The Chinese Government's cunning ploy?

Economics Economics Questions
1

I was talking with a friend yesterday and he switched me on to something I had pondered but never really resolved. By effectively pegging their currency to the US dollar the Chinese have been creating an enormous real estate boom on their own turf for the past few years,while for a long time depreciating the purchasing power of their own citizens. I couldn’t figure out why before. But could this actually be a strategic/military ploy by the Chinese government?

With manufacturing and other businesses in the US stifled by inflation and regulation, while not even being able to benefit from lowered exchange rates with other currencies, the Chinese are effectively allowing for the long run neutralisation of the US as a world power while democratically elected rent seekers work hard to fritter away what was once it’s economic strength? This would leave China in the future to pretty much take the stage as the predominant world power, both militarily and industrially, especially in any scenario that could potentially lead to one of war in which tradelinks would be cut.

2

Yeah, pretty much. I have long been suggesting that the United States destruction of it’s industrial base is quite deliberate, demanded by the Chinese government in return for buying our debt.

3

The more likely reason is good old fashioned Mercantilism. After WW2 the Japanese, Koreans, folks in Hong Kong, Singapore, Tiawan, etc adopted similar domestic policies that encouraged exports over imports. With a little bit of freedom and the USA spending huge amounts of its time building weapons, maintaining a military, blasting things into space, providing healthcare for old folks and giving folks money; these countries flourished by providing things the USA could not longer afford to make.

Well when China began the same experiment with the special economic zones and they found the same formula worked well. Only this time a Communist bureaucracy was at the helm. And if you think change is hard in a democracy, well it is at least 10 times that hard in a totalitarian socialist government. So they pegged the currency to the dollar and up until 2002 everything was just peachy. Then Greenspan changed the “Virtual Greenspan Put” into reality after Sept 11 and the realestate boom clicked into high gear.

4

States do not work like that, I’m afraid. Perhpas they did back in the day of 5% over GPD, but certainly not anymore. They do not plan anything in advance. Both the US and China are ruled by their unelected civil service, not by their premiers. And any specific civil servant minds his own turf and that alone. So no one plans for 20 years in advance, but stuff just turns out. We’re dealing with a spontaneous sub-system here: no one person controls or even knows what’s going on!

To prove this point, think that China is gaining nothing at all form pegging to the dollar. Nothing at all.

5

I certainly agree the Chinese people themselves are being shafted by the dollar peg, just like the Germans are by the Euro, but I was wondering more whether the ruling class were doing so for their own power interests. One one level, it’s certainly more plausible in the absence of democracy that those at the top in China might be able to engage in this kind of long run, strategic thinking. But as you mention, this may just be the side-effects of malevolent spontaneous orders with civil service turf wars being one example.

Non-market spontaneous order makes for a fascinating subject, and as far as I can tell not that far explored yet. Roderick Long’s ASC talk this year touched on this somewhat.

6

Geopolitical leverage. The more dollar reserves China has, the more power it has to use as a negotiating tool if they ever decide to do anything drastic (attack Taiwan if it falls too far out of line, for example).

Of course, if the Federal Reserve keeps printing money China’s leverage will weaken considerably.

And don’t think that China’s central bank and dollar reserve policy has anything to do with lower level civil servants, it all takes place in the upper halls of power.

7

The Chinese ruling elite is getting something. They want their people employed to ensure stability and stay in power. They are lowering the purchasing power of Chinese citizens to make them more competitive in the world market and get more of them employed. Which isn’t such a bad idea when going through a belated industrial revolution that’s on crack because all of this modern technology is available. In a way it’s egalitarian. I think US economic policy largely is the aggregate of special interest turf wars, exploiting the populations superstition about the usefulness of the state. But the Chinese government is still planning in advance. They mostly want to stay in power, build their own industrial base while eroding that of the US and gain strategic leverage.

8

To be frank I never understood why would anyone think that devaluing one’s currency helps with exports. If you devalue you must print. If you print prices rise. In you print, your currency is devalued and your prices in foreign terms are lower, but they are also higher due to inflation. The net effect is zero! There could be a net effect only in the first few months as exchange rates change much faster than commodity prices. But after commodity prices catch up no more export-subsidization will be gong on. That’s why I say the Chinese ruling elite has nothing to gain by pegging to a devaluing currency.

