China, the US, and the Financial World War

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Chuffed.
The discussion surrounding the global financial crisis is plagued with dishonesty. In most cases, the crisis is used by commentators and politicians as an excuse to promote their agenda - big/small government, nationalization/chapter 11 for banks, more/less regulation, etc.

While US commentators differ widely in their analysis of the causes for the crisis and their proposed solutions, most of them have one thing in common: a reluctance to accept the fact that the crisis was caused by anyone other than the US and that the prevention of the next crisis requires more than just regulatory and political change in the US. In a Post Traumatic Stress Disorder of sorts, Americans blame themselves for the crisis, and seem to enjoy describing the fall of their own empire and the invalidity of their own values.

And so, I was pleasantly surprised to read Paul Krugman's article in yesterday's New York Times. Krugman seems to be America's new economic oracle, and has been an ardent critic of Bush and Obama's response to the current crisis. In the article, Krugman is finally pointing his analytical skills towards China and stating a few important facts:

  • China has been manipulating its currency.
  • This led to a severe trade imbalance.
  • China used the proceeds from this unfair trading to buy US Treasury Bonds in order to maintain low interest rates in the US and perpetuate the American consumption binge.
  • This led to a credit bubble in the US that fuelled the current crisis.
  • The Chinese are now "stuck" with trillions of US dollars.
  • The value of these US dollars can collapse very quickly if China decides to use them and/or if America will continue to print more money.
  • So, China has a lot of cash on paper, but it has a limited ability to use it and is at the mercy of external forces.
I have been saying this for months. Earlier this week, Richard Spencer, the China correspondent for the Telegraph, published a blog entry along similar lines.

What both Krugman and Spencer did not mention is that we're in the midst of a full scale Financial World War. China and the US are in a tangle, and each one of them will have to hurt the other in order to get out of it. The US currently owes trillions of dollars to China. However, the US also has the capacity to determine the actual value of this debt by printing more dollar bills.

Quantitative easing (printing more money) causes inflation and 'punishes' the people who saved money by reducing the value of their cash. However, unlike previous cases were this method was used (Japan comes to mind), in this case, the savers who will be punished by America's latest moves are the Chinese.

In fact, its safe to say that America's latest moves are a calculated and conscious response to China's own currency manipulation during the past decade.  China is starting to realize this, and so it seeks to undermine the dollar's global status by trying to supplant it with a "global currency" that will help it protect the value of its investment. Sadly for China, this is not very likely to happen any time soon.

So, both countries are going to get hurt. The question is which one of them has the agility and pragmatism needed to come out of this crisis stronger. My bet is on the US. Why? in my next entry.

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Note: The views and observations expressed on this web site are published for the sake of public discussion and do not represent my personal opinion or the opinion of my companies, clients, and/or employers. If you would like to get my opinion on anything, ask me.

This page contains a single entry by Dror Poleg published on April 4, 2009 11:52 AM.

In Honor of China's Public Servants was the previous entry in this blog.

Separation Anxiety. is the next entry in this blog.

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