Sunday Reflections
China is a banker over a barrel
By: Derek Scissors
Sunday Reflections Contributor
March 14, 2009
Trade, human rights, North Korea, naval standoffs… America and China have plenty to talk about.
Nothing new about that. But in the last six months or so, whenever these issues come up, someone--a Chinese official, a journalist, sometimes even an American official—will pipe up and claim the U.S. can’t press our interests firmly because “China is our banker.”
Bunk.
If China’s our banker, it’s the kind of banker I’d want. A banker who:
* Gets his money from me in the first place;
* Has nothing to do with most of the money except give it back;
* Is less important to me with each passing minute; and, oh by the way,
* Needs me to provide jobs for a nice chunk of the town he lives in.
A closer look at the U.S.-P.R.C. economic relationship, including the financial part, reveals that it’s the P.R.C. that needs to be cautious, not the U.S.
The relationship starts with trade. Americans buy things made in China. Lots of things, to the tune of $337 billion last year. We trade with them to get very cheap, high quality clothes and consumer electronics; they trade with us to get the jobs making those things. Advantage: U.S.
Why? Because we can get our clothes elsewhere, at prices not too much higher. But the Chinese would have a tough, probably impossible, time replacing the high-quality jobs involved in sending $337 billion worth of stuff to the U.S. Here’s the up-side to our credit card culture: The American consumer is irreplaceable.
That leaves the financial side, where they buy our bonds. Does this balance our greater power in trade? Not really. Buying our bonds doesn’t give the P.R.C. that much leverage over us because they lack viable alternatives—largely because so much money is involved.
Subtracting how much China paid for U.S. goods and services last year from what we paid them leaves the P.R.C. $266 billion ahead. The year before, they racked up $256 billion that way. And they have even more dollars from investment and trade with countries that use dollars. The bottom line: Beijing has a whole lot of greenbacks on its hands, even by Washington, D.C., standards, and the number has been getting bigger every year.
Now for the most important part of the discussion: China can’t spend the money at home.
Beijing has set up a system whereby (1) money can’t flow freely in and out, and (2) China’s central bank—the People’s Bank—must buy dollars from whoever wants to sell. Say the Chinese government gives 100 billion in dollars to the Ministry of Education to improve schools and the Ministry sends that money out to the provinces. Schools can’t use dollars to pay teachers or construction workers because those people use yuan to buy food, clothes, and so on. Individuals can’t even, by law, send dollars to another country.
Whoever ends up with the dollars will want yuan. Who gives them the yuan? You got it: the People’s Bank, which buys back the dollars it just gave away. The People’s Bank must, by law, buy all dollars it is offered. So nearly all dollars end up right back where they started. Nobody seems to quite believe this, especially inside China. Poor Yi Gang, People’s Bank deputy governor, has to repeat every month that reserves must “unavoidably” or “inevitably” be invested outside the P.R.C.
Now, “outside the P.R.C.” still seems to leave Beijing a lot of investment options. Here’s where the sheer amount of dollars comes in: It’s very hard to find places to invest all that money. For example, China already has bought more oil than it can store and there’s not enough gold available on the planet to buy with just a year’s worth of China’s trade surplus.
Chinese state firms are working hard to invest overseas, but this isn’t nearly enough, either. Excluding bonds, China’s “outward” investment soared 64 percent last year. But that was still less than half of “inward” investment. Beijing just can’t keep up. Countries including the U.S. are keen for China’s dollars, but only on very narrow terms: They seek very large sums for small stakes in troubled companies. But those same countries basically forbid the P.R.C. from buying the colossal amounts of stock or property it could afford to buy.
The only market open to the P.R.C. and big enough to absorb its dollars is our bond market. That’s why China has at least $1.1 trillion, and maybe as much as $1.7 trillion, already invested in American bonds. That’s why China moved $200 billion into U.S. Treasury bonds last year, even though the interest rate was dropping like a stone. Beijing knows it has no real choice, even if it’s very useful to pretend it is America which has no choice.
One last thing: while the U.S. has the stronger hand, we’re using it to slap ourselves. China is about to get much less important as a buyer of our bonds. The amount they buy is tied tight to their trade surplus with us, which isn’t going to soar this year and may drop. Meanwhile, the amount we are going to borrow (from everyone) is going to soar, so President Obama and Congress can have their $1.75 trillion deficit. While we’re patting ourselves on the back that Chinese bond purchases don’t mean much, we should remember that selling all these bonds to anyone is a sign the U.S. is in trouble.
Derek Scissors is a Research Fellow for Asia Economic Policy at The Heritage Foundation's Asian Studies Center.
