February 17, 2012
Lately, I’ve been hearing a lot of people, both in the alleged news media and in daily life, lamenting the fact that the United States has, for several years now, been borrowing money from China in record quantities. This is not, they say unanimously, a good plan for this country, for our future, for the institution of democracy, and so on. With all due respect, I strongly disagree. Borrowing money from China, the more the better, is the best plan this country has had in recent memory. To understand why, it is important to understand a few facts of modern economics (and politics), which, unfortunately, are not common knowledge, but which should be taught in every fifth grade social studies class in this country.
First, it is important to understand what “national debt” means. Debt, as incurred by the United States, as opposed to by an individual, is not like the debt you run up on your credit card in your (hopefully infrequent) deficit-financed shopping sprees at the mall. In such unfortunate moments of weakness, you borrow from a bank’s money supply in exchange for your promise to pay that bank back from your own, presumably much smaller, money supply at some future date. The national debt, in contrast, is the U.S. money supply. Put simply, the debt = the money supply. This has been the case in principle since the United States ratified the National Bank Act of 1863, and more absolutely true since the decision was made by then-president Richard Milhous Nixon and his Treasury Secretary, John Connally in August, 1971 to “close the gold window”; to withdraw from the Bretton Woods international monetary system and sever the United States dollar’s final, tenuous bond to gold. In other words, money is actually just a physical representation of the perception of value, or as the Federal Reserve pragmatically states, “a tool used to facilitate transactions”. Yes, it really is just paper and ink; there is no magic at work (aside from those really neat magnetic strips and watermarks which almost, but not quite, completely fail to differentiate real dollars from counterfeit ones). So when a country like the United States “borrows” from another country (China, for non-arbitrary example), what the first country actually does is print money (also known as treasury notes) and give those treasury notes to the second country, in exchange for the second country’s treasury notes. Actually, it’s a bit more complicated than that, but not much, so the above narrative is more than sufficient for the purposes of this blog.
Incidentally but interestingly, between March 31, 2005 and November 18, 2011, the national debt increased by about 7.323 trillion dollars – nearly doubling over that period from $7.777 trillion to $15.1 trillion (94.16%) – unquestionably an alarming surge. However, during that same period, U.S. debt held by foreign countries (including China) only increased from about $3.2 trillion to $4.7 trillion (47.16%), while debt held by the public increased from about $4.57 trillion to $10.325 trillion (125.8%) (http://www.savingsbonds.gov). So if all this debt truly is the imminent crisis that so many Americans seem to believe it is, then perhaps it is they, and not China, who should stop buying U.S. treasury notes. After all, admitting you have a problem is half the solution.
More to the point, when a country prints large numbers of treasury notes, the value of those treasury notes decreases. This is known as “inflation”, or “currency devaluation”. Inflation is generally regarded as undesirable, as it causes prices of goods and services to rise – in the long run – and therefore causes individuals holding money and other fairly liquid assets, such as bonds and crack, to become relatively less wealthy. But something else also occurs when a country’s currency is devalued: labor becomes correspondingly less costly in that country, making it desirable for manufacturers, both foreign and domestic, to manufacture there. This is important, for reasons which will become clear shortly.
For several decades, the United States has been losing manufacturing jobs and capital investment – at an increasing rate – to countries like Mexico, India, Thailand and, not trivially, China, where the currency value is low and labor is, therefore, relatively inexpensive. This influx of capital investment strengthens, and in some cases drives, many countries’ economies. Conversely, loss of capital investment (and therefore manufacturing jobs) can weaken, sometimes severely, a country’s economy. This has been the case in the United States since the 1960’s, a condition escalated by the signing of the North American Free Trade Agreement (NAFTA) by President George Herbert Walker Bush on December 17, 1992 – after he lost to Bill Clinton in the 1992 presidential election, but about a month before he vacated the Oval Office (I’m just saying) – but since then intermittently moderated by various artificial “bubbles” in the U.S. market, such as the so-called “dot-com bubble” of the late 1990’s, and, more recently, the disastrous “housing bubble” of a few years ago.
This weakening effect, rather than being mitigated by natural market equilibrium, is actually exacerbated in the United States because U.S. currency is externally strengthened by the fact that the U.S. dollar is, and has been since the formation after World War II and expansion in the 1960’s of the Organization of Petroleum Exporting Countries (OPEC), the world’s unofficial oil currency (hence the term, “petrodollar”). Put simply, OPEC countries trade the vast majority of their oil, at present the single most vital commodity to the world’s economies, in exchange for U.S. dollars. This makes the dollar a very important currency, and therefore, commensurately, extremely and enduringly valuable. (An interesting and illustrative aside to this is the fact that in late 2000 and early 2001, three countries – Iran, Iraq, and North Korea (listed here alphabetically to avoid the appearance of favoritism) – were all seriously pushing to switch their own oil currency to Euros; a blasphemous proposition which earned them collectively the (second) Bush administration nickname “Axis of Evil” and ultimately helped lead to (some might even say wholly precipitated) the invasion and subsequent pulverization of Iraq by U.S.-led U.N. forces. Passive-aggressive behavior of this kind often produces similar results).
