[Paleopsych] American Conservative: Paul Craig Roberts: Who Owns the Dollar?: Our currency and our economy are held hostage by Asia.

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Who Owns the Dollar?: Our currency and our economy are held hostage by Asia.
July 4, 2005 Issue

    China is the leading scapegoat for America's economic ills. On May 20,
    New York Times columnist Paul Krugman blamed China for the U.S.
    housing bubble. If only China were not lending us so much money,
    mortgage rates would be higher, forestalling a housing bubble. Krugman
    says China is a poor country and should be investing its capital at
    home, not lending it to the U.S.

    Krugman could just as well have said, "If only U.S. manufacturers
    produced in America instead of outsourcing to China, the Chinese would
    not have any money to lend us. Thus, no housing bubble."

    Krugman is correct that if foreign lending to the U.S. slows, interest
    rates will rise, putting a speculative housing market in trouble. But
    the interest of the U.S.-China relationship goes far beyond the effect
    on the U.S. housing market. Economists set in traditional ways of
    thinking miss the really important aspects of the relationship.
    For example, Krugman notes that China is a poor country and is slowing
    its own development by lending to the U.S. We do think of China as a
    Third World country with large supplies of underemployed labor.
    China's trade relationship with the U.S., however, suggests the
    opposite. The U.S. trade deficit with China is larger than with any
    other country, including highly industrialized ones such as Japan and
    Germany. Think of all those Toyotas, Hondas, Nissans, office machines,
    and video games that Americans buy from Japan. Yet in the first
    quarter of this year, the U.S. trade deficit with China is running 50
    percent larger than the deficit with Japan. Indeed, the U.S. trade
    deficit with China is larger than the deficit with all of Europe. It
    is larger than with Canada and Mexico combined, two countries in which
    U.S. corporations manufacture cars, appliances, and a variety of
    big-ticket items for American markets.

    What are Americans buying from China? With China a poor country and
    the U.S. a First World superpower, you would think China would have a
    trade deficit as a result of selling us cheap goods and importing high
    value-added manufactured goods. Instead, it is the other way around.
    The U.S. is dependent on China for manufactured goods, including
    advanced technology products. In the first quarter of 2005, U.S.
    imports from China are 5.7 times higher than U.S. exports to China.
    Last year, U.S. exports to China were $34.7 billion. Imports were
    $196.7 billion for a U.S. trade deficit with China of $162 billion.

    It was not always this way. In 1985, U.S. trade with China was in
    balance at $3.8 billion. Ten years later, U.S. imports from China were
    four times U.S. exports to China.

    The U.S.-China economic relationship is a highly unusual one between a
    First World and a Third World country. Moreover, the U.S. trade
    deficit with China in manufactured goods and advanced technology
    products is growing rapidly. What explains the U.S. dependence on a
    poor country for First World products?

    The answer, and the key to China's rapid development, is that
    corporations in First World countries--American businesses chief among
    them--use China as an offshore location where they produce for their
    home markets. More than half of U.S. imports from China, and as much
    as 70 percent from some of China's coastal regions, represent offshore
    production by American firms for U.S. markets.

    What economists overlook is that when we speak of the Chinese economy,
    we are speaking in large part of the relocation of American
    manufacturing to China. Those millions of lost domestic manufacturing
    jobs were not lost. They were moved. The jobs still exist, only they
    are not filled by Americans.

    In a world where capital and technology are highly mobile
    internationally, these critical factors of production flow to
    countries with the lowest cost of labor. China has attracted
    manufacturing, and India has attracted professional services. This has
    left the American work force with job growth only in lower-paid
    domestic services, which provide no export earnings.

    The rapid transformations that have occurred in some Indian cities,
    which have become high-tech centers, and along the coast of China are
    unprecedented in economic history. The changes are so rapid because
    they are driven by the relocation of First World businesses seeking
    the lowest labor cost.

    Economics relies on automatic adjustments to rectify trade imbalances.
    The trade deficit with China should cause the Chinese currency to
    appreciate relative to the dollar, raising the dollar cost of Chinese
    labor. In the long run--in which, J.M. Keynes said, "we are all
    dead"--adjustments would occur until U.S. and Chinese wage rates and
    living standards equalized.

    Considering the disparity between American and Chinese wage rates and
    living standards, the adjustment would be extremely painful for
    Americans. But the adjustment is forestalled by two factors.

    China keeps its currency pegged to the dollar, so when the dollar
    falls, the Chinese currency falls with it and there is no adjustment.
    China does not permit its currency to be traded, and there is not
    enough of it in international markets for currency speculators to be
    able to force the Chinese off the peg.

    The other factor is the dollar's role as world reserve currency. The
    reserve-currency role means that every country has a demand for
    dollars in order to pay its oil bills and settle its international
    accounts. The world demand means that the U.S. can run large deficits
    for many years before the chickens come home to roost.

    In the meantime, Asian countries are accumulating hundreds of billions
    in dollar assets, making them America's bankers. Industrially
    developed countries such as Japan, Taiwan, and South Korea have little
    need to use the dollars that they earn from their trade surpluses with
    the U.S. to import American capital goods to fuel their further
    development. They use the dollars that we pay them for their goods to
    purchase U.S. government bonds and American companies, real estate,
    and corporate bonds.

    China, which has been growing at about 10 percent annually for a
    number of years, could conceivably use its export surplus with the
    U.S. to expand its infrastructure more rapidly in order to develop
    even more quickly. But a 10 percent annual growth rate is probably the
    highest rate of change with which China wants to contend. As First
    World firms are flooding China with their capital and technology,
    China doesn't need to use its trade surplus with the U.S. to purchase
    capital goods.

    As a result of many years of persistent trade surpluses with the
    United States, the Japanese government holds dollar reserves of
    approximately $1 trillion. China's accumulation of dollars is
    approximately $600 billion. South Korea holds about $200 billion.

    These sums give these countries enormous leverage over the United
    States. By dumping some portion of their reserves, these countries
    could put the dollar under intense pressure and send U.S. interest
    rates skyrocketing. Washington would really have to anger Japan and
    Korea to provoke such action, but in a showdown with China--over
    Taiwan, for example--China holds the cards. China and Japan, and the
    world at large, have more dollar reserves than they require. They
    would have no problem teaching a hegemonic superpower a lesson if the
    need arose.

    Last year the U.S. trade deficit with the rest of the world was $617
    billion. In the first quarter of this year, our trade deficit is $174
    billion--$35 billion higher than in the first quarter of last year. If
    this figure holds for the remaining three quarters and does not
    increase, the U.S. trade deficit in 2005 will be $700 billion.

    Offshore outsourcing makes it impossible for the U.S. to rectify its
    trade imbalance through exports. As more and more of the production of
    goods and services for U.S. markets moves offshore, we have less
    capability to boost our exports, and the trade deficit automatically
    widens. Economic catastrophe at some point in the future seems

    In the meantime, even a small country could pop the U.S. housing
    bubble by dumping dollar reserves--which is some fix for a superpower
    to be in, especially one that is disdainful of the opinion of the rest
    of the world. Comeuppance can't be far away.

    The hardest blow on Americans will fall when China does revalue its
    currency. When China's currency ceases to be undervalued, American
    shoppers in Wal-Mart, where 70 percent of the goods on the shelves are
    made in China, will think they are in Neiman Marcus. Price increases
    will cause a dramatic reduction in American real incomes. If this
    coincides with rising interest rates and a setback in the housing
    market, American consumers will experience the hardest times since the
    Great Depression.

    Paul Craig Roberts was Assistant Secretary of the Treasury under
    President Reagan.

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