Deficits and Chinese Finance

A favorite argument of deficit hawks is that concerns over US financial integrity will drive away the foreign investment that finances part of the budget. I’ve argued before that though I agree running large deficits in perpetuity will have negative consequences, this is not a concern for the near-term, and what’s more, is overblown. Anyway, with that as context, I’m really glad Ezra Klein posted this today, along with two charts. I don’t want to steal his entire post, so definitely check it out, but these graphs are enlightening. First, Treasury debt holders:

As you can see, only 27.9 percent of US debt is financed by foreign investors. Hardly inconsequential, but definitely more of a garden hose than a fire hose. Now, as for the Chinese:

So, of that 27.9 percent of Treasury bonds held by foreign investors, only 24.07 percent of that is held by the Chinese, for a grand total of 6.71 percent of total debt. Again, not inconsequential, but a lot smaller than I think people realize. More directly to the point though, the issue isn’t so much the size of the debt, as much as it is that the strength of the US import economy is an integral feature of Chinese development strategy. Ok, now I’ve pretty much stolen Ezra’s entire post. Sorry.

Advertisements

About That Deficit

While I previously stated a desire to avoid cherry picking Henry’s posts, I really couldn’t disagree more with this in Henry’s post on the budget deficit:

I am highly skeptical of the Obama team’s insistence that financing health care reform first is the best way forward. While lowering health costs in America—an enormous issue best left to its own post—is critical for our long term economic strength, I think making drastic eliminations to our government entitlements ought to be the immediate priority.

As commenter jackofspades83 says, millions of Americans rely on so-called entitlement programs, and cutting them in the midst of a recession would have dire consequences. Further reduction in the spending gap would result in an even worse economic outlook as those who already spend a high share of their income would be forced to spend even less. Of course, this doesn’t even address the cruelty of imposing drastic cuts to social security benefits, from which a full two-thirds of elderly households (65 and up) receive more than half of their income and a full third of elderly households receive over 90 percent of their income.

As for health care, let’s just look at this graph that was put together by the Center for Economic Policy and Research. It plots out how various levels of health care spending in other countries would look if applied to the United States. The skyrocketing blue line is a world where we fail to enact any health care reform at all.

As you can plainly see, the easiest way to lower the deficit would be to lower health care expenditures so they matched per capita spending in other countries. As you can also plainly see, failing to do so will exponentially increase the share of health care spending as part of GDP. Now, it’s quite possible health care legislation currently being considered won’t have that sort of impact, but to illustrate what even modest savings do to spending, the Council of Economic Advisers put together this report.

Even if we assume only .5 percent cost containment, the results are pretty sizable as we move forward. If we select the very realistic 1.5 percent, we begin to see enormous savings as we extrapolate outwards. From the report’s executive summary:

[P]roperly measured GDP could be more than 2 percent higher in 2020 than it would have been without reform and almost 8 percent higher in 2030. The real income of the typical family of four could be $2,600 higher in 2020 than it otherwise would have been and $10,000 higher in 2030. And, the government budget deficit could be reduced by 3 percent of GDP relative to the no-reform baseline in 2030.

Those are serious numbers. Given that the article Henry himself cites reports that only 3 percent of the deficit would come from Obama’s agenda on health care, it’s really difficult to see how now is not the time to reform the health care system. It would be like refusing to use a credit card to have a plumber fix a pipe that’s threatening to flood your entire basement.

Now, as for concern over Treasury yields, let’s look at another graph, this time of the historical rates of 30 Year Treasury bonds.

You’ll note that the interest rates on Treasury bonds are still very low by a historical average, but more to the point, as Martin Fox argues here, this is a healthy balancing of priorities as investors decide there are more worthwhile investments than the least risky proposition around. Consider as evidence the ability of many banks to repay TARP funds with capital they have raised privately. And with respect to China — whatever their misgivings — there’s simply no avoiding the fact that as owners of such large quantities of US debt, it’s in China’s best interest for the US economy to prosper. As Gao Xiqing, president of the China Investment Corporation argued about the bailout in December:

With so much of China’s money at stake, did U.S. officials consult the Chinese about the rescue plan?

Not directly. We were talking to people there, and they were hoping that we would be supportive by not pulling out our money. We know that by pulling out money, we’re not serving anyone’s good. Including ourselves. So we’re trying to help, at least by not aggravating the problem.

Finally, I’m not sure why Henry elided the possibility of raising taxes. The fact is, after 30 years of Republican electoral domination, taxes have been reduced to an unsustainably low level, and they’re going to have to come up.

Tied Together

I was a in recent debate with a friend of mine about the dangers of accumulating foreign debt. His contention was that the risk of foreign governments abruptly “calling in our debt” would have catastrophic ramifications. My point, in the broadest sense, was that because of the interconnectivity of the global economy, it wouldn’t really be in anyone’s interest — and in particular, not China’s — to sink the world’s largest consumer economy. That is, China has lent us a great deal of money, which has in turn allowed us to buy a great deal of Chinese goods. This is part of the reason China has sustained unprecedented growth, and indeed, part of the reason the Communist party has held such a grip on government. If economic growth halts, the Communist party risks fomenting dissent. It is therefore in the best interest of both China’s economy and the government in power not to cripple the American economy. But why take my word for it? Here’s Gao Xiqing, president of the China Investment Corporation, which manages most of China’s the “high-visibility investments.”

With so much of China’s money at stake, did U.S. officials consult the Chinese about the rescue plan?

Not directly. We were talking to people there, and they were hoping that we would be supportive by not pulling out our money. We know that by pulling out money, we’re not serving anyone’s good. Including ourselves. So we’re trying to help, at least by not aggravating the problem.

