U.S.-China Codependency

Premier Wen Jiabao has been lecturing the United States on how it should reform its shaky financial system. Wen got some attention by publicly worrying about the safety of China's U.S. investments. He also revealed that China diversified its investments into more risky equities just before the U.S. market started to unwind and they lost some $40 billion. This reveals more about the big U.S. rip-off of China (see "How We Ripped Off China" post May 2008)--China manufactures real goods and sells them to the United States for pieces of paper that turn out to not to be worth much.

The U.S. and China are equally at fault. They have a co-dependent relationship. U.S. consumers want to consume. China needs to keep hundreds of millions of people busy, employed, happy, and believing in slogans like "Without the Communist Party, there would be no New China." China is the United States' enabler. It grabs farmland for a pittance and sells it to a factory on the cheap. Workers flock to the factory gate, thrilled to work for the equivalent of $100 a month because it's boring back in the village. (See last year's book, Factory Girls, for an up-close look at the girls who make the stuff.) The workers routinely have a couple of months pay withheld that they forfeit when they "jump" to another job.

When stuff is cheap, Americans buy even when they don't need stuff. They are happy to pay with worthless pieces of paper. The paper has been piling up rapidly. In 1990, China had the equivalent of $10 in foreign exchange reserves per person. It was up to $166 in 2001, when China joined the WTO. The total went up over $300 per person last year and is now up to $1,465 for every man, woman, and child in China. The total reserves are $1.95 trillion, the largest in the world. Much of it is parked in U.S. Treasury Bills. They also had money in Fannie Mae, Black Rock, J.P. Morgan, and who knows what else. Here's some irony--I understand China has been the major buyer of securities that fund the U.S. farm credit system--Chinese money is keeping interest rates for big American farmers low at the same time less than 9% of Chinese farmers are able to borrow money.



All these dollars flowing into U.S. credit markets mean low interest rates for Americans. Greenspan has been defending his record by claiming that long-term interest rates didn't budge when he tried to push up short-term rates--the Fed lost control of interest rates. The flood of capital was a major reason behind this phenomenon.

The policy prescriptions now are calling for more of the same. Americans--consume more! borrow more! The surge in Chinese bank lending is taken to be a sign of strength, but China's problem is lack of demand, not lack of credit. Chinese authorities are trying to keep more money at home, but demand remains weak. They are subsidizing rural consumer purchases, but there's just one problem--rural incomes are low and likely to fall this year as farm prices fall, input prices rise, and migrant jobs dry up. Now Chinese exporters are calling for devaluation of the Chinese currency--good news is that China's monetary officials may hold the line on the exchange rate. A devaluation probably wouldn't help much, competing countries would devalue to match it, and a devaluation would draw the ire of the U.S. and E.U.

What can break the spell? How can we wean the American consumer from his/her consumption addiction, yet get production going in the U.S. economy? How does China keep all those people employed? Sorry, no answers here...

China Can Learn from Native Americans

China's collective land ownership system seems odd to most Americans, but we have something very similar here in the United States--the Native American tribal reservations. A March 16 piece on the Wall Street Journal's opinion page by Terry L. Anderson of Montana State University provides a window on the inefficiency of land use when nobody in particular owns it.

The situation on tribal reservations is remarkably similar to that in rural China--underutilized empty land, a deeply ingrained culture of poverty and hopelessness. Fleeing to the city is the only way out. The land ownership and legal system behind it is also similar to that of rural China. Mr. Anderson argues that 19th-century laws that put Native American lands under the trusteeship of the U.S. Dept. of Interior's Bureau of Indian Affairs prevents lands from being sold, used as collateral, or passed on through inheritance. I understand that Native Americans were not given ownership because authorities thought they might sell it off for a pittance and be left with nothing.

Mr. Anderson cites an accidental experiment that demonstrates the value of well-defined ownership. Some tribes took back control of their lands and prospered as a result. He notes that the rule of law was strengthened in some reservations when they were placed under state jurisdiction in 1953. Anderson documents faster economic growth and lower rates of loan rejection on reservations where they have discarded the weak federal system.

