10.6% of GDP in 2008! They were ruthless during the crisis.
If you look around the internets, you can find a little bit about China’s 12th 5 year plan. Here is one of the key components of the 5 year plan.
“Rise in domestic consumption”
There are not many ways to do this on a large scale. One way would be for China to cut their Current Account Surplus. A current account surplus maintained through a unnaturally low exchange rate is a tricky idea. It gives people jobs, but these jobs are lower paying than they “should” be.
bBut for countries like China, those jobs with artificially low pay are still better jobs which feed domestic demand. In general, it works well for countries that are able to do it, like China did for the last 40 years or so.
But at some point, it becomes obvious jobs should be better, and people start to get upset at bad working conditions and low pay. This is why one focus for China will be increasing domestic consumption.
“China’s current-account surplus for 2011 shrank to $201.1 billion, from $305.4 billion in 2010. More important, as a ratio of gross domestic product, the current-account surplus fell to about 2.7%. That’s close to a decade low and below the 4% threshold that suggests an exchange rate out of whack with equilibrium.”
Here at MMR, one of the our big ideas is “The Current Account Deficit is a drag on domestic demand”.
In plain English, we like jobs for people here in the states more than we like cheap toys from China. We like the spillover effects of having industry based here.
Of course, there are good ways to move jobs back to the U.S. in ways which don’t result in shooting wars. We need to be very aware of the twin deficits, the Government deficit and Foreign Sector deficit.
But it’s possible the next 5 years will be different than the last 40 in some major ways, and one of these ways will be the lack of a gigantic demand vacuum out of Asia. We may have more help fighting this battle than we expected. A smaller CAD with China automatically moves jobs back to the United States, without anyone lifting a finger.
Great post Mike. Remember in the old days when politicians asserted that America could close the trade gap by making and exporting “clean energy” products? Yeah, how did that work out?
“In 1995, more than 40 percent of all silicon-based solar modules worldwide were made in the US; now it’s 6 percent. In less than two years, at least eight solar plants have closed or downsized, eliminating nearly 3,000 American manufacturing jobs, including the 1,100 employees who saw their jobs disappear with Solyndra’s spectacular September 2011 bankruptcy. China now accounts for more than half of global photovoltaic output, and Chinese-made modules are up to 20 percent cheaper than American ones.”
http://www.wired.com/magazine/2012/01/ff_solyndra/all/1
If the Chinese want to increase domestic demand, they’ll need to increase domestic wages. Increasing their wages would result in American labor costs becoming more competitive (assuming American wages do not rise as quickly), thereby making it more attractive to manufacture here in the states (all else remaining equal). At some point Chinese wages would in theory rise enough so that domestic production becomes more cost effective, at which point businesses begin using domestic labor again. As a result the CAD will decrease, since purchases will be occurring from domestic producers versus foreign.
The CAD is problematic for full production because money is funneling out of the domestic sector into the foreign sector without being replenished by the government sector. Here’s the argument: Given current prices and current money velocity, there is a baseline minimum quantity of money needed by the domestic sector to support full domestic production. This level of money has to be maintained to retain full production and presumably stable prices. However with a CAD, we know the domestic sector is purchasing a disproportionate quantity of goods from the foreign sector. This is equivalent to financial assets flowing from the domestic economy to the foreign. Looking at sectoral balances, if there are three entities to consider–the government, the domestic population, and a foreign population (defined as all entities not domestic or governmental)–if money is flowing from the domestic population to the foreign population as evidenced by the CAD, if the government does not replace the money which has shifted sectors, the domestic sector from which the shift is occurring will not have sufficient money in it to support full domestic production, again given current prices and money velocity. Think of a bathtub full of hot water waiting eagerly for a bather. The bathtub is the domestic economy, the water in the tub is analogous to the quantity of money needed to support full production (in other words, the ideal quantity needed to take a bath). If the bathtub has a leak in it, this leak is progressively removing the ability of the bather to bathe. If one simply turns on the faucet, while there is still a leak, the water flowing from the faucet replenishes what has leaked out. The net effect to the bather is zero (at least in the short term). If the government doesn’t replace the money going out of the domestic sector, the citizenry will not have sufficient money available to them to support full domestic production.
