America and China have a problem. A very big multi-trillion dollar problem that shows no sign of going away whatever the financial crisis throws at it. China's huge holding of US dollars has been built up over years as US consumers snapped up Chinese goods and Beijing built an economic power house off the back of those exports.
This relationship was at the heart of the global growth story in the build up to the 2007 credit crisis and ultimately led to a global imbalance that no one would now deny needs to be, as the economists would put it, rebalanced. But when you owe a country around $2 trillion, actually making this happen is not easy even if the will is on both sides, which it is not.
A New Economic Order
Barack Obama has on numerous occasions since the G20 meeting in London warned that the American people will no longer be the consumer of last resort for the rest of the world. He wants other countries like China, Germany and Japan to pick up the slack that a more frugal America would leave. Faced with the prospect of having to raise trillions of dollars via the bond markets over his first term Obama is looking for an exit strategy from his trade deficit at a time when his budget deficit is set to balloon to historic levels.
The authorities in Beijing view this shift in policy from Washington with trepidation. They say if you owe the bank $100 then it is your problem but if you owe the bank $1 million then it is their problem. When the numbers you are owed are close to $2 trillion then you have an unprecedented problem.
The Chinese economy has weathered the crisis better than any other major economy as the authorities have used their huge cash pile to throw money at infrastructure spending and consumers and businesses via the Chinese banking system. The problem with this policy is that is does not take into account the new reality of the US position. Stephen Roach, the Morgan Stanley economist and one of the world's most famous bears says in his new book, The Next Asia, that this policy shows "worrisome signs that China just doesn't get it, that it is clinging to an antiquated policy and economic growth strategies that presuppose a classic snapback in global demand."
China Does Get It
Roach is correct to criticize China's recent stimulus spending on those grounds, but he may be wrong to say that policy makers in Beijing do not "get it". The Chinese know there is a problem but in the midst of the recent crisis had little option but to throw money at the economy in ways that would shore up demand that had collapsed when the US consumer cut back on spending.