The China Puzzle
Published: May 13, 2009
On Timothy Geithner’s first day as a Dartmouth freshman, while he was walking across campus on his way to register for classes in the fall of 1979, he heard a man speaking Thai — swearing in Thai, to be precise — from a balcony. Geithner found this amusing, because only a couple of months before, he left his home in Thailand, where his father worked for the Ford Foundation, to move to Hanover, N.H. So he stopped to talk to the man, who turned out to be David Keenan, a Chinese teacher at Dartmouth. The two quickly realized that they had a lot in common; among other things they attended the same schools, about a decade apart, in Bangkok and Delhi. (The cause of Keenan’s swearing, alas, has been lost to history.) Having established a rapport, Keenan then decided to do a little salesmanship. He urged Geithner to take Chinese, the only Asian language that Dartmouth offered at the time.
Geithner did, and found that he liked it. Learning another Asian language, he told me recently in his soaring office at the Treasury Department, “was a nice little piece of continuity for me.” He ended up majoring in government and Asian studies and taught basic Mandarin classes to make some money. After Dartmouth, he attended the School of Advanced International Studies at Johns Hopkins. He then spent three years at Kissinger Associates, working with Brent Scowcroft, the future national security adviser, and helping Henry Kissinger write chapters on China and Japan for one of his books. From there, he joined the Treasury Department and began a meteoric rise through the bureaucracy.
In the five months since Barack Obama introduced him as the next Treasury secretary, Geithner has already run through what seems to be a career’s worth of images: the brilliant technocrat whose appointment caused stocks to soar; the neophyte public figure who flopped in his debut; the regulator who has grown too close to Wall Street; the Obama adviser with the same unflappable nature as his boss. One image that hasn’t yet attached itself to him, however, is his original professional image. By training, Tim Geithner is a China hand. And though the immediate financial crisis is likely to dominate his tenure at Treasury, the economic relationship between the United States and China may ultimately prove just as important. It could be crucial to preventing the next crisis.
Over the past decade, China and the United States have developed a deeply symbiotic, and dangerous, relationship. China discovered that an economy built on cheap exports would allow it to grow faster than it ever had and to create enough jobs to mollify its impoverished population. American consumers snapped up these cheap exports — shoes, toys, electronics and the like — and China soon found itself owning a huge pile of American dollars. Governments don’t like to hold too much cash, because it pays no return, so the Chinese bought many, many Treasury bonds with their dollars. This additional demand for Treasuries was one big reason (though not the only reason) that interest rates fell so low in recent years. Thanks to those low interest rates, Americans were able to go on a shopping spree and buy some things, like houses, they couldn’t really afford. China kept lending and exporting, and we kept borrowing and consuming. It all worked very nicely, until it didn’t.
The most obviously worrisome part of the situation today is that the Chinese could decide that they no longer want to buy Treasury bonds. The U.S. government’s recent spending for bank bailouts and stimulus may be necessary to get the economy moving again, but it also raises the specter of eventual inflation, which would damage the value of Treasuries. If the Chinese are unnerved by this, they could instead use their cash to buy the bonds of other countries, which would cause interest rates here to jump, prolonging the recession. Wen Jiabao, China’s premier, seemed to raise this possibility in March, in remarks to reporters at the end of the annual session of China’s Parliament. “We have lent a huge amount of money to the U.S.,” Wen said. “Of course we are concerned about the safety of our assets. To be honest, I am definitely a little worried.” In all likelihood, this was mostly posturing. Were China to cut back sharply on its purchase of Treasury bonds, it would send the value of the bonds plummeting, hurting the Chinese, who already own hundreds of billions of dollars’ worth. Yet Wen’s comments, which made headlines around the world, did highlight an underlying truth. The relationship between the United States and China can’t continue on its current path.
It has already helped create the global economic crisis, by splashing cheap money around the world and enabling American indebtedness and overconsumption. This country is now suffering through its worst recession since the early 1980s, one that could ultimately become the worst since the Great Depression. In China, the collapse of global trade has eliminated 20 million jobs along the industrial southern coast, according to Beijing’s official numbers. One Obama adviser told me the real number may be much higher.
