China cannot be the world's white knight
.jpg?itok=NnPHupUI&v=1664941948)
Can China save the world?
The past few weeks have seen an onslaught of proposals about the mainland's possible role in either overcoming or exploiting the global financial crisis. An article published last week in a London newspaper, for example, suggested Beijing use US$500 billion of its US$2 trillion foreign currency reserves to lend to the United States Treasury as part of the bank bailout, but with conditions that would serve mainland interests.
A rather militant mainland editorial a few days later suggested Beijing should stop helping the US out of its plight by refraining from buying more US treasuries. It even suggested that by seizing the right moment to sell US treasuries, it could make matters worse for the US and speed up China's relative rise.
As exciting as it may be to discuss these proposals and suggestions, many of them are based on misperceptions about foreign currency reserves and the balance of payments. There are four points that render most of the proposals meaningless.
First, foreign currency reserves are neither wealth nor even a proxy for wealth. They are simply accumulated net investment and trade inflows that the central bank purchases with money obtained from borrowing domestically. Reserves are a form of insurance policy needed mainly by countries that lack permanent access to the international capital markets. Developing countries accumulate large levels of reserves mainly to guarantee their access to imported commodities and to pay external obligations.
The mainland's US$2 trillion of reserves, by far the largest in the world, does not make it the richest country in the world. The total wealth of the US and Europe is many times greater than that of China but together have reserves equal to a fraction of the mainland's. On the other hand, the total economic value of China is far greater than its reserves, but it nonetheless remains a poor, albeit very large, country.
Second, reserves are not cash. They exist in the form of debt. When analysts looking at the mainland's US$2 trillion in reserves suggest that the mainland can 'use' this money to lend to the US or European governments, they fail to realise that this money has already been lent out. In that case, asking the US, for example, to repay US$500 billion of loans so that Beijing can lend the money to the US is fairly meaningless.
Third, in financial matters governments are not analogous to people. If I want to borrow money, I must find some other person to lend it to me, but if the US government wants to borrow money, it does not need to find a foreign government willing to lend. It is very easy for Washington to raise US$500 billion, or any other amount, by simply issuing debt, which would be purchased mostly by Americans but also by any number of foreign investors. No other country can raise large amounts of money as easily as the US can.
Fourth, and most importantly, trade and capital flows are inextricably linked - one causes the other, although the causality can be created at either end. If foreign capital stops flowing into the US, the US trade deficit must automatically disappear. Of course other countries' trade surplus with the US must automatically disappear too.
This has important implications. The decision to 'lend' money to foreigners, which is often not really a 'decision' since the lending countries have no choice if they want trade surpluses, is in China's case simply the obverse of a trade surplus with the US.
As long as Beijing chooses to run monetary and fiscal policies aimed at promoting exports to the US - and consequently runs a trade surplus - it has no choice but to finance the US trade deficit. It can choose between buying US Treasury bonds, investing in Manhattan real estate, buying stock, or even acquiring art by New-York artists. But in the end only the largest markets, such as the US Treasury market, can accommodate the sheer size of necessary mainland investments.
Most of what is said about China's putative role in responding to the financial crisis is, for these reasons, meaningless. Aside from the fact that the mainland itself has a very shaky domestic financial system and needs to worry more about escaping the ravages of the global crisis than about rescuing the world, its options are fairly limited. Its trade policies have been at the heart of the global imbalance and its own economy is one of the possible casualties of the crisis.
Given its own domestic susceptibilities and its willingness to act responsibly as one of the main players in the world of international finance, China's main contribution is to co-operate with international organisations and the governments and central banks of the major trading nations to bring stability to the markets.
The country should do what it can to boost domestic demand and to minimise dislocations in the international payments and financial systems, and all the evidence suggests it is doing exactly this. China is part of the crisis, not an interested bystander, and it cannot ride in on a white horse and save the world.
Michael Pettis is professor of finance at Peking University
