All Paulson can do is buy time before Americans stop buying

PUBLISHED : Friday, 04 April, 2008, 12:00am
UPDATED : Friday, 04 April, 2008, 12:00am

US Treasury Secretary Henry Paulson sought to calm Beijing's concerns over the US credit crisis when he met mainland leaders yesterday.

SCMP, April 3

And having calmed Beijing's concerns over the credit crisis he promptly stirred up its concerns over the Olympics again. Why does a US Treasury secretary think that Beijing's relations with Tibet have anything to do with him? Does the US no longer have an ambassador in Beijing?

But let's leave this aside. I myself have nothing worthwhile to contribute to any debate on Tibet. What concerns me is the nature of Beijing's concerns over the US credit crisis.

The most immediate concern must be Beijing's direct one as a creditor. It has US$1.65 trillion in foreign reserves, the vast bulk of it in US dollar instruments and the majority of this, in turn, in debt instruments.

But Beijing has so far always insisted that it has only a slight exposure to the mortgage-backed securities that are most at risk in the overall US credit crisis. I think we can safely assume the bulk of the US dollar investment is in US government debt issues and these are not at risk or, at least, will soon no longer be. George W. Bush leaves the White House in 10 months.

The next most immediate concern must be the continuing weakness of the US dollar against almost all currencies, which has forced Beijing to allow the yuan to appreciate further and faster against the US dollar than was earlier envisaged.

But little as any US Treasury secretary can do about matters in Tibet there is even less he can do to stop the dollar from sliding when a credit crisis sends the US economy into recession.

If there is anyone in the US government who could do anything in this respect it would be Federal Reserve chairman Ben Bernanke and he hasn't yet taken his helicopter to Beijing.

But I think the biggest concern is one about which Mr Paulson can really do nothing at all.

One of the features of the credit market in the US is the way that so many homeowners spend unrealised paper profits on their homes through credit card purchases in big box stores. You would expect this practice to end abruptly with US housing prices now tumbling, particularly when, as the first chart shows, you also see the expectations measure of the US consumer confidence index at a 30-year low.

But only car sales out of all the major segments of US retail sales show any signs of slowdown and China does not sell cars to the US. The growth rate of US retail sales excluding cars is in fact rising, as the second chart shows.

This is a puzzling anomaly. All the other evidence says that the subprime crisis has truly shaken the US financial system and that the US is entering a recession.

Yet here is evidence that US consumers do not seem to notice or care.

I think we have to assume that this is a delayed reaction alone, that US consumers will soon feel the bite of recession, that their purchases will decline and this will have a profound effect on the sales receipts of big box stores.

For big box stores, read China's exports to the US and, if these start to decline, there will be immediate knock-on effects on the mainland. Industrial production growth in Guangdong, for instance, is already weak because of rising costs and protective legislation. There could well be a contraction here, the first in decades, and Guangdong would not be alone.

Then there would be knock-on effects on the financial position of big exporters with consequent knock-on effects on the financial position of lenders and of equity investors, all this at a time when rising inflation is undermining economic growth.

It's not a welcome scenario but it is one that the authorities in Beijing must have in mind if they have any concerns about the US credit crisis.

Trouble is that Hank Paulson can do nothing to push US consumers back into the shops if they don't want to go there and nothing to stop the knock-on effects of this on China's foreign trade. What we have here is another pointless Paulson visit.