say that the US intends to honor its debts, but isn’t that what anyone who desperately needs money will say? Why should the Chinese believe him over any other indicator of America’s creditworthiness? It reminds me of an old adage, if you owe the bank $10,000 you are in trouble. If you owe the bank $1,000,000,000 the bank is in trouble. Sorry China, but you are the bank, and if America is in trouble, so are you.

The article goes on to point out that:

Some believe that China’s investment in American debt is now so vast that, should it need foreign exchange in some emergency, it would be unable to sell its Treasury securities without flooding the market and driving down their price.

This is a statement that I very much agree with. If China starts to sell, or stops buying, what will that do to confidence in the dollar? China can’t sell out without destroying the value of its holdings, and if China stops buying, it could encourage other holders of US debt to try to sell out before the Chinese can. All of this while causing problems for America will also cause a lot of problems for China. This is the downside of global economic integration. Oh to be North Korea at a time like this!

But even more frighteningly:

At Friday’s news conference, Mr. Wen said he believed that China’s economic problems were less severe than in many Western nations because, he said, China’s banks remain relatively healthy. While the United States and Europe are battling both a recession and financial-system collapse, he said, “we haven’t had to use money to fill a financial hole.”

This goes back to one of my biggest problems with the Chinese government. They seem to assume that we should take whatever they say at face value, and that any questioning of the veracity of their statements, or thier actual intentions is somehow an insult. This is not a productive way to discuss policy, especially when it needs to be constructed in an international environment.

But going back to Mr. Wen's quote, I think what he means to say is “we haven’t had to use money to fill a financial hole…yet.” Chinese banks are being ordered to lend to keep the economy moving. There was no political will to look at bad debts in these banks before the current crisis, and there certainly isn’t now. In fact the opposite is happening. The west is taking criticism from China based on how well they have avoided catastrophe. In the end, they are setting themselves up for a fall. Capital is being misallocated by banks ordered to spend by the central government. I have no doubt that these banks are piling up bad debts to keep companies in business so they do not have to acknowledge their existing inventory of non performing loans. As these volumes increase, the final bill will be much larger than it might be. The west is paying the price for their financial overindulgence now, and we will come out of it with a reformed financial system which should prove more efficient and resilient in the future. China on the other hand is simply building up greater and greater problems.

My final point is this. If the US government defaults on its debts, their concern over the repercussions this may cause will not be high on their list of priorities. If the US and world economies have collapsed to that point, everyone will have bigger problems to deal with than getting their money back from America.