UnbalancedThe Codependency of America and ChinaStephen RoachYale UP © 2014344 pages

CodependencyThe basic problem for both the United States and China, is the US’s unsustainable consumer frenzy, which Chinese exports feed. If the US does not borrow from China, it must seek other financial sources because Americans habitually do not save, but they must start. If they do not, the US faces continuing dependency. With its savings rate at 12 times that of the US, China is in the opposite position. With its mounting foreign exchange reserves, China must commit to buying dollar-valued investments to protect its renminbi, thereby supporting US growth. US policy makers duck their responsibility – for bubbles, lack of oversight and the erosion of workforce skills – by blaming China. If China revalues the renminbi, the price of its goods would rise, resulting – in effect – in a tax on US consumers. Or China could sell its US Treasury bills, to devastating effect.

Politics and “False Prosperity”China and the US have been committed to growth as “the elixir of prosperity.” Growth was no problem for America after the end of World War II. The nation first failed to tighten its fiscal policies during the Vietnam War and the 1960s Great Society. Growth at any price – coupled with consumerism – became the US economic battle cry. The public sought equities and real estate investments, creating bubbles that burst. Savings sank to 2.3% of disposable income, forcing the government to run up massive borrowing deficits while swimming in a sea of false prosperity. In China, Mao Zedong’s economic inflexibility gave way in 1978 to the “opening up,” via Deng Xiaoping’s “Four Modernizations.” An unprecedented production boom followed – at the expense of internal development. “From 1980 to 2010, China’s growth rate in real GDP averaged 10% per annum.” Those years expose the foolhardiness of growth at any cost.While China bet on developing external markets, the US relied on cheap foreign products and capital. The two nations’ codependency was born and, for a while, it flourished. China protected the renminbi, allowing its value to rise slowly. In buying US Treasury bills, China supported increasing US consumption, funded by the bubble in American home prices. Europe’s similar false prosperity originated when the European Union admitted economically peripheral nations like Greece or

Portugal. Low interest rates encouraged the inflow of Chinese goods to these markets. Throughout the 1980s and early 1990s, Chinese exports flowed based on European and American demand. And, “the bulk of China’s export impetus has come from subsidiaries of Western-owned companies.”

Leadership and PowerThen-US Federal Reserve Chairman Alan Greenspan attempted to resolve the US stock market crash of 1987 by having the government buy Treasury notes. For years, Greenspan followed a laissez-faire philosophy despite bursting stock, housing and credit bubbles. An enthusiastic pro-growth champion, Greenspan abetted growth at any cost. In China, Zhu Rongji became vice premier of banking and finance in 1991. He sparked semireforms of state enterprises and championed China’s membership in the World Trade Organization (WTO). He created a successful foreign export engine and sowed the seeds of imbalance.Zhu and Greenspan had the same problem: determining how to maintain growth. As Chinese production success kept US prices and inflation low, Greenspan expanded his monetary policies. China’s business practices led to domestic job losses, environmental damage, and excessive depletion of energy and resources. The US drifted into “bubble and- debt-dependent growth.” As the treadmill sped up, neither Greenspan nor Zhu knew how to dismount.Premier Wen Jiabao, uneasy about social and income instabilities, supported political reform and opposed the prevalent neo-Maoism. In 2007, Wen cited the “Four Uns,” calling the Chinese economic system “unstable, unbalanced, uncoordinated and ultimately unsustainable.” Despite his successes, Wen did not deliver meaningful structural reforms. Fed chairman Ben Bernanke – a disciple of using monetary stimulus to solve financial contraction – believed the Fed would spend less cleaning up after a bubble than acting before it burst. When the US federal funds rate reached zero in 2008, Bernanke prescribed frequent “quantitative easing,” which swelled the Fed’s balance sheet. Meanwhile, the dollar’s value dropped 25% from 2002 to 2013. Intentionally or not, the central bank underwrote fiscal and monetary adventurism.

Today’s Goal: StabilityStability is now paramount for the American as well as the Chinese economy. China is rebalancing its external demand model, but the US still pursues continued full employment and price stability. China’s National Development and Reform Commission (NDRC) develops and implements five-year plans. Its vertical structure and ultimate responsibility to the Chinese Communist Party make it the world’s premier planning agency. Washington, DC’s planning is less structured. The National Economic Council (NEC) and the complex Office of Management and Budget (OMB) – responsible for budget monitoring and forecasting – advise Congress. Politicization hobbles the NEC so that it cannot perform higher-level strategic planning. Overly optimistic projections and faulty assumptions mar the OMB’s forecasts. At heart, politics drive China and US strategies. Each nation faces the same crisis: Prior

growth models no longer work. The Chinese can operate based on the Four Uns. The US is not so fortunate, because ideology limits its central bank. US planners attempt to resurrect consumerism while paying lip service to genuine economic reform. Resolving this issue is pivotal to the nations’ codependency, given the linkage between the US’s lack of savings and China’s propping up US growth. However, the US cannot resolve its savings dearth by dealing with China only. America is a global borrower, in debt to 102 countries, so a “China fix” alone will not do the job. China remains a developing country with a fragile currency. While protecting its money from global economic turmoil, China has allowed the renminbi to increase 35% versus the dollar since 2005.

