I should be really pleased with Thomas Friedman's column today. Entitled "In MItt's World," Friedman pens a substantive column criticizing Romney's foreign policy rhetoric to date and wishing that Romney displayed the same analytic acumen about foreign policy that he displayed as CEO of Bain Capital.
So I should be happy, except that I passed out from banging my head against my desk after reading the first two paragraphs:
Mitt Romney has been criticized for not discussing foreign policy. Give him a break. He probably figures he’s already said all that he needs to say during the primaries: He has a big stick, and he is going to use it on Day 1. Or as he put it: “If I’m president of the United States ... on Day 1, I will declare China a currency manipulator, allowing me to put tariffs on products where they are stealing American jobs unfairly.”
That is really cool. Smack China on Day 1. I just wonder what happens on Day 2 when China, the biggest foreign buyer of U.S. debt securities, announces that it will not participate in the next Treasury auction, sending our interest rates soaring. That will make Day 3 really, really cool.
No. No, no, no, no, no, and no.
To elaborate a bit further:
First, it wouldn't be enough for China to stop buying Treasuries -- as Joe Weisenthal showed with some fun charts a few weeks ago, China has pared back its Treasury purchases intermittently over the past few years -- with zero appreciable effect on U.S. interest rates. (see non-panda-hugger Paul Krugman on this point as well). No, for China to have the effect that Friedman envisions, they would also have to actively dump most of their holdings of U.S. debt as well.
So what if they do? Well, second, while Romney's stated China policies border on the destructive, the "labeling" move is bone-headed rather than truly calamitous. China wouldn't dump its debt unless things got really bad between the two countries. Not even Stephen Roach thinks this would be the initial Chinese response -- and I think Roach is being way too gloomy about Sino-American relations under Romney.
The reason China won't respond with the nuclear option of dumping all its U.S. debt holdings is that -- to repeat a theme -- this move would hurt China way more than it would hurt the United States. The far more likely response by China would be to retaliate with trade measures. This would not be good, as China is now the third largest export market for the United States. Beijing can hurt a Romney administration by reducing its American imports far more adroitly than trying to trigger another financial crisis.
Now, for the record, I don't think Romney should label China as a currency manipulator on day one, and I think Friedman makes some trenchant observations on Romney's consequences-free foreign policy statements later in his column. But this Niall Ferguson-lite version of Sino-American relations is bad international relations theory and really bad economics -- and yet Very Serious People keep trotting it out.
I really, really wish this would disappear from public discourse. But it won't. So, most likely, my desk is gonna get dented a few more times before Election Day.
Yesterday your humble blogger gave a talk about the state of the 2012 presidential race to a group of
really rich people international institutional investors. At the end of the talk, the convener asked for a show of hands about who they thought would (not should) win the race, and an overwhelming majority said Obama. In talking to the organizers, I learned that this was the sentiment of other groups of overseas bankers that had met earlier in the month. Indeed, there was apparent surprise at the suggestion that Mitt Romney could actually win.
Why did this sentiment exist? I don't think it had much to do with ideology -- we're talking about the global one percenters here. Based on my conversations, I think it was based on a few stylized facts:
1) The U.S. economy is outperforming almost every other developed economy in the world;
2) They assume that in times of uncertainty, Americans will prefer the devil they know rather than the devil they don't;
3) President Obama's foreign policies seem pretty competent;
4) Mitt Romney's policy proposals either seemed really super-vague (this will be an American Century) or, when specific (designating China as a currency manipulator) made him seem like an out-of-date clown.
So, consider the following a Global Public Service Announcement from the hard-working staff at this blog:
Dear Rest of the World,
Hey there. I understand that the overwhelming lot of you believe Barack Obama will be elected to a second term. I can sorta see that, as that is the current prediction from recent polls, some of our prognosticators and prediction markets. If you look closely, however, none of these predictions are very strong. Or, to put it as plainly as possible: there is still about a 50/50 chance that Mitt Romney will be sworn in as president in January 2013.
I can hear your derisive snorts from across the oceans. Ridiculous! Surely Americans would reject such ludicrous ideas as a trade war with China. Surely Americans understand that their economy has done pretty well in comparison to the rest of the world. Surely Americans can see that many long-term trends are pretty positive.
