Twofish's Blog

January 13, 2010

Notes on Chinese inflation

Filed under: Uncategorized — twofish @ 1:48 am

I don’t see that much of a mystery. The primary way in which the Chinese government controls the economy is through reserve requirements, in which the banks are forced to take a huge amount of their wealth, and keep it in the form of government bonds. The “other liabilities” that you see on the PBC balance sheet consists of bonds issued by the PBC which it forces the banks to hold in as part of it’s required reserves.

Forcing banks to hold required reserves has two major goods point in that:

1) it makes the banks more resistant to shocks. If you have a massive drop in real estate prices, then you have the reserves to prevent a liquidity crisis while you figure out a way of recapitalizing the banks.

2) it gets you out of the liquidity trap. One reason that the Chinese economy bounced back very quickly from the recession, is that the PBC pushed down reserve requirements allowing banks to pump massive amounts of cash into the Chinese economy.

All of this requires a huge savings rate. If you don’t have savings then you can’t have the banks hold large amounts of reserves.

Quote: At some point, the PBOC will no longer be able to keep up this balancing act.

I’d be curious to know why not.

Quote: In theory, I think, it should be sustainable as long as Chinese firms remain profitable enough to finance themselves via retained earnings despite the fact that a big chunk of those earnings wind up metaphorically sitting in the PBOC coffers.

And I don’t see why this can’t continue for another generation. PRC companies have no shortage of capital which they use to build factories which increases productivity which creates more money that gets put into the bank. As long as productivity can be increased by capital expenditure, there isn’t anything that keeps things from growing.

All this will end when you have enough urbanization and capital investment at it’s that point that you might see either a Soviet or Japanese crisis, but that’s at least 20 years in the future. The other thing that will cause disruption is when you have retirees pull money out of the banks, but by that time, you have enough profitable factories so this is possible,

January 3, 2010

Disagree with Krugman, Fallows, and Pettis

Filed under: china — twofish @ 4:44 pm

Disagree pretty strongly with Krugman, Fallows, and Pettis about the RMB revaluation.  I think that they are vastly overestimating the amount of political pressure that exists in the US for protectionism, and making incorrect comparisons with the 1930’s.  There are a number of differences….

1) First of all, outside of some very specific industries, it’s not obvious to anyone that tariffs are going to help employment.  The problem is two-fold.  First is that you have many industries (Walmart and software) that benefit from cheap Chinese goods, and there are some major interest groups that have switched from being pro-tariff to anti-tariff over the last thirty years (organized labor).  The second issue is that a lot of the groups that would be protectionist really don’t care about China.  If you move Chinese factories to Indonesia, it won’t help anyone in the US.

2) Second, is that we have an international framework for trade now, and this limits what people can do.  In order to do something really drastic, the US would have to decide to pull out of WTO, which would be politically difficult because of factor 1).  There are too many people benefiting from international trade for the plug to be pulled.

3) Finally, I think that people vastly overestimate the importance of legislation and economic policy in globalization.  There hasn’t been any major trade liberalization legislation passed since the late 1990’s, and the many things that create globalization are technological.  I can be sitting in an office in NYC, and type on a computer in Hong Kong, and I do this pretty routinely.  Instant messaging, cheap phone calls, and jet travel have reduced the costs of international trade enormously and since the 1990’s, *those* have been the driving factors for trade liberalization, not legislation.

Having said that, personally I think that as a mechanism for resolving trade dispute, protectionist tariffs as a tools are *MUCH* better than currency revaluations.  The trouble with currency revaluations is that they always have massive global unpredictable effects.  Targeted industry specific tariffs within the framework of WTO are much, much less unpredictable.  Even when they cause bad things to happen, they tend to be known bad things, whereas tinkering with currency policy tends to cause generally unknown bad things to happen.  Having the US stick tariffs on Chinese steel might be annoying, but it’s not going to kill either the Chinese or US economy, whereas there is a laundry list of countries that have had their economies wrecked by bad currency policy.

So if it’s necessary to protect a class of politically sensitive constituents with tariffs, then I think it’s a good idea for the US or China to raise tariffs at that specific industry.  All of this can be discussed and negotiated within a WTO framework.  US puts tariffs on steel, China raises a counter tariff on something else, WTO blesses everything and we just carry on business. It’s especially good, because one you have tariffs to protect steel workers or textile workers, they aren’t going to care about tariffs in other areas.  You’ll only have problems if people want to try to raise tariffs on everything, but that would require pulling out of WTO, and you’ll blow up the industries that *do* generate jobs from trade.

This poses a general problem with macroeconomic solutions which is why I like industry-specific tariffs.  Macroeconomic solutions tend to be extremely blunt and can’t really be used to micromanage an economy.  If you have steel workers that are screaming at you, the only think that an economist can tell you to do is to do something like raise interest rates, which then changes the whole world in unpredictable ways.  If you just do targeted industry tariffs and then negotiate with your trading partners over what tariffs *they* can raise, then you end up with “known bad stuff” happening.

Create a free website or blog at