Intellectual Property RightsCharges of intellectual property rights violations, a pillar of the US’s “China Gripe,” are exaggerations. Most cases going to court do so inside China. Its government must establish and enforce proper intellectual property rules because China needs protection; the country filed 35.6% of global patents from 1995 to 2008. The issue of cyberhacking touches on security and intellectual property theft. The Chinese People’s Liberation Army’s hacking is comparable to the US National Security Agency’s (NSA) spying. Neither country holds the high moral ground.

“Warning Shots”The US suffered the 2008 global economic crisis as China dealt with a recession, caused partly by unbalanced growth. Ripples spread across global trade. Trade GDP dropped 0.6%, after 29 years of positive figures. Trade volume dove 12.2%. In Asia, the drop amounted to 35% of aggregate GDP. China suffered an export decline of 27%. China righted itself quickly but failed to come to grips with Premier Wen’s Four Uns. These crises suggest the following conclusions: First, many paths lead to false prosperity. Second, errors cause poor assessment of market risks. Third, crises damage economies so badly that they take years to recover. Finally, the jury is still out on “the Keynesian stimulus approach” versus austerity; neither one works well in Europe or the US. The recent crises were unusual only in their severity. There have been 11 such shocks since the 1980s. They increase in frequency and severity. Responses replicate the way earlier crises were met and do not address false prosperity.China and the US cannot sustain their codependency based on US consumers’ hunger for Chinese goods. If China were to draw down its substantial savings, its appetite for US Treasuries would diminish. This poses the possibility of serious rancor. Issues of imbalance imperil economies across the globe. Stumbling blocks include nations’ self-interest versus “supranational accountability” and the politics that support false prosperity.

“Smoot-Hawley Redux”US Senators Chuck Schumer and Lindsey Graham are developing a China-centric bill that could be as destructive as the 1930s Smoot-Hawley Tariff Act. Its general

tone displeases the Chinese, but it is not law yet. The US economy remains in the doldrums, and American debt to China towers over all. Forced to do something, politicians are all too capable of starting trade wars. Today’s anti-China legislation has bipartisan support that ignores the likelihood of retaliation in the form of export declines and diminished capital inflows. Possible deflation adds a further resemblance to past economic pictures.

ResolutionStructural reform is difficult. The US might begin by lowering the “personal consumption share of GDP” to 64% over the next few years. China should direct roughly 5% of its GDP toward private consumption. Due to the forced stimulus following China’s 2008 misfortunes, changes in its economic model will encounter stiff domestic resistance. China must develop a consumer economy; the US needs a producers’ focus. The US culture of consumerism infects its body politic. The question of whether either country will rebalance remains open. China will follow its Twelfth Five-Year Plan for raising personal income and urging citizens to spend their money. That means the Chinese government must increase wages and create more jobs. Though addressed in the Plan, improving citizens’ financial security poses almost insurmountable problems, given China’s 764 million workers.China is likely to address its economic model before the US addresses its own. This will reduce America’s capital inflow, leading to forced domestic savings and federal debt reduction. Failure to bite this bullet will mean a weaker dollar and higher interest rates. The American economy must change as well. The most viable growth areas are net exports and capital spending. Challenges in constructing a new model include regaining a competitive edge, raising the savings rate, as well as guaranteeing financial stability, possibly with appropriate legislation.

“The Next America Meets the Next China”The US has always been an active exporter to China. Trade expanded 16.2% annually between 2005 and 2012. Now the task is to coordinate US exports with an increasing need for Chinese consumer goods. This requires meeting the challenges of “market share, competitiveness and vision.” America can provide a model consumer society for China and offer helpful supporting services. China’s population and undeveloped service sector make it an ideal market, worth an estimated $12 trillion by 2025.

“Codependency, the Internet and a Dual Identity Crisis”At the beginning of 2013, 42% of the Chinese people were connected to the Internet. This number will rise, along with the number of Chinese “microbloggers” and social media users. The Internet can spark political opposition – an issue China’s leaders have been dealing with since 1989. History demonstrates that individual freedom and prosperity go hand in hand. And, the Party has made timid steps toward local-level democracy – evidence of pragmatism rather than straightforward reform. In China’s closed society, connection to the web leads to greater transparency and

increased consumerism. In the US, the Internet exacerbates polarization. Washington must consider its fivefive-year lack of a federal budget, the inadequate level of planning forced by a two-year election cycle, its neglected infrastructure, and its income inequality and worsening education system. Providing China with needed exports may offer an escape from the labyrinth.