Valid questions. To which I must respond: The overwhelming majority of Americans do not give a flying f**k about the rest of the world.
Really, they dont. Take a look at these poll numbers about priorities for the 2012 presidential campaign, and try to find anything to do with international relations. There ain't much. It's almost all about the domestic economy.
See, most Americans don't compare the U.S. to other major economies -- they compare the U.S. now to, say, the U.S. of 2005. And things don't look so hot based on that comparison. As for the notion of a trade war with China, go read how Americans feel about absolute vs. relative gains with China -- they'll superficially welcome a trade war, when they bother to even think about it. Which they don't.
As for foreign policy or counterterrorism, yes, you could argue that the Obama administration has been pretty competent. But, again: Americans. Don't. Care. If anything, the foreign policy competency removes the issue from the campaign, and just concentrates the minds of everyone on the state of the domestic economy.
The fundamental fact of this election is that the American economy is pretty sluggish, voters blame the incumbent when that happens, and the incumbent happens to be Barack Obama. Indeed, it is only because Obama is seen as pretty likable -- and that voters do still tend to blame George W. Bush for the current situation -- that this race is even remotely close.
I'm not saying Mitt Romney is gonna win. If the economy picks up over the summer, Obama should win pretty handily. However, you, the smart money, should think about it this way: what are the chances that between now and November, none of the following will happen: another Euro-implosion, a rapid deflating of the China bubble, or a war in the Middle East? If you're confident that these events are not in the cards, bet on Obama. If any of them happen, all bets are off.
Will it matter to you? Think of it this way: compare and contrast who Mitt Romney would pick as the next Fed chairman versus Barack Obama. And plan accordingly.
Enjoy the summer! All the best,
Daniel W. Drezner
Am I missing anything?
Periodically, Reuters' Emily Flitter files a story on the Sino-American financial relationship that contains great reporting. Unfortunately, analysts and pundits often take that reporting and misinterpret what it means. The hardworking staff at this blog hereby dubs this phenomenon The Flitter Warning.
Her latest story, which got the Drudge link and was widely linked to, reveals that China no longer has to go through Wall Street to buy U.S. Treasuries:
China can now bypass Wall Street when buying U.S. government debt and go straight to the U.S. Treasury, in what is the Treasury's first-ever direct relationship with a foreign government, according to documents viewed by Reuters.
The relationship means the People's Bank of China buys U.S. debt using a different method than any other central bank in the world....
China, which holds $1.17 trillion in U.S. Treasuries, still buys some Treasuries through primary dealers, but since June 2011, that route hasn't been necessary.
The documents viewed by Reuters show the U.S. Treasury Department has given the People's Bank of China a direct computer link to its auction system, which the Chinese first used to buy two-year notes in late June 2011.
China can now participate in auctions without placing bids through primary dealers. If it wants to sell, however, it still has to go through the market.
The change was not announced publicly or in any message to primary dealers.
Now, this sounds like China is getting some kind of sweetheart deal, or at a minimum preferential treatment in its dealings with the U.S. Treasury, which ruffles the feathers of the easily ruffled. The Blaze, for example, suggests: "Considering the fact that China is America’s greatest creditor, as well as the fact that they are becoming increasingly antagonistic in cyber security attacks, maybe – just maybe – granting the Communist country a direct computer link to the treasury auction system isn’t the wisest decision."
A closer look at Flitter's story, however, reveals a more nuanced picture. First, China isn't getting a direct discount by bypassing Wall Street. As Flitter notes, "Primary dealers are not allowed to charge customers money to bid on their behalf at Treasury auctions, so China isn't saving money by cutting out commission fees." On the other hand, China is likely saving some money by keeping Wall Street a little more in the dark about its buying intentions (and thereby preventing traders from driving up the price of securities China intends to purchase).
Second, and this is really important -- Flitter fails to explain an important strategic reason why the United States might agree to this arrangement. She proffers two possibilities. First, that because this financial relationship is so politically sensitive, both sides have an incentive to keep the depths of it under wraps. Second, U.S. Treasury officials want to make the Chinese purchasers of U.S. debt happy.