If they need to amass dollars for any future currency war, they need just buy dollars with their budgetary surplus, not go the long way of pegging. Also the wisdom of buying so many expensive dollars to dump them latter is dubious since, thanks to the Fed, the value of these reserves when (or if) the time to dump comes will be much lower than originally, hence their disruptive effect much inferior to what anyone could hope.

Perhaps foreigners will be more willing to invest in if they known the Yuan is pegged to the dolalr? Imagine how much more willing to invest would they be if they knew the Yuan would overtake the dollar? At the very least pegging to some basket including the , Canadian and Australian dollars, the Yen, the Euro and the Swiss Franc would have been much more appetizing to foreigners.

So, I must stress that I really se no good at all of pegging the Rembibi to a declining currency when has none of the structural problem of the just yet.

9

The real estate boom in China is mostly the result of internal policies aimed at obtaining staggering GDP growth results and financing local governments. All Chinese industries linked in some way to the housing market (steel, cement, glass etc) have massive overcapacity. A report I read last year said the cement industry, despite the present housing boom, is running at about 70% capacity. This is linked to the command economy: if the bureaucrat in charge of cement factory X is given a production goal by his boss in Beijing or Shanghai he will meet or exceed that goal regardless of demand. The reason is very simple: bureaucrats stand to gain or lose personally. Exceed the goals and you will be rewarded richly. Don’t and you will be punished harshly. The same apply to the banking sectors: bank employees (and given the fact the four main Chinese banks are all government owned and the rest tightly controlled they can be considered bureaucrats) are incentivated to meet or exceed goals set by government officials without regard to market conditions. Chinese banks have a long history of hiding underperfoming loans to the point nobody knows how many “junk loans” Chinese banks hold. In 2007 a report was issued putting the grand total at around US $ 900 billions. The report was later withdrawn because of “insufficient data”: it’s probably considerably higher than that. In short if you are ordered to give a massive loan to a cement factory to increase its production well over projected market demand, you will give them the loan. If the loan turns out to be a dud you will “get creative” to hide the fact it’s a subprime financial product. Going to your boss and telling him it’s lunacy will land you into big troubles.

As for exports, China is probably one of the more mercantilist countries in existence. Currency peg is only part of the plan. The massive purchases of US treasury bonds serve the same purpose as Japan’s: to prop up the faltering US dollar, hence favoring exports to the US. Of course right now Europe is coming up as a “rival” of sorts, as it’s producing billions of freshly minted “eurobonds” clearly aimed at Asia. In short the US and Europe are competing for China’s money, not with industrial machinery or agricultural commodities, but with debt. Strange times we live in indeed. Another lesser known scheme is the incentives Chinese exporters get straight from the State. Until 2008 an exporter could get up to 22% value of the goods exported in tax returns. This has been amended to a 17% maximum. I discovered this when I went to a motorcycle fair and saw the many stands of Chinese companies peddling goods which nobody in his right mind would buy, such as clones of ancient Suzuki motorcycles (or, much more likely, the Chinese bought blueprints and tooling at a bargain price from the Japanese). These goods can be sold at cost or even at a loss since the exporter will be able to turn a profit thanks to tax returns. That’s why a Chinese scooter will sell for under 1000€. Yes, it’s a dangerous pile of junk (and in my humble opinion they even lowered quality recently) but at that price it will find buyers. And of course Chinese are getting smart enough to get around tariffs. Chery recently opened a plant in Italy to assemble cars out of knock-off kits sent straight from China. Historic German motorcycle brand MZ was bought by the Hong-Leong Group (using a German façade company) and now assembles Chinese scooters and bicycles. As European manufacturers import huge quantities of automotive components from China, tariffs are low, much much lower than they would be for complete vehicles.

At the moment I don’t see a “masterplan” by China to take over the world. The first preoccupation of their leadership is to keep people appeased by increasing living conditions at a steady pace. They know their country’s history well and know revolutions can pop up literally overnight and be extremely difficult to be put down. Their histeria over the Falun Gong movement was probably dictated by remembering the infamous Tai’Ping rebellion, which was only put down at an immense cost in human lives and by employing thousands of foreign mercenaries. More critically it was also a crippling blow from which China took almost a century to recover.

