Do you remember MAD, or mutually assured destruction, that feared, possible, but successfully avoided hot outcome to the Cold War waged during some 40 years between the US and the Soviet Union? In this month’s Atlantic James Fallows writing about the present somewhat "warmer" cold war between the new super powers, China and the US, describes the existence of what might be another kind of mutually assured destruction, this time not nuclear but economic.
According to Fallows and others no longer do the atomic bomb holdings of the new rivals, although no less present, place them, and the world, at great risk of nuclear holocaust, but in this new rivalry the unstable trade relationships between the two place not only them but the entire world at great risk of a devastating economic downturn if that "stable" instability were to come to a sudden end. To Fallows such seems not unlikely and he raises what he calls the 1.4 trillion dollar question.
What is the unstable and possibly precarious trade relationship between the two trading partners? On the one side the dollar holdings of China are growing at the rate of $1 billion a day, now totaling $1.4 trillion. That’s $1 billion that are not needed for meeting current obligations and can be set aside for any purpose that the government wishes.
On on the other side is the burgeoning trade imbalance of the US, currently growing at the rate of more than $2 billion a day (about a third of that representing the trade imbalance with China) and betraying an economy that continues to consume more that it produces, a situation according to Fallows that is not tenable over the long run.
Why is the trade imbalance with China a threat to the US? Because China may use its surplus dollars, no longer to support the US consumer by purchasing US Treasuries, but begin to "unload" them, and thereby weaken the dollar even further in the world currency exchange markets.
China may, for example, buy Euros or gold instead of Treasuries and US stocks. Or surprising everyone and probably most of all itself, it may even invest its surplus billions in its own people, providing its imprisoned citizens, for the first time in the Communist era, some of the basics elsewhere taken for granted, such as heated classrooms, adequate housing, clean air and water, and by doing so significantly lessening the demand for the dollar.
Fallows points to a recent paper by Eswar Prasad of Cornell in which the economist writes: "The important question to ask about the U.S.–China relationship is whether it has enough flexibility to withstand and recover from large shocks, either internal or external.”
In response to Prasad I would say that the US, not the relationship, does have enough flexibility to withstand a large shock to the value of the dollar. The trade imbalance with China is not the whole of that imbalance. It represents about one third of the total, and in any case does not possess the destructive force, if it were set free, of a flight of nuclear armed intercontinental missiles.
But China may not be flexible enough to withstand the loss of trade with the US. China is probably much more at risk than we are, and this inequality of risk is probably what most of all protects us. We are a golden goose for China and China won’t do anything to lose us. Furthermore from our side of the relationship there is even less risk that we abandon our spendthrift habits and begin to save, reducing our need for China imports.
My general response to the questions that Fallows raise is that the two economies are not comparable, they are apples and oranges, that which Fallows doesn’t sufficiently take into account. Furthermore, he doesn’t recognize that our economic trajectories are at widely different points in their histories, and to talk about them intelligently one needs to separate them.
Fallows makes the same mistake that we made throughout the Cold War. He is assuming a kind of economic parity between the US and China. There is no such parity.
That the Soviet Union was no less a superpower than the US, as was often repeated during the Cold War, was in fact never the case. We only realized this, and to our great chagrin, at the moment of the collapse of the Soviet Union and the Fall of the Berlin Wall in 1989. Only then did we understand that in respect to the size and reach of its economy the Soviet Union was never a superpower at all. Only their stocks of nuclear armed intercontinental missiles made them a threat to our nation.
The economies of the US and China, described in respect to PPP or puchasing power parity, or in any other manner, are vastly different in size and reach. China’s per capita GNP in PPP (2005) of $1,740 makes it number 108 in the world, the USA’s $43,740 per capita GNP makes it number 6. And what is appropriate for the one in respect to economic strategies is probably not appropriate to the other. China’s 50% savings rate and our 0 or negative rate may be just fine, given our differences and where we are in our respective trajectories.
Also the US with less than 5% of the world population accounts for
some 33% of the global GDP, and China with 21% of the world population
accounts for just 4% of global GDP. This alone ought to push us to think differently in regard to what is good for each of the two nations.
So what is the answer to Fallows’ 1.4 trillion dollar question? The value of the dollar may not even depend on what China does, whether it buys Euros with its dollars, nor on our spending and saving habits, no matter how deplorable they may seem to the descendants of Ben Franklin.
The value of the dollar stems from the value of our economy, still the most valuable economy in the world. Our golden goose is the creation of new wealth, and those responsible for that new wealth, the innovators and entrepreneurs. We might worry when our entrepreneurs begin to leave us for China. So far that is not happening, rather the reverse is still happening, with China entrepreneurs coming and being made here.
It is true as Fallows makes clear that the Chinese are subsidizing rich Americans by investing their excess dollars in our economy, and it does stand to reason that this won’t continue indefinitely. But Fallows doesn’t introduce a realistic time frame, doesn’t point to anything out there on a near horizon that might be coming along. And in time, which he doesn’t imply we don’t have, much can change to resolve the situation, and most likely without a major dollar collapse and/or economic downturn.
One tries to envision what would happen if the Chinese begin to unload their dollar assets. One easily sees that this would be disastrous for their economy, highly dependent upon our purchase of their goods. But for us, probably nothing much would happen.
With China’s exit other countries would probably step in and take up the slack. The emerging economies of Africa and South America would like nothing better than to have the same access to our markets that China has now. The principal result would be that we would see fewer of the Made in China labels on our consumer goods.
The answer to Fallows’ further question, "are we playing them for suckers—or are they playing us," is, neither the one or the other. We are profiting, both of us, from the existing relationship as unequal as it is, and only when either one of us decides that the relationship is no longer profitable will it come to an end, most likely bringing greater after shocks to China than to us…