So putting the global economy onto a more sustainable path will require dealing with the imbalances between China and the United States. In the broadest terms, this will mean that Americans must consume less and that Chinese must consume more. Domestically, Obama’s economic agenda is organized around the first half of this equation. He has said that economic growth must rely less on consumer spending than it has, and he is pushing for a series of investments — in education, science, medicine and alternative energy — the fruits of which are meant to replace consumption. But those fruits won’t mature as quickly as American households are paring back. For the sake of the global economy, persuading China to consume more will be crucial, too. It will also make a big difference to China’s 1.3 billion citizens. Most are still poor enough that consumption doesn’t mean yet another Barbie or iPod; it means basic comforts, like medical care and transportation.
Moving to an economy based more on consumption and less on exports happens to be the policy of the Chinese government, and has been since 2003. Its latest five-year economic plan, announced in 2006, was organized around the idea. “The biggest problem in China’s economy,” Wen said in 2007, “is that the growth is unstable, imbalanced, uncoordinated and unsustainable.” Remarkably, though, the Chinese economy has become even less reliant on household spending, and even more reliant on business and government spending, in recent years. Consumer spending now makes up about 35 percent of China’s gross domestic product, down from 40 percent in 2004 and almost 50 percent in the early 1990s. By comparison, the share is 54 percent in India, 57 percent in Europe and 70 percent in the United States.
The challenge for Geithner and the rest of the Obama administration, then, is persuading China to live up to its own five-year plan.
Given Geithner’s history with China, his tenure as Treasury secretary could hardly have gotten off to a worse start. As part of his confirmation process, senators gave him a long list of written questions. One question was from Charles Schumer, the New York Democrat who has frequently criticized China for artificially holding down the value of its currency, the renminbi, who asked Geithner whether the U.S. should confront China on the issue. Geithner replied, in writing: “President Obama — backed by the conclusions of a broad range of economists — believes that China is manipulating its currency.”
The answer immediately became the big story about the confirmation hearing. It seemed to signal that the Obama administration would take a tougher line than the Bush administration on probably the most sensitive subject between the two countries. Many Chinese leaders were incensed.
Foreign-exchange rates are maddeningly complex, but the debate over the renminbi is really just a part of the broader issue of the economic imbalances between China and the United States. When a country exports more than it imports, as China has, the value of its currency tends to rise. Exports then become more expensive (and thus decline), while imports become relatively cheap (and increase). It’s a self-correcting system that, theoretically, prevents big trade gaps between countries. But China has frequently intervened in the foreign-exchange markets to hold down the value of the renminbi and keep its exports booming. It has become less aggressive about doing so over the past few years, responding to international pressure, and the renminbi has risen more than 20 percent relative to the dollar. Still, many American economists say that it still appears to be undervalued by about 10 to 20 percent. The Chinese tend to take umbrage at this analysis, because it suggests their boom has come at the expense of others.
Against this backdrop, Geithner’s debut as Treasury secretary struck a nerve in China. It was also personally painful for him. In the four months since, he has set out to undo the damage. After the hearing, administration officials quickly put out the story that the words about manipulation weren’t really Geithner’s. They were written by a midlevel staff member, who was helping Geithner answer the hundreds of written questions from senators. Geithner, staff members said, did not mean to signal a new hard line.
Once in office, Geithner himself also began reaching out to the Chinese. “I have talked to my counterparts in China over the past few months much more than I’ve talked to my counterparts from any other country,” he told me. During the G-20 meetings in London last month, he traveled to the Mandarin Oriental Hotel for a late-night meeting in the suite of Vice Premier Wang Qishan. The two have also spoken regularly by phone. When I asked Geithner whether his language skills were good enough to make translators unnecessary, he laughed and said it had been a long time since he taught Mandarin. But he and Wang still seem to have developed a tentative rapport, thanks in part to their similar backgrounds. Wang has been nicknamed the Fireman because, like Geithner, he owes his rise to the work he has done on various economic crises. “He’s my kind of person,” Geithner said, “pragmatic” — the ultimate compliment in the Obama circle — “very direct.”
