The End of U.S. Influence Is Not at Hand

Joseph Nye takes a step back from the recent China hyperbole and notes the obvious:

First, the U.S. is not in decline. Americans and others have been predicting decline regularly over the years: after the Soviets launched Sputnik in 1957; again when Nixon closed the gold window in 1971; and when the American rust-belt economy seemed to be overtaken by Japanese manufacturers in the 1980s.

Predicting the decline of the U.S. has been something of a cottage industry over the past 5 or 6 decades. One of the foundational IPE texts took it as a given in the mid-1980s. The end of the Cold War stopped all of that talk temporarily, but it is difficult to keep those dogs at bay. Talk of the end of American influence has been popping up all over the place since the financial crisis. Nye explains why they are wrong:

But when one looks at the underlying strength of the American economy, it is not surprising that the World Economic Forum ranks the U.S. second (just behind Switzerland) among the most competitive, while China ranks some 30 places below.

Second, the fact that China holds so many dollars is not a true source of power, because the interdependence in the economic relationship is symmetrical.

True, if China dumped its dollars on world markets, it could bring the American economy to its knees, but in doing so it would bring itself to its ankles.

China would not only lose the value of its dollar reserves, but would suffer major unemployment. When interdependence is balanced, it does not constitute a source of power.

Even more fundamentally, I don't know if it's possible for a country with an extremely export-biased economy to provide global leadership. How would that work? The simple fact that China has felt it had to stockpile so many dollar reserves is evidence of American, not Chinese, strength: China is largely dependent on the U.S. for its growth. China's internal market will be a source of strength one day, but it will remain a weakness until they can employ all of their citizens in productive work and enact public policies (like a social safety net) that make massive domestic savings less necessary.

Emmanuel takes issue with Nye, noting that the U.S. has looming demographic problems. This is true, but the U.S. is not unique in this regard. Europe, Japan, and even China are all similarly on the wrong side of the demographic curve. Which is why productivity and competitiveness are so important. Here, the U.S. are still ahead of any other large country.

The recent crisis demonstrated that the world is not ready for the end of U.S. leadership. The saying used to be that if the U.S. sneezes the world catches a cold. Well, in the last few years the U.S. caught a nasty bug, but the rest of the world caught pneumonia. If only one lesson can be learned from the present downturn, it is this: the end of U.S. influence is not at hand.

The Non-End of Influence

Thought I'd toss out this video of Stephen Cohen talking about his book (with Brad DeLong) The End of Influence. The discussion frustrated me, because both discussants kept talking about how important politics was in shaping economic outcomes without ever mentioning how it was important, why it was important, what politics had to do with outcomes, how political incentives shaped history, or really anything substantive about politics. It's difficult to pull out any one wrong thing in it to pick on, mostly because the discussion is too vague to pin down any clear, consistent argument beyond "being in debt is a bad thing for America", but also because there are half-truths and "yeah, but..." moments throughout. And also because it's an hour long and basically everything said in it is incomplete, wrong, or begs a question that it doesn't answer.

For example: the title of the book is The End of Influence, and yet nowhere in the interview does Cohen explain how America has lost its influence or even defend the notion that it has. At the very end he actually says the opposite: that despite the financial crisis nothing much seems to be changing at all. Earlier, he argues that China is unable to use its massive dollar holdings to exert much influence, because that would require domestic political tradeoffs that they are not prepared to make. Umm... if you're giving an interview to promote a book with a provocative title, shouldn't you defend the thesis instead of arguing against it? At least a little bit?

I don't have time these days to actually, you know, read the book (oh summer, come quickly), but if the sentiments expressed by Cohen in this interview (and in the FP book excerpt) are the same as those in the book then I'm with Drezner: I wish they'd talked to some actual political scientists, rather than just pay lip-service to their existence.



(ht: DeLong)

China's Dollar Problem

Jean Paul Getty famously said "If you owe the bank $100, that's your problem. If you owe the bank $100 million, that's the bank's problem." Such is the position in which China finds itself:

Indeed, China has little incentive to talk down the dollar and such calls are regarded as little more than pleas to the US authorities to keep their finances in check.

Simon Derrick, at Bank of New York Mellon, says China is not in a position to sell a significant portion of its dollar holdings in the open market without causing considerable damage to itself. This means that it must explore a number of different short- and long-term strategies to deal with the problem.

“Developments this year indicate that China now believes that its best long-term strategy is to increase the international role of the renminbi, including its use as a reserve currency,” he says. “This might be the first signal that China is now considering a potential timetable, presumably over years rather than months, for moving towards capital account convertibility.”

