Monday, March 30, 2009

China's Quid Pro Quo

China seems happy to support the dollar regime by buying up new US Treasury debt issues, provided they're allowed to use their dollars to acquire real wealth.

Here's an outline:

1.  The expanded US spending requires someone to give the government dollars now in exchange for a promise by the government to pay them even more dollars in the future.

2.  If enough people aren't willing to buy US Treasuries, then Treasury auctions will fail and the US government will run short of funds.  The result could run from the mild (government needs to scale back spending plans a bit, or shift the maturity or return on their debt issues) to the extreme (perception of future inability to raise enough debt to pay off current debt leads to fears of a default, widespread selling of Treasuries, and a collapse in both the Dollar and the ability of the US government to fund even basic expenditures this year).

3.  Aside from being the single largest purchaser of US Treasuries, China is also the single largest holder.   They're a bit stuck between a rock and a hard place--stop risking more dollars on US debt and the value of their existing holdings may plummet, but keep buying it and they increase their exposure to dollars that may plummet in value regardless.

4.  China also recognizes that it has a huge thirst for natural resources of all types, and that it will need to secure future supplies if it (here, the Chinese Communist Party) is to continue to deliver standard of living improvements to its citizens--the tacit trade-off the Communist Party makes for civil order.

5.  One solution:  keep supporting the US Treasury issues while spending as large a share of foreign currency reserves as possible on locking up large supplies of natural resources around the world.  If the "West" permits this, then China will keep supporting the dollar regime as long as the dollars it already has can be used to buy "real" assets.  If the West balks, then let one or two treasury auctions fail and see if their position changes.  If not, then all those dollars China has in existing Treasury holdings aren't worth anything anyway, so there's no point in throwing good export revenues after bad future promises.

This appears to be exactly what China is doing.  While there was stiff resistance to an earlier attempt to acquire UNOCAL (something the Chinese covet for its Burmese resource holdings), China seems to be trying again, first with attempts to acquire a larger share of Rio Tinto and OZ Minerals (the latter has already been blocked by the Australian government).

What will China target next?  My guess is that there will be a concerted acquisition spree this Spring.  If China targets outright ownership of various reserves through purchasing resources companies or exploration rights, especially in regions where China has greater ability to exert (present or future) military control, or where governments can be easily swayed to support Chinese rights, then that supports the argument that China is taking a mercantilist approach.  South East Asia, Papua New Guinea, Indonesia, many African nations, and parts of South America (Venezuela, for example) are likely early targets.  

Of course, even if the West permits these critical resources to be acquired by China through peaceful purchases, this only extends the debt-spending period for as long as China can still purchase attractive resources.  At some point it is likely that 1) prime acquisition targets run out, or 2) the West catches on to this game and calls China's financing bluff.  It's a bit like the advice given by Jon Voigt's character in "National Treasure":  the US government's budget will remain intact as long as the status quo remains unchanged.  As soon as China can't get anything of real value (in its perception) for its dollars, it no longer has any reason to support the dollar regime by diverting a significant portion of its economic product into Treasury holdings.

Something to keep an eye on over the next few months...

9 comments:

quesalid said...

In the meantime the US can

1) borrow money from China

2) spend borrowed money to restructure its economy (less energy intensity, more localization, optimal resource consumption, less military spending, small industry network - instead of big playerz too big to fail -, affordable social welfare, local credit (NOT finance), etc. )

3) if China stop supporting US dollar, with the new economy in place, this event can be managed quite well

Rice Farmer said...

You are not the only one to note this mercantilist approach. For example: "China: From Crony Capitalism to Geopolitical Mercantilism?"
http://seekingalpha.com/article/128451-china-from-crony-capitalism-to-geopolitical-mercantilism

China has in fact been busy the past year or two in building up this approach. Note its activities in Africa, for example.

Jeff Vail said...

Quesalid:

I agree that we could do this, but I'm guessing that we both are quite certain that we won't.

In some sense, the smart, selfish move for the US would be to load up on debt while we still havea good credit rating (perceived, anyway), and then default. But, as you said, this is a one-time deal: we need to use that one-time windfall to transition to a localized, sustainable economy.