Frequent as the conversations with the Chinese have been, though, their content is telling. They have not focused on the imbalances in consumption and trade. Instead, the discussions have been about the comparatively tame issue of what the two countries have been doing to stimulate the global economy. Unlike most European countries, the United States and China have enacted big stimulus programs. Geithner has also walked Wang through the administration’s plan for bringing down the budget deficit in the future, which is meant to assuage Chinese fears that the dollar, and the value of Treasury bonds, could crash.
Since Geithner’s confirmation hearing, the Obama administration’s general approach to China has been something of a charm offensive. When Secretary of State Hillary Clinton went to Beijing in February, she made sure to avoid any suggestion that she was criticizing the government’s human rights record, as she did during a 1995 visit as first lady. At his G-20 bilateral meeting with Chinese leaders, Obama described China as “a great power,” a phrase Wen is fond of using. And when the Treasury Department issued its annual report on foreign currencies in mid-April, it concluded that China was not manipulating its currency. Instead, Geithner praised China for taking “steps to enhance exchange-rate flexibility,” a reference to the recent rise in the renminbi.
The message that has been coming from Beijing, meanwhile, has sounded almost hostile. In the weeks that followed Wen’s comments at the end of the Parliament session, Chinese leaders made clear that the aggressive posture wasn’t a one-time event. In late March, Zhou Xiaochuan — the head of China’s central bank and the senior official who’s closest to Geithner — gave a speech suggesting that the dollar be replaced as the world’s reserve currency. In late April, the minister of commerce published an op-ed in The Wall Street Journal saying that American complaints about China’s trade policy would “seriously test China-U.S. economic and trade relations.”
The most remarkable aspect of these remarks is how much of a departure they are from China’s usual stance. Deng Xiaoping, the Chinese leader who ushered in its market reforms starting in the late 1970s, famously gave his country the following advice: “Observe calmly; secure our position; cope with affairs calmly; hide our capacities and bide our time; be good at maintaining a low profile; and never claim leadership.”
Obama administration officials take comfort in the fact that the Chinese haven’t followed up their confrontational words with confrontational actions. This seems to indicate that the words are intended to soothe a domestic audience upset about job losses more than they are a sign of actual policy (much as Geithner’s and Obama’s rhetoric on trade is). But if nothing else, the last few months have suggested that China is no longer content to maintain a low profile.
When economists describe the relationship between China and the United States, it often sounds circular and even permanent. We save too little and they save too much. They export too much and we consume too much. The situation can seem to be a reflection of Chinese and American cultures, with their respective attitudes toward thrift and hedonism.
Yet the huge imbalances between the two economies are actually a very recent phenomenon. Throughout most of the 1990s, China’s current account surplus — the value of exports minus the value of imports — equaled less than 2 percent of its gross domestic product. As late as 2001, this surplus was only 1.3 percent of G.D.P. But then it began soaring. Last year, it was 10 percent of G.D.P., according to the World Bank. In more concrete terms, China sold $338 billion worth of goods to American consumers and business, more than the combined annual revenue of Microsoft, Apple, Coca-Cola, Boeing, Johnson & Johnson and Goldman Sachs. American businesses sold only $71 billion to the Chinese.
How did this happen? Nicholas Lardy, a China expert at the Peterson Institute for International Economics in Washington, compares the relationship to that of an addict and a drug dealer. Americans became hooked on cheap goods and cheap money, and China came to depend on the income from selling those goods. Chinese leaders didn’t set out with a grand plan to create an enormous trade gap, Lardy argues, but each step along the way seemed to make sense. “I think they genuinely fell into this,” he says. The authoritarian government could stifle dissent with jobs. Local party leaders were rewarded for presiding over economic growth, and exports were the easiest way to achieve it. Once the export sector was built up, the cost of allowing the renminbi to appreciate was enormous.
If you think of the exports as the first link in the causal chain, the resulting pile of Chinese savings is the second. Much of this savings has been by the corporate sector, which is subsidized by the government in all sorts of ways (an undervalued currency, low interest rates, cheap energy). The economic boom brought big profits, and companies held on to much of them. The government has also increased its savings in this decade by collecting more taxes and, until the financial crisis, running a budget surplus. And households increased their own savings in the 1990s, in reaction to the dismantling of many bloated state-run companies and the cradle-to-grave benefits, known as the “iron rice bowl,” they once provided to their workers. When a Chinese citizen is rushed to the hospital after a car accident today, the first stop for the victim’s family is often the cashier’s window. Many hospitals won’t admit patients until they have paid, and many families have no health insurance. Instead, they insure themselves, by saving.