I'd suggest a third -- through this arrangement, U.S. officials now have better data on just how much debt China is purchasing. For years, Beijing has tried to conceal the extent of its U.S. debt purchases by going through intermediaries in London and elsewhere (see this Setser and Pandey paper for more on the details). Flitter notes in her story that "in 2009, when Treasury officials found China was using special deals with primary dealers to conceal its U.S. debt purchases, the Treasury changed a rule to outlaw those deals."
This arrangement seems like a win-win deal to me. China, by bypassing Wall Street, saves a bit on its debt purchases by not moving the market so much. The United States, by dealing with Beijing directly, gets more accurate information on just how much U.S. debt China is purchasing. Flitter's reportage, in other words, simply confirms the existence of mutual interdependence between China and the United States, not asymmetric dependence. Which sounds... awfully familiar.
So, let the Flitter Warning go forth -- interesting new facts, but not much to worry about here.
There's a lot that's happened over the past week with respect to Chen Guangcheng's status, and your humble blogger could write a 5,000 word essay on it if
someone wanted to pay me gobs and gobs of cash because I'm remodeling my home I had the time. I don't however, so I have one big thought on the matter.
Before I begin, given the rapid real-time developments in the Chen case, I'm operating on the assumption that China's last Foreign Ministry statement suggests the denouement: Chen and his family will be able to go to the United States to study, and he then may or may not be allowed back into the country.
My Big Thought: contrary to just about every headline I've seen in the past three days, I think Chen's case demonstrates the surprising resilience of the Sino-American relationship. Recall what I wrote earlier in the week:
The fact that both Beijing and Washington have kept their mouths shut on Chen is a pretty surprising but positive sign about the overall stability/resilience of Sino-American relations. Bear in mind that according to the latest reports, much of the leadership in Beijing takesan increasingly conspiratorial view of the United States. As for the mood in Washington, well, let's just call it unfriendly towards China. Both sides are in the middle of big leadership decisions, making the incentive to cater to nationalist domestic interests even stronger than normal. With the rest of the Pacific Rim trying to latch themselves onto the U.S. security umbrella, this could have been the perfect match to set off a G-2 powderkeg.
Despite all of these incentives for escalating the dispute, however, it hasn't happened. Kurt Campbell was dispatched to Beijing, talks are ongoing, and neither side appears to be interested in ramping up domestic audience costs. That escalation hasn't happened despite massive political incentives on both sides to let it happen suggests that, contrary to press fears about Chen blowing up the bilateral relationship, there are powerful pressures in Washington and Beijing to find a solution that saves as much face as humanly possible for both sides.
Now, in the three days since I wrote that post, Chen has been released, calling every Chinese dissident, U.S. congressman and international reporter with a phone/recording device/Twitter account and is loudly and frantically describing the intimidation he and his family have experienced. The man has asked to be flown out on Hillary Clinton's plane as she departs from the Strategic and Economic Dialogue. In other words, everything that has transpired in the past three days has given a black eye to both the Chinese and American governments' handling of this case.
Despite the near-overwhelming incentive to ramp up bilateral tensions, however, it really hasn't happened. China's Foreign Mnistry has issued a couple of garden-variety press statements demanding a U.S. apology that won't be forthcoming. There have been no leaks or anonymous criticisms of the United States otherwise, despite the fact that this entire case is a burr in China's saddle at veery awkward moment. None of the U.S. State Department statements or press leaks have been terribly critical of the Chinese side either. Indeed, as the Washington Post observes:
Neither Clinton nor her Chinese counterparts mentioned Chen in their formal remarks at the end of their two-day meeting, saying instead that U.S.-Sino differences on human rights issues must not disrupt the broader relationship between the two world powers.
State Councilor Dai Bingguo, China’s top foreign policy expert, said his country and the United States still have “fundamental differences” on human rights issues. “Human rights should not be a disturbance in state-to-state relations,” Dai said. “It should not be used to interfere in another country’s internal affairs.”
Clinton promised to “continue engaging with the Chinese government at the highest levels” on the “human rights and aspirations” of all people.