Capital account convertibility will not happen in the immediate future, but eventually China will have to go there. The question is what they can, or should, do in the meantime. If they slow the export boom they will be forcing millions into unemployment. A model of economic growth based on boosting domestic consumption cannot grow 10% per year, and the process of structural adjustment will have destabilizing effects in the economy. And of course, any destabilization of the economy could destabilize the Chinese regime.

They can't let that happen. So in the short run, at least, the U.S. debt held by China will remain China's problem.

Is China Really Pulling Away from American Debt?

The Chinese say that they will be diversifying away from T-Bills:

“This is reserve diversification in a broader sense. Instead of accumulating foreign exchange reserves and short-term financial assets, the government wants the nation to accumulate more long-term corporate real assets.”

State-owned groups, particularly in the oil and natural resources sectors, have stepped up their hunt for overseas companies and assets on sale because of the global crisis.

Of course if China stops buying T-bills it will put downward pressure on the dollar, make the servicing of our deficits more costly, and making our imports more expensive (thus making us poorer). So if the Chinese are truly diversifying away from the dollar, or away from government debt, then it could spell trouble. This is the "Great Adjustment" that economists like Nouriel Roubini have been warning about for years. This was how Chimerica was supposed to fall apart.

But the Chinese have been making these sorts of threats for years without following through, and I've learned over the years to never form an opinion on Chinese sturm und drang without consulting Brad Setser first. He says:

For a while in 2007 and 2008 the growth in China’s US holdings lagged its reserves. Chalk that up to diversification. The gap between China’s known US assets and its reserve growth came at a time when China was buying more “risky” US assets, like equities — and likely increasing its exposure to a host of potentially “risky” emerging economies. Or chalk it up to increased use of private fund managers, including the money market funds used by the CIC. China’s dollar holdings likely increased a bit more rapidly than the US data implies.

Then for a brief period last fall China’s “safe” US holdings rose far faster than its reserves. That likely reflects a shift out of riskier assets – and a shift away from privately managed funds — back towards classic reserve assets. I don’t know precisely what drove the surge in recorded inflows to the US. But something changed. After a period when inflows to the US lagged, they suddenly surged — with almost all the inflow going toward short-term bills

And now China’s US holdings – particularly its Treasury holdings – seem to be rising in line with China’s reserves.

China is still buying other assets. Chinese state firms have been actively bidding for mineral rights – and companies that have mineral rights. And China has been stockpiling commodities. But over the last few months SAFE has essentially been buying Treasuries at – best I can tell – more or less the rate implied by China’s reserve growth.

Setser has charts and graphs to prove it, if that's your thing. The gist seems to be that China is diversifying, but their reserves are so large (over $2tn, and growing rapidly) that they are still buying T-Bills as well. Remember, the China Investment Corporation got burned badly when the equity markets tanked last fall, and the Chinese government has demonstrated strong risk-aversion time and time again. So while they do continue to diversify, their holdings of T-bills will continue to grow as long as their foreign reserves keep growing.

Emmanuel at IPEzone offers further comment.

American debt don't taste too good anymore

With the interest in China over the past week or so on this blog, this excerpt from today's NY Times caught my eye: 

The declining Chinese appetite for United States debt, apparent in a series of hints from Chinese policy makers over the last two weeks, with official statistics due for release in the next few days, comes at an inconvenient time.

On Tuesday, President-elect Barack Obama predicted the possibility of trillion-dollar deficits “for years to come,” even after an $800 billion stimulus package. Normally, China would be the most avid taker of the debt required to pay for those deficits, mainly short-term Treasuries, which are government i.o.u.’s.

In the last five years, China has spent as much as one-seventh of its entire economic output buying foreign debt, mostly American. In September, it surpassed Japan as the largest overseas holder of Treasuries.

But now Beijing is seeking to pay for its own $600 billion stimulus — just as tax revenue is falling sharply as the Chinese economy slows. Regulators have ordered banks to lend more money to small and medium-size enterprises, many of which are struggling with lower exports, and to local governments to build new roads and other projects.

Now this development is not that big of a deal in the short run, as demand for Treasury's is at an all-time high and yields on everything from 4-week to 3-month Treasury's have gone negative over the past month. So a short run Chinese pullback from purchasing US debt may very well be usurped by increasing demand and a strong market for the extremely safe asset. 

However, in the medium term (say 12-18 months from now), this development may indeed hurt the United States. As China pulls back (forecasts show that China’s foreign reserves will increase by $177 billion this year, down sharply from an estimated $415 billion last year) and continues to pull back, and the markets rebound in the medium term, demand will shift from the debt markets to equities or whatever new instruments are in vogue at that time. This would drive up the interest rates that investors would demand for Treasury's, thus making it more expensive for the US to borrow. Interesting development to watch for over the next 12-36 months.