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China is a fascinating topic.
Does the CCP want to take over the world and become the dominant power, maybe become the global reserve currency?
Or do they just want to be left alone, share among themselves and live in common prosperity like good communists?
These arguments pop up constantly even though they're pointless & rhetorical.
It's easy to get lost and come out way more confused than when you started.
So, let's start with the golden rule:
Nobody knows what the CCP wants long-term
Even if they DID know, real-world constraints mean they might not get what they want...
High debt levels are definitely one constraint...
More importantly, WHY would the CCP want to become the dominant reserve currency?
On one side, it keeps borrowing costs low and also confers power to the issuer: Leverage on the geopolitical playing field.
On the other, a persistent trade deficit is the penalty the issuer pays (The Triffin Dilemma):
Reserve Currency Considerations
By "agreeing" to have its currency used as a reserve currency, a country pins its hands behind its back. To keep the global economy chugging along, it may have to inject large amounts of currency into circulation, driving up inflation at home.
The more popular the reserve currency is relative to other currencies, the higher its exchange rate and the less competitive domestic exporting industries become.
This causes a trade deficit for the currency-issuing country but makes the world happy.
If the reserve currency country instead decides to focus on domestic monetary policy by not issuing more currency, then the world becomes unhappy.
Reserve Currency Paradox
Becoming a reserve currency presents countries with a paradox.
They want the "interest-free" loan generated by selling currency to foreign governments, and they need to be able to raise capital quickly because of high demand for reserve currency-denominated bonds.
At the same time, they want to be able to use capital and monetary policy to ensure that domestic industries are competitive in the world market and to make sure that the domestic economy is healthy and not running large trade deficits.
Unfortunately, both of these ideas—cheap sources of capital and positive trade balances—usually can't happen at the same time.
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So, the world needs the US to run a trade deficit, and the US runs a massive trade deficit, everyone wins?
See, the whole point of trade between countries is that it's supposed to be positive sum for both countries.
It's the entire premise of Adam Smith's international trade model:
Trade taking place as a result of countries having absolute advantage in production of particular goods, relative to each other.
Far more complex these days.
So why does it matter, especially for China...?
Well, the US is the trade deficit nation, while China is the trade surplus nation...
Put another way, China is the world's factory, while the US is the world's consumer.
That imbalance is not narrowing... 👇
(Bloomberg) The nation’s trade surplus with the U.S., a source of trade tensions between the world’s two largest economies, rose to 2.08 trillion yuan ($325 billion) in the 10 months through October from 1.75 trillion yuan a year earlier, partly because Chinese imports of U.S. soybeans slowed due to weather-related issues in recent months.
Running such a persistent and excessive trade deficit with China causes problems in the US.
Again, the idea of free trade is that both countries maximally benefit.
Both countries open their markets to each other's consumers instead of trying to out-compete each other (in a race to the bottom, there are no winners).
You're better at producing electronics, I'm better at producing soybeans. You let me sell my soybeans to your people, and I'll let you sell your electronics to my people. Everyone wins.
That's the theory.
In practise, it's never quite as simple.
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At the risk of oversimplifying, the key dynamic right now is wages relative to productivity.
China became the world's factory largely because of low relative wages.
If incomes do not rise as productivity increases, domestic demand does not increase to the extent that it should.
This is what we've seen in China...
China should have a nice healthy consumer by now, willing to buy US goods/services and balance out the trade relationship.
Largely due to wage suppression, this hasn't happened (or at least not to the extent that it should have)...
In order to remain competitive, other surplus nations suppress wages too, while the US continues to bear a large share of the consumption burden...
Exchange rates create distortions too.
China's currency is 'managed'...
Germany benefits (disproportionately) from the euro as we've mentioned before 👇
Michael Pettis (co-author of 'Trade Wars are Class Wars') posted two excellent Twitter threads on this over the weekend:
Thinking about what this means for the global economy going forward, some key questions to answer:
- If the US isn't consuming at the same pace (fiscal cliff) what does this mean for global demand?
- Will this missing demand be replaced by 'surplus' nations?
- If not, which is the more likely outcome? A global slowdown or runaway inflation?
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