U.S. and China: Joined at the Hip

A very well-done article by David M. Dickson in the Washington Times, "China's Economic Bargaining Chip," explains the economic co-dependency of the United States and Chinese economy. As I've attempted to explain elsewhere on this blog, the U.S. economy is addicted to consuming more than it produces and consequently to debt while the Chinese economy is compulsively producing more than it consumes. China sends the cash from its trade surplus back to the U.S. to invest in Treasury Bills--i.e. it is financing much of the growth in U.S. government debt. It turns out that China's financial wizards have lost a lot of dough investing in U.S. companies like Blacksone, Fannie Mae, and Freddie Mac just before their stock dropped like a rock. There was some discussion about this on my recent trip to China. Another interesting tidbit--the article notes that some Chinese citizens have noticed that China has been ploughing cash back into the U.S. economy, facilitating low interest rates and massive consumption by fat U.S. consumers while hundreds of millions of Chinese citizens eek by on a dollar or two a day.

The editors tried to play up the concerns about China getting a stranglehold on the U.S. economy through its increasing ownership of U.S. companies. These alarm bells have been sounded before--the Saudis in the 1970s and Japanese in the late 1980s.

The more alarming aspect is whether this co-dependency can be broken without the whole thing spinning out of control. The U.S. is trying to avert the consequences of its profligacy by spending even more on a big tax "stimulus", commitments to bail out failing financial firms, the new mortgage bill, and pumping even more money into the economy by keeping real interest rates near zero. Meanwhile, China has gotten itself into a hole by holding its exchange rate down too long. It has been trying to gradually appreciate its currency over the last year-plus, but that has attracted lots of hot money with nowhere else to go. As long as the Chinese exchange rate is ticking upward at a steady predictable pace, it makes lots of sense to put your money in China, and lots of investors are doing just that. Consequently, China's foreign exchange reserves are exploding--up to $1.8 trillion now and expected to reach $2.5 trillion next year. China's monetary authorities are struggling to keep inflation under control. At the same time, its lucrative property market--the source of much of China's new-found glitz and wealth--has turned south.

Some have raised this interesting point: If we're learning that U.S. financial institutions were not as healthy as we thought, what hidden hazards might hidden in the balance sheets of Chinese banks?

The train doesn't seem to be slowing down; it's gaining momentum. Can it be slowed without leaving the tracks?