I’m not an economist and I’m still trying to understand the fascinating and encouragingly optimistic theories explained on this site and Pragmatic Capitalism. I’m puzzled by the idea, which seems to be advanced above, that the trade deficit drains money from the economy. If China purchases treasuries with the dollars we give them, doesn’t that put the money back into the government sector to be spent here? I’m guessing that Chinese-held treasuries must represent what’s left after China covers their production costs, and its the money spent on labor and materials in China that represents the actual drain from our economy? I don’t really understand how dollars get converted to renminbi to pay Chinese workers and to pay for materials in China. I always thought that it didn’t really involve dollars “entering” China in any way. Maybe the currency exchange markets represent the limbo in which dollars spent on exports get lost to the American economy? How does this work? I’d appreciate a response with minimal jargon or abbreviations.
“I’m not an economist and I’m still trying to understand the fascinating and encouragingly optimistic theories explained on this site and Pragmatic Capitalism. I’m puzzled by the idea, which seems to be advanced above, that the trade deficit drains money from the economy. If China purchases treasuries with the dollars we give them, doesn’t that put the money back into the government sector to be spent here?”
You have it right. If the Chinese spend all of their surplus on U.S. securities, and if the U.S. government in turn respends all the borrowed money back into the domestic economy, there would be no net difference. You would have a sectoral loop–from domestic to foreign to government to domestic. The money can take a hop, skip, and a jump before making its way passed “Go” again. In the end, if what’s out is back in, you have no net difference.
That is unless there is enough lag time between sector shifts, which is another way of saying the velocity of the transfer matters too. Lag time is = no spending over that time. If the Chinese theoretically sat on the money for 10 years, for 10 years that money will have been a drain.
We’ve established that the scenario you’ve proposed, with a sufficient velocity of trade, leads to no net difference. But our question isn’t only is it possible; is it actually occurring? Without trying to gather up the numbers, if every single penny spent by Americans on Chinese products has been utilized to purchase U.S. securities, then not one penny has added to the financial assets of a single Chinese citizen or business. Keep in mind sectoral balances applies in all frames of reference, each with its own domestic, government, and foreign sectors. Your scenario would suggest not a single financial asset from the U.S. has made its way, through the exchanges, into the Chinese domestic economy.
Also the scenario you propose has political constraints; it is a debt loop for U.S. government. Solvency isn’t an issue, paranoid hysteria over debt is.
“I’m guessing that Chinese-held treasuries must represent what’s left after China covers their production costs, and its the money spent on labor and materials in China that represents the actual drain from our economy? I don’t really understand how dollars get converted to renminbi to pay Chinese workers and to pay for materials in China. I always thought that it didn’t really involve dollars “entering” China in any way. Maybe the currency exchange markets represent the limbo in which dollars spent on exports get lost to the American economy? How does this work? I’d appreciate a response with minimal jargon or abbreviations.”
Consider some Chinese manufacturing company: this company sells a Chinese manufactured product to some U.S. business (the product is eventually sold by the U.S. business to the U.S. end user, assuming it isn’t itself the end user). The U.S. business uses U.S. currency to execute the transaction. This Chinese company now possesses a financial asset denominated in U.S. currency.
The Chinese economy is denominated in Renminbi. Should this company want to use their newly acquired financial asset in the Chinese domestic economy, it must be converted. Ultimately the supply of Renminbi comes from the Chinese government. I’m not saying this is the actual exact procedure, but given the Chinese government would find U.S. money of value, they would have incentive to create Renminbi to satisfy some of the domestic demand for it by trading some of this printed Renminbi for the U.S. currency. The Chinese government created a financial asset to acquire a financial asset.