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March 15, 2005


Dave Schuler
My cocktail party soundbite on the dollar has been this: if the Chinese pull the plug on the dollar, we will have a recession in the US, and a revolution in China.
That's my take, too, Tom. If the history of China is anything to judge by, the present oligarchs will be willing to go to very great lengths to preserve stability i.e. their own power.
Warmongering Lunatic

I'm glad to see other people, who presumably know more about economics than I do (my education coming entirely from buisness magazines) have reached the same conclusion I did.


So if the "stability" of the Cold War was propped up by nuclear Mutually Assured Destruction, does this imply that any similar situation with China would be stability propped up by economic M.A.D.? Interesting...


Ferguson is a funny guy. As a historian, or even as an economic historian, he develops these grand themes, e.g. "Empire" and "Colossus" being two of his recent self-defined book titles, and then proceeds to write essays for various periodicals propounding such themes, thereby promoting the sale of these tomes.

But his historical analyses fails to capture the dynamism of the information age in world trade. International trade of 50, 100, or 200 years ago were settled in all types of manner precisely for the purpose of converting the US currency received, back into the foreign (home) currency (or in gold), and vice versa. These were high cost, and high risk transactions, with very little transparency. (And hence, resulted in low relative levels of trade.)

Today, as in the case of China, they simply skip the currency conversion, and invest the proceeds in US Treasuries, or other securities--in the deepest (low cost) and most liquid (low risk) securities market in the world, with all the attendant price, trade execution, and custody that goes with our transparent (IT-driven) markets. (Making high, and growing, levels of trade possible.)

The flip side of the trade deficit coin is a capital surplus. Were our trade deficit not settled by capital surpluses supplied by foreign creditors, then the process of equilibrium would've found another way. The US dollar moving toward a (lower) exchange level would've been long underway. Such a process would've resulted in higher domestic interest rates (to attract foreign capital), higher import prices (reducing trade with foreign suppliers), and cheaper US export prices--all moving the trade deficit/capital surplus to equilibrium.

By fixing the exchange rate of the renminbi to the dollar, and investing their US trade surplus in US securities, Bejing is using the Federal Reserve, by proxy, to set China's monetary policy, thereby aiding low inflationary growth in both the US and China. China is aided in this policy by an extremely high domestic savings rate (and forbidding foreign investments by its people) thereby filling the Chinese domestic investment gap created by their US trade surplus invested in US securities. (And stocking their central bank balance sheet with securities denominated in the world's principal reserve currency.)

While this arrangement, to some, may appear as a sort of high-wire act, any comparison of the US to the demise of the British Empire in 1945 is fatuous, even as Ferguson hints at it. Certainly compared to the US, Britain's working age male population, along with its fiscal condition, had been fairly devastated in WW I & II. Britain fought for it's existence in WW II, and sacraficed its inperial power in exchage for its life--knowing that it could live as a second fiddle to the US.

In the pecking order of wealth and demographics, the US is both wealthier and younger than Europe and Japan. China's challenge is that they are likely to become old (due to one-child policy) before they become wealthy--defined as able to avoid old age poverty through savings. (Nick Eberstadt at AEI has done some interesting work in this area.) China is racing against time to grow their economy and raise their living standards before the significant burden of a largely old age population stagnates their economy.

Long way around to say that if the music stops, we'll have a recession, and China will have a revolution.

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