The situation is very similar in rural China and tribal reservations--a paternalistic authority protects the powerless from themselves by depriving them of ownership of their most valuable asset. Left poor and powerless, the authorities drip in enough welfare benefits and programs to keep residents barely surviving in their rural enclaves (and keep them from congregating in cities).

Give Chinese farmers (and Native Americans) ownership, rule of law, and economic power!

Big Soybean Harvest In Storage

In 2007, China had a short soybean harvest. There was a severe drought in soybean areas of the northeast and a campaign to plant grain too area from soybeans (and rapeseed). Consequently, China's imports of soybeans and vegetable oil zoomed upward in 2007-08, contributing to soaring oilseed prices.

In 2008, China's soybean production bounced back. We thought this would reduce China's demand for imports this year, but the bigger harvest went into storage bins--not much of it made it into the market--and China continues to buy up soybeans.

World soybean prices started plummeting in the fall of 2008, just as the new harvest came in. Chinese officials were worried about keeping farmers' incomes up and preserving incentives to plant soybeans again in 2009, so they announced a support price for domestic soybeans well above the market price.

A chunk of domestic soybeans were bought for government reserves at the support price and stored in bins. They were too expensive to process, so they sit in the bins. Moreover, Chinese farmers had trouble selling their beans at the support price. A lot of them couldn't meet the quality standards for reserve purchases. No one wants to buy domestic soybeans that are more expensive than readily available imported beans. So one report from Heilongjiang Province says at least half of soybeans in the major producing area are still stored on farms.

The Grain Administration just announced a plan to ship corn and soybean reserves from its bulging warehouses in Heilongjiang and other northeastern provinces to other provinces. They have to do this because they ran out of space to store the reserves they've been buying up. Also, they probably have to get the grain/beans out of storage before they rot/mold.

Meanwhile, the big chinese harvest had no impact on the market. China continues importing soybeans at a torrid pace. Much of the Chinese harvest is in storage where it may rot if not dried or stored properly or feed rats and vermin. Thus, the Chinese support price is a highly wasteful policy that is also sending a false signal to the world market that China needs more soybeans than it actually does.

Seed subsidy evolves

Heilongjiang Province held a teleconference on March 6 to announce the details for distributing "quality seed" subsidies. This is one of three kinds of direct subsidies to grain producers introduced in 2004. It has never been clear how the subsidies are distributed--the methods may differ from province to province--but an article describing the conference gives some clues. The details revealed by the Heilongjiang Province finance department show that the subsidies have become more closely linked to actual production than in the past.

The subsidies were originally based on a standard of 10 yuan per mu, apparently based on historically grain plantings. This year, Heilongjiang has announced that the subsidy will be 15 yuan per mu for rice, 10 yuan for corn, soybeans and wheat. It is emphasized that the subsidies are to be allocated according to actual planted area. You get a subsidy if you plant; none if you don't. The link to actual plantings moves this subsidy into "amber box" of market-distorting subsidies in terms of reporting to WTO and counts against its 8.5% cap on subsidies.

The funds will be distributed to counties based on 2007 census records of plantings of each crop, then parceled out to villages and then to farmers. The actual subsidies paid depend on actual planted area. They are to be distributed to farmers by the end of March, i.e. before planting. This is also a change. Initially, subsidies appear to have been distributed after crops were already planted, but this year officials have been careful to give out subsidies and announce support prices before planting decisions were made.

Subsidies are paid by depositing them in an account they can access with an ATM card. Some of the prohibited practices reveal past abuses. You have to base the subsidy on actual area, not a diluted area that raises the average subsidy. No skimming funds, deductions, withholding, misappropriation allowed. The quality seed subsidy fund province-wide will exceed 1.35 billion yuan (about $200 million), an average of 80 yuan (less than $12) per farmer. Each farmer is to fill in a "quality seed subsidy area card" and subsidy distribution is to be publicly announced so farmers know how much is due them.