CHINA'S DOLLAR TRAP- A REVIEW AND INTERPRETATION

Paul Krugman

China's Dollar Trap
http://www.nytimes.com/2009/04/03/opinion/03krugman.html?em


Krugman (Paul Krugman, NY Times April 2, 2009) states that trade with China, often ridiculed as a "one –way-street" finally turned out to be a "fair exchange" after all. They sold us melamine-laced milk products, sulfurous gypsum boards that stunk up our new houses, lead painted children’s toys, and we got back at them by off-loading toxic securities on their markets.

I posted a related idea when I posted in an earlier blog that the economic crisis has been a two way street with China. They helped to feed our "affluenza" while their controlled Yuan (kept at parity with the dollar) encouraged a trade situation that fed our exuberant buying spree. Without China's collusion we would not have been able to get ourselves (as easily) into this mess.

But Krugman carries the review of our China relationship further. In the depths of the economic crisis the "fair exchange" deal we joined-in with them has finally broken down. China’s cheap products are not as attractive to a nation with little or no bank savings, financial institutions virtually shut down, home values collapsing, our premier GM motor company on the skids, credit cards tapped-out and nearly one in ten out of work. And on the other side of the world, as they watch us stumble into stagnation and negative GDP, those securities they bought from us are beginning to generate concern.

Krugman considers that the big news last week was that the Chinese floated a call to drop the dollar as a reserve currency. their plan would establish a new 'reserve world currency' in the form of a "basket of national currencies" (perhaps the average value of a group of currencies such as the Yen, Yuan, British Pound, German Mark, Swiss Frank, etc.) and use that "value" as a reserve. According to Mr. Krugman, "paranoid Republicans" viewed this as a sinister plot to attack the dollar’s preeminence in the world market, and as an attack on our economy. That was not the case, states Mr. Krugman in this piece. In fact, he concludes that the monetary suggestion of the Chinese was rather a revelation that the Chinese have got them selves in a "dollar trap" that they got into and now do not know how to get our of unscathed! It was a plea for help. He sees no one jumping to their aid.

Early in this decade, China, a nation which prides itself on its hard working, simple-living people devoted to Confucius who encouraged a culture of saving and an aversion to extravagance (See http://www.international-relations.com/cm4-1/Zhang.htm Economic Lessons from Confucius for the New Century, Youmin and Tianchen, 2000. In 1988, 74 Nobel Prize winners made the assertion in Paris that if human beings want to live in peace and prosperity in the 21st century, they must look back 2,500 years and seek the wisdom of Confucius.) found itself in the enviable position of selling more goods abroad than those it imported (i.e. running a trade surplus) and at the same time it attracted large sums of foreign "inflows of capital" for investment. These factors would naturally cause its currency (yuan) to rise in value. Were that to happen, the higher value would tend to decrease its export volume. The big attraction of Chinese products were always their low cost. They did not want exports to decrease, so rather than let their currency fluctuate they chose to keep the value of the Yuan "more or less fixed"(1 Yuan = @ 0.15 cents). That of course, made it difficult for us to sell China our (more expensive goods). Their policy also protected their native industries from import competition. The US complained, but in general, I suspect the vast number of importers and consumers were happy and the government kept silent since it helped to sustain our economic bubble..

To prevent the yuan from rising in value, the Chinese had to "buy up dollars as they came flooding in. As the years went by, these trade surpluses just kept growing—and so did China’s hoard of foreign assets."

See Telegraph.UK article on "China prepares to buy up foreign oil companies" http://www.telegraph.co.uk/finance/newsbysector/energy/4781037/China-prepares-to-buy-up-foreign-oil-companies.html

Krugman notes that the "fair exchange" story above, though amusing, was not really accurate. The Chinese did not buy many "toxic" securities. They mainly accumulated US Treasury Bills. These "T" bills are safe, but they have a very low rate of return (right now about zero). China eventually accumulated over $2 trillion dollars of these low-yielding T bills—turning it into the "T bill People's Republic". According to Krugman they did it not out of any sinister intention but "in a fit of absence of mind", and only now realize they have a problem.

These US securiites were purchased in "dollar value" so any fall in the value of the dollar in the future would mean a "big capital loss for China". So if China were to desert the dollar and diversify its currency holdings it will have to sell its dollars and drive the value of its holdings down. That would be a no no.

According to Mr. Krugman's analysis they seem to simply want it to keep the status quo. That is, to continue to produce products for the US and other world market and permit their workers to save more and invest abroad what they can not use at home. "In other words go on as we were. The world has changed "and that is …not going to happen," concludes Krugman.

China has not yet faced up to the "wrenching changes that will be needed to deal with this global crisis," and neither have we." states Krugman.

But we can not go back to the paradigms of the past.

See: http://www.nytimes.com/2008/12/13/business/yourmoney/13wealth.html.

In the recent decades investors were fixated on wealth-generation. They concentrated on stock positions, derivatives, hedge funds, and any esoteric securities that might maximize profits. These greed-based motivations led to our present disaster. Now the emphasis has turned to simple wealth preservation.

For the individual "the era of the house as a constantly appreciating asset is over." Monetary advisors ask now: What is your risk level? Are you living above your means? Are you saving enough?

These are questions individual must ask to prevent disaster. But our national government should be looking in the same mirror. Are we as a nation living above our means? Are we saving enough? Are we afflicted with the "affluenza"?.

Over the last decades the USA, has evolvied into a culture deeply afflicted a disease, which encourages its citizens to measure their worth only by the narrow meter of financial success and material possessions. One might only scan our media outlets, newspapers, magazine shelves and repeated adverts day after day bombarding us in the electronic media to demonstrate how pervasive these ideas have become(After Wikipedia definition of "affluenza").

Krugman states we must face up to "wrenching changes" but what are they? What can we do trapped as we are in an economy of blatant consumerism and militarism? How can we save ourselves and our Nation from these twin plagues? Some seem only to suggest we go back to drink from the same polluted trough.

We need a new paradigm. But who can guide us? President Barak Obama increasingly seems to eschew that role--of savior and guide into new territory. So far he seems to be simply guiding us back into the same beat-up vehicle which lays a hulk, just crashed at a crowded intersection. He pats us on our heads and tells us to be more careful next time. Then sends us back to cruise the same dangerous roadways.