Let me start by saying I could be completely wrong about this, but it seems to me that it doesn’t even matter to China whether or not we ever pay them back, so long as we have the ability to do so. China’s finances are trusted, in large part, precisely because they own so much US debt. Furthermore, barring utterly catastrophic economic collapse (they run a yearly surplus), China wouldn’t need to call in American debt because they can simply print money with the understanding that it’s backed by the $17 trillion yearly US economy. This is why we are no longer use commodity based money.

This is not to say there aren’t long term scenarios that present less than ideal outcomes for Americans. For example, if the Chinese are able to induce domestic demand for Chinese products (not at all a given thanks to cultural considerations that heavily value saving), the need for American trade is lessened quite a bit.

Anyone who knows more about global economics than me is welcome to comment.

Chinese Pragmatism

No, not that Axl Rose project without any of the real G ‘N’ R members, but that ancient Chinese philosophy that’s led to enormous economic growth recently and less recently, a really big wall. Unlike the relatively eco-friendly development of the Great Wall however, industrial development can take a higher toll.

Here’s the lede:

BEIJING — A noxious cocktail of soot, smog and toxic chemicals is blotting out the sun, fouling the lungs of millions of people and altering weather patterns in large parts of Asia, according to a report released Thursday by the United Nations.

Yikes. I can personally vouch for the existence of so-called “atmospheric brown clouds”, which in addition to their fecundity for scatological humor, prohibit seeing the sun on an otherwise “sunny” day.

Missing the Point 101

This quote comes from the Post story I linked to collecting global reactions to Obama’s win, but I sort of thought it should have it’s own post.

“Obama is half white, half black, so the progress in the U.S. is not that big,” said Hu Jing, 25, a [Chinese] paralegal. “It will take dozens of years to elect a person who is 100 percent black.”

I took Chinese in high school, and I still remember my teacher explaining to me how the Chinese had classified the words used in poetry by type (beautiful, sad, etc.) so as to create a metric for the art. I’ll leave it at that.

How They Do It Elsewhere

Kevin Drum points to this article in the LA Times about the decidedly different tenor of corporate failures in China:

First, Tao Shoulong burned his company’s financial books. He then sold his private golf club memberships and disposed of his Mercedes S-600 sedan.

And then he was gone. And just like that, China’s biggest textile dye operation — with four factories, a campus the size of 31 football fields, 4,000 workers and debts of at least $200 million — was history.

….In recent weeks, there have been many fires, increasingly large-scale. In Zhejiang province, south of Shanghai, Ye [Hang] counted at least six major bankruptcies, including Jianglong; Feiyue Group, China’s biggest sewing machine maker; and Zhejiang Yixin Pharmaceutical Co., among the largest in that industry.

“Of these six, one [owner] committed suicide, one was detained by police, and the remaining four all escaped,” he said. “I can imagine that in the future, there would be more such cases as a result of the chain reaction.”

Kevin admits, “I confess that the thought of Wall Street executives in failed banks either being detained by the police or going to ground and hiding in terror holds a certain appeal,” and I have to admit I’m inclined to agree. In China they hara-kiri, in the US, they’re given millions of dollars in golden parachutes.

Ratcheting Back Hysterics

Francis Fukuyama, notable ex-neocon and professor at JHU’s SAIS, takes to the pages of The Washington Post today, helping tamp down the notion that emerged with 9/11 that we are in perpetual witness of great crises. Notably, despite what might be percieved as a worldwide resurgence of autocratic power (especially in China and Russia), these states lack the truly dangerous motivating ideologies of a Fascist Germany or Soviet Union and in fact, spend a fair amount of energy kowtowing to various democratic principles. More importantly, our more “dangerous” competitors — again, Russia and China — have relied heavily on capitalism to propel their economic growth (especially so in China), and as such, are considerably less likely than their ideological counterparts to pursue worldwide domination that lies counter with their prospects for prosperity.

Indeed, in today’s global economy, a country’s economic growth can increasingly rely on sound foreign policy. This is precisely what Fukuyama fears: that worldwide economic growth will fail to match the pace of increased commodity demands, resulting in a “Malthusian world in which one country’s gain will be another country’s loss.” This can already be evidenced in increasing food prices in response to shifts agricultural production towards corn ethanol in the United States. Fukuyama warns that in this world, securing peace through liberal internationalism will be increasingly difficult.

Fukuyama’s warning underscores the current need to distance ourselves from a neocon foreign policy which envisions a unilaterally acting U.S., freely moving on behalf of and clamoring towards its perceived hegemony. While the past few years have sufficiently proven the fallacy in this line of thinking, Fukuyama’s point about economic prosperity demonstrates why rolling back the hawkish neocon policies of the Bush administration (and those unquestionably shared by a future McCain administration) is not merely a matter of morality, but more importantly that of national self-interest. In hinting at the difficulties confronting a liberal world order, Fukuyama inadvertently makes this point himself:

The totalitarian dictatorships of the 20th century induced us to draw a sharp distinction between democratic and authoritarian states, a habit of mind that is still with us. But democracies don’t automatically all have the same interests (just look at the clashing U.S. and European views on Iraq), and neither do autocracies.

Fukuyama fails to distinguish between U.S. policy towards Iraq and U.S. views on Iraq. Indeed, most of Europe has been hostile to the War in Iraq, and the U.S. has been simply hostile to Iraq, but as this past week’s agreement on troop withdrawal evidences — a measure McCain had denounced as recently as July 2008 — our extracation from occupation of Iraq is at once congenial to worldwide opinion and our own national self-interest.