Stop The US vs China Nonsense

People love enemies. Enemy gives us a sense of purpose, a uniting force. Just look back at the cold war era. Did we obsess endlessly about politician's extra-marital affairs or bicker bitterly about a few billion dollars' pork barrel in spending bills? No, of course not. Let's kill the enemy first. Politicians and media know this very well. Every President must fight at least one war. This is Politics 101. If oil price stays high and Putin stays in power forever, it'd make the job so much easier for US politicians.

Unfortunately, oil has crashed (for now) and Russia looks shaky (for now). China will have to do. It's not ideal, but not bad, either. For one, it's big, unlike Venezuela or North Korea (and Iran somehow just doesn't have the credibility). Even though it's still weak, it's been growing fast. Menacing enough. Secondly, the "communist" label is perpetually handy. Never mind the fact that true Marxists/Maoists/Communists have long been completely pushed out of the political spectrum and exist only at the fringes of common society in China, and many aspects of rule-of-the-jungle capitalism there make most of the self-proclaimed "capitalists" in this country look like socialists. Ignore all that, preface "China" with "communist" and you're done.

The current crisis, of course, makes finding an enemy all the more urgent. China presented itself at the perfect time. First of all, China looks like the only country relatively unscathed by this mess. Even better, their newspapers started calling for abandoning USD as the hard currency. There, done, crisis is over (in the sense that the 300 point drop on the Dow last Friday was a huge relief).

This stupidity must end. US and China need to work together even more closely, at least in economy and finance, to face the numerous post-crisis challenges. Yes, I think the crisis is over and the short-term bottom is behind us. Now we have to solve the difficult problems of global recession, long-term inflation, and structural flaws of international financial system.

First of all, China will not be greatly damaged by this crisis and it's good news for everybody, just as it was when China effectively stopped the contagion of Asian financial crisis in 1997. There are several reasons for my assertion:

1. China's financial system remains relatively arcane and closed to the rest of the world, which turned out to be their biggest blessing this time.

2. Chinese government and central bank have very strong balance sheets as cushion and ammunition against shocks.

3. High savings rate provides cushion. Low leverage lessens the shock.

4. It's true that housing bubble is bursting in China, banks have (potentially significant amount of) bad assets, and some companies do have exposure to the international financial market. But none of these comes even close in relative magnitude to those in developed world. The housing bubble is fundamentally different from those in US and Europe in that the chain-reaction multipliers of subprime and structured finance are completely absent. By all measures, the bad asset problem in Chinese banks in 1999 was much bigger. Yet they got through it fine.

5. It's true that Chinese economy will suffer if the demand for export decreases, especially if it's prolonged. But the domestic market has expanded greatly in recent years with the emerging middle class. There's still ample need for infrastructural improvement to create demand, and the government has the firepower to finance it. Furthermore, China has been diversifying their export destinations in recent years with some success. As long as world demand stabilizes in no more than a year, they'll probably be ok.

6. Contrary to the common misconception, Chinese economy is NOT an export economy. It's much more appropriate to call it a value-added import-export economy. This is a key difference between the Chinese economy and Japanese. Since Japan migrated towards the higher end of value chain in the 70's and 80's, their export relies less and less on importing raw materials (with the notable exception of oil). China, on the other hand, still heavily relies on imported raw materials and components. In my opinion, this is the most important reason why China got through the 1997 Asian financial crisis fine while the currencies of virtually all their competitors' were massively devalued overnight. Chinese economy is much more exchange-rate neutral, except RMD-USD, than most of the world thinks.

And it's a good thing that China doesn't get pulled under by this mess. The economic inter-dependency between US and China is even greater in the post-crisis world. It is to China's self-interest to prevent turmoil in world economy, and to keep the status quo in international trading and USD's position in many more aspects than changing it. Here's why:

1. China has been arguably the biggest beneficiary of the status quo in international trade over the last twenty years or so. Any significant change would take them a long time to adjust and pose challenges and uncertainties.

2. USD's fall from international hard currency would be devastating for China, almost as much as for the US. It'd take them at least a decade to make the transition. This may be the long-term hope for China, France, Germany, Russia, Japan, or Iran. But none of them is ready for it, and will remain unready for years. Yes, there was an article in the English edition of China Daily on "US plundering the wealth of the world". But I find the ensuing hysteria here, excuse my blunt choice of words, laughable. If you actually read the English edition of China Daily regularly, as opposed to occasional glance over second-hand digests and commentaries, you'd find quite a bit of views and opinions not reflecting the government official view or policy. I know this is a surprise to some in the western world but the limit on dissenting views in China has been slowly creeping outward since the 80's. Perhaps more relevant to this case, the Chinese government has been slowly learning the art of public opinion manipulation in the international arena. My reading is this article is more of their gesture to Sarkozy and, indeed, much of the rest of the world. It's the Chinese government's version (in the international arena) of US presidential candidates' "I feel your pain and frustration." No, they don't, in both cases.

3. A devalued dollar (against other major currencies) is bad for China as it almost certainly translates into higher commodity prices, besides the direct impact on their foreign exchange reserve. The dynamic here is quite different from the relative exchange-rate neutrality against other currencies I mentioned above.

On both sides of the (other) pond, there're persistent political forces trying to make an enemy out of the other side. And the leader-wannabes in both countries invariably put up the hawkish face during campaign (internal campaign among power brokers and political elites in China's case). But, also invariably, they come to recognize the interdependency between the two countries soon after coming to power, despite real and important issues and differences. It's a pathetic political circus.

Politicians need enemies to make their lives easier and get them more power. Do we?