10

By effectively pegging their currency to the US dollar

Meaning giving away their stuff for free to us

the Chinese have been creating an enormous real estate boom on their own turf for the past few years,

And like all booms created by printing money [which is how they peg to us. We print, they print to keep up], is creating malinvestments and wasting resources. In their case, ghost towns.

while for a long time depreciating the purchasing power of their own citizens.

Which is creating unrest for them, suicides even.

I couldn’t figure out why before. But could this actually be a strategic/military ploy by the Chinese government?

If your strategy is to burn all your food and ammunition before the war even begins, yes.

With manufacturing and other businesses in the US stifled by inflation and regulation,

Right there is where they have us defeated without lifting a finger.

while not even being able to benefit from lowered exchange rates with other currencies,

We do not benefit from lowered exchange rates, we lose from it. If the dollar is worth 5 yuan, we get things five times cheaper from then than if the dollar is one yuan. Sure, a small group, exporters, think they are gaining because they sell their stuff faster by selling it cheaper to foreigners, but they lose it right back by getting less yuan for what they sell.

the Chinese are effectively allowing for the long run neutralisation of the US as a world power while democratically elected rent seekers work hard to fritter away what was once it’s economic strength?

The Chinese are actually saving our necks, giving us free stuff. We are ruining ourselves very well on our own, thank you very much.

This would leave China in the future to pretty much take the stage as the predominant world power, both militarily and industrially, especially in any scenario that could potentially lead to one of war in which tradelinks would be cut.

Sure they benefit militarily if we are weak. But they only stand to lose if we are weak economically. There is no “economic war” in which the stronger side wins. If both sides are strong, both sides benefit. If someone gets weaker, both sides lose.

The reason is very simple. When everyone produces more, there is more to go round. Everyone gets richer.

11

I’m not that well versed in these matters, what is the Chinese government doing with the newly created money? Are they using it to buy Dollar bonds, meaning Americans can then spend them on Chinese goods? In that case purchasing power is removed from Chinese factory workers, which would help exports. Or is the Chinese government using the newly created money to buy products in China, e.g. stadiums and ships? In that case it would merely drive up local prices.

12

Hear the madness…

Say that the exchange rate is 100 yuan/dollar now. During the next year, the dollar’s supply is increased by 10%, and the Yuan’s by 5%. Assuming a very simple market, the market exchange rate would have fallen to 95 Yuans/dollar. But the Chinese central banks has promised that it will buy dollars from anyone at 100, and no one will sell dollars for less. So dollar holders sell dollars to the central bank, which is forced to ‘redeem’ those for 100 yuans. So the peg forces the Chinese central banks to hand out newly printed yuans to dollar holders.

If China had no capital controls, any American could sell dollars, and than exchange yuans for Swiss francs, and Swiss francs back into dollars, making a huge profit. That would drive China to hyperinflation in a few months, or force it to break the peg.

But as only Chinese can sell dollars to the central bank, as far as I know, the newly printed yuans are given to the only Chinese who can get a hold of dollars in their daily activity: exporters. So, it’s all a convoluted subsidy to exporters. All it does is tax everyone in China to subsidize exports. To balance the balance of payments, imports rise too. The net effect is zero, and all that is being achieved here is the creation of malinvestments in the export industry in China.

Now, can anyone really think that any higher up in the Chinese government though of this stupid scheme? It’s a unintended consequence of the administrative state, pure and simple.

13

I see. But are you sure this does not reduce the purchasing power of Chinese factory workers, the effect being that they are more competitive? Because when the Chinese central bank prints money, it mostly taxes those who have to buy groceries, normal people. But that purchasing power is then used to overpay those who can get their hands on Dollars, exporters. In effect, it transfers purchasing power from workers to factory owners, who can then use it to hire more workers. Although this certainly does not make the country better off (it impoverishes people so they’ll be more competitive) it would help exports by making Chinese labor is more affordable. And if the goal of the Chinese leadership is to get more of it’s people employed for the sake of social stability, the policy does it’s job.

