FAREED ZAKARIA GETS CHINA (MOSTLY) RIGHT

Fareed Zakaria has a very good piece on the CNN homepage right now that is helping to move us in the right direction by dispelling one of the great myths in modern economics – the myth that China owns the USA.

Fear is a powerful tool.  As I’ve described before, fear and discouragement are extraordinarily destructive assuming we allow ourselves to succumb.  This Chinese myth is often trotted out by people who: a) don’t understand how the monetary system works and/or b) people who are trying to scare you into believing their propaganda (such as here).

Mr. Zakaria goes to great lengths to try to show how the USA and China are dependent upon one another and essentially intertwined in a game of mutually assured destruction.  That’s how global trade works.  For every trade deficit nation there is a trade surplus nation.  It can be no other way.  One nation ships real goods and services.  The other receives pieces of paper in exchange.  The key part that is missing in Fareed’s piece is that the USA doesn’t need China to buy our bonds in order to continue operating.

You see, China chooses to import dollars because their corporations are able to employ millions of workers by doing business with US corporations.  These are jobs that their domestic economy cannot currently support.  So, if China wanted to stop importing US dollars they would also have to accept the fact that they are doing a lot less business with one of the world’s largest exporters.  That would be a lot like Home Depot telling homeowners they are no longer welcome in their stores.   More importantly, there just isn’t much that China can do with the dollars they import.  They can only buy US dollar denominated assets but as we’ve seen before, they aren’t exactly allowed to buy Chevron or US ports.  So what do they do?  They buy the safest bonds in the world.  And as we see every week in the bond auction data, these purchases by China aren’t making or breaking the bond market.  There’s no such thing as an autonomous monetary system in a floating exchange rate system requiring funding of any kind.

All in all, this works out to be a pretty fair trade-off for everyone involved (that’s why they call it “international trade“). China gets to strengthen their domestic economy as they piggyback off of a much larger economy, employ millions of workers and sustain high growth that will make them more prosperous.  In the meantime, they forego some of their domestic consumption by sending real goods and services abroad.   America gets the benefit of consuming real goods and services at reduced prices.

This all means several things.  First of all, China can’t crash the US Treasury market because it would be disastrous for their own economy.  And second, because China doesn’t “fund” our spending, they do not “own” the USA.  If the Chinese want to believe that they “own” us or that we “owe” them money then let them believe that (I think Timothy Geithner should offer to move all of their US T-bonds, what is in essence a savings account, into the equivalent of a US checking account to calm their concerns!).

In short, don’t let anyone scare you into believing the hype about China.  If you do, the only person you’re hurting is yourself.