These vast piles of savings have made up the crux of what Ben Bernanke, the Federal Reserve chairman, has called the “global saving glut.” By this telling, the imbalances can seem to be overwhelmingly China’s fault. But that’s not really the case. Just as policy makers in Beijing encouraged the rise in savings and exports, American policy makers took steps that encouraged overconsumption. They allowed incomes for most families to stagnate, which made savings a luxury that many couldn’t afford and debt a way to finance rising living standards. Alan Greenspan and, to a lesser extent, Bernanke encouraged a series of financial innovations, like cash-out mortgage refinancings and interest-only mortgages, that tempted people to spend more and save less. Washington pretended — even argued — that there was no housing bubble. As Justin Yifu Lin, a Chinese economist who became the World Bank’s chief economist last year, says, “You can’t put this all on China.”
Even more to the point, China, like the United States, is now paying a price for the two countries’ co-dependent relationship. The coastal cities that experienced tremendous booms over the past decade are struggling with mass unemployment. Millions of recent college graduates, the demographic that often starts protest movements, are unemployed across China. Stocks have fallen more sharply than they have here. These are the consequences of the unsustainable growth Wen worried about in 2007. And they provide the Obama administration with perhaps its one compelling argument for why Beijing should listen to their advice: It’s in China’s interest.
“There is symmetry,” Geithner says. “We want the world to emerge from this with a different balance of domestic and export growth, here and around the world, and we want recovery to be a little less driven by the U.S. consumer, both for our purposes as well as for the world.” A more vibrant consumer economy in China would, by definition, mean spreading more of the bounty from China’s boom to its masses, rather than allowing it to pile up in corporate or government coffers. A better safety net would give households enough peace of mind to spend their money. The Chinese consumer could begin replacing some of the spending that had been done by the once-indefatigable American consumer. This spending would benefit companies all over the world, but none more than those in China.
At the end of a discussion with Lardy about the imbalances between the U.S. and China, I asked him what forms of leverage he thought the Obama administration had. “We have no leverage,” he replied. He then couched this slightly, saying that the administration could threaten the Chinese with trade barriers but that such threats weren’t likely to be very credible.
Geithner had told me that he considered Lardy one of the more insightful China analysts, and so I repeated the point about leverage to Geithner and asked for his reaction. He made it clear that he essentially agreed. “When I was last in this building,” he said, referring to his time as an international expert in the Clinton Treasury Department, “I was always thinking, What’s our next point of influence, of leverage?” But he could rarely find a good one.
Geithner then mentioned reading an old newspaper interview with Michel Camdessus, the head of the International Monetary Fund in the 1990s. Camdessus’s tenure included the Asian financial crisis and Mexican peso crisis, and some European leaders were unhappy about the extent to which the I.M.F. followed the advice of American policy makers, Geithner among them, in managing these crises. Geithner recalled that when the interviewer asked about this, Camdessus replied that America had influence disproportionate to its weight in the institution only when it had an idea others were willing to follow. The Camdessus strategy — make sure you have an idea worth following — will be the Treasury Department’s approach to China.
The strategy actually dates to the Bush administration and a series of meetings with Chinese leaders that Henry Paulson, Geithner’s predecessor, helped set up. If Obama’s advisers admire one aspect of President Bush’s economic policy — and coming up with another isn’t easy — it’s the effort to nurture a relationship with China. The meetings, which began in 2006, were called the Strategic Economic Dialogue. For the first sessions, Bernanke accompanied Paulson as a demonstration of respect to the Chinese and a sign of how seriously United States viewed the agenda. American and Chinese officials are now negotiating the logistical details of the next round of the dialogue, which will be jointly led by Geithner and Clinton. Internally, officials from State, Treasury and elsewhere in the administration have been jockeying for influence over China policy. But they all seem to agree that one of the main goals of the dialogue is to bring a wide variety of important Chinese officials — including those who represent industries and regions that have benefited from the imbalances — into the same room for the talks.