Unlike the United States dollar, China’s currency, the renminbi (RMB), also known as the yuan, is not linked directly to any valuable resource or commodity, and is therefore not tied to any nonpolitical external factor in its valuation. Additionally, and also unlike the U.S., China is not bound by any democratic influence in its fiscal and monetary policy. The Chinese government, since unpegging the RMB from the U.S. dollar in 2005, has had nearly complete control over the value of its currency, and thus makes pertinent decisions without any internal political or economic restriction of any kind (external political and economic pressure, as we shall see, is another matter). Viewed through this lens, and far from being the Marxist Communists U.S. media pundits often accuse them of being, the Chinese are in fact what many in the United States, particularly those with conservative political inclinations, seem to aspire to: free market capitalists on steroids. Essentially totalitarian capitalists in their approach to monetary policy, the Chinese can fluctuate their currency value at will via – among other mechanisms – manipulation of currency markets, thereby attracting as much or as little foreign capital as they want, and creating as many, or as few, new jobs as they need – a useful ability to have when you’ve got two billion mouths to feed. And they have done so, to great effect, for the better part of a decade. Not coincidentally, China is now arguably the second most important economy in the world. Or maybe even the first.
What does all this mean for the United States? Historically, China’s currency has been of little value or consequence outside of China. Until relatively recently, the Chinese economy was mainly agrarian, producing little other than food and other basic goods and resources (with the exception of military technology, most of which was “borrowed” – a term used somewhat loosely here – rather than developed by China). This created conditions ideal for allowing the Chinese to attract huge amounts of foreign investment capital and manufacturing operations which should, in turn, have correspondingly increased the value of Chinese currency. But because the Chinese government wants to keep its economy booming, it has continued to keep the value of its currency low (this is what is meant by “artificial devaluation”, “currency market manipulation”, “undervaluation”, and so on; terms you should get used to because, if you haven’t heard them already, you will soon – probably ad nauseum – from the media outlet(s) of your preference). At present, the world generally, and the United States in particular, are beginning – increasingly in light of current U.S. and world economic difficulties – to feel the pinch of jobs and capital lost to China. And so there is escalating international pressure on the Chinese government to stop “artificially” devaluing its currency and let market conditions prevail (see, e.g., http://globalpublicsquare.blogs.cnn.com/2011/10/13/u-s-takes-aim-at-yuan/), and a number of countries, led, naturally, by the United States, are already beginning to talk about imposing economic sanctions (http://www.cfr.org/china/confronting-us-china-economic-imbalances/p20758). Therefore, it is becoming more difficult and less desirable every day for the Chinese to keep their currency value low. And at some point, probably in the very near future, China will have to begin allowing its currency value to rise, and to rise significantly (in fact, even with the Chinese government intervening vigorously to keep the RMB undervalued, it still appreciated by nearly 6% in 2010).
For over a decade now, the United States has been frenetically printing treasury notes and exchanging U.S. dollars for yuan; “borrowing” money from China. This behavior has produced the dual effect of devaluing U.S. currency and of transferring large amounts of Chinese currency to the United States (although, mostly thanks to our 90210 spending habits, we haven’t held onto nearly as much of it as we might have). So when the Chinese finally decide to raise their currency value, two things will happen: first, the value of Chinese currency – including that in U.S. hands – will increase dramatically, earning huge profits for anyone holding it in any significant quantity (ahem, Goldman Sachs, cough, Barclay’s, sneeze); and second, it will become correspondingly more costly to manufacture in China. Conveniently, since the United States has been devaluing its currency during the same period by printing and distributing trillions of dollars, it will become commensurately less costly for manufacturers (including domestic manufacturers) to produce in the United States – a condition which can fairly easily be augmented by providing additional fiscal (tax) incentives for manufacturers operating in the U.S. – thereby bringing capital investment, more than likely large amounts of it, and therefore much-needed jobs, to the United States.
Some (probably many) will argue that, even though the United States may in some ways stand ultimately to profit from these developments, borrowing as a matter of course is still unwise, and that the resulting inflation is highly undesirable at best. This is both understandable and an exceptionally lucid and rational argument. It is not the purpose of this essay to suggest that significant inflation is desirable – it certainly is not. But neither is high unemployment. And if the interminable fighting in the Mideast and recent high unemployment rates at home should have taught us anything, it is that the United States cannot continue to rely on foreign oil, either as a critical resource or as a means of bolstering its currency value, for much longer. And in order to base U.S. dollar value on something safer and more reliable, it is imperative that the United States become, once again, a production-based economy. This means bringing manufacturing, on a massive scale, back to the U.S., Which means, at least in the short term, bringing the value of the U.S. dollar back to a reasonable level – and keeping it there. Which means we will, at least for the foreseeable future, have to cope with some inflation, and with the reduction in standard of living that that entails.
In the meantime, please feel free to keep complaining about the so-called “debt crisis” and to vacillate over your nebulous and implausible fears about scary Chinese “communists” taking over the world. And I’ll keep buying Chinese currency so that a few years from now, when you’re employed at a lower real wage than you earn now and complaining after work into your empty beer glass about how expensive beer has suddenly become, I’ll be able to buy you another beer to console you, and help you through the hard times.