The problem with that approach is that it requires admitting that we're not going back to the perpetual growth promise. This is simply untenable for American politicians. I agree with you that it's the best choice--to admit that the growth/debt model is done and to transition to a sustainable, no-growth model--but I give it a 0.0% chance of happening proactively within our current political model.

China has the power over us to follow its mercantilist acquisition plan (ongoing, as Rice Farmer also noted) precisely because it knows that the one thing our current political system cannot realistically do is to concede an end to growth and transition to a sustainable model. We need to maintain the illusion that we'll return to growth, so we need to keep increasing debt, so we need China...

Theo_musher said...

"What will China target next? My guess is that there will be a concerted acquisition spree this Spring. If China targets outright ownership of various reserves through purchasing resources companies or exploration rights, especially in regions where China has greater ability to exert (present or future) military control, or where governments can be easily swayed to support Chinese rights, then that supports the argument that China is taking a mercantilist approach. South East Asia, Papua New Guinea, Indonesia, many African nations, and parts of South America (Venezuela, for example) are likely early targets."

My impression( from talking to students from places like Liberia and SE Asia) is that its not so much military threats, that is the key to influencing countries in the developing world, but rather China's ability to create slightly better will in development projects. Its really not that hard, considering the dismal track record of the West.

I mean I am not so naive as to see it in a light other than a resource grab. But The Chinese aren't so haughty about it like the U.S. with this phony doctrine of spreading "liberal democracy" wherever they go in addition to exploiting resources.

The Chinese don't seem to care what kind of government third world countries have. All they have to do is offer slightly better deals than the West to these developing countries.

I think that is what they are doing and they have better good will or "soft power" or whatever you want to call it.

The next arms race is developing the third world. I think China will win, and then age itself out of prominance with their low birth rate.

Then who knows maybe the third world will actually get developed in a positive sustainable way.

This author that just won the Man Booker award for literature wrote a novel called "the White tiger" some good lines in it. Like the next millennium is the millennium of the yellow man and the brown man.

AR said...

Jeff,

Three years ago you posted about the M3 in A Peak Behind the Curtain.

I had sent your post to my cousin, a neoliberal investment manager. He called me the next day in high dudgeon, and lambasted me (you), saying that "no one would buy oil from Iran in Euros because they wouldn't be able to trust Iran to deliver on futures contracts, and that the dollar would remain the reserve currency for oil."

I posited that China would do well to spend their dollars buying up ores, oil and other resources, before confidence in the dollar collapses.

After berating me for five minutes, hurling ad hominems at Paul Krugman, John Kerry, the ACLU and others, he finally admitted that the US dollar is worthless, and that the national debt will never be paid off, "So what?" He insisted that the rest of the planet will never call us on our debt because it would lead to global economic catastrophe. When I told him I wasn't so sure that the rest of the planet would not get to a point where they would be willing to write us off and take their licks, he said "It's the cities that will have to worry, but you'll be fine with your garden and all of your canned food."

Recently, in our conversations, he has been hurling vitriol Algore's way. Whenever I posit something which is in evidence now, and which flies in the face of his neoliberal orthodoxy he changes the subject and starts fulminating against global warming, ridiculing Al Gore, etc. So I sent him today's brilliant CSM parody: Scientists worldwide admit global warming is a hoax.

Tomorrow I'll send him this post. I already, two weeks ago, sent him an email in which I paraphrased our three-year-old conversation, and included links to articles pointing to the impending realization of what you had posited, and asked him what his current thoughts are on the topic. So far, silence.

Neven said...

I saw a documentary about a year ago called 'China vs US: the Battle for Oil'. I didn't find the documentary particularly good (I was looking for things about Peak Oil), but it was the first time I saw how China's tactics to gain resources work. Like Theo_musher said, China won't bother African countries with demands for human rights and added to that they offer to build infrastructure such as roads and telecommunication.

http://www.cbc.ca/passionateeyemonday/feature_171207.html

But won't it in the end, maybe not in the foreseeable future, all boil down to a war between China and the US? Somehow it feels logical, to put it paradoxically.

Theo_musher said...

Yeah, that's what China does in Laos. They build roads in exhange for timber.

In Africa if a country is run by some tribal warlord, they deal with the tribal warlord. They don't really give a crap how people do things in whatever country. That comes across as way less arrogant.

As far as a war goes, I think it will be a cold war.

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