During the initial 2006 meetings, in a speech at the Chinese Academy of Social Sciences in Beijing, Bernanke laid out the essential parts of the argument that the Americans are likely to make this year. He began by ticking off what he called China’s “remarkable accomplishments”: the quintupling of per capita economic output, the lifting of 200 million people out of poverty and the like. But then, in the polite, technical manner of a central banker, he turned to its imbalances. He argued that by overinvesting in heavy industry, China had failed to grow as quickly as it could have (and to create more jobs for its people). It was devoting significantly more of its output to such investments than Japan or South Korea had during their respective rises in the 20th century, yet China was growing no faster than they had. That ran counter to economic theory and suggested, though Bernanke didn’t say so in these terms, that China was wasting resources. Rather than spreading the bounty of its boom and allowing households and businesses to find productive uses for it, China was spending so much on heavy industry and its export sector that it was necessarily propping up weak businesses. In 2006, this argument might have sounded like nit-picking. It doesn’t today.
There have recently been some signs that China has become more serious about dealing with its imbalances. For the first time since 2000, its trade surplus shrank, relative to G.D.P., last year. Late last year, China also cut taxes on fuel-efficient vehicles, which led to a surge in sales that helped Chinese consumers surpass American consumers, at least for now, as the world’s largest purchasers of vehicles. China’s economic planners also seem to have focused more in the last few years on highways and other infrastructure that would help households and sectors other than industrial ones. David Loevinger, the Treasury Department’s representative in Beijing, told me that when he visited the Great Wall recently, he drove on a highway that didn’t exist a year ago. And China has announced a plan to provide health insurance to hundreds of millions more people over the next three years. Jim O’Neill, the chief economist of Goldman Sachs, recently wrote that the health care expansion could prove to be “the most important development in the world economy.”
Geithner, along with other administration officials, insists that he is cautiously optimistic about the path China is on. And that’s understandable. It’s not especially pleasant to think about what the global economy will look like if China and the United States fail to fix their dysfunctional relationship.
The frequent flares of social unrest in China could spread, and the government could decide that its short-term problems take precedence over its long-term ones. It might then try to stimulate its economy at the expense of everyone else — the beggar-thy-neighbor approach — by reversing the recent rise of the renminbi, lavishing new subsidies on exporters and restricting imports. In an otherwise optimistic article in a recent issue of The Atlantic Monthly, James Fallows, an American writer living in China, pointed out that the United States followed a similar protectionist strategy during the Great Depression. As a big exporter, it felt the need to help its struggling manufacturers. Other countries soon retaliated, and the depression deepened.
For China, such a strategy would resemble a doubling down. It would benefit the same parts of the economy — the industrial sectors, the coastal south, the wealthy — that have already done the best. Living standards for the rest of China would continue to grow more slowly than the pace of economic growth suggests they should.
For the rest of the world, China’s retreat would mean slower growth. The much-anticipated day when the Chinese middle class became a global economic force would be pushed back. If China remained committed to a smokestack growth policy, the efforts to slow climate change would become all the more difficult. China’s energy needs have already caused it to become closer to the governments in Iran and Saudi Arabia, and if China moved even closer, it could further complicate the already complicated balance of power in the Middle East.
Here in the United States, we could delude ourselves into thinking that our consumer economy really was sustainable. We could put off the hard choices, and sacrifice, that will inevitably be part of building a new one. There may not be a single one of the world’s most vexing problems, in fact, that isn’t aggravated by the imbalances between the United States and China.
In an odd way, that reality makes Obama’s advisers more hopeful. Jeffrey Bader, who now runs the East Asian affairs office for the National Security Council, has pointed out that China has made a series of choices since Deng’s reforms — allowing more imports, joining international organizations, building ties with foreign governments it previously tried to overthrow — that were all “designed to be supportive of the existing order.” Geithner makes the same point: “They have a deep stake in the system now. And they recognize this.”
So it’s only reasonable to think that the United States and China will figure out how to solve their problems. Unsustainable economic trends are just that — unsustainable. But they can, unfortunately, cause a lot of damage before they are resolved.
David Leonhardt is an economics columnist for The Times and a staff writer for the magazine. His most recent article was an interview with President Obama.