China has put too many eggs in the American basket

In one the most bizarre explanations of the present global financial and economic situation, a NYT article of December 26 titled Dollar Shift: Chinese Pockets Filled as Americans’ Emptied gives the absurd impression that China is taking away America’s riches. In fact, the reverse is probably true.

The article cites the financial writings of Ben BernankeBen Bernanke, current Chairman of the Federal Reserve. In 2005 he wrote that the problem was not that Americans spent too much, but that foreigners saved too much. The Chinese had accumulated so many dollars that they lent money to the United States at low rates, underwriting American consumption.

The American consumer comes across as a helpless addict hooked on to cheap money. Over ten years, China ploughed more than $1 trillion, mostly export earnings, into American government bonds and government-backed mortgage debt. That lowered interest rates and provided banks with lots of money to lend to consumers, not only to buy more goods and services, including Chinese manufactures, but also houses that they could not afford.

American economists and government officials have repeatedly blamed China for pegging the price of the renminbi at an artificially low level vis a vis the US dollar. In retrospect, fixing a low rate of the yuan was a blunder, because it encouraged a flood of cheap Chinese manufactures into the USA. In effect, the American consumer was buying subsidized consumer goods at the expense of the Chinese wage earner, who was paid less than a fair price for his or her labor. The Chinese worker was being squeezed dry for the benefit of the Chinese capitalist and the American consumer.

The mistake was further compounded by the policy of massively investing China’s export earnings in US treasury bonds, Fannie May bonds and other securities. The NYT cites analysts who estimate that China owns $1 of every $10 of America’s public debt. What the article does not mention is China has put too many eggs in the American basket and now too many of the eggs have started to rot.

The intriguing part of this unfolding drama is that more of the same appears in store for the two economic giants. The NYT reports that the US Treasury will be auctioning more bonds than ever to finance the $700 billion bailout of the banks. More capital will be needed to finance the Obama administration's stimulus package. Will the Chinese keep buying that debt, or will they turn a new leaf? American policy makers expect the Chinese to keep recycling their money to buy US paper. Perhaps the Chinese are in too deep to make any drastic change in the short run, for fear that it could lead to a further depreciation of their paper wealth.

In retrospect, China ought to have purchased far more from the United States, especially machine tools and cutting edge technologies, rather than paper, which has lost so much of its original value. China’s export earnings should have been used to make China more green and the Chinese worker more comfortable and prosperous.