This is pretty extraordinary. Even more extraordinary is the possiblity that despite Chen's outspokenness, he actually could be able to leave the country with his family.
Now, as the Post shrewdly observes, "China’s Foreign Ministry said the self-taught lawyer would have to apply 'through normal channels ... like any other Chinese citizen' — which would mean returning home to the village where he has been confined and beaten, in order to obtain a passport." Still, if the rhetoric between the U.S. and China on this boils down to Clinton asking the Chinese government to "expeditiously process" Chen's visa application, then this is a really big dog that didn't bark.
What do you think?
After last night's stunningly useless set of speeches, I'd put the odds of the U.S. not raising the debt ceiling by August 2nd at 1 in 2. Like many other observers, I'm finding it increasingly difficult to envision a deal that would get through the Senate while attracting a majority of House Republicans [You meant a majority of the House of Representatives, right?--ed. No, I meant a majority of House Republicans. I'm pretty sure that Boehner and the rest of the House GOP leadership will refuse to pass any debt ceiling plan that relies too much on House Democrats.]
So, it's gonna be a fun few weeks for those of us who study the global political economy. Let's start by thinking the unthinkable -- what will happen if there is a default?
I've expressed my feelings on the matter already, and I'm hardly the only one. That said, I've also
hedged my bets been flummoxed by the lack of market reaction to the DC stalemate. The lack of market reaction to date has emboldened House GOP members to stand fast. Could they be right?
Tom Oatley, who pooh-poohed my fears of the debtpocalypse last week, makes an interesting point about the composition of U.S. debt-holders:
By these figures, about 63% of US government debt is owned by central banks (foreign and domestic) and/sovereign wealth funds. Most of these entities are American friends and allies. Another 4% is owned by US state and local governments. That leaves 33%--about $4.8 trillion--in private hands. Of this, the financial institutions with the most restrictive regulations regarding asset ownership (depository institutions) own only 2% of the total ($290 billion). Mutual Funds, who may or may not have to dump downgraded debt, hold another 9% ($1.35 trillion).
What's the point? The discussion about the impact of US default revolves around the market response to default. Useful to recognize that most of the US government debt is held by public-sector agents who are much less sensitive to balance sheet pressures and regulatory constraints. These public sector agents are also substantially more sensitive to "moral suasion" and direct appeal than private financial institutions. The structure of ownership of US debt might dampen the negative impact of any default that does occur.
This is pretty interesting. Oatley focuses on "moral suasion," but there's also a national-interest motive for many U.S. debtholders. Most of the official holders of U.S. debt have a strong incentive for a) the value of their holdings not to plummet; and b) the United States economy to continue to snap up other their exports. If China, for example, is buying up U.S. debt to sustain its own growth, then neither a technical default nor a ratings downgrade should deter China or other export engines from continuing to buy U.S. debt even if there's a spot of trouble.
So it appears that complex interdependence will force America's rivals to continue to hold U.S. debt even after the debtpocalypse!! The United States in the clear, right?
Not so fast. Here are five "known unknowns" I can think of that might complicate Oatley's analysis:
1) What if the creditors form a cartel? In my 2009 paper, this was the one scenario that gave me the heebie-jeebies, because it's the one scenario under which creditors can wring geopolitical gains from debtor states. Any kind of default can act as a focal point moment in which U.S. creditors decide it's time to apply a haircut to American power and influence.
I don't think this is going to happen, because the national interests of American debtholders remain divergent. That said, if U.S. allies interpret default as a signal of U.S. unreliability in times of crisis, then all bets are off.
2) What about the economic nationalism of China? China is the largest foreign debtholder, which gives it a certain agenda-setting power in moments of crisis. There are a lot of compelling reasons why China would decide to try to minimize the economic disruptions . On the other hand, there's a lot of resentment on Chinese Internet boards already about the Chinese purchases of U.S. debt. During a period in which the CCP is already concerned about domestic instability, one could envision a scenario whereby they try to mollify nationalists at home by acting out against the United States.
