China's Economic Threat

In my previous blog I wrote about the transition of the Chinese economic system from a state-owned and controlled model to a more western style free-market economy. In this blog I explore the implications of an ever-expanding Chinese economy for the U.S.

In a sense the Chinese government uses the free-market model to get what it wants -- an ever-expanding economic influence around the world and growing political force to be reckoned with. The increasing power of the Chinese economy equates with increasing state power, and it is essential to maintain stability and growth thereby ensuring continued Communist party rule.

A question that has been frequently raised the past few years is whether China is playing by the rules of the game or exploiting government policies to keep the Yuan (Chinese currency) artificially low to enable Chinese exports to be unrealistically low in price while making the imports of other countries relatively expensive. You can do those things when the government has a major role in running corporatized state-owned-enterprises (SOEs). Most of the rest of the world allows its currencies to freely float on the foreign exchange market. Western critics claim that China's practices are a form of mercantilism aimed at piling up wealth by manipulating trade. They point to China's $2.6 trillion in foreign-exchange reserves.

So, what is China doing with the enormous amount of foreign reserves? Today, it is largely invested by sovereign-wealth funds and by purchasing rich countries' (read U.S.) government bonds. Tomorrow, it could be used to buy companies and protect China against possible devaluations and defaults of wealthy countries. Chinese firms own just 6% of global investment in international business compared to the peak ownership of 50% by the U.S. in 1967.

Some countries fear China's moves to acquire natural resources to ensure its continued economic growth and development. The nationalistic fervor in response to such deals has killed a few of them. Most notably in 2005, CNOOC, a Chinese oil firm, withdrew a bid for Unocal, a Californian producer, after American politicians weighed in on the worrisome loss of national control over the country's own resources. In 2009 Rio Tinto, an Anglo-American mining firm, withdrew from a deal to sell a series of minority stakes to Chinalco, a Chinese metals firm, after Rio's shareholders (and some claim the Australian government) opposed the sale.

So, should we fear the Chinese or welcome it with open arms? It's not an easy question to answer. On the one hand, where would we be today without China buying up our government debt and financing the deficit? On the other hand, what happens if China sells off their investment in U.S. government securities or uses it as a stick to exert more and more influence over our economy? Given America's appetite for imported goods including those from China, would it be a good thing for the American consumer if Chinese goods were made more expensive by "forcing" the Chinese to loosen its controls over the YUAN? Do we really think China would import more from the U.S. if the value of the dollar were to weaken in relation to the Yuan? The fact is the Chinese have us just where they want us. We need them more than they need us. It's not China's fault. We're to blame because of our attitude of spend, spend, spend that existed prior to the financial crisis of 2008. We're to blame because of our ever-expanding entitlement programs and involvement in two wars that has mushroomed the national debt. Finally, we wanted and supported the Chinese in its movement towards a more market-oriented economy. We shouldn't blame them because they have been beating us at our own game.