America's Debt is not China's Fault

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The American media is in combative mood: A year and a half after Lehman's collapse, the pundits are finally waking up to the fact that China bears a significant share of the blame for the current financial crisis. And so, the Krugmans of this world are calling for the US government to 'punish' China through a variety of protectionist measures. 

I have been writing about China's role in creating the current crisis for a long time. And still, I think it is wrong to blame China for America's pains - namely, a collapsing credit bubble, rising unemployment, and a ballooning government debt. 

Yes, the Chinese are manipulating their currency. By doing so, they make it easier for Americans to buy Chinese goods for less and make it harder for Chinese citizens to increase their purchasing power. They are also making it more difficult for Chinese companies to move up in the global supply chain and produce better, more innovative products for higher prices. China's currency manipulation, on its own, damages no one other than the Chinese people. 

So how come America is in pain? Well, as noted above, China's currency manipulation encourages Americans to buy Chinese goods. The Chinese use a large share of the US Dollars they receive from such sales to buy US Treasury Bills. By doing so, they are practically sending Dollars back to America and making it easier for the US Government to run large deficits and for the US Federal Reserve to maintain low interest rates. These low interest rates, in turn, make it easier for American consumers to keep buying Chinese goods. They also make it easier for American consumers to borrow money for new apartments and speculative investments. The end result is a bubble in the stock and housing markets and a soaring national debt. 

So, does this mean that China is to blame for the global financial crisis and for America's debt? Not exactly. China's actions facilitated the creation of a credit bubble in the US: China's purchase of US Treasury Bills makes it easier for the US Government to increase its deficits, and China's sales of artificially-low-priced goods tempers the rise in US consumer prices. This means that the US Government could spend billions on wars in Iraq and Afghanistan as well as on other government programs, without a significant rise in taxes or the price of goods ("inflation"). At the same time, China's government benefited from the American "boom" by avoiding rapid changes in the structure of its labor market and maintaining social stability.  

In essence, China was (and still is) "exporting" unemployment in exchange for "importing" inflation. At the same time, the US is "exporting" inflation and importing "unemployment". The arrangement allowed the governments of China and the US to meet their short-term political goals at the expense of their citizens' futures. The Americans have no one to blame for their troubles other than their own politicians (and central bank), just like the Chinese have no one to blame for their relative poverty (and future stagnation) other than their own government. 

The US and China should shift to long-term, sustainable political programs at home before they start pointing fingers at each other. It might cause some pain in the short term, but would benefit both countries, and the world at large.

(Of course, expecting politicians to make long-term decisions might be too much, but that's a different story).


I know you're trying to make it a two way fault though china's role is much less harmful, and much more understood then the American one.

As the world's leading and most experienced economy you would expect much more maturity from the leadership and consumers then what America actually had shown.

As for China:
It might be second largest economy in the world, but it's still a very young one and a very unique one political structure wise.

pulling millions annually out of poverty and creating a chance for a better future for so many that never dreamt of that possibility with the simple cost of keeping the currency under priced and tampering with our western economy norms is something acceptable from such an inexperienced (got nothing to lose) economy as china.

Out of the two, China does have it's priorities set right.
America never was concerned when it was buying Chinese goods under priced with borrowed Chinese dollars.
it only saw it as a problem when the free ride was over.
you eat what you cook.

As for your closer:
China is building some long term programs (Some false some genuine), it has all the reasons to do so:
Stable government, supportive local media, hungry citizens.
Where as America is still scratching it's head trying to realise how it lost what it had and just looking for quick ways to get on that free ride again.

Thanks, Yoni. Let's begin:

1. I am not trying to make it a "two way fault"; I am trying to make it clear that the fault is on governments and that the people of each country need to settle their grievances with their own politicians before they start pointing fingers. The fact that China contributed to the creation of the crisis is indisputable.

2. China indeed "pulled millions out of poverty", but so did plenty of other countries, many of which did much better than China. China is still on par with Angola on GDP per capita. China's achievements put it somewhere in the middle, between remarkable countries like Korea and failed states like Bangaladesh. Either way, sympathy for the poor is not a valid argument when analyzing an economic process. Maybe China had no better options than their current policy, and maybe they did it in good faith - I only care about the consequences.

3. Most importantly, if you do care about the people of China, is that I do not think the current model is sustainable, and the way I see it, China's current policies would eventually lead to a violent 'break' - the Chinese are no likely to reach the level of wealth they dream about without going through a violent crisis. This means that admiring China's marginal progress so far is nice, but if you put it in perspective and see where it is headed, you understand that we are watching a disaster in the making.

4. The above also answers your comment about China having its priorities right. It has its short-term priorities of social stability right, but it is causing itself a lot of damage in the long term. Sure, there are a lot of good things and some investment in infrastructure, but it is too little too late, and it is overshadowed by all the misallocation of resources and malinvestment.

5. To say that it was bad of Americans to buy cheap goods and that it was not bad of Chinese to sell them is a value judgement. In the bottom line, it was a short-sighted policy by both countries. If you have more sympathy for one of them, it is ok, but it does not affect the result of this analysis.

6. Finally, China is much more fragile than America is. China is held together by force and lies. A sudden rise in unemployment or any other sudden "shock" puts the whole system at risk. Both China and the US are tied together, but if both of them have to go down, China is the one who is not likely to be able to stand up again.

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 March 21, 2010 11:20 AM.

How I Learned to Stop Worrying and Love the Bubble was the previous entry in this blog.

Iceland's Volcanic Cloud: Europe's Black Swan? is the next entry in this blog.

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