3) What would be the effect of a mild market reaction on the House of Representatives? The less the markets react, the less that the House GOP will feel a need to do anything. There will come a point, therefore, when official debtholders might need to signal to the House that, in IPE lingo, "s**t needs to get done." That signal would in and of itself roil markets, not to mention the effects the current uncertainty is already having on the real economy.
4) What is the fiscal shock from a default? There are two causal mechanisms through which a default could affect the global economy. The first is through panic and uncertainty roiling financial markets. The second, however, is from a dramatic fiscal contraction due to limited government spending. Given the lackluster state of the current recovery, it wouldn't take much to tip the United States back into recession.
5) What if there's another AAA bubble? FT Alphaville's Tracy Alloway provided another interesting chart earlier this month on the distribution of AAA securities:
As Alloway warns:
[W]atch what starts happening from 2008 and 2009.
The AAA bubble re-inflates and suddenly sovereign debt becomes the major force driving the world’s triple-A supply. The turmoil of 2008 shunted some investors from ABS into safer sovereign debt, it’s true. But you also had a plethora of incoming bank regulation to purposefully herd investors towards holding more government bonds, plus a glut of central bank liquidity facilities accepting government IOUs as collateral. Where ABS dissipated, sovereign debt stood in to fill the gap. And more.
It’s one reason why the sovereign crisis is well and truly painful.
It’s a global repricing of risk, again, but one that has the potential for a much largerpop, so to speak.
We know that a downgrade of U.S. Treasuries would likely lead to a downgrade of state and municipal bond ratings as well. We also know that the ripple effects from the collapse of asset-backed securities were much larger than anticipated before the 2008 crisis. This is why the possible knock-on effects of downgrade so many AAA asserts makes me itchy. Even if banks and other financial institutions have minimal exposure to U.S. Treasuries, I don't think it's possible for them to have minimal exposure to all U.S.-based AAA sovereign debt.
These are just the five known unknowns that I could think of in the past hour -- there are probably many, many more. Readers are strongly encouraged to add them in the comments.
To date, your humble blogger has never meet a free-trade agreement (FTA) he didn't like. Sure, in a perfect world I'd like to see the multilateral trade rounds have priority. The perfect is often the enemy of the good, however, and FTAs often carry with them significant non-economic benefits. Signatories to U.S. FTA's, for example, often see an improvement in their human rights record.
I have to admit, however, that the
FTA Economic Cooperation Framework Agreement being talked about in this NYT article by Jonathan Adams gives me some serious pause:
As negotiations move ahead on a Taiwan-China trade deal that could lower tariffs on handmade shoes and hundreds of other products from the mainland, fears are mounting that the island’s traditional industries — like shoemaking — may suffer, even as high-tech, financial services and other sectors gain from freer access to the giant market across the strait.
The government, however, contends that the benefits would far outweigh the costs, and Taiwan’s president, Ma-Ying-jeou, hopes to use the agreement to fully normalize economic relations with Beijing while expanding the island’s access to other markets.
“We can handle diplomatic isolation,” Mr. Ma said last month, “but economic isolation is fatal.”
The Economic Cooperation Framework Agreement, the Ma administration says, would be a prelude to similar deals with Malaysia, Singapore and, eventually, Japan or the United States. “Once E.C.F.A. is signed, we want to sign other free trade agreements and try to use mainland China to link with international markets,” a trade official involved in the negotiations, Hsu Chun-fang, said....
The economies of Taiwan and China are already connected. Taiwan has invested $150 billion in China since the early 1990s, according to a Taiwan government estimate. About 40 percent of Taiwan’s exports already go to China, where they face average tariffs of 9 percent. Half of those exports are semifinished goods that are shipped to factories for assembly and other value-added services and then re-exported, according to Mr. Ma.
I get the economic logic behind this E.C.F.A. -- it would unambiguously benefit Taiwan's economy to have something like duty-free access to the mainland.
The security ramifications are troubling, however. While China's economic leverage over the United States is limited, this kind of agreement would ratchet up the asymmetric dependence of Taiwan on the Chinese economy. Maybe Taiwan has already crossed the point of no return with regard to interdependence with the mainland -- but this agreement would surely guarantee crossing that threshhold.