14

You are right that all that is being achieved here is to tax ordinary folks and hand the money to exporters. It also follows that more people will be employed in the export industry that otherwise. What doesn’t follow is that aggregate employment soars.

For this policy artificially increases both imports and exports. So, more people are being employed in the export industry, and less in factories producing for internal consumption. All that has been achieved is to shift employment to export industries, which sooner or later will crumble as they are unneeded.

And going furtherer, if ’s idea is to promote social stability, they have found the worst way. What makes for social stability, shifting million of families form the hinterland to overcrowded costal cities so that husbands can work in (unneeded) export factories, or having them work closer to home, even in their own farms perhaps, where they are actually needed? There is no good, from anyone’s POV, in this mad policy.

15

Nero,

Let’s take an extreme version of the same situation. The govt enslaves everyone and forced them all to work for free. We’ll assume the slaves do this happily as well, so that none of the disadvantages of slavery kick in. Also, the govt tells the exporters to give the stuff away to the US. Can’t get more competitive than that.

What is the effect of this policy on the US? All the factories close down. Resources are freed up that can go to the military.

Come to think of it, this is exactly what is happening. The US govt spends $1.5 trillion on their wars every year. The Chinese trade deficit [=giving us free stuff] is about half a trillion every year. So that the Chinese are financing one third of the US war effort.

16

That is true, but as I understand it this policy does not increase imports of goods, because what they import is Dollar bonds. Meaning production for internal consumption is not hurt by imports. So there actually is a net increase in employment. I agree that this is very bad for the country, but it does increase employment. In effect, it spreads newly created industrial employment to more of the unemployed peasants by lowering their purchasing power.

As for social stability, millions of peasants moving to the cities is not something the Chinese leadership has control over. That is happening because people have gotten a taste of capitalism and are no longer content in rural poverty. They will move to the cities whether there’s work for them or not. Essentially the Chinese government faces the challenge of supercharging their economy to keep as many of these people busy so they won’t stage revolts. Which that scheme seems to achieve.

As for the sustainability of this scheme, it is unsustainable (a bubble) in the Austrian sense, but as long as the Yuan keep getting devalued it could go on until those factory workers sweat away for practically nothing.

17

Dave, I don’t get your point regarding the effect on the US, but looking at the extreme is a good way to illustrate the effects on China. So everyone works for free and the products are given away for free, can’t get more competitive than that. Under these conditions certainly a lot more people in China would be employed because they are so cheap. So, we can say that this would increase exports and employ lots of additional people, which is the goal of the Chinese government. Since those workers get no compensation, they cannot purchase any imports, so this policy will not hurt employment for internal consumption. Their purchasing power is taken away to amass Dollar bonds.

18

This is actually backwards. If you ‘import’ dollars you increase imports, not exports (if you get money, you must buy stuff). So, if the Chinese government is subsidizing exports and importing dollars in the form of US debt (unrelated with its peg), it will have face huge increase in imports and also in investment to foreign countries (Africa and Latin America anyone?) . So employment is shifted, not increased.

And of course I take the issue of massive urban migration to be ‘an issue’ only because it is in part caused by this artificial policy. Beyond that, there is nothing wrong with urban migration, to be sure.

19

I don’t understand. The Chinese central bank prints Yuan, they trade them for Dollars from exporters, now the Chinese central bank has Dollars. And they use them to buy Dollar bonds. Meaning that in effect the purchasing power of factory workers is transferred to bonds sitting in a vault. How does that increase imports?

20

Nero,

I think we differ on what the Chinese get from us in return for the free stuff they give us. This wil help determine if it is a nefarious scheme to destroy us.

Everyone seems to be in sgreement that we get Chinese stuff made by them “for free”, and give them US bonds in return, or dollars.

What can they do with those bonds and/or those dollars? Short answer: make larger and larger piles of them. That’s it.

Of course, they might try buying huge swaths of real estate and American stocks, but so far they haven’t, and I suspect laws will be passed to forbid them if they do it on as large a scale as they can afford.

So for right now, the situation is we get their stuff for free, get to keep all our resources, and slip them IOUs and dollar bills in exchange. We are getting by far the better deal. If it’s a plan to destroy us, it’s like a plan to empty the ocean by pouring water into it.