What would China do with this leverage? I don't know, I really don't. If Beijing plays the long game, they would allow for the build-up of political interest groups in Taiwan with a powerful incentive to appease the People's Republic in order to keep the economic relationship unruffled. The thing is, China has often been clumsy in its initial attempts to translate economic power into political influence, and I could easily see such a misstep occurring a few years from now.
Perhaps I'm being paranoid about this. The one thing I'm certain about, however, is that the most likely flashpoint for a great power confrontation between the United States and China is anything involving Taiwan. So I get veeeeeeerrrrrrry nervous about anything that upsets that particular apple cart.
For those three readers not transfixed by today's Healthcareapalooza: your humble blogger is in Washington, DC today to
talk China-watchers down off the ledge testify before the U.S.-China Economic and Security Review Commission. I'll post a link to the actual testimony once it's online. UPDATE: here's a link to everyone's testimony.
As is standard in these settings, I'm pretty sure I'm the least qualified person on the expert list.
So, you might have heard that Google is having a spot of trouble in China -- and is threatening to pull out of the Middle Kingdom altogether.
Both FP's Evgeny Morozov and Jack Shafer suggest that Google isn't just doing this out of the goodness of their heart -- they have to be doing it because their market share is eroding to Baidu and this is the way to deflect with dignity. Today's stock market suggests that they might have a point.
The thing is, a 33% share (and possibly rising) in that market is not a trivial amount of dollars. An estimated $600 million in cabbage is not easy to walk away from. A true cynic would have predicted that Google would have kept its mouth shut, taken its lumps, and still tried to outcompete Baidu. Google didn't.
The New York Times's Keith Bradsher and David Barboza make a more intriguing argument -- the Chinese government is making life increasingly miserable for Western multinationals:
Google is far from alone among Western companies in its growing unhappiness with Chinese government policies, although it is highly unusual in threatening to pull out of the country entirely in protest.
Western companies contend that they face a lengthening list of obstacles to doing business in China, from “buy Chinese” government procurement policies and growing restrictions on foreign investments to widespread counterfeiting.
These barriers generally fall into two broad categories. Some relate to China’s desire to maintain control over internal dissent. Others involve its efforts to become internationally competitive in as many industries as possible.
Then there's this from the Wall Street Journal's Ian Johnson and Jason Dean:
The Google syndrome caps growing complaints by foreign businesses over a deteriorating business environment. Both the European Chamber and the U.S. Chamber of Commerce in China have issued reports sharply critical of China's business environment. During the 1980s and '90s, foreign businesses were assiduously courted by China's leaders and responded by bringing to China technology, training and international best practices.
In recent years, however, foreign businesses have complained that the official line has shifted. Younger bureaucrats are more nationalistic and skeptical of the value of letting in foreign companies, [head of the European Chamber of Commerce in China Jörg ] Wuttke says. Last year, for example, foreign executives said bidding practices for wind energy were rigged to exclude foreign companies.
"There's a general attitude in the foreign business community that it's getting tougher to do business here," said James McGregor, a senior counselor at APCO Worldwide and author of a book on doing business in China. "This could be a bellwether."
Not all Western multinationals feel this way. Still, this raises a question I find most interesting -- how much of what China is doing is intentional and how much of it is a PR cluster f**k?
I can see it going either way. China is definitely more powerful than it used to be, and maybe they've been drinking the Robert Fogel kool-aid. Greater power usually leads to greater nationalist pride, so I can kinda sorta see this being a conscious strategy by Beijing to throw its weight around.
The thing is, it's a remarkably clumsy effort. Consider James Fallows on this point:
In a strange and striking way there is an inversion of recent Chinese and U.S. roles. In the switch from George W. Bush to Barack Obama, the U.S. went from a president much of the world saw as deliberately antagonizing them to a president whose Nobel Prize reflected (perhaps desperate) gratitude at his efforts at conciliation. China, by contrast, seems to be entering its Bush-Cheney era.
China could be throwing its weight around -- or it's bureaucrats could be much less cohesive than outside observers believe.
Daniel W. Drezner is professor of international politics at the Fletcher School of Law and